The Suntory and Toyota International Centres for Economics and Related Disciplines

On the Harris-Todaro Model with Intersectoral Capital Mobility

Author(s): J. Peter Neary
Source: Economica, New Series, Vol. 48, No. 191 (Aug., 1981), pp. 219-234
Published by: Blackwell Publishing on behalf of The London School of Economics and Political Science
and The Suntory and Toyota International Centres for Economics and Related Disciplines
Stable URL: http://www.jstor.org/stable/2552914 .
Accessed: 11/02/2011 04:27

Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at .
http://www.jstor.org/page/info/about/policies/terms.jsp. JSTOR's Terms and Conditions of Use provides, in part, that unless
you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you
may use content in the JSTOR archive only for your personal, non-commercial use.

Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at .
http://www.jstor.org/action/showPublisher?publisherCode=black. .

Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed
page of such transmission.

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of
content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms
of scholarship. For more information about JSTOR, please contact support@jstor.org.

Blackwell Publishing, The London School of Economics and Political Science, The Suntory and Toyota
International Centres for Economics and Related Disciplines are collaborating with JSTOR to digitize,
preserve and extend access to Economica.

http://www.jstor.org
Economica, 48, 219-234

On the Harris-TodaroModelwith
IntersectoralCapitalMobility
By J. PETER NEARY

Trinity College, Dublin

INTRODUCTION

In a pioneering article, Harris and Todaro (1970) presented a simple general

equilibriummodel consisting of an urban and a rural sector, in which equilibrium
is characterizedby persistent unemployment in the urban sector. The source of
this phenomenon is the equalization of the actual wage in the rural sector and the
expected wage in the urban sector, with one minus the urban unemploymentrate
assumed to measure the perceived probabilityof a ruralmigrant'sfinding a job in
the urban sector.
Both the positive predictions and the normative implications of the
Harris-Todaro (henceforth HT) model differ in important respects from
conventionalwisdom in developmenteconomics and in the theory of international
trade. Not surprisingly,therefore, considerable attention has been devoted to the
model in each of these fields. While developmenteconomists have concentratedon
testing and relaxing the underlyinglabour market assumptions of the model (see,
for example, Todaro, 1976, and Fields, 1975), internationaltrade theorists have
been concerned with relating its analysis and results to the existing literatureon
factor market distortions in open economies. In particular, Bhagwati and
Srinivasan (1974, 1975) and Corden (1974) have re-examined the welfare
implications of the HT model in the light of the theory of distortions and welfare,
and Corden and Findlay (1975) have extendedthe model to allow for intersectoral
capital mobility, thus bringing it more closely into line with the Heckscher-
Ohlin-Samuelson model of internationaltrade theory.
The purpose of the present paper is to consider furtherthe positive properties
of the HT model with intersectoral capital mobility, extending the analysis of
Corden and Findlay and examining a number of issues not considered by them.
Principal among these is the dynamic behaviour of the model: Corden and
Findlay explicitly confined attention to a comparative statics analysis, but this
seems undesirablein a model that purports to examine such essentially dynamic
phenomena as rural-urban migration and intersectoral capital reallocation.
Moreover a consideration of the model's dynamic behaviour throws light on the
question of the'dynamic stability of long-run equilibrium:HT showed that with
sector-specific capital the model is always stable, but it will be shown below that
when capital is intersectorallymobile this is no longer the case. On the contrary, a
condition assumed without discussion by Corden and Findlay-that the
manufacturing sector is relatively capital-intensive-turns out to be necessary
though not sufficientfor stability. Another question examined below is the sign of
the economy's aggregate supply response; this is relevant to the implications for
trade patterns of labour market distortions of the HT kind, a question first
analysed by Kreuger (1977). Various other comparative statics propertiesof the
model are also explored. In particular, a necessary and sufficient condition is
220 ECONOMICA [AUGUST

derivedfor a paradox whose possibility was noted by Corden and Findlay: that an
increase in the minimum wage in manufacturing may increase manufacturing
output.
The plan of the paper is as follows. Section I reviews the HT model when
labour is the only intersectorallymobile factor and when relativecommodity prices
are given by world markets. Section II relaxes the assumption of sector-specific
capital and illustrates how the economy gradually adjusts to a change in world
prices, while Section III considers the effects of a change in the urban minimum
wage. Both of these sections make two key simplifications of the original HT
model that commodity prices are parametric,and that land is not a scarce factor
in agriculture which make it possible to rely on mainly geometric tools and to
concentrateon the novel implicationsof the HT hypothesis about the operation of
labour markets in less developed countries. The consequences of relaxing these
two assumptions are noted in Section IV. Finally, Section V summarizesthe main
findingsof the paper, and concludes with a comparison between the HT and other
types of factor market distortion, and with a general discussion of the significance
of assuming that capital is intersectorally mobile. An Appendix to the paper
(available on request from the author) sets out the model in algebraic form and
sketches the derivationof the principal results.

