Economies of Developing Countries Many

Economies of Developing Countries

Many developing countries are concerned with the employment dynamics between their rural and urban areas and how to best strike a balance for the overall good of the country and its workers. The work of Harris and Todaro (1970) help developing countries better understand these interdependencies. The key hypothesis of Harris and Todaro is that the rural-urban migration decision is influenced by economic incentives, earnings differentials, and the likelihood of getting a job in the urban environment. The Todaro model assumes that if the urban expected wage is greater than the rural one, the rural agricultural worker will make the decision to migrate to the urban area. The model makes several other key assumptions such as non-existent unemployment in the rural agricultural sector, and a perfectly competitive rural agricultural industry and its labor market. Thus, the model sets the agricultural rural wage equal to agricultural marginal productivity. The rural-urban migration rate is zero in equilibrium where the expected rural income equals the expected urban income. However, an inconsistency referred to as the Todaro Paradox occurs when an increase in urban employment results in higher levels of urban unemployment and perhaps even reduced national product. This paradox has important implications for economic development strategies in developing countries.

Author Ben Jelili Riadh summarizes why the Todaro paradox occurs, "When choosing between labor markets, risk-neutral agents consider expected wages; that the probability of obtaining urban employment is approximated by the ratio of urban jobs to the urban labor force; and that the urban wage rate is considerably and consistently higher than the rural wage rate." Under these assumptions, the inter-labor market (rural-urban) equilibrium mandates urban unemployment." This happens because unemployment ensures that the expected urban wage is equal to the rural wage; in other words, lower rural wages are compatible, in equilibrium, with more people moving into an urban area and, thus, causing lower urban employment rates.

Harris and Todaro (1970) admit that a limitation of the Todaro model is that assumes potential migrants are risk neutral agents. In fact, they may well prefer a certain expected rural income vs. An uncertain expected urban income. In the real world, risk aversion could make them choose the rural option or to wait for an offer of higher urban income to make the risk of uncertain employment prospects worth their while. But, Harris and Todaro (1970) argue that they could easily adapt their model to reflect risk aversion and would still reach the same conclusions.

In summary, policies aimed at reducing urban unemployment can actually raise urban unemployment rather than reduce it as the Todaro paradox demonstrates. According to Todaro and Smith (2002), there are important conclusions to be drawn from the Todaro model of rural-urban migration including: