The Todaro model

1
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
2
In a perfectly competitive market
D
A
Agricultural wage
Urban formal wage
W
C
B
3
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.
4
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
D
A
agricultural wage
Urban formal wage
C
B
LF
LI
LA
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
First, lets define real per capita income in the
rural sector
PAagricultural prices Pgeneral price
level QTAtotal agricultural production.
Next we define urban formal sector income
WF the wage paid for good jobs in the city.
Nthe number of hours worked per period per
worker uthe formal sector unemployment rate
Finally lets define urban informal sector income
where wIthe 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
k 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
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 ...
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
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From this result we can show the following
1. u will increase if wF increases! 2. u will
increase if n increases! 3. u will increase if k
drops. 4. u will increase if QTA/NTR falls. 5. u
will increase if wI increases! 6. u will increase
if PA/P decreases
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 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.
Utility
2000
payoff
6000
10000
10
Debrajs 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 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.