Economics Revision notes - Unit 5

Course ECO 331

Created @December 2, 2021 10:15 PM

https://www.allianceexperts.com/en/knowledge/countries/asia/opportunities-in-
urbanisation-in-india/ https://www.conserve-energy-future.com/causes-effects-
solutions-
urbanization.php https://bmcpublichealth.biomedcentral.com/articles/10.1186/s12889-
Materials 019-6674-8 https://www.businesswire.com/news/home/20170623005403/en/Urban-
Education-Research-Report-2017-The-Benefits-of-Urban-Education-the-Argument-
for-Decentralization-and-the-Impact-on-the-Local-Economy---Research-and-
Markets https://www.flashparking.com/blog/the-impact-of-urbanization/

Property

Type Revision Notes

Urbanization and Informal sector

Urbanization
As the world’s population is increasing, a rising number of people are moving from rural areas to
more urban settings.
This global phenomenon is called urbanization — essentially increasing the population of rural
areas (an area with 2500 residents or fewer), and turning them into urban areas (a central city, and
surrounding areas, with a population exceeding 50,000 people).
Urbanization refers to the population shift from rural to urban areas, the corresponding decrease in
the proportion of people living in rural areas, and the ways in which societies adapt to this change.
More than half of the world’s population now lives in urban areas, and this shift in population is
driven by a variety of factors like better job opportunities, better healthcare, sanitation, etc.

Urbanization in India
Urbanization in India is neither unique nor exclusive but is similar to a world-wide phenomenon.
Indian urbanization has proceeded as it has elsewhere in the world as a part and product of
economic change.
Occupational shift from agriculture to urban-based industry and services is one part of the change.
At the same time, increased agricultural performance has also promoted urbanization as noticed in
several top rice and wheat producing districts in the country.

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 Population and economic growth has fostered urbanization in the country and the number of urban
towns and cities have drastically increased. This growth is expected to continue in the years to
come and India has to step up its game in order to catch up with this kind of change. Investments
have to be made in order to better serve the country.
New industrial investments and expansion of the services industry in new location is also another
factor.
As for the magnitude, in 1901, only 25 million people constituting 10.84 per cent of population lived
in urban areas in India.

In the 100 years since then, the urban population has grown 12 times and it is now around 285
million people constituting 28 per cent of the total population.
In the following 20 years (2001-21), the urban population will nearly double itself to reach about 550
million.
According to the World Urbanization Prospects (the 1996 Revision), the urban population in the
year 2025 will rise to 42.5 per cent (566 million).
These figures, however, do not portray a full picture. The state-wise variations are significant. The
pace and spread of urbanization are not uniform.
Maharashtra (50.45%), Gujarat (44.45%), Tamil Nadu (42.54%), Karnataka (41.12%) and Andhra
Pradesh (39.13%) will be the most urbanized states in the country in that order.

Maharashtra will be more than half urban while Gujarat and all the southern states will be more than
40 per cent urban.
Among the northern states, Punjab, Haryana and Western Uttar Pradesh will have
significant urbanization levels.
There are several factors at play that have led to the urbanization in India – population growth and
migration as one of the 2 major factors.
Recently, a third factor has been seen as a huge contributor to the urbanization growth: the
expansion of towns and cities.
This factor is due to the high economic growth that the city has witnessed over the years.
Because of this, the government in India has decided to grab the opportunity: projects to further
thrust the country into urbanization, a number of smart cities to be put up in various locations, and
other initiatives.
Currently, there are nine major cities in India: New Delhi, Mumbai, Bangalore, Hyderabad,
Ahmedabad, Chennai, Kolkata, Surat and Pune.
Urbanization begins in these massive cities as each one is teeming with varied businesses,
advancement and spatial complications.

