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be considerable. Where hours worked is the relevant measure, labor has a positive marginal productivity.

Even though capital–labor ratios are alterable in agriculture, they might not be so in industry, especially in such sectors as steel or chemicals. The last resort for labor not employed in profit-maximizing industry is with the clan, or extended family, in agriculture. Agriculture’s absorption of this labor means marginal productivity and wage that will be lower than in industry. Yet the possibilities of substantial laborintensive agricultural jobs, as Viner indicates, means that the marginal product of agricultural labor would be positive.

Do field investigations support this supposition? Several studies between 1930 and the early 1950s purported to show that LDC output in agriculture remained constant or increased with reduced labor. But these studies lacked evidence that capital formation and the level of technology remained constant (Kao, Anschel, and Eicher 1964:129–144). Obviously, labor’s marginal productivity can be positive – even if output expands with less labor – if capital and technology increase.

Rural–Urban Migration

Although overall the LDC labor force grows at an annual rate of 1.6 percent, the urban labor force and population are growing annually by 2.4 percent! The urban share of total LDC population has grown from 27 percent in 1975 and 35 percent in 1992 to 40 percent in 2003 (75 percent in Latin America, 38 percent in Asia, and 33 percent in Africa, compared to 75 percent in DCs and 47 percent for the world total) and is projected to increase to 47 percent in 2010 and 56 percent in 2030 (Cohen 1976:12–15; U.N. Department of Economic and Social Information and Policy Analysis 1993:74–75, 106–107; World Bank 1994i:210–211, 222–223; U.N. Development Program 1994:148–149; U.N. Population Division 2002; Population Reference Bureau 2003). From 1975 to 2000, the number of cities in LDCs with populations over 1 million has been increasing from 90 to 300. Twenty-seven LDC urban agglomerations had populations of at least 10 million and three agglomerations (Mumbai, India; Sao Paulo, Brazil; and Mexico City, Mexico) had at least 15 million in 2000 (Table 9-3).

Low returns to agriculture and the prospect of higher wages in industry spur migration from rural to urban areas. A substantial proportion of the growth in the urban labor force is because of such migration, especially in predominantly agricultural countries that are newly industrializing. Thus, migration to the cities is a larger contributor than natural population growth to urban labor growth in sub-Saharan Africa, the least industrialized LDC region, than it is in more industrialized Latin America, where natural increase is the major source of urban growth.2

2 The merging or expansion of villages can create a statistical illusion of townward migration. For example, two villages of 2000 each can, through natural increase, expand their builtup areas until they meet to form a single village of 5000, the usual threshold for reclassification as an urban area. Mumbai and Delhi, India, and Kuala Lampur, Malaysia, contain villagelike enclaves (Lipton 1977:225–226).

TABLE 9-3. Populations of Urban Agglomerations, 1950, 1970, 1990, 2000, and 2015 (in millions) – ranked by 2015 population

Sources: U.N. Department of Economic and Social Information and Policy Analysis 1993:126– 127, 139–143; U.N. Population Division 2002.

THE LEWIS MODEL

Remember the Lewis model in Chapter 5 that explained how LDC economic growth originated from the increase in the industrial sector relative to the subsistence agricultural sector. The Lewis model also explains migration from rural to urban areas in developing countries. The simplest explanation for rural–urban migration is that people migrate to urban areas when wages there exceed rural wages. Arthur Lewis elaborates on this theory in his explanation of labor transfer from agriculture to industry in a newly industrializing country. In contrast to those economists writing since the early 1970s, who have been concerned about overurbanization, Lewis, writing in 1954, is concerned about possible labor shortages in the expanding industrial sector.

THE HARRIS–TODARO MODEL

The Lewis model does not consider why rural migration continues despite high urban unemployment. John R. Harris and Michael P. Todaro, whose model views a worker’s decision to migrate on the basis of wages and probability of unemployment, try to close this gap in the Lewis model. They assume that migrants respond to urban–rural differences in expected rather than actual earnings. Suppose the average unskilled rural worker has a choice between being a farm laborer (or working his or her own land) for an annual income of Rs. 3000 or migrating to the city where he or she can receive an annual wage of Rs. 6000. Most economists, who assume full employment, would deduce that the worker would seek the higher paying urban job. However, in developing countries with high unemployment rates, this supposition might be unrealistic. Assume that the probability of the worker getting the urban job during a

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1-year period is 20 percent. The worker would not migrate, as the expected income is Rs. 6000 × .20, or Rs. 1200, much less than Rs. 3000 (3000 × a probability of 1) on the farm. But if the probability of success is 60 percent, expected urban earnings would be Rs. 6000 × .60, or Rs. 3600. In this case, it would be rational for the farm worker to seek the urban job. And because most migrants are young (under 25), it would be more realistic to assume an even longer time span in the decision to migrate. The migrant may consider lifetime earnings. Thus, if the present value of expected lifetime earnings in the urban job is greater than on the farm, it would be rational to migrate.