I. THE HARRIS-TODARO MODEL WITH SECTOR-SPECIFIC CAPITAL

The distinctive feature of the HT model is that labour is assumed to migrate

from rural to urban areas until the actual wage in the rural or agriculturalsector,
WA, equals the expected wage in the urban sector, we.' The latter in turn is
assumed to equal the wage in industry, WM' times the urban employment rate.
which measures the perceived probabilityof an urbanjob-seeker's obtaining a job
in industry.2In obvious notation, this equilibriumcondition may be writtenas

( 1) WAZ~ e LM WM.
LMA+ U
As we shall see, it is condition (1) that gives rise to the model's novel predictionof
persistent urban unemployment as an equilibrium phenomenon. However (1)
alone is not sufficient to guarantee this outcome; rather, this is implied by the
combination of (1) with what is from many points of view the model's crucial
assumption,that the wage in industryis exogenously fixed by institutionalfactors.
(Strictly speaking, it is the minimumwage in manufacturingthat is fixed, but we
assume throughout that this constraint is strictly binding, since otherwise the
model reduces to the usual full-employment one.) By contrast, the wage in
agricultureis assumed to be perfectly flexible, and to adjust instantaneously to
equate demand and supply in the rurallabour market.
In all other respects the model is of a conventional, neoclassical, two-sector
type. Output in each sector is produced by a constant-returns-to-scaleproduction
function, using fixed stocks of capital and variable amounts of labour, with the
aggregate supply of the latter assumed to be fixed. Enterprisesin both sectors are
assumed to maximize profits in the face of given wage rates, and so employment
levels are chosen such that the value marginal product of labour in each sector
equals the appropriatenominal wage. Hence, with commodity prices fixed on the
19811 THE HARRIS-TODARO MODEL 221

WM V? WA
q VM

QM M
G~ J F QA

(/M5. 0 1 A

Labour-
FIGURE1 Effects of an increase in the relative price of manufactures.

world market, the determinationof labour market equilibriummay be illustrated

in the upperpart of Figure 1 (which is identicalto Corden and Findlav's Figure 1).
If the wage in both sectors were free to adjust, a full-employmentequilibrium
would obtain corresponding to point Z, the intersection of the two demand-
for-labour schedules,Vd and VM. However the existence of a minimum wage in
manufacturing,I'M, at a level above the full-employmentwage reduces equilibrium
employment in manufacturingfrom QMJto QMG. As Corden and Firidlayshow,
the distributionof the remainderof the labour force between rural employed and
urbanunemployedmay be established by constructinga rectangularhyperbolaqq
through point H. At all points on such a curve the Harris-Todaro equilibrium
condition (1) is satisfied, and so its intersection with the VA schedule at point R
determines the equilibriumlevels of employment and wages in agriculture.The
equilibriumlevel of urbanunemploymentis thereforeequal to GF.
The comparative statics properties of this model may now be deduced by
manipulating the upper part of Figure 1. Consider first an increase in the
minimumwage in manufacturing.It is clear from the diagram that employmentin
222 ECONOMICA [AUGUST

manufacturing must fall, but that the changes in employment and wages in
agriculturedepend on whether the slope of JOMis greater or less than that of the
curve qq. Since the elasticity of a rectangularhyperbola is unity, this criterion is
equivalentto whether what Corden and Findlay call the manufacturing elasticitv
(the absolute value of the elasticity of demand for labour in manufacturing)
is greater or less than one. As drawn in Figure 1. the manufacturingelasticity
is less than one-the case that HT (Harris and Todaro, 1970, p. 130) claim
is empirically plausible-and so an increase in the manufacturing wage
attracts migrants into the urban sector, leading to a rise in the agriculturalwage
(though by a smaller proportion than the increase in WM, unless both J0Aand VOM
are vertical), a fall in agricultural employment and an increase in urban
unemployment.On the other hand, if the manufacturingelasticity is greaterthan
one, an increase in the manufacturingwage depresses the demand for labour there
to such an extent that outmigration to the rural sector is actually encouraged,
raising agriculturalemployment and output and lowering the agriculturalwage.
This outmigrationis unlikely to offset the decline in manufacturingemployment
and actually reduce urban unemployment,but it might do so if the unemployment
rate is already high. Finally, it is clear that an increase in the manufacturingwage
must lower manufacturingoutput in absolute terms;however,if the manufacturing
elasticity is less than unity, it is possible that agriculturaloutput could fall by an
even greater proportion, leading to a rise in the relative output of -the
manufacturingsector.
Turning to the effects of changes in factor endowments, a rise in the total
labour force has no effect on manufacturing employment, but increases both
agricultural employment and urban unemployment. Capital accumulation in
agriculture raises employment, output and wages there, so lowering urban
unemployment;while capital accumulation in manufacturingraises employment
in manufacturingbut lowers it in agriculture.The net effect of the latter on urban
unemploymentis ambiguous but is likely to be negative unless the unemployment
rate is already high.
The final exogenous change to be consideredis an increase in the relativeprice
of manufactures,the effects of which depend to a considerableextent on the good
in terms of which Lhemanufacturingwage is pegged. (The general case where the
wage is fixed relative to a price index comprising both goods is considered in the
Appendix.) If the manufacturing wage is indexed in terms of manufacturing
output, then the change has no effect on the real wage facing entrepreneursin
manufacturing,and so employment and output there are unaffected.3However the
labour market equilibriumcondition (1) is disturbed,encouraging migration into
the urban sector, which merely raises the number of urban unemployed. By
contrast, if the manufacturingwage is pegged in terms of agriculturaloutput, the
price increase reduces the real wage facing industrialentrepreneursand so they
expand employment.This also encourages in-migration,but in this case the level of
urban unemploymentis likely to fall. In both cases employment and output fall in
agriculture,so the economy's price-output response is normal.
It is clear from the foregoing that the properties of the HT model are
somewhat different from those of the corresponding full-employmentmodel, as
presented for example in Jones (1971). However, so far we have retainedthe HT
assumption that labour is the only intersectorallymobile factor. We turn in the
next section to the consequences of relaxingthis assumption.
1981] THE HARRIS-TODARO MODEL 223

II. SHORT-RUN AND LONG-RUN EFFECTS OF A PRICE CHANGE IN THE

HARRIs-TODARO MODEL

The model of the previous section may be viewed as providing a complete

descriptionof the effects of exogenous changes on the economy. This was the view
adopted by Harris and Todaro themselves, since the model is essentially identical
to theirs, apart from its assumption of fixed commodity prices. Alternatively,as a
prelude to exploring the properties of the HT model with intersectoral capital
mobility, it is convenient to reinterpretthe sector-specificcapital model of Section
I as referringto the short run, and to examine the effects of exogenous changes in
relative commodity prices on the incentives for capital reallocation. This also
allows us to illustrateexplicitly the path that the economy follows towards a new
long-runequilibrium,using a diagrammaticdevice introducedin Neary (1978a).
Returningto Figure 1 therefore, we assume that, correspondingto the initial
short-run equilibriumrepresented by points H and R in the upper part of the
diagram,points B and D in the lower part representan initiallong-runequilibrium
as well. For this to be so, the rental on capital in manufacturing, which
corresponds to the capital-labour ratio OMB, must equal that in agriculture,
corresponding to the capital-labour ratio OAD (not drawn). (Recall that, with
constant returnsto scale and fixed commodity prices, there is a one-to-one inverse
relationshipbetween the capital-labour ratio and the rental in each sector.) The
lower part of Figure 1 is of course a standardEdgeworth-Bowley box (similarto
Corden and Findlay's Figure 2), and so at the initial equilibriumcapital is fully
employed, BD (which equals GF) is the level of urban unemployment, and
manufacturingis the relatively capital-intensive sector. This last assumption is
anythingbut innocuous: its significancewill become apparentbelow.
Consider now an increase in the relative price of manufactures, where for
simplicity we assume that the manufacturing wage is fixed in terms of
manufactures. (The consequences of assuming that it is fixed in terms of
agriculturaloutput may easily be established using the same tools.) In the upper
part of the diagramthis change may thereforebe representedby a downwardshift
in the VA schedule to VA, leading to the short-runeffects noted in the last section:
manufacturingemployment is unchanged and urban unemployment rises at the
expense of agriculturalemployment. In the lower part of the diagram the new
short-runequilibriumis representedby points B and E (since the economy must
remainon the initial capital allocation line KMKAin the shortrun).4But these points
cannot represent a situation of long-run equilibrium,since in order to restore
capital marketequilibriumfollowing the rise in the relativepriceof manufacturesit
is necessary for the real rental in agricultureto rise. This impliesin turn a fall in the
capital-labour ratio in agriculture:the magnitudeof this fall depends of course on
the elasticity of substitution in agriculture, and we assume that the new
equilibriumcapital-labour ratio in agricultureis that representedby the ray OAS.
How does the economy move from the short-run equilibriumat B and E
towards its new long-run equilibrium?Since the rentalin agricultureat E is below
that in industry at B, capital will be reallocated in the medium run out of
agriculture and into industry. Assuming that capital remains fully employed
throughout the adjustment period, the effect of this capital reallocation on the
equilibriumwage in agriculture may be deduced by adapting the reasoning in
Neary (1978a). If the production point in agriculturewere to move along the ray
224 ECONOMICA [AUGUST

OAE, the agriculturalwage would remain constant but the urban unemployment
rate would steadily rise, thus violating the labour marketequilibriumcondition (1).
Alternatively,if the production point were to move along the ray OME, the urban
unemployrnent rate would remain constant but the agricultural wage would
steadily fall. Therefore,in order that condition (1) be maintained at all times, it is
necessary for the agricultural production point to move away from E in a
north-easterlydirection, tracing out a locus that lies betiweenthe rays OAE and
0,ME and is at all points more steeply sloped than a ray from OA to that point but
less steeply sloped than a ray from OMto that point. This curve may be called the
"labour market equilibriumlocus"' correspondingto the new price ratio; clearly,
the initial long-runequilibriumD lies on a similar locus, and the effect of the price
change is to shift this locus rightwards. The new long-run equilibriumis finally
attained at the point D' where the locus intersectswith the ray OAS, at which both
labour and capital markets are in equilibrium. Since the real wage facing
entrepreneursin manufacturingis fixed throughout the adjustment period, they
expand output along the ray OMB, hiring only as much additional labour as is
necessary to operate the new capital at the same factor intensity. Hence urban
unemployment, swelled by continual migrationfrom the rural sector, rises in both
absolute and relative terms during the adjustmentperiod, reaching the level B'D'
in the final long-runequilibrium.
So far, we have adopted the asymmetric assumption about relative adjustment
speeds implied by the "short-runcapital specificity"hypothesis of Neary (1978a),
that labour migrates instantaneously, relative at least to the speed at which the
capital stock is reallocated. However, it is a straightforwardmatter to extend the
analysis to allow for intermediateassumptions about relative adjustment speeds.
Consider Figure 2, which repeats the salient features of the lower part of Figure 1,
for a single long-run equilibrium,correspondingto a given relative price ratio and
a given minimumwage in manufacturing.The production poinltin manufacturing
must always lie along the ray OA,,R,and if rentals in the two sectors are to be equal
the production point in agriculture must lie along the ray OAD. But this means
that OAD is itself the capital market equilibriumlocus: if the initial allocation of
capital between the two sectors corresponds to a point above the ray, the rental in

-, ....
FIGURE . -.2SaiiywethubnscoisrlieOA
.. .
... ..- . ... ... ,

::.,::.,...:.:.-.:.:::
-:::.-................ .
'"'"'''''"-'''''''''''''''''' :