Causes of Urbanization
Economic Problems: Many people may choose to migrate from a rural area, as it is generally not
as economically stable or wealthy as a booming urban city.
Political Turmoil: War, civil unrest, and other sources of political disorder often are woes of
developing areas. This turbulence and potential danger can be enough to make anyone want to

Economics Revision notes - Unit 5 2

 move.
Modernization: New technology upgrades the infrastructure of urban areas. Better communication,
medical facilities, and various social amenities can attract those from rural areas
Industrialization: Industrialization is a trend representing a shift from the old agricultural economics
to a novel non-agricultural economy, which creates a modernized society. Through the industrial
revolution, more people have been attracted to move from rural to urban areas on account of
improved employment opportunities.
The industrialization has increased employment opportunities by giving people the chance to work
in modern sectors in job categories that aids to stir economic developments.

Commercialization: Commerce and trade play a major role in urbanization. The distribution of
goods and services and commercial transactions in the modern era has developed modern
marketing institutions and exchange methods that have tremendously given rise to the growth of
towns and cities.
Commercialization and trade come with the general perception that the towns and cities offer better
commercial opportunities and returns compared to the rural areas.
Social Benefits and Services: There are numerous social benefits attributed to life in cities and
towns. Examples include better educational facilities, better living standards, better sanitation and
housing, better health care, better recreation facilities, and better social life in general.
On this account, more and more people are prompted to migrate into cities and towns to obtain a
wide variety of social benefits and services which are unavailable in rural areas.
Employment Opportunities: In cities and towns, there are ample job opportunities that continually
draw people from rural areas to seek a better livelihood.
Therefore, the majority of people frequently migrate into urban areas to access well-paying jobs as
urban areas have countless employment opportunities in all developmental sectors such as public
health, education, transport, sports and recreation, industries, and business enterprises.
Services and industries generate and increase higher value-added jobs, and this leads to more
employment opportunities.
Rural-urban Transformation: As localities become more fruitful and prosperous due to the
discovery of minerals, resource exploitation, or agricultural activities, cities start emerging as the
rural areas transform into urbanism. The increase in productivity leads to economic growth and
higher value-added employment opportunities.
This brings about the need to develop better infrastructure, better education institutions, better
health facilities, better transportation networks, the establishment of banking institutions, better
governance, and better housing.

As this takes place, rural communities start to adopt the urban culture and ultimately become urban
centers that continue to grow as more people move to such locations in search of a better life.
Urbanization is a complex process, as many of its driving factors play into and give rise to one
another. Once a rural city becomes urbanized, it may begin to thrive from several beneficial features
— most of which are what attracts more people to them.

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 Combination of a hub-and-spoke transportation system and the location of the political
capital in the largest city: political culture of rent seeking and the capital market failures that make
the creation of new urban centers a task that markets cannot complete.
Unfortunate consequences of political economy
Firms advantage in establishing in cities: level of protection, population and economic activity have
an incentive to concentrate in a single city, largely to avoid transportation costs.
This concentration in turn attracts still more firms and consumers in a circle of causation
Consequences of dictators’ efforts to remain in power: On average, a much larger share of a
country’s urbanized population (37%) lives in the first city in unstable dictatorships than in stable
democracies (23%).
Unstable dictatorships (fearing overthrow) must provide “bread and circuses” for the first city
(usually the capital) to prevent unrest; this extreme urban bias in turn attracts more migrants to the
favored city and a still larger need for bread and circuses.
To remain in power and prevent popular uprisings and coups, which were generally thought to be
most threatening when launched from the capital city, governments had an incentive to “buy off” the
population of the largest city.
The availability of better opportunities, whether the equivalent of the grain handouts or jobs, wages,
infrastructure, and other government services concentrated in the capital city of many of today’s
developing countries, attracts an ever-growing migrant population, in turn leading to larger
precautionary government spending as the fear of political instability grows.

Positive effects of urbanization

Urbanization yields several positive effects if it happens within the appropriate limits. Some of the
positive implications of urbanization, therefore, include the creation of employment opportunities,
technological and infrastructural advancements, improved transportation and communication,
quality educational and medical facilities, and improved standards of living.
Especially for those coming from rural areas, urban areas can create an overall better quality of life
in several ways. When urban areas become bustling cities and towns, they become a society of
culture that can facilitate financial and educational growth.
Employment Opportunities
With industrialization comes the creation of jobs.
Usually making a shift from an agricultural economy, industrialization paves the way for modern
industries and will need more people to perform various jobs.
Rural jobs such as farming and mining may be labor-intensive (that is, if they have not been taken
over by machines or automatic devices), while urban employment opportunities — such as
healthcare, business, and education — will need a considerable amount of people with a variety of
skills to fill many jobs.
Modernization
Modern technology provides for a better city infrastructure.