According to Harris and Todaro, creating urban jobs by expanding industrial output is insufficient for solving the urban unemployment problem. Instead, they recommend that government reduce urban wages, eliminate other factor price distortions, promote rural employment, and generate labor-intensive technologies, policies discussed later (Harris and Todaro 1970:126–142; Todaro 1971:387–413).

CRITICISMS OF THE HARRIS–TODARO MODEL

Even without amenities, an ILO study indicates that the ratio of average urban to rural income is more than 2 in Asia and Latin America and 4–5 in Africa (after adjustments for living costs). Assuming a ratio of 2, urban unemployment must be 50 percent to equate urban and rural expected income. But LDC urban unemployment rarely exceeds 10–20 percent, indicating migration does not close the urban and rural expected wage gap. We can explain the gap by adding to the Harris-Todaro urban formal and rural sectors the urban informal sector, where petty traders, tea shop proprietors, hawkers, street vendors, artisans, shoe shiners, street entertainers, garbage collectors, repair persons, artisans, cottage industrialists, and other selfemployed generate employment and income for themselves in labor-intensive activities with little capital, skill, regulation, and entry barriers (ILO 1972:5–8).3 These small enterprisers have low start-up costs and profit margins, negotiate agreements outside the formal legal system, and hire workers at less than minimum wage. A substantial share of the LDC urban labor force is relegated to the informal sector: 34 percent of Mexico City’s; 45 percent of Bogota, Colombia’s; 43 percent of Kolkata, India’s; and 50 percent of Lagos, Nigeria’s.

The informal-sector’s labor supply is affected primarily by wages and population growth in the rural sector. The substantial absorption of rural emigrants in the informal sector explains why migration stops long before rural expected incomes attain urban formal sector ones. Many migrants are neither unemployed nor receiving the prevailing formal sector wage but are working in informal jobs, which facilitate their entry into the urban economy (Sethuraman 1981:17; Jagannathan 1987:57–58; Lecaillon, Paukert, Morrisson, and Germidis 1984:54–57;

3A part of this sector includes “the urban in-migrant who, instead of doing absolutely nothing, joins Bombay’s army of underemployed bootblacks or Delhi’s throngs of self-appointed (and tippable) parking directors, or who becomes an extra, redundant salesman in the yard goods staff of the cousin, who according to custom, is going to have to provide him with bed and board anyway” (Lewis 1962:53). Underemployment of this type is widespread in Asian, African, and Latin American cities.

Cole and Sanders 1985:481–494; Gillis, Perkins, Roemer, and Snodgrass 1987:190– 191).

In some economies, especially former socialist economies, many people consider the informal (even the small private) sector to be questionable. Soviet attitudes toward the “black” market or predatory economy carried over to attitudes to private or informal enterprises in the former Soviet Union in the first decade of the 21st century: “Money earned through state jobs was respectable and public; money or goods earned in the so-called second (private) economy were questionable, even ‘dirty.’ The second economy had flourished in . . . the Soviet Union, but individuals used their official affiliations as a cover when their actual wealth derived from bribes or other forms of corruption” (Dudwick et al. 2003:220–221).

THE EFFECT OF OTHER AMENITIES

The decision to migrate is not based merely on differences in earnings. Workers considering migration will look at many other factors; they will compare housing, shops, transport, schools, hospitals, and other amenities in the two places. This decision encompasses much more than the difficulty of keeping youths on the farm once they have seen the bright lights of Paris, Lagos, New Delhi, or Sao˜ Paulo. In fact, it is rare in developing countries for a rural youth to seek a city job without family support. Typically, job applicants are sent to the city by their families to diversify family income. When in the city, they may stay with relatives during the job search. The Western stereotype of young urban immigrants as rebels against the family is not common in developing countries, where young people rarely have cars or money essential for independence and they depend heavily on the family for employment, a good marriage, and economic security.

