“Urban Job Creation and Unemployment in LDCs” - 2011 Handout Group 8: Ye Chuen, Manuel Ludwig-Dehm, Yin Xiao, Zulma Barrail 1. Introduction In his paper, Blomqvist considers two seminal papers on urban job creation and unemployment in LDCs, one by Todaro (1969) and one by Harris and Todaro (1970), in the following for convenience referred to as HT. While both of these papers were motivated by the curious economic phenomenon of sustained rural-urban migration in LDCs - despite significant levels of urban unemployment and positive marginal products in agriculture - Blomqvist synthesis is motivated by the apparent incoherence between the above mentioned papers and their results. While Todaro coined the notion of the “Todaro paradox”, which basically states that urban job creation in LDCs will lead to increased unemployment and is thus not a recommended policy, and claimed to observed it empirically [Todaro (1976)], HT find a payroll subsidy to be welfare improving even in the case of positive urban unemployment. In his analysis the author reveals that the different results stem from the different views of the authors regarding the interplay between migration and the urban labor market, and only to a much lesser extend from the emphasis on the short- and long-run effects, respectively. He thus suggests a new framework that combines the two models by taking into account the speed of react ion of migration, which is inherently different in Todaro’s and in the HT model. Furthermore, he explicitly models the turnover rate in existing jobs as this is the second main difference between the models examined. 2. Todaro vs. Harris and Todaro Blomqvist starts with introducing the seminal model published by Todaro in 1969. As he works towards the conclusion that one of the major differences between this and the HT model, which will be presented in the following, is the respective authors view of the interplay between migration and the urban labor market, he introduces the migration function of Todaro’s model given by (1). In (1) M denotes the flow of rural-urban migration per unit of time, E is the number of employed urban workers, w is a measure of the urban-rural wage differential and p is the probability of getting a job. In order to simplify the model Blomqvist chooses to use a continuous time formulation instead of adopting the discrete version used in Todaro (1969). Hence, Todaro assumes that migration is an increasing function of the wage differential and the probability of finding a job. The probability of finding a job is specified as 1
“Urban Job Creation and Unemployment in LDCs” - 2011 Handout Group 8: Ye Chuen, Manuel Ludwig-Dehm, Yin Xiao, Zulma Barrail (2), where U denotes the number of unemployed urban workers and is the proportional rate of growth in the number of urban jobs. Thus, strictly speaking, p is not the probability of finding a job, as it depends on the unit of time in which it is measured and thus can exceed unity. Blomqvist states that 1/p intuitively can be interpreted as the expected duration of unemployment for an immigrant arriving in the city, when assuming that everyone has the same chance of being picked for a job. Hence he assumes that workers are homogenous. Blomqvist subsequently introduces the model published by Harris and Todaro (1970) and contrast its assumption with those of the above introduced Todaro model. Harris-Todaro (1970) describe a two sector model of rural-urban migration which recognizes the existence of a politically determined minimum urban wage at levels substantially higher than agricultural earnings. The ‘’permanent’’ urban sector produces manufactured goods which partial ly are exported to the rural sector in exchange of agricultural goods. The rural sector has a choice of either use all available labor to produce an agricultural good (some of which is exported to the urban sector), or using only part of its labor to produce this good while exporting remaining labor to the urban sector. Furthermore the HT model considers that both sectors are perfectly competitive. Farmers in the rural sector maximize their profits and earn their marginal product, being restricted by a fix aggregate amount of land, and firms in the urban manufacturing sector do so with a fixed amount of capital. This implies that both sectors set the real wage according to the marginal productivity of labor, but in the urban case, the real wage is constrained to be equal to the institutionally (thus exogenously) fixed minimum urban wage. Though not of immediate importance at this point it is necessary to keep in mind that both the manufacturing as well as the agricultural sector are assumed to exhibit positive but decreasing marginal productivity with respect to labor. The hypothesis of this model is that migration to the urban area is a positive function of the urban-rural expected wage differential. A crucial assumption for individual rational behavior is that rural-urban migration will continue so long as the expected urban real income at equals the real agricultural marginal product. Thus, migration will cease only when the expected income differential is zero. This implies a hidden assumption as well: Individuals , since prospective migrants are indifferent between earning a given agricultural wage and earning an expected wage at the city, are risk neutral. These prospective rural migrants behave as maximizers of the expected utility. In other words, in equilibrium 2
“Urban Job Creation and Unemployment in LDCs” - 2011 Handout Group 8: Ye Chuen, Manuel Ludwig-Dehm, Yin Xiao, Zulma Barrail (4) Wage in agriculture. ‘’institutionally fixed’’ wage in manufacturing. : Measure of the probability that a randomly selected member of the urban labour force will be holding a job. The HT model additionally assumes that there is a random job selection process from the combined pool of urban workers (consisted by permanent urban workers without ties to the rural sector and available supply of rural migrants), in other words, they assume all workers to be homogeneous, thus having equal chances to be picked for a job. Furthermore, the authors justify the use of this measure of the probability by assuming that all urban jobs are reallocated between workers from the given combined pool at each instant of time. One can interpret this as if in each instant of time all urban workers that had been holding a job were fired or quitted their job. The industrial sector needs to hire new ones, which are then randomly drawn from the whole available labor force. This implies a variety of equivalent observations: 1) b (turnover rate) is infinitely large 2) The Todaro measure of the probability of getting a job would go to infinity. 3) The expected duration of unemployment used in Todaro, (1/p), would go to zero. 4) The expression measures the fraction of time any urban job seeker would be holding a job.Whereas Todaro’s analysis is focused on how the expected length of unemployment influences the flow of migration, the HT model states that this measure of p (presented above) plays an equilibrating role in their analysis of labor allocation. The authors prove that due to the imposition of a high minimum wage in the urban sector, equilibrium is only achievable with unemployment and hence, loss of potential output of both goods. Therefore, a policy instrument is needed to correct this market failure (wage level). However, one single market failure won’t be corrected as usual with a single policy instrument. This is because H -T model is based on the idea that urban wage wouldn’t only set the level of employment in the manufacturing sec tor but also it would determine the allocation between rural and urban areas. Even though a subsidy would change the urban employment level, it wouldn’t change the minimum wage perceived by the worker, so migration would still continue when the agricultural earnings are less than the expected urban wage and unemployment would still exist. On the other hand, restriction of migration prevents the minimum wage to have its effect on unemployment but does nothing to increase the level of industrial employment. 3
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