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 With modernization, cities can adapt to cultural needs and provide support systems for future
development. Additionally, modernization can make for a more sustainable city layout, with better
housing/businesses, market centers, and public transit systems.
For example, in advanced cities, mobile technology can assist large businesses in advanced
mobility hubs for vehicles— significantly reducing the amount of traffic in growing cities.
The very presence of the Internet and technology can expand communication to nearly any corner
of the globe, and has the capability to efficiently run utilities and lighting for a whole city.
These are just a few illustrations of how technology and modernization can provide efficient
solutions to many facets of life, facilitating a better standard of living.
Access
Industrialization coupled with modernization brings an ample amount of access for a city and the
citizens within it.
Accessibility to the Internet, better healthcare, education, recreational activities, social services, and
more all improve livability.
Additionally, modern cities have the potential to better plan their city for sustainability and boost their
economy.
Quality educational and medical facilities
Urbanization can result in an “urban advantage” with improved access to healthcare services,
education and employment opportunities, and strengthened social connections (compared to their
rural counterparts), while the youth demographic dividend represents an opportunity for economic
growth through a growing skilled workforce.
Urban students typically gain greater overall access to education, receive a higher quality
education, and outperform their rural counterparts. This urban advantage varies across countries,
but is present in both the developed and developing world.
Improved standards of living.
Many urban areas allow for better living standards, including superior educational facilities, better
access to healthcare, modern housing, and more recreational activities.

Problems of Urbanization
In theory, urbanization is a brilliant concept. However, urbanized cities are running into more
problems as a result of a rapidly growing population.
Many urban cities have seen a population explosion that can be hard to plan for.
As a result, employment opportunities may dry up quicker than expected — leading to
unemployment.
Additionally, housing problems may arise with a very high population density and can lead to poor
housing conditions.
These housing conditions are only exacerbated by unemployment issues.
Unemployment and poor housing (or, the unattainability of adequate housing) is creating an influx of
crime in urban cities as well. As it stands today, urbanization has several major drawbacks.
Congestion

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 With so many people moving from rural areas, many urbanized cities are starting to see an
overcrowding issue.
Major cities such as New York and Hong Kong are dealing with major congestion problems.
Overpopulation is contributing to extreme traffic, the depletion of resources, pollution, and
unemployment among many other issues.
This presents a range of additional unwanted side effects.
Environmental Hazards
Water and sanitation issues are surfacing because of rapid population increases.
With so many people needing resources such as food, water, fuel, and waste management, the
population of urbanized cities are suffering from a lower quality of life because of environmental
issues such as water scarcity, pollution, and sanitation.
Additionally, this is leading to the spread of disease and poor health in heavily populated areas.
Unemployment
The problem of joblessness is highest in urban areas and it is even higher among educated people.
It is estimated that more than half of unemployed youths around the globe live in metropolitan cities.
And, as much as income in urban areas is high, the costs of living make the incomes seem horribly
low. The increasing relocation of people from rural or developing areas to urban areas is the leading
cause of urban unemployment.
Development of Slums
The cost of living in urban areas is very high. When this is combined with random and unexpected
growth as well as unemployment, there is the spread of unlawful resident settlements represented
by slums and squatters.
The growth of slums and squatters in urban areas is even further exacerbated by fast-paced
industrialization, lack of developed land for housing, a large influx of rural immigrants to the cities in
search of a better life, and the elevated prices of land beyond the reach of the urban poor.
Water and Sanitation Problems
Because of overpopulation and rapid population increase in most urban centers, it is common to
find there are inadequate sewage facilities.
Municipalities and local governments are faced with serious resource crisis in the management of
sewage facilities. As a result, sanitation becomes poor and sewages flow chaotically, and they are
drained into neighboring streams, rivers, lakes, or seas.
Eventually, communicable diseases such as typhoid, dysentery, plague, and diarrhea spread very
fast leading to suffering and even deaths. Overcrowding also highly contributes to water scarcity as
supply falls short of demand.
Poor Health and Spread of Diseases
The social, economic and living conditions in congested urban areas affects access and utilization
of public health care services. Slum areas in particular experience poor sanitation and insufficient
water supply which generally make slum populations susceptible to communicable diseases.

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 Environmental problems such as urban pollution also cause many health problems namely
allergies, asthma, infertility, food poisoning, cancer and even premature deaths.

Urban Crime
Issues of lack of resources, overcrowding, unemployment, poverty, and lack of social services and
education habitually lead to many social problems including violence, drug abuse, and crime.

Most of the crimes such as murder, rape, kidnapping, riots, assault, theft, robbery, and hijacking are
reported to be more prominent in the urban vicinities. Besides, poverty-related crimes are the
highest in fast-growing urban regions. These acts of urban crime normally upset the peace and
tranquility of cities/towns.

Solutions to Urbanization
Urbanization is a double-edged sword.
Experts are finding successfully reaping the benefits of urbanization while minimizing its major
drawbacks may lie in the reconsideration of several aspects.
It will fall upon the city government to prepare and plan for a rapidly growing population. Planting
trees, conserving energy and resources, and educating public can make for a more efficient city.

Better Resource & City Planning

Newly urbanized cities can take note from smart cities, and the technology they use to power their
city in response to urban activity.

Future-ready technology can solve many congestion issues facing urban population by facilitating a
more efficient transportation ecosystem.

To reduce traffic congestion and pollution further, cities will have to consider technology that
provides parking solutions to reduce the number of cars driving around on the roads.
Cities can work with hospitals, businesses, and hotels (all traffic-heavy enterprises) to create an
efficient answer to parking and traffic issues.

City planners also have to consider either controlling their population growth or expanding their city
– and how to economically prepare and adapt for these changes.
Improved Mobility Solutions

Starting with smarter parking management, cities can start to design improved mobility solutions
that include micro mobility options like e Scooters plus future-ready options like both DC fast and
standard EV charging can ultimately make urban areas and cities more livable for a wider range of
residents.

With the foundation of a smart, cloud-based parking system, cities can start layering on these
services based on the insights delivered by an AI-powered intelligence system.

Automation Improvements in Public Transportation

By automating transportation and parking services, you free up human resources to focus on other
aspects of managing urbanization.

Electric, autonomous busses, trains, and street cars are becoming popular solutions for smart cities
that want a brighter, more sustainable future.

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 Transit needs to be connected and mobile, too.

Consumers look for everything from groceries to parking spaces online.

When they are deciding whether to call a shared ride or hop on the bus, consumers also need to be
able to see their full range of options.

Create Opportunities

To combat unemployment and crime, urbanized cities must create more job opportunities to
accommodate their citizens.
It will be essential for urbanized cities to foster job growth and creation by working with new
technologies, creating new and innovative companies within its city, and considering new global
markets.

Rural - Urban Migration

Rural-urban migration can be defined as the movement of people from rural villages, towns, and
farms to urban centers (cities) in search of jobs.

Statistics show that rural migrants constitute anywhere from 35% to 60% of recorded urban
population growth.
About three-quarters of developing countries responding to UN surveys indicated that they had
initiated policies to slow down or reverse their accelerating trends in rural-urban migration, and/or
desire to do so.
The Lewis model tells us that agricultural surpluses and labor must be transferred in tandem for
industrial development to begin.

But as we have already noted, labor moves from one sector to another in obedience to their own
wishes and objectives.
To the extent that these objectives may be out of line with social goals or policies, we might have
over- or under migration to the cities. The purpose of this section is to discuss patterns of rural–
urban migration.
The classic theory of rural–urban migration is based on Harris and Todaro [1970].

Harris - Todaro Model

The Todaro migration model is a theory that explains rural-urban migration as an economically
rational process despite high urban unemployment.
Migrants calculate (present value of) urban expected income (or its equivalent) and move if this
exceeds average rural income
Harris-Todaro model is the equilibrium version of the Todaro migration model that predicts that
expected incomes will be equated across rural and urban sectors when taking into account
informal-sector activities and outright unemployment.

The main idea of the Harris–Todaro model is that the formal urban sector pays a high wage to
workers and it is this high wage that creates urban unemployment.
Many reasons might be provided for the phenomenon of an overly high urban wage.

Economics Revision notes - Unit 5 8

 The sector may be subjected to collective bargaining over wages, whereas other sectors of the
economy are not remotely as organized, so that wages are more flexible in those sectors.
In addition, the urban formal sector is often treated as the showcase of government policy, so that
minimum wage laws, pension schemes, unemployment benefits, day care, and other facilities may
be required by law.

These provisions may not raise the wage directly, but amounts to the same thing, because such
forms of compensation raise worker utility.

Rationale behind wage differential

Finally, it may well be the case that firms in the urban formal sector deliberately pay wages that
exceed levels found elsewhere so they can hire workers of the best quality and fire inferior workers
after their quality is revealed.
Even if there are no quality differences across workers, “supermarket” wages may still be paid if
firms wish to elicit effort from their workers.
The idea is that if such effort is not forthcoming, then workers are fired and returned to the informal
or rural labor market.

The threat of being fired induces higher effort.

Of course, being fired can carry no threat if the wage package is no different from what the worker
can get elsewhere; in other words, to make being fired a serious punishment, the firm must “buy the
threat” by paying a higher-than-normal wage.
In contrast to the high wages paid in the formal urban sector, the informal urban sector and the rural
sector have low wages that fluctuate according to supply and demand considerations.

The government policy is difficult to implement.

Moreover, if the bulk of labor is family labor (as it is in much of the urban informal businesses, as
well as in rural family farms) or if the bulk of labor effort is readily monitorable, then there will be little
incentive for employers in these sectors to pay higher wages as a potential threat.

Even if there were such an incentive, the net effect is unlikely to dominate the huge premiums that
are paid in the urban formal sector.

Migration in the Harris–Todaro model is then viewed as a response to the significant wage gap that
prevails between the two sectors.
Of course, not everyone can be absorbed into the formal sector at these high wages: some people
are unlucky and fail to find a job, in which case they turn to the urban informal sector for some
meagre sustenance.
Thus the migration decision is akin to leaving behind a relatively sure thing (employment as an
agricultural labor or on the family farm) for the great uncertainty of employment as a formal laborer.

Those who fail in this quest join the queue of the unemployed, perhaps in disguised form in the
informal sector.
Thus the urban informal sector (in the Harris–Todaro view) contains the failed aspirants to the
formal sector dream—the lottery tickets that didn’t win.

Economics Revision notes - Unit 5 9

 A verbal description of the Todaro Model
Starting from the assumption that migration is primarily an economic phenomenon, which for the
individual migrant can be a quite rational decision despite the existence of urban unemployment,
the Todaro model postulates that migration proceeds in response to urban-rural differences in
expected income rather than actual earnings.
The fundamental premise is that migrants consider the various labor market opportunities available
to them in the rural and urban sectors and choose the one that maximizes their expected gains from
migration.

In essence, the theory assumes that members of the labor force, both actual and potential,
compare their expected incomes for a given time horizon in the urban sector (the difference
between returns and costs of migration) with prevailing average rural incomes and migrate if the
former exceeds the latter.

Illustration example
Suppose that the average unskilled or semiskilled rural worker has a choice between being a farm
laborer (or working his own land) for an annual average real income of, say, 50 units or migrating to
the city, where a worker with his skill or educational background can obtain wage employment
yielding an annual real income of 100 units.
The more commonly used economic models of migration, which place exclusive emphasis on the
income differential factor as the determinant of the decision to migrate, would indicate a clear
choice in this situation.

The worker should seek the higher-paying urban job. It is important to recognize, however, that
these migration models were developed largely in the context of advanced industrial economies
and hence implicitly assume the existence of full or near-full employment.

In a full-employment environment, the decision to migrate can be based solely on the desire to
secure the highest-paid job wherever it becomes available. Simple economic theory would then
indicate that such migration should lead to a reduction in wage differentials through the interaction
of the forces of supply and demand, in areas of both migration and immigration.

Unfortunately, such an analysis is not realistic in the context of the institutional and economic
framework of most developing nations.
First, these countries are beset by a chronic unemployment problem, which means that a typical
migrant cannot expect to secure a high-paying urban job immediately.

In fact, it is much more likely that on entering the urban labor market, many uneducated, unskilled
migrants will either become totally unemployed or will seek casual and part-time employment as
vendors, hawkers, repairmen, and itinerant day laborers in the urban traditional or informal sector,
where ease of entry, small scale of operation, and relatively competitive price and wage
determination prevail.
In the case of migrants with considerable human capital in the form of a secondary or university
certificate, opportunities are much better, and many will find formal-sector jobs relatively quickly.

But they constitute only a small proportion of the total migration stream. Consequently, in deciding
to migrate, the individual must balance the probabilities and risks of being unemployed or

Economics Revision notes - Unit 5 10

 underemployed for a considerable period of time against the positive urban rural real income
differential.

The fact that a typical migrant who gains a modern- sector job can expect to earn twice the annual
real income in an urban area than in a rural environment may be of little consequence if the actual
probability of his securing the higher-paying job within, say, a one-year period is one chance in five.
Rather than equalizing urban and rural wage rates, as would be the case in a competitive model,
we see that rural-urban migration in our model equates rural and urban expected incomes.

For example, if average rural income is 60 and urban income is 120, a 50% urban unemployment
rate would be necessary before further migration would no longer be profitable.

Because expected incomes are defined in terms of both wages and employment probabilities, it is
possible to have continued migration despite the existence of sizable rates of urban unemployment.
In our example, migration would continue even if the urban unemployment rate were 30% to 40%.

A diagrammatic representation of The Harris Todaro Model

This process of achieving an unemployment equilibrium between urban expected wages and
average rural income rather than an equalized rural-urban wage as in the traditional neoclassical
free-market model can also be explained by a diagrammatic portrayal of the basic Harris-Todaro
model.
Assume only two sectors, rural agriculture and urban manufacturing.

The demand for labor (the marginal product of labor curve) in agriculture is given by the negatively
sloped line AA’.

Labor demand in manufacturing is given by MM’ (reading from right to left).

The total labor force is given by line OAOM.

In a neoclassical, flexible-wage, full-employment market economy, the equilibrium wage would be

established at WA = WM , with OALA workers in agriculture and OM LM workers employed in urban

Economics Revision notes - Unit 5 11

 manufacturing.

All available workers are therefore employed.

But what if urban wages are institutionally determined (inflexible downward) as assumed by Todaro
at a level -WM , which is at a considerable distance above W*A ?

If for the moment we continue to assume that there is no unemployment, OMLM workers would get
urban jobs, and the rest, OALM, would have to settle for rural employment at OAWA wages (below
the free-market level of OAWA * ).

So now we have an urban-rural real wage gap of -WM – WA , with institutionally fixed -WM.
If rural workers were free to migrate, then despite the availability of only OMLM jobs, they are willing
to take their chances in the urban job lottery.
If their chance (probability) of securing one of these favored jobs is expressed by the ratio of
employment in manufacturing, LM, to the total urban labor pool, LUS , then the expression

shows the probability of urban job success necessary to equate agricultural income WA with urban
expected income LM/ LUS (¯WM), thus causing a potential migrant to be indifferent between job
locations. The locus of such points of indifference is given by the qq curve in the graph above.

The new unemployment equilibrium now occurs at point Z, where the urban-rural actual wage gap
is WM - WA
OALA workers are still in the agricultural sector, and OMLM of these workers have modern (formal)-
sector jobs paying ¯WM wages. The rest, OMLA – OMLM are either unemployed or engaged in
low-income informal-sector activities.
This explains the existence of urban unemployment and the private economic rationality of
continued rural-to-urban migration despite this high unemployment.

