Dual economy. There exists two different economies and societies producing and exchanging within the same geographic space, e.g.:Rural
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1. Rural-Urban Interaction Features of developing economy
Structural transformation:Lewis-Ranis-Fei Model
Urban migration:Harrod-Todaro model
2. Dual economy There exists two different economies and societies producing and exchanging within the same geographic space, e.g.:
Rural & Urban, or
Manufacturing & Agriculture, or
Modern Commercial Agriculture & Peasant Agriculture, or
Modern Mining & Traditional Agriculture
Their heterogeneity can result from:
Different religions or ethnicities
Different information and knowledge
Different laws for different groups
3. Lewis model Dualism
Agriculture and industry (tradtional&modern)
Close interlinks between the two sectors
Agriculture provides surplus food and labour to industry
Industry provides machines and tools to agriculture
Assumes Rural surplus labor exists
But Scale of modern sector is limited by supply of capital=>similar to Harrod-Domar model
Transfer of surplus labor from agriculture does not affect the production. Why?
4. Labor allocation in agriculture (household model)
5. Income sharing in agriculture Surplus labour equates MP=0
Wage based on average product not marginal product
Disguised unemployment wage>MP
Economic development proceeds by the transfer of surplus food-grain production, which sustains that part of the laborforce engaged in non-agricultural activity.
6. Lewis –Ranis-Fei Model Traditional economy has labour surplus
Development is result of modern sector growth
Capital accumulation is engine of industrial sector growth
More capital induces rural-urban migration of labor supply
Initially transfer of excess labor does not reduce agriculture surplus
But gradually average agriculture surplus falls due to sustained transfer of labor
Terms of trade turns against industry as wages have to increase to meet higher food prices
Pace of development is limited by ability of economy to produce surplus of food
8. Limitations Assumpton that ag wages renmain fixed till the phase of commercialisation is untenable.
If remuneration in ag sector is based on avgerage surplus, will not wages increase when labor shifts from ag to non-ag?This implies:
Ag surplus available to indstry is rediced
Indutry wage must rise even in surplus labor phase
Industry has vested interest in keeping ag income low
9. Policy implication Keeping agriculture prices low is a need for urban development
Prevent the rise in agricultural wages as a result of increased average production through:
Agriculture taxation: affect small farmers worst. Large farmers can pull down wages and benefit on the ground of taxation
Suppress agricultural prices: subsidise agriculture inputs, offer support price to farmer but control retail price. Needs fiscal support and may not be in longrun interest of ag sector.
10. Rural-urban migration: Harris-Todaro model Urban sector has formal and informal sectors
Higher urban formal sector wages, induce migration
Higher and inflexible salaries bcos of unionisation, subject to minimum laws, pension schemes and forms like to pay above average pay for quality workers in order to extract best productivity by making the threat to fire a valid threat
Informal urban and rural sectors have lower wages, latter higher than former.
11. Floors on formal wage If formal wage is fixed at a higher than equilibrium level, formal sector can employ only less people
Rest of the labor is employed at lower than equilibrium wages, no unemployment
If equality of wages is imposed, then there is unempoyment. If they move to ag, they drive down wages. They must be have migrated to inflexible urban sector.
Migrants hence face risk of unemployment
13. Harris-Todaro equilibrium At equilibrium, no rural-urban migration
14. Paradox of formal sector expansion Deliberate efforts to remove the eyesore of informal urban sector by creating more formal jobs ironically leads to larger informal sector through greater migration.
HTequilibrium is set by the probability of finding jobs in formal and informal sectors. If higher probability of formal jobs exists, it increases migration until total labor urban market expands and increases share of informal sector, bringing down expectations.
This increased migration also increases agriculture wages after a point.
New HT equilibrium is arrived at
Although increased migration occurred,
the informal sector shrinks
in proportion of total urban sector. However informal
sector may increase in proportion to total labor force.
15. Efficient allocation and migration policy Why should policy try to get ride of informal sector?
Maximise NI through best resource allocation
Asuming demand curves reflect Marginal Products, if equilibrium is not at intersection of curves, there is possibility to increase NI through better allocation.
Two ways to remove informal sector:
16. Migration restriction Migration restriction does remove informal sector but does not achieve efficient allocation. Too few labor in urban sector compared to efficient allocation
17. Wage subsidy Subsidy given to formal urban employer to pay wages
Worker receives w^ but employer pays only W^-s hence able to employ more Lfs.
Agriculture wage is oushed up as a result of increased demand from urban sector upto point where no more migration occurs.
But not efficient allocation bcos too much labor in urban sector now. Opposite effect of migration restriction! So combine both!
18. Combination policy Wage subsidies to formal urban sector allows employment in formal sector to be at equilibrium level.
Wage level of agriculture lower than formal sector and can trigger migration
Migration restriction needed to prevent this.
Another way is to subsidize agriculture wages as well
19. Uniform wage subsidy Demand for rural and urban formal labor increases with wage subsidy. Informal sector shrinks, drives up urban wages.ag wages follows to restore equilibrium. This continues till subsidy reaches w^-w*, where ag and urban wages equal and there is no informal sector. Migration stops without migration restriction.
20. Practical issues Getting right subsidy (w^-w*) is difficult as it requires full info regarding shape of dd curves. But same results can be achieved even if subsidy given is more than required as long as it is uniformally in both sectrors. Subsidy should not be lower than necessary.
Subsidy by govt creates budgetary strain. Can be financed by increased profit tax which is redistributed in form of wage subsidy to prevent jobless growth.
Lastly, subsidy needs accurate employment data to prevent scams. Monitoring may be expensive in ag sector in developing countries.
21. Other migration issues HT model assumes risk-neutrality of labor.
People in general are risk averse.risk averse person looks not just at expected value but craves insurance as well. No migration at HT equilibrium. Expected wage must be strictly higher than assured agriculture wage to induce migration.
Urban informal sector will be smaller and ag sector larger than predicted by HT model.
22. Social capital and insurance in the rural sector also dampens migration. The support system and insurance available is not counted in ag wages. Therefore migration will be induced only if expected income is above not just wages but the full measure of payoff of ag sector.
Wage in ag is based on avg returns not marginal returns. As avg returns is higher than MR,a family income maximiser will migrate even if expected urban income is less tan the ag income per person as long as the former exceeds the MP on the farm.
This argument predicts excessive migration to the HT model.