The concentration of social services in LDC urban areas has led to overurbanization, especially in Africa. A visitor who ventures beyond an African capital city is likely to be shocked by the economic and social disparity existing between the city and the hinterlands. For example, in 1968, the eight-story, 500-bed Centre Hospitalier Universitaire, one of the largest and most modern hospitals in Africa, was built in the affluent section of Abidjan. But the project’s funds, given by the French government, were originally intended for twelve regional hospitals in Coteˆ d’Ivoire. Housing, transport, sewerage, fuel, and staple foods are often government subsidized in urban areas, where their cost is far more than in rural areas (Gugler and Flanagan 1978).

WESTERN APPROACHES TO UNEMPLOYMENT

The classical view of employment, prevalent in the West for about 100 years before the Great Depression, was that, in the long run, an economy would be in equilibrium at full employment. Flexible wage rates responding to demand and supply ensured that anyone who wanted to work would be employed at the equilibrium wage rate. In the idealized world of classical economics, there would never be involuntary unemployment!

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John Maynard Keynes’s general theory of income and employment was a response to failure of the classical model in the West in the 1930s. In the Keynesian model, a country’s employment increases with GNP. Unemployment occurs because aggregate (total) demand by consumers, businesses, and government for goods and services is not enough for GNP to reach full employment. The Keynesian prescription for unemployment is to increase aggregate demand through more private consumption and investment (by reduced tax rates or lower interest rates) or through more government spending. As long as there is unemployment and unutilized capital capacity in the economy, GNP will respond automatically to increased demand through higher employment.4

However, Keynesian theory has little applicability in LDCs. First, businesses in LDCs cannot respond quickly to increased demand for output. The major limitations to output and employment expansion are usually on the supply side, in the form of shortages of entrepreneurs, managers, administrators, technicians, capital, foreign exchange, raw materials, transportation, communication, and smoothly functioning product and capital markets. In fact, where there are severe limitations in supply response (where output or supply is price inelastic), increased spending may merely result in higher inflation rates.

Second, open unemployment may not be reduced even if spending increases labor demand. As indicated previously, open unemployment occurs primarily in urban areas. However, labor supply in urban areas responds rapidly to new employment opportunities. The creation of additional urban jobs through expanded demand means even more entrants into the urban labor force, mainly as migrants from rural areas.

Third, LDCs cannot rely so much as DCs do on changes in fiscal policy (direct taxes and government spending) to affect aggregate demand and employment. Direct taxes (personal income, corporate income, and property taxes) and government expenditures make up a much smaller proportion of GNP in LDCs than in DCs (see Chapter 14).

Fourth, as the discussion concerning Table 9-2 suggested, employment growth is likely to be slower than output growth. In fact in some instances, increasing employment may decrease output. In the 1950s, when Prime Minister Jawaharlal Nehru asked economists on the Indian Planning Commission to expand employment, they asked him how much GNP he was willing to give up. The idea of a tradeoff between output and employment, which astounded the Indian prime minister, is consistent with a planning strategy in which capital and high-level technology are substituted for labor in the modern sector. For example, milling rice by a sheller machine rather than pounding by hand increases output at the expense of employment. However, this tradeoff between employment and output may not be inevitable, as we indicate in the discussion of employment policies.

4Todaro (1977:174–179) has a thorough discussion of the classical and Keynesian theories of employment.

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that make wages higher and interest rates and foreign exchange costs lower than market-clearing rates.

High wages in the modern sector. Marx’s collaborator, Friedrich Engels, who wrote in the late 19th century, referred to Britain’s regularly employed industrial proletariat, with its wages and privileges in excess of other European workers, as a labor aristocracy. Today, some scholars apply Engels’s concept to LDCs, pointing out that urban workers tend to be economically far better off than the rural population.

It is true that the prevailing wage for unskilled labor in the modern sector in LDCs is frequently in excess of a market-determined wage because of minimum-wage legislation, labor union pressure, and the wage policies of foreign corporations operating in these countries. Often trade unions try to influence wages in the modern sector through political lobbying rather than collective bargaining. Frequently, unions became political during a colonial period, when the struggle for employment, higher wages, and improved benefits was tied to a nationalist movement. After independence was gained, the political power of the unions often led to the widespread establishment of official wage tribunals, which frequently base a minimum living wage on the standards of more industrialized countries rather than on market forces in their own country. When foreign firms pay higher wages than domestic firms, the motive may be to gain political favor, avoid political attack, and prevent labor strife, as well as to ensure getting workers of high quality.

In many LDCs, the income of workers paid the legal minimum wage is several times the country’s per capita GNP. Even when we adjust for the average number of dependents supported by these workers, the per capita incomes of their households are still usually in excess of the average for the country as a whole. This disparity exists because the minimum wage (when enforced) usually applies to only a small fraction of the labor force, workers in government and in firms with, say, 15 to 20 or more employees. The wage structure for these workers in the formal sector is usually higher than those with comparable jobs in the informal sector. Wage–employment studies indicate that wages higher than equilibrium reduce employment in the formal sector.

Stabilization and wage–price decontrol during the 1980s and 1990s, usually under IMF and World Bank auspices, contributed to reductions in aggregate demand, real wages, and inflation rates. Food prices increased and real wages fell as Africa decontrolled agricultural and industrial prices during the 1980s. Compared to 1980, real nonagricultural wages dropped considerably during adjustment programs – in Tanzania by 40 percent to 1983; in Zambia, 33 percent to 1984; in Malawi, 24 percent by 1984; in Kenya, 22 percent by 1985; in Zimbabwe, 11 percent by 1984; in Mauritius, 10 percent by 1985; and in Swaziland, 5 percent by 1983 (Nafziger 1993:156–158). Also compared to 1980, Latin America underwent substantial realwage reductions – in Bolivia by 50 percent to 1986, and in Chile by 27 percent to 1986 (Horton, Kanbur, and Mazumdar 1991:549). Unfortunately, adjustment programs that contributed to these real-wage losses were accompanied by reduced government social spending that removed social safety nets, such as food subsidies,

health expenditures, and free primary education. Thus, any country reducing wage distortions needs programs to protect the basic needs of urban wage earners during the transition and help them retrain for jobs in expanding sectors. For example, whereas the adjustments of the 1980s in Africa and Latin America reduced the incomes of wage earners in domestic-oriented industries, public sector employees, and informal-sector workers, these same adjustments increased the incomes of commercial farmers, their wage labor, export-oriented industries, and traders benefiting from exchange-rate and price changes (Commander 1989:239).

Low capital costs. Capital costs in LDCs may be artificially low. Programs encouraging investment, such as subsidized interest rates, liberal depreciation allowances, and tax rebates are common. But at least as important are policies that keep the price of foreign exchange, that is, the price of foreign currency in terms of domestic currency, lower than equilibrium.

The LDC central bank restrictions on imports and currency conversion, although ostensibly made to conserve foreign exchange, may actually create foreign currency shortages by keeping the foreign exchange price too low. For example, such restrictions may allow Nigeria to keep the foreign exchange rate at N25 = $1 rather than a market-clearing rate of N50 = $1. This low price of foreign currency means that an imported machine tagged at $1,000 costs N25,000, instead of N50,000 (at equilibrium exchange rates). The low foreign exchange price gives importers of capital goods (as well as other goods) an artificial inducement to buy. However, because most countries assign a high priority to importing capital goods, these importers have a better chance of acquiring licenses for foreign exchange from the central bank than do other importers (see Chapter 17).

The low foreign exchange price and the official preference for imported capital goods combine to make the actual price of capital cheaper than its equilibrium price. And when this occurs with wages higher than market rates, LDCs end up using more capital-intensive techniques and employing fewer people than would happen at equilibrium factor prices. Distortions in these prices and fairly inflexible factor requirements for some production processes result in higher unemployment. The end effect is increased income inequalities between property owners and workers and between highly paid workers and the unemployed.

Removing capital cost distortions in India. In 1991–95, as part of liberalization, the World Bank and IMF required India to reduce distortions of capital, foreign exchange, and other financial markets. For India, this meant raising the real rate of interest to a competitive level, substantial devaluation of the rupee, and reduced protection.

Several entrepreneurs unable to expand because of a lack of credit during nonprice rationing of bank loans have been able, since 1991, to acquire capital for innovation and expansion. Others, including managers of large private capital-intensive steel enterprises, have complained about how higher rates of interest have choked off planned expansion. Overall, the higher interest rates have rationalized bank

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lending. However, several smalland medium-sized entrepreneurs have complained about the continuing subsidies for competitors in the public sector (for example, steel), where lower decontrolled prices after 1991 has meant many units in this sector continue to expand despite generating surplus less than a competitive rate of interest.

The liberalized foreign-exchange regime (higher rupee price of the dollar and delicensing of many foreign purchases) is a welcome change for a South Indian marble products producer, who has reduced his time for clearing imported machines through Indian customs from an average of one month before 1991 to two days since 1993. Several other entrepreneurs have found that foreign-currency decontrol has created easier access to imports to improve plant and machinery (albeit at higher rupee prices) and spurred them to seek markets overseas (Nafziger and Sudarsana Rao 1996: 90–103).

In India, state-owned enterprises have opposed financial liberalization, fearing a substantial decline in output with a withdrawal of favorable access to bank credit. Labor unions are disproportionately represented by workers in state-owned enterprises and in government, who generally enjoy relatively high wages and secure jobs. Unions are important political agents, providing financial and electoral support for political parties, such as the Congress Party and the Bharatiya Janata Party. The fact that public firms and large private firms with long-standing access to input licenses are supported by politically powerful unions threatens bank, interest-rate, and foreignexchange deregulation in India.

UNEMPLOYMENT AMONG THE EDUCATED

The secondary school enrollment rate is 44 percent in low-income countries and 70 percent in middle-income countries (World Bank 2003h:82). Regrettably, scattered studies suggest that LDCs, especially those with secondary enrollment rates more than 50 percent, have unemployment rates of well over 10 percent among persons with some secondary schooling. Sri Lanka, Iran, and Colombia, where the overwhelming majority of youths receive some secondary education, have unemployment rates in this educational group in excess of 15–20 percent. The unemployment rate for people with some primary education may be close to 10 percent; for those with some postprimary education even lower; and those with no schooling lower yet. Even so, there is no evidence of a rising unemployment trend among the educated in LDCs, although there is higher unemployment in countries that have instituted universal primary education or rapidly expanded secondary enrollment during the past decade.

Unemployment among the educated appears to be associated with how the labor market adjusts to an influx of school graduates (and dropouts). Although political pressures force many LDC public education systems to expand, there are rarely enough jobs for these people once they graduate. Job aspirations among the educated simply cannot be met. During the initial years of educational expansion and replacement of foreigners by locals just after independence from colonial rule, graduates were readily absorbed in high-level positions in the civil services, armed forces,

government corporations, schools, and private business. However, in subsequent years, there have been far fewer vacancies at these levels.

High unemployment among the educated is in part because the wage structure adjusts slowly, especially if the public sector is the major employer of educated workers. Frequently in government service, wages are based on the cost of acquiring the training essential to meet the legal requirements for the job rather than on labor supply and productivity. The signals from this perverse wage-setting mechanism do not provide consistency between educational output and employment opportunities. Furthermore, graduates may be encouraged to wait for well-paid jobs rather than immediately accept a job that pays much less. If the wage difference is high enough and the probability of obtaining a higher paid job is sufficiently large, a period of job seeking will yield a higher expected, lifetime income.

These explanations are consistent with the unemployment patterns indicated earlier. Illiterate people cannot wait for a better paid job. They remain on the farm or take the first job offer. At the other extreme, highly trained people are scarce enough in most LDCs that university graduates get well-paid jobs immediately. But those in between, primary and secondary school graduates (or dropouts), are neither assured of high-paying jobs nor completely out of the running for them. Thus, there may be a substantial payoff in a full-time search for a job. The educated unemployed tend to be young, with few dependents, and supported by their families. Most eventually find work, usually within two years, although some have to lower their job expectations (World Bank 1980i:51). Mark Blaug, P. R. G. Layard, and Maureen Woodhall (1969:90) found that whereas 65 percent of secondary school graduates in India were unemployed in the first year after completing their education, only 36 percent were in the second year, 20 percent in the third, 11 percent in the fourth, 6 percent in the fifth, and 2 percent in the sixth. Except for possible political discontent, the costs associated with this unemployment are not so serious as they might appear.

Policies for Reducing Unemployment

POPULATION POLICIES

As we have already said, rising LDC unemployment is caused by slowly growing job opportunities and a rapidly growing labor force. Family-planning programs and programs to improve health, nutrition, education, urban development, income distribution, and opportunities for women can reduce fertility and population growth, thus decreasing labor force size 15 to 20 years hence (Chapter 8). Such fertility reduction should be pursued.

POLICIES TO DISCOURAGE RURAL–URBAN MIGRATION

Unemployment can be reduced by decreasing rural–urban migration. The key to such a decrease is greater rural economic development. As indicated in Chapter 7, this development can be facilitated by eliminating the urban bias in development projects; removing price ceilings on food and other agricultural goods; setting the