/
.."''.''-'''.".''..;.
'
'.';.......
...M.
.. . . . . .. . . . . .
FIGRE . i.re.ti.l.ca.ta-aundnt
Sabiitywhn.te......scto
1981] THE HARRIS-TODARO MODEL 225

agricultureexceeds that in industry, and so there is an incentive to move capital

out of manufacturing and into agriculture. Conversely, if the initial allocation
point lies below this ray there is an incentive to move capital into manufacturing.
These tendencies are indicatedby the vertical arrows in the diagram.'
As for the labour market equilibriumlocus, the curve OADOM, the earlier
analysis assumed that labour migrated sufficiently rapidly that the factor
allocation point always lay on this locus. If we relax this assumption, then the
locus divides the Edgeworth-Bowley box into two regions of labour market
disequilibrium. In the region below and to the right of the locus, the urban
unemployment rate is sufficiently high that the expected wage in urban areas is
lower than the agriculturalwage, thus encouraging migration out of the urban
sector; and conversely for the region above and to the left of the locus. These
tendencies are representedby the horizontal arrows in the diagram.
It is clear from the diagram that the equilibriumat D is both locally and
globally stable. Moreover, because of the restrictions on the shape of the labour
market equilibriumlocus, D is the only possible unspecialized equilibriumpoint.
Hence, irrespectiveof where in the unshaded part of the box the initial allocation
point lies, the economy will converge towards the long-run equilibriumpoint D.6
Of course, such convergence need not be monotonic: it is possible in general for
either labour or capital (though not both) to move initially in one direction and
later in the opposite direction,although as we have already seen such reverseflows
cannot take place following a change in relative commodity prices when the
industrialwage is pegged in terms of manufactures.7
So far we have implicitly assumed that the rural sector is relatively
labour-abundant,so that the equilibriumpoint D lies above the diagonal of the
Edgeworth-Bowley box. However, the situation is very different when the rural
sector is relatively capital-abundant, as shown in Figure 3.8 Exactly the same
arguments as before now show that the labour market equilibriumlocus is less
steep than OAD, and hence that the equilibriumpoint D is a saddle point. This
means that there is only one locus of initial capital and labour force allocations
from which the model will converge towards the equilibrium point D; this

R OA

...............,.,...,,, .

.... .....,, ,...* / .. / .

......,, ... .... .. .. .. ..
. ...............;,...//
......,.......
1 - 1 ......
. , , .. ..
;;;- :;...;;/D...........
;/E.
.
// /
.......-.... ./ / /

::::::::::::::: /

B^ /

FIGURE 3 Instability when the urban sector is relatively labour-abundant(although manufacturing

is relatively capital-intensive).
226 ECONOMICA [AUGUST

knife-edge locus is marked EE in the diagram. From all other starting points the
model is unstable; starting at points above and to the right of EE-that is, initial
situations characterized by a relatively large urban labour force or a relatively
high proportion of the capital stock in manufacturingor both-the model will
tend towards specialization in manufacturing(i.e., the agriculturalsector will be
eliminated);while from starting points below EE the opposite will take place; i.e.,
the economy will specialize in agriculture. Of course when labour is instan-
taneously mobile between sectors, the economy must lie along the labour market
equilibrium locus at all times, and so all initial allocations in Figure 3 are
dynamically unstable.
Lest it be thought that unstable situations are highly improbablein this model,
it should be emphasized that the stability condition refers not to a comparison
between the techniques in use in the two sectors, but to a comparison between the
relative amounts of the two factors present in the two sectors. In other words, the
crucial stability condition is not that manufacturingbe capital-intensiverelativeto
agriculture, but that the urban sector be capital-abundanitrelative to the rural
sector, or, in symbols, that

Km KA
(2) L>-L
LC LA
That manufacturingbe relativelycapital-intensive(as was assumed by Corden
and Findlay) is necessary for stability,but it is not sufficient:it is quite possible for
the model to be unstable although manufacturingis relatively capital-intensive,
i.e., for

KM KA KM
(3) -<~~< <
LC LA LM
Indeed, such a case is illustratedin Figure 3: the ray OMR is steeper than OAD,
indicatingthat at the equilibriumrepresentedby points B and D manufacturingis
relatively capital-intensive,but instability still arises because point D is below the
diagonal of the production box: in other words, the level of urban unemployment
is sufficiently high that the urban sector as a whole (manufacturingplus urban
unemployed) is relatively labour-abundant. Moreover it is quite possible that,
under the circumstances depicted in Figure 3, manufacturingis the "naturally"
capital-intensivesector, in the sense that, in the absence of the minimum wage in
manufacturing,the "undistorted"contract curve would lie above the diagonal of
the production box. Conditions necessary for this situation to be consistent with
instabilitywill be noted in the next section.
The final issue to be considered is the sign and magnitude of the economy's
price-output response. We have seen already in Figure 1 that when the initial
equilibriumis stable an increase in the relative price of manufacturesraises their
output in both absolute and relative terms. Figure 3 shows that when the initial
equilibrium is unstable a comparative statics analysis predicts precisely the
opposite: a rise in the relative price of manufactures shifts the equilibriumloci
from the solid to the dashed lines, and the move from D to D' representsa fall in
manufacturingoutput. Of course, such a move will not in fact be observed, since
both D and D' are dynamically unstable under the adjustment mechanisms
assumed, and in the unlikely event of the economy's actually finding itself at D,
1981] THE HARRIS-TODARO MODEL 227

the slightest disturbance to that equilibriumwould lead it to specialize in one or

other commodity. In this respect the HT model with intersectoralcapital mobility
resemblesthe Heckscher-Ohlin-Samuelson model, with proportionalintersectoral
factor price differentials,in that the hypothesis of dynamic stability of equilibrium
is necessary and sufficientto rule out a paradoxicalprice-output response in both
models (see Neary, 1978b).
Finally, as regards the magnitude of the economy's price-output response in
the stable case, it is shown in the Appendix that this is strictly positive even when
the elasticities of substitution in both sectors are zero. This contrasts with the
Heckscher-Ohlin-Samuelson model with or without factor market distortions of
the proportionalfactor price differentialkind (see, for example, the definition of
the aggregate supply elasticity for the latter model in Jones, 1965. page 563). The
reason for this difference is that in the HT model a change in relative prices
changes the equilibriumlevel of unemployment, and the accompanying intersec-
toral reallocation of factors permits some flexibility in aggregate supply response
even when factor proportionsused in productionin each sector cannot be altered.

