Transcript The Harris -Todaro Model If wages were perfectly flexible, equal wages would be paid in industry and agriculture and there would be.

The Harris -Todaro Model
If wages were perfectly flexible, equal wages would be paid in
industry and agriculture and there would be no involuntary
unemployment
The Todaro model
Hypotheses:
1-Migration is an individual rational decision
2-Migration proceeds in response to urban-rural differences in
expected income rather than actual earnings
3. Compare of expected incomes for a given time horizon in the
urban sector (returns minus costs of migration) with prevailing
average rural incomes in a context of a urban job lottery
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In a perfectly competitive labor market
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For a variety of reasons however workers in the urban formal sector
are paid higher than equilibrium wages
1. Unions
2. government policy
3. incentives to workers to expend effort when labor cannot be
directly supervised without tremendous costs.
4. The threat being fired. Then one would have to return to the
country or find work in the urban informal sector.
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Here LF workers find employment in good jobs in the cities, LA remain
behind in the countryside working at a lower wage of wA. Those who
migrated from the countryside to the city find themselves employed in the
urban informal sector, LI
W
WA
LI
How does the urban labor work? The Harris-Todaro Migration
model
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As a result, many people end up in relatively unproductive dead-end
service sector jobs in the cities.
Urban overcrowding due to high rates of migration from rural areas to
cities and high informal sector employment is a fact of life in many low
and middle income countries.
The Harris-Todaro model helps to explain this seemingly irrational
phenomenon
PA QAT
First, let’s define real per capita income in the rural sector= ( P )( N T )
R
PA=agricultural prices
P=general price level
QTA=total agricultural production.
NC T  NU
WF N{(
)}  WF N (1  u )
T
NC
Next we define urban formal sector income=
WF =the wage paid for good jobs in the city.
N=the number of hours worked per period per worker
u=the formal sector unemployment rate
Finally let’s define urban informal sector income=WI Nu
where wI=the wage per hour paid in the informal sector.
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It is sensible to assume that migration continues as long as urban
incomes are significantly higher than rural incomes.
Or in other words migration occurs when
PA QAT
WF N (1  u )  WI Nu  k{( )( T )}
P NR
where, k, is a measure of the degree of risk
aversion.
Now think about u, the rate of unemployment in the formal sector
(1) The higher u is, the more people there are actively seeking formal
sector employment that are unable to find it.
(2) The higher u is the lower the probability of a new migrant from the
country finding a formal sector job.
(3) Without a social safety net, a migrant has to “create” a job for
themselves in the informal sector.
Because of the preceding LHS in the above expression
WF N (1  u )  WI Nu
can be thought of as the wage one can expect if they move to the city.
Thus, the lower is u, the higher the expected wage
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The main point of Harris-Todaro is that if the expected urban wage ...
WF N (1  u )  WI Nu
1. equals rural income there is no incentive to migrate.
2. is greater than rural income there is a great incentive to move
from country to city
3. were less than rural incomes there would be an incentive to move
in the other direction. (South Korea in recent years)
The expected urban wage depends on what type of job you land, that
depends on probabilities and these are linked to current urban
unemployment rate as defined above.
Therefore to understand the model set rural and expected urban incomes
equal and solve the above for u, the urban unemployment rate
PA QAT
{WF N  (k[( )( T )}
P NR
u
N (WF  WI )
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Given the urban unemployment rate, u
PA QAT
{WF N  (k[( )( T )}
P NR
u
N (WF  WI )
From this result we can show the following:
1. u will increase if wF increases!
2. u will increase if n increases---i.e the number of hours worked per
period per worker !
3. u will increase if k drops i.e. less sensitivity to risk
4. u will increase if QTA/NTR falls, i.e. agricultural output per rural
worker falls
5. u will increase if wI increases—i.e. the wage per hour paid in the
informal sector !
6. u will increase if PA/P decreases due to either PA falling or general
inflation, P
One failing of the Harris-Todaro model assumes migrants are riskneutral. This means that the utility of a gamble where the payoff is
$6000 is the same as the utility of $6000 guaranteed.
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This is not realistic. Especially poor migrants will be risk averse
This means that to the degree potential migrants are risk-averse.
The less net migration out of rural areas will be, given the gap between
rural and urban wages. Consider k a measure of the degree of risk
aversion.
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Debraj’s discussion of social capital
Debraj raises an interesting point in relation to this issue of risk aversion.
1. He begins by pointing out that information availability is high and
mobility is low in rural areas
2. In other words, every one knows your business in a small village
and it is hard to move.
This means that
1. In terms of insurance and credit, rural areas provide a strong support
network for the poor (this is his “social capital”)
2. If someone runs into trouble ,the community knows why.(If not due to
own negligence, individual receives some support)
3. Low mobility also gives rise to “reciprocity”. One helps others in
their time of need knowing that they will help them in return.
Once migration starts however
This social capital will be eroded and thus, all else equal, lowers the cost
of migrating since local rural support breaks down.
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