Harris-Todaro Chapter 10 D Ray

8/6/2019 Harris-Todaro Chapter 10 D Ray

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The Harris-Todaro Model

If wages were perfectly flexible equal

wages would be paid in industry andagriculture and there would be no

unemployment


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In a perfectly competitive market


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For a variety of reasons however workers in

the urban formal sector are paid higher than

equilibrium wages Unions

government policy

incentives to workers to expend effort whenlabor cannot be directly supervised withouttremendous costs.

The threat being fired. Then one wouldhave to return to the country or find work inthe urban informal sector.


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At the same time, in the rural sector and the informal urban

sector wages rise and fall according to supply and demand.

Such conditions

give rise to the

following:


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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


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As a result, many people end up

in relatively unproductive dead-

end service sector jobs in thecities.

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. (review table 2.4, page 39)


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The Harris-Todaro model helps

to explain this seemingly

irrational phenomenon

First, lets define real per capita

income in the rural sector:(PA/P)(Q

TA/N

TR)


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Definition of terms

PA=agricultural prices

P=general price levelQTA=total agricultural production.


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Next we define urban formal

sector income

wF*n*((NT

C-Nu)/NT

C)=wFn(1-u)


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Definition of terms

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

(other terms defined in class).


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Finally lets define urban

informal sector income

WI *n*u

where wI=the wage per hour paid inthe 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 otherwords migration occurs

when wFn(1-u)+wInu>k[(PA/P)(Q

TA/N

TR)]


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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, he or she

will have to make work for themselves in

the informal sector.


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And because of the preceding

wFn(1-u)+wInu

Can be thought of as the wage one

can expect if they move to the city.And the lower u is the higher the

expected wage


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The main point of Harris-Todaro is

that if the expected urban wage ... equals rural income there is no incentive to

migrate.

is greater than rural income there is a greatincentive to move from country to city

were less than rural incomes there would be an

incentive to move in the other direction. (South

Korea in recent years)


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The expected urban wage

depends on what type of

job you land, that dependson probabilities and these

are linked to current urbanunemployment rate as

defined above.


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Therefore to understand the model

set rural and expected urban

incomes equal and solve the abovefor u, the urban unemployment rate

U={wFn- (k[(PA/P)(QTA/N

TR)]}

/n(WF-WI)


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From this result we can show the

following: U will increase if wF increases!

U will increase if n increases!

U will increase if k drops.

U will increase if QTA/NT

Rfalls.

U will increase if wI increases!

U will increase if PA/P decreases.


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One failing of the Harris-Todaro

model assumes migrants are risk-

neutral

This means that the utility of a

gamble where the payoff is $6000 isthe same as the utility of $6000

guaranteed.


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This is not realistic. Especially

poor migrants will be risk averse


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This means that to the degree

potential migrants are risk-averse

The less net migration out of rural

areas will be given the gap betweenrural and urban wages. Consider k a

measure of the degree of risk

aversion.


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Rays discussion of social capital

Ray raises an interesting point in

relation to this issue of risk aversion.He begins by pointing out that

information is high and mobility is

low in rural areas


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In other words, every one

knows your business in asmall village and it is hard

to move.


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This means that

In terms of insurance and credit, rural areas

provide a strong support network for the poor (this

is his social capital)

If someone runs into trouble the community

knows why.(If not due to your own negligence

you will receive some support)

Low mobility also gives rise to reciprocity . Onehelps others in their time of need knowing that

they will help them in return.


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Once migration starts however

This social capital will be eroded and

thus, all else equal, lowers the cost ofmigrating since local rural support

breaks down.

Harris-Todaro Chapter 10 D Ray

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