III. SHORT-RUN AND LONG-RUN EFFECTS OF A CHANGE IN THE URBAN

MINIMUM WAGE
The fact that, at a stable unspecializedlong-run equilibrium,the urban sector
must be relatively capital-abundantenables us to assert immediatelythat some of
the comparativestatics propertiesnoted as possibilitiesby Corden and Findlay are
necessary outcomes in this model, once we confine attention to stable long-run
equilibria. In particular, the effects of changes in endowments follow from the
Rybczynski theorem: since manufacturingis necessarily capital-intensive,capital
accumulation must increase, and labour force growth must reduce, the levels of
manufacturingoutput and employment as well as the level of urban unemploy-
ment. However the rate of urban unemployment is independent of factor
endowments in the long run: manipulation of equation (1) shows that the
unemploymentrate is uniquelydeterminedby relativewage rates:

(4) a=1- W
WM

Hence, with intersectoral capital mobility and no specialization, the usual

international factor price equalization theorem implies also the international
equalization of urban unemployment rates between free-tradingcountries whose
labour markets conform to the HT hypothesis with the samne urban miinimum
wage.
When we come to the effects of an increase in the urban minimum wage,
however, stability is not sufficientto rule out the possibility noted by Corden and
Findlay of its leading to an increase in manufacturingemployment. (Recall from
Section I that this cannot happen when capital is sector-specific.)To illustratethis
paradox of a "perverse distortion-output response" that is consistent with
dynamic stability (unlike the case of proportional intersectoral factor price
differentials studied in Neary, 1978b), consider Figure 4. We return, for
expositional purposes only, to the assumption that labour migrates instan-
taneously, and we confine attention to the case where the manufacturingelasticity
is less than unity. Hence, in the short run the increase in the urban minimumwage
228 ECONOMICA FAUGUST

WM WA

W1.

WM X

QM QA

l ~~~~~~... .. . . ...... ..

KA

FIGURE 4 Effects of an increase in the urban minimum wage.

shifts the production point in manufacturingfrom H to H' and that in agriculture

from R to R'. In the lower part of the diagram the new short-run equilibrium
corresponds to points B' and D', and so in the final long-run equilibriumthe
production point in manufacturing must lie along the ray OMB' and that in
agriculturealong a new labour marketequilibriumlocus through D'. However, the
precise location of the new long-run equilibriumdepends crucially on where the
new capital marketequilibriumlocus lies.
Since at constant commodity prices the rise in the urban minimumwage has
lowered the rental in manufacturing (so raising the equilibrium capital-labour
ratio there from OMB to OMB'), the rental in agriculturemust also fall to restore
capital market equilibrium. Hence the capital market equilibrium locus (OAD
before the increase in the urban minimum wage) shifts counter-clockwise, the
magnitudeof its shift dependingon the potential for factor substitution(i.e., on the
elasticity of substitution)in agriculture.If this elasticity is relativelylarge, then the
new locus will lie below D' as illustratedby the locus O4S; in this case the rise in
the urban wage has lowered the rental in manufacturingrelative to agriculturein
the short run, and so in the medium run capital flows out of manufacturing,
leading to return migration from the urban to the rural sector. Thus manufactur-
1981] THE HARRIS-TODARO MODEL 229

ing employment and output fall both in the short run (moving from B to B') and
throughoutthe adjustmentperiod (moving from B' to B").
However, if the elasticity of substitution in agricultureis low, the new capital
market equilibriumlocus may lie above D'. Now capital moves out of agriculture
in the medium run, causing the equilibriumpoint to move along the new labour
market equilibriumlocus from D' to a point such as E, and inducing continued
rural-urban migration. In this case the initial declines in manufacturing
employment and output (representedby the move from B to B') may be partially
or wholly offset by the influx of additional capital from agriculture, which
necessitates the hiringof additionalworkers. One special case in which the output
of manufacturingmnustrise in the long run is, as noted by Corden and Findlay,
when the elasticities of substitutionin both sectors are zero. In this case both the
demand-for-labourschedules in the upper part of the diagramare vertical, and the
increase in the manufacturingwage does not lead to any movement away from B
and D in the short run, but raises the agriculturalwage by an equal proportionate
amount in order to maintain labour-marketequilibrium.Since manufacturingis
relatively capital-intensive,an increase in wages by the same proportion in both
sectors raises the relative rental there, and so capital is encouraged to flow into
manufacturingin the medium run.9Thus output and employment in manufactur-
ing increase steadily (as does the level of urban unemployment) until the final
long-runequilibriumrepresentedby points such as E and F is attained.
Of course, as Corden and Findlay make clear, fixed coefficients in both sectors
are only a sufficient condition for an increase in the manufacturingwage to raise
manufacturingoutput. A necessary and sufficient condition for this outcome is
derived in the Appendix, from which it may be deduced that the paradox is more
likely the lower are the elasticities of substitutionin production, and the greater is
the differencein factor shares betweenthe two sectors.10
Finally, we may note a further consequence of an increase in the urban
minimumwage: starting from an initial equilibriumsuch as D, which is above the
diagonal of the productionbox, and hence dynamically stable, it is possible for an
increase in the manufacturing wage to move the long-run equilibrium to an
unstable point below the diagonal. Necessary conditions for this outcome are: that
the manufacturing elasticity be less than unity, and that the elasticity of
substitution in the agricultural sector be relatively high a combination of
relatively high substitutabilityin agricultureand relatively low substitutabilityin
manufacturing,which was considered empirically plausible by Eckaus (1955)."
This confirms the claim made at the end of the last section that, even when
manufacturing is the "naturally" capital-intensive sector, it is possible for a
sufficiently high level of the minimum wage to lead to so much urban
unemployment that the urban sector as a whole becomes relatively labour-
abundant,and so a stable unspecializedlong-runequilibriumis ruledout.