However, although it may be privately rational from a cost-benefit perspective for an individual to
migrate to the city despite high unemployment, it can, as will soon become clear, be socially very
costly.

Extension of the Harris Todaro Model

First, the earlier equation simplifies by assuming that those who migrate and do not get a modern
job receive no income; but if they instead receive urban informal-sector income, we modify
expected income accordingly.

Second, note that if instead of assuming that all urban migrants are the same, we incorporate the
reality of different levels of human capital (education), we can understand why a higher proportion
of the rural educated migrate than the uneducated—because they have a better chance (a higher
probability) of earning even higher urban wages than unskilled migrants.

Third, we often observe that migrants from the same rural region tend to settle in common cities,
even the same neighborhoods of cities, that are relatively distant from the migrants’ place of origin.
In a model earlier migrants create a positive externality for later potential migrants from their home

Economics Revision notes - Unit 5 12

 region by lowering their costs of moving by helping with resettlement and lowering their probability
of unemployment by providing them with jobs or information about available jobs. Thus the search
for employment, selection into the migration decision, and forward-looking behaviour may all be
incorporated into an equilibrium migration model.

Fourth, The Todaro and Harris-Todaro models are relevant to developing countries even if the
wage is not fixed by institutional forces, such as a minimum wage.

Recent theoretical research on rural-urban migration has confirmed that the emergence of a high
modern-sector wage alongside unemployment or an urban traditional sector as seen in these
models can also result from market responses to imperfect information, labour turnover, efficiency
wage payments, and other common features of labour markets.

Four Basic Characteristics of the Todaro's migration model

1. Migration is stimulated primarily by rational economic considerations of relative benefits and
costs, mostly financial but also psychological.

2. The decision to migrate depends on expected rather than actual urban rural real-wage
differentials where the expected differential is determined by the interaction of two variables, the
actual urban-rural wage differential and the probability of successfully obtaining employment in
the urban sector.

3. The probability of obtaining an urban job is directly related to the urban employment rate and
thus inversely related to the urban unemployment rate.

4. Migration rates in excess of urban job opportunity growth rates are not only possible but also
rational and even likely in the face of wide urban rural expected income differentials. High rates
of urban unemployment are therefore inevitable outcomes of the serious imbalance of
economic opportunities between urban and rural areas in most underdeveloped countries.

Informal Sector
Importance
The important role that the informal sector plays in providing income opportunities for the poor is
clear.

There is some question, however, as to whether the informal sector is merely a holding ground for
people awaiting entry into the formal sector and as such is a transitional phase that must be made
as comfortable as possible without perpetuating its existence until it is itself absorbed by the formal
sector or whether it is here to stay and should in fact be promoted as a major source of employment
and income for the urban labor force.

The formal sector in developing countries often has a small base in terms of output and
employment.
To absorb future additions to the urban labor force, the formal sector must be able to generate
employment at a very high rate.

This means that output must grow at an even faster rate, since employment in this sector increases
less than proportionately in relation to output.

Economics Revision notes - Unit 5 13

 This sort of growth seems highly unlikely in view of current trends.
Thus the burden on the informal sector to absorb more labor will continue to grow unless other
solutions to the urban unemployment problem are provided.

But young people face increasingly difficult job prospects

The informal sector has demonstrated its ability to generate employment and income for the urban
labor force.

As pointed out earlier, it is already absorbing an average of 50% of the urban labor force. Some
studies have shown the informal sector generating almost one-third of urban income.

