Harris-Todaro Model

BIBLIOGRAPHY

In the 1960s the government of newly independent Kenya faced a difficult situation: Unemployment in Nairobi and other major cities was high and apparently rising. To cope with this problem, Tripartite Agreements were reached in which private-sector and public-sector employers agreed to increase employment in exchange for unions agreeing to hold wages at their current levels. The larger number of jobs was expected to reduce unemployment. However, in the event, urban unemployment appeared to have increased following the Tripartite Agreements rather than decreased, as far as anyone could tell.

In light of these events, John Harris and Michael Todaro formulated the Harris-Todaro model to explain the puzzle. At the core of the Harris-Todaro model were the following features. First, real wages (adjusted for cost-of-living differences) are higher in urban formal-sector jobs than in rural traditional-sector jobs. Second, to be hired for a formal-sector job, one has to be physically present in the urban areas where the formal-sector jobs are located. Third, and as a consequence of the first two features, more workers search for formal-sector jobs than are hired, employers hire some of the job seekers but not all of them, and those not hired end up unemployed. Fourth, for equality to be maintained between the expected wage associated with searching for an urban job and the expected wage associated with taking up a lower-paying rural job, the equilibrium arising in such a setting is characterized by urban unemployment. And fifth, any temporary difference in the expected wages between one sector and another is eroded as workers migrate from the low-expected-wage labor market to the high-expected-wage labor market.

The Harris-Todaro model produced two powerful policy results. The first concerns the policy of formal-sector job creation to employ the unemployed (who, in the Harris-Todaro model, are all in urban areas, because that is where the formal-sector jobs are assumed to be located). Such a policy, they concluded, would increase the formalsector labor force by more than the number of new jobs created, thereby raising the number of urban unemployed. Thus, the solution to urban unemployment is not to create urban employment.

The second policy option that Harris and Todaro considered was a policy of rural development. If such a program could increase the rural traditional-sector wage, unemployment would then fall. Thus, in the Harris-Todaro model, the solution to urban unemployment is rural development.

Soon after the model was published, the government of Kenya followed the Harris-Todaro precepts by putting into place an integrated program of rural development. The result was that unemployment in Kenya fell.

Harris and Todaro’s fundamental contribution was building a model that fit the stylized facts of the labor market they were analyzing and that was based on sound micro foundations. The fact that the model remains part of the economist’s intellectual toolkit today is a tribute to its basic insight and enduring analytic power.

The original model has been both simplified for some purposes and expanded for others by later contributors, including Stiglitz, Bell, Khan, Anand and Joshi, Bourguignon, Corden and Findlay, and others (Fields 2005). Harris and Todaro formulated general processes for determining prices of the products produced by the two sectors and also for determining a rural-sector wage that varies inversely with the number of people in the rural sector. A simplified version of the Harris-Todaro model was developed in which product prices and rural-sector wages are taken as constant. Numerous additional analytic and policy results were derived in the simplified Harris-Todaro model. At the same time, some of the assumptions of the Harris-Todaro model were judged to be too restrictive, and so the model was generalized in the years that followed to nest their specific formulation within a broader framework. The initial Harris-Todaro model has been extended to allow for on-the-job search from a rural agriculture setting, the existence of an urban informal sector, preferential hiring of the better-educated, employment fixity, duality of production conditions and earnings levels within the rural sector, capital mobility, endogenous urban wage setting, risk aversion, and a system of demand for goods, among other factors.

As an early multisector labor-market model, the Harris-Todaro model set forth a principal alternative framework for policy analysis. It showed how employment and wage levels in one labor market reflect supply, demand, and institutional conditions not only in that labor market but also in other labor markets.

In terms of pro-poor economic growth, the Harris-Todaro model and other multisector-labor-market models can help policy makers avoid two mistakes. One is to assume that development efforts should be channeled to the sectors where the poor are. The other is to assume that efforts should always be focused on getting the poor out of the sectors in which they now are. Careful cost-benefit analysis based on well-specified labor-market models is required to decide among such alternatives.

SEE ALSO Development Economics; Distortions; Dual Economy; Migration