IV. EXTENSIONS: VARIABLE PRICES AND LAND IN AGRICULTURE

In this section we briefly consider the implications for the stability issue of
combiining intersectoral capital mobility with two assumptions made in the
original HT model: that relative commodity prices are determinedendogenously
by the interaction of supply and demand, and that land is a scarce factor in the
agriculturalsector.
230 ECONOMICA [AUGUST

When the small open economy assumption of fixed relative prices is dropped,
geometric arguments can be used to suggest that stability is now more likely: for
example, in Figure 3 a path starting at point B tends to converge towards OM'
reducing the output of manufactured goods. However, if relative commodity
prices are endogenously determined, the resulting scarcity of manufactures will
tend to raise their relativeprice; from Section II above, this will cause the ray QAD
to swing in a clockwise direction, thus making it possible for the path from B to
converge towards a stable unspecializedequilibrium.This question is investigated
more formally in the Appendix, where it is shown that a sufficientlyhigh degree of
price responsiveness on the demand side guarantees stability of the model even
when the urban sector is relativelylabour-abundant.12
If the economy is displaced from a locally unstable equilibrium when
commodity prices are endogenous, there are three possible outcomes. Firstly,
specialization in one good may occur even in a closed economy, if the other good
is inessential in consumption (i.e., if the social indifferencescurves intersect the
axis in the commodity space that corresponds to that good).'3 Second, the
economy may never attain a stable equilibriumbut instead may enter a limit cycle.
Third, unlike the fixed-prices case of previous sections, an unspecialized equil-
ibrium need not be unique, and so the economy may converge towards a stable
unspecialized equilibriumpoint. Without making further restrictive assumptions,
it does not appear to be possible to determinewhich of these three outcomes is
most likely to occur in general.
Returningto the case of parametricworld prices, the additionof a third scarce
factor-land-in agriculturegreatly complicates the analysis of the model. The
condition for dynamic stability becomes a cumbersome expression involving the
Allen partial elasticities of substitution between the three factors in use in
agriculture.Even if, following Corden and Findlay, we assume that capital and
labour are separablefrom land in the agriculturalproductionfunction, the stability
condition does not lend itself to easy interpretation.'4All that can be said is that
the possibility of instability is no less likely in this more general case, and that,
under plausibleconditions, stability is more likely the greateris the capital-labour
ratio in the urban sector relative to the rural sector. But the simple necessary and
sufficient condition of Section II, that the urban sector be relatively capital-
abundant,must be abandoned.

V. SUMMARY AND CONCLUSION

This paper has examined some of the positive propertiesof the Harris-Todaro
model when capital is assumed to be intersectorallymobile. The main conclusions
of the paper may be summarizedas follows.
(a) When relative commodity prices are fixed (because, for example, all goods
are traded and the economy is small relative to its trading partners) and capital
and labour are subject to constant returnsto scale in agriculture,an unspecialized
equilibrium is dynamically stable if and only if the urban sector (i.e.,
manufacturing plus the urban unemployed) is capital-abhiidaiit relative to the
ruralsector.
(b) As a consequence of this result, the assumption (made by Corden and
Findlay) that manufacturingis capital-intensive relativeto agricultureis necessarl
for stability but not su ficienit. Indeed, dynamic instability may arise for a
1981] THE HARRIS-TODARO MODEL 231

sufficiently high level of the minimum wage in manufacturing, even if the

manufacturingsector is at all times capital-intensiverelative to agriculture.This
outcome is more likely when the potential for factor substitutionis relativelylow
in manufacturingand relativelyhigh in agriculture.
(c) As pointed out by Corden and Findlay, when capital is intersectorally
mobile, a higher minimum wage in manufacturingmay increase (both absolutely
and relatively) the output of manufacturing. This paradox of a perverse
distortion-output response is not inconsistent with dynamic stability of the model,
and is more likely the smalleris the potential for factor substitutionin both sectors
and the greater is the difference between factor shares in manufacturing and
agriculture.
(d) Provided the initial equilibrium is stable, the economy's price-output
response is strictly positive, even when factor substitution is ruled out in both
sectors.
(e) The assumption that relative commodity prices are determined en-
dogenously by the interaction of demand and supply (rather than being given
parametricallyby world markets) reduces the likelihood of dynamic instability of
equilibrium.
(f) The introduction of a third scarce factor-land-in agriculture greatly
complicates the analysis, and makes it impossible to derive simple and clear-cut
results. However, the characterof the model is not substantiallyaltered,and under
plausible conditions dynamic stability continues to be less likely, the less
capital-abundantis the urban sector relativeto the ruralsector.
In conclusion, it may be noted that nothing has been said about the welfare
and policy implicationsof assuming that capital is intersectorallymobile. It would
be possible to make detailed comparisons between alternative policies along the
lines of the analysis of the sector-specific capital model carried out by Bhagwati
and Srinivasan (1974, 1975). However, it seems unlikely that any new insights
would be gained by this exercise. The general principles of the theory of
distortions and welfare, as applied to the present model by Corden and Findlay
(1975, Section 3), provide an adequate guide to the design of optimal policies, if it
is thought that the model of the present paper is empiricallyrelevant.
A differentissue which has not yet been considered is the relationshipbetween
the Harris-Todaro labour market assumption and the alternativeassumption of a
constant proportional differentialbetween wage rates in different sectors, which
has been extensively analysed by internationaltrade theorists (see Magee, 1976.
for a survey). It might be thought that the key distinguishing feature of the
Harris-Todaro model is the assumption that the actual wage in agriculture is
equated to the expected wage in the urban sector, since it is this assumption that
gives rise to the model's novel predictionof a positive rate of urban unemployment
even in long-runequilibrium.However this is not in fact the case: the key feature
of the Harris-Todaro model from many points of view (and, in particular, with
referenceto dynamic stability) is its assumption of a fixed minimumwage in one
sector. Thus it is possible to rework the model of the present paper, replacing the
institutionallygiven minimum wage in manufacturing,WM?in equation (1) by a
constant parametertimes the wage in agriculture;this "expectations-augmented"
wage-differentialmodel mav be shown to resemble closely, and to imply the same
stability condition as the usual full-employmentwage-differentialmodel of Magee
(1976) and Neary (1978b). Similarly, the presence of a minimum wage in the
232 ECONOMICA [AUGUST