Characteristics of the people engaged in the informal sector

1. Absence of official protection and recognition

2. Non coverage by minimum wage legislation and social security system

3. Predominance of own-account and self-employment work

4. Absence of trade union organization

5. Low income and wages

6. Little job security

7. No fringe benefits from institutional sources

Characteristics of the activities of the informal sector

1. Absence of official protection and recognition

2. Non coverage by minimum wage legislation and social security system

3. Predominance of own-account and self-employment work

4. Absence of trade union organization

5. Low income and wages

6. Little job security

7. No fringe benefits from institutional sources

Characteristics of the informal sector land and housing

1. Unauthorized use of vacant public or private land

2. Illegal subdivision and/or rental of land

3. Unauthorized construction of structures and buildings

4. Reliance on low cost and locally available scrap construction materials

5. Absence of restrictive standards and regulations

6. Reliance on family labor and artisanal techniques for construction

7. Non-availability of mortgage or any other subsidized finance

Economics Revision notes - Unit 5 14

 Characteristics of informal sector credit markets
1. Unauthorized use of vacant public or private land

2. Illegal subdivision and/or rental of land

3. Unauthorized construction of structures and buildings

4. Reliance on low cost and locally available scrap construction materials

5. Absence of restrictive standards and regulations

6. Reliance on family labor and artisanal techniques for construction

7. Non-availability of mortgage or any other subsidized finance

Advantages of Promoting informal sectors

First: informal sector generates surpluses even in a hostile policy environment that denies it
access to the advantages offered to the formal sector, such as credit, foreign exchange, and tax
concessions. Thus the informal sector’s surplus could provide an impetus to growth in the urban
economy.

Second, as a result of its low capital intensity, only a fraction of the capital needed in the formal
sector is required to employ a worker in the informal sector, offering considerable savings to
developing countries so often plagued with capital shortages.

Third, by providing access to training at substantially lower costs than provided by formal
institutions and the formal sector, the informal sector can play an important role in the formation
of human capital.

Fourth, the informal sector generates demand for semiskilled and unskilled labor whose supply
is increasing in both relative and absolute terms and is unlikely to be absorbed by the formal
sector with its increasing demands for a skilled labor force

Fifth, the informal sector is more likely to adopt appropriate technologies and make use of local
resources, allowing for a more efficient allocation of resources.

Sixth, the informal sector plays an important role in recycling waste materials, engaging in the
collection of goods ranging from scrap metals to cigarette butts, many of which find their way to
the industrial sector or provide basic commodities for the poor.

Finally, promotion of the informal sector would ensure an increased distribution of the benefits
of development to the poor, many of whom are concentrated in the informal sector.

Disadvantages of Promoting informal sector

1. Promoting the informal sector lies in the strong relationship between rural-urban migration and
labor absorption in the informal sector.

2. Migrants from the rural sector have both a lower unemployment rate and a shorter waiting
period before obtaining a job in the informal sector.

3. Promoting income and employment opportunities in the informal sector could therefore
aggravate the urban unemployment problem by attracting more labor than either the desirable
parts of the informal or the formal sector could absorb.

Economics Revision notes - Unit 5 15

 4. Furthermore, there is concern over the environmental consequences of a highly concentrated
informal sector in the urban areas.

5. Many informal-sector activities cause pollution and congestion or inconvenience to pedestrians

(e.g., hawkers and vendors).

6. Moreover, increased densities in slums and low-income neighborhoods, coupled with poor
urban services, could cause enormous problems for urban areas.

Policies for the Urban informal sector

In terms of its relationship with other sectors, the informal sector is linked with the rural sector in that
it allows excess labor to escape from extreme rural poverty and underemployment, although under
living and working conditions and for incomes that are often not much better.

It is closely connected with the formal urban sector: The formal sector depends on the informal
sector for cheap inputs and wage goods for its workers, and the informal sector in turn depends on
the growth of the formal sector for a good portion of its income and clientele.

Informal-sector incomes have remained persistently higher than those in the poorest rural regions,
despite the continued flow of rural-urban migration.
The lack of capital is a major constraint on activities in the informal sector.

The provision of credit would therefore permit these enterprises to expand, produce more profit, and
hence generate more income and employment.

Microfinance institutions have been leading the way in providing enhanced credit access
Access to improved technology would have similar effects.

Providing infrastructure and suitable locations for work (e.g., designating specific areas for stalls)
could help alleviate some of the environmental and congestion consequences of an expanded
informal