labour-intensive sector of a fully employed small open economy necessarily

implies dynamic instability, even without the HT expectations mechanism (see
McCulloch, 1974). This shows that, especially from a stability point of view, it is
essential to distinguish between two differentforms of labour market distortion:a
parametrically given minininumwage in one sector, and a parametricallygiven
intersectoral wage differential; the presence or absence of unemployment in
long-runequilibriumis irrelevantto the stability issue."5
Finally, it must be asked what significance should be attached to one of the
main findings of the present paper: that the Harris-Todaro model with fixed
relative commodity prices and intersectoralcapital mobility is dyniamicallystable
if and only if the urban sector is capital-abundantrelative to the rural sector? As
already noted, it is not sufficientto claim that this stability condition is empirically
plausible, since capital abundance in this context is not solely a technical concept,
and instability can arise even when manufacturing is the "naturally" capital-
intensive sector. An alternative reaction is to echo Solow's (1961) comment on
Uzawa's two-sector growth model: that it is unsatisfactoryfor stabilityto hinge on
such a "casual property"of the model as a relative capital-abundancecondition.
In the present context this would suggest that it may simply be inappropriateto
combine a "short-run"assumption of a fixed minimum wage in manufacturing
with a "long-run"assumption of complete intersectoral mobility of capital. As a
general rule, it seems to be the case that such a combination of assumptions
appropriateto differenttime horizons tends to lead to curious behaviour. (For a
criticism along these lines of the assumption of intersectoralcapital mobility, see
Neary, 1978a.) However, irrespective of whether or not this instability result is
taken as prima facie evidence against the plausibilityof the model, it is clear that it
must be kept in mind by internationaltrade theorists working with models that
assume sector-specificminimumwages.

ACKNOWLEDGMENTS
This paper, based on a chapter in my D.Phil. dissertationsubmittedto the
Universityof Oxfordin July 1978, was revisedwhile I was a VisitingScholarat the
MassachusettsInstituteof Technology.I am gratefulto S. Glaister.M. Hamer,F. P.
Ruane,N. H. Stern anclJ. E. Stiglitzfor helpfulsuggestions,and to two refereesfor
detailedcommentson earlierdrafts.

NOTES
1 We use C (for "city") to designate the urban sector, since U is used below to represent the
level of unemployment.
2 This formulation makes a number of assumptions about the operation of the labour market,

including that: all jobs in manufacturing turn over every period; job-seekers are risk-neutral;urban
unemployment yields no income; and urban dwellers and potential migranitshave identical tastes.
The consequences of relaxing some of these assumptions are examined by Corden and Findlay and
by Fields (1975). Stiglitz (1974) presents a somewhat different theory of internal migration and
urban unemployment, whose general equilibriumimplications when capital is intersectorally mobile
could be examined using the methods of the present paper.
3 Thus, with sector-specific capital and the manufacturing wage pegged in terms of
manufacturing output, the locus of competitive outputs, or the market transformation curve, is a
straight line parallel to the agricultural output axis. See the diagrams in Bhagwati and Srinivasan
(1974) and Kreuger (1977), and see Eckaus (1955, page 373) and Magee (1976, Chapter 3) for the
distinction between "technical"and "market"transformation cuirves.
4As drawn, point E lies above the diagonal of the Edgeworth-Bowley box. Although there is
nothing in the model that guarantees this outcome, it plays a crucial role, as the subsequent
discussion will show.
19811 THE HARRIS-TODARO MODEL 233

5 The arrows show the direction of movement of the factor allocation poinlt in the
Edgeworth-Bowley box, and so factors are encouraged to move between sectors in the opposite
directions to the arrows.
6 We ignore points in the shaded area to the left of O,R. since at such points the manufacturing
wage is at a level higher than the "minimum" wage corresponding to the capital-labour ratio 041R.
It seems most in the spirit of the HT analysis to assume that the urban wage is subject to a "ratchet
effect"; i.e., that, once having reached a higlherlevel, it will be prevented by political or trade union
pressures from falling below that level. This assumption ensures that if the initial allocation is to the
left of OMR, that ray will itself swing to the left. representing an increase in the urban minimum
wage, with a consequent adjustment in the location of the equilibrium point D. In examining the
dynamics of the model, therefore, we may assume that any required initial increase in the urban
minimum wage has already taken place, and hence may confine our attention to starting points that
are either on or to the right of 041R.
Geometrically, the impossibility of non-monotonic factor flows following a commodity price
change may be explained by noting that, if D in Figure 2 is the post-change equilibrium, then the
pre-change equilibrium must lie in one of the regions betiieen the two equilibrium loci. In these
regions the adjustment of factor allocations is monotonic. and once the economy enters one of these
regions it cannot leave it but must move directlv towards D. Since all roads (in the
Edgeworth-Bowley box) lead to them, it is appropriateto call such a region a "ROMA" (for "region
of monotonic factor adjustment").
8 These two situations do not exhaust the range of possibilities, for there may exist no
unspecialized equilibrium,stable or otherwise.
9 With fixed coefficients in agriculture,the production point there must always lie along the ray
OAD. Hence both factor market equilibrium loci coincide with OAD, although this does not mean
that long-run equilibrium is indeterminate, since there is only one point on OAD that is consistent
with equilibriumin both markets.
10The necessary and sufficient condition is that the following expression be positive:
CA LA KA LM + GM(XLAXK4IOLM + 1C42A 0KA0LA - 4C4A (OKM - OKA), wherea, kI and 0.. are the
elasticity of substitution, the proportion of the economy's endowment of factor i and the value share
of factor i in sector j respectively. Note that the final term in this expression is necessarily negative,
since manufacturingis relatively capital-intensive.
11However the source of unemployment in Eckaus's model is very differentfrom that in the HT
model.
12 The necessary and sufficient condition for stability is that the following expression be positive:

GD(4KM
-
LC)0+LA
? 'GA(LAOKA
? KA0LA) + 4LC where aD iS the elasticityof intercommodity
substitution in demand and the other parameters are defined in 10 above. This in turn implies three
alternative sufficient conditions: (i) isKM > ALC' that the urban sector be relatively capital-abundant;
(ii) GD < GA; and (iii) GD < 1/OLA. Note that this expressionis Jones's "aggregateelasticityof
substitution", modified to allow for factor market distortions of the HT kind, in that it gives the
proportional change in the ratio of capital to labour demanded in the economy following a change in
the ratio of the agriculturalwage to the rental, and assuming that commodity prices adjust fully to
the change (provided urban unemployment is interpreted as an additional source of labour
"demand"):see Jones (1965).
13 For example, if aggregate demands are generated by a CES utility function, both goods are
inessential if and only if the elasticity of substitution in demand exceeds unity.
14 The equivalence between weak separability of the production function and certain equality
restrictions on the Allen partial elasticities of substitution is established by Blackorby and Russell
(1976). Details of the derivations reported in the text are available on request from the author.
15A further distinction between the two kinds of distortion is the magnitude of each that is
requiredto destabilize the economy. Starting from a situation where factor markets are undistorted,
the introduction of an infinitesimally small intersectoral wage differential will displace the initial
equilibriumby an infinitesimally small amount without introducing instability. A wage differential
of finite (and, in most cases, relatively large) size is requiredto reverse the stability condition given
in Neary (1978b). By contrast, the introduction in the labour-intensive sector of a minimum wage
that is only an infinitesimally small amount above the competitive level renders the unspecialized
equilibriumdynamically unstable.

REFERENCES
BHAGWATI,J. and SRINIVASAN, T. N. (1974). On reanalyzing the Harris-Todaro model: policy
rankings in the case of sector-specific sticky wages. American Economic Review, 64, 502-508.
(1975). Alternative policy rankings in a large, open economy with sector-specific, minimum
wages. Journal of Economic TheorY,11, 356-371.
BLACKORBY,C. and RUSSELL, R. R. (1976). Functional structure and the Allen partial elasticities of
substitution:an application of duality theory. Review of Economic Studies, 43, 285-291.
234 ECONOMICA

CORDEN,W. M. (1974). Trade Policy and Economic Welfare, Oxford: Clarendon Press.
and FINDLAY,R. (1975). Urban unemployment, intersectoral capital mobility and
development policy. Economica, 42, 59-78.
ECKAUS,R. S. (1955). The factor-proportions problem in underdeveloped areas. American
Economic Review, 45, reprinted in A. N. Agarwala and S. P. Singh (eds), The Economics of
Underdevelopment.New York: Oxford University Press, 1963, pp. 348-378.
FIELDS,G. S. (1975). Rural-urban migration, urban unemployment and underemployment, and
job-search activity in LDCs. Journal of Development Economics, 2, 165-187.
HARRIS,J. R. and TODARO,M. P. (1970). Migration, unemployment and development: a two-sector
analysis. American Economic Review, 60, 126-142.
JONES,R. W. (1965). The structure of simple general equilibrium models. Journal of Political
Economy, 73,557-572.
(1971). A three-factor model in theory, trade and history. In Trade, Balance of Payments and
Growth: Essays in Honor of C. P. Kindleberger, (J. N. Bhagwati et al., eds). Amsterdam:
North-Holland.
KREUGER,A. 0. (1977). Growth, Distortions, and Patterns of Trade Among Many Countries.
Princeton Studies in InternationalFinance no. 40. Princeton: University Press.
MAGEE,S. P. (1976). International Trade and Distortions in Factor Markets, New York: Marcel
Dekker.
MCCULLOCH, J. H. (1974). The effect of a minimum wage law in the labour-intensive sector.
Canadian Journal of Economics, 7, 316-319.
NEARY,J. P. (1978a). Short-run capital specificity and the pure theory of international trade.
Economic Journal, 88,438-510.
(1978b). Dynamic stability and the theory of factor-market distortions. American Economic
Review, 68, 671-683.
SOLOw,R. M. (1961). Note on Uzawa's two-sector model of economic growth. Review of Economic
Studies, 29,48-50.
STIGLITZ, J. E. (1974). Alternative theories of wage determinationand unemployment in LDC's: the
labour turnover model. QuarterlyJournal of Economics, 88, 194-227.
TODARO,M. P. (1976). Rural-urban migration, unemployment and job probabilities: recent
theoretical and empirical research. In Economic Factors in Population Growth, (A. J. Coale,
ed.). Proceedings of a conference held by the InternationalEconomics Association at Valescure,
France. London: Macmillan, pp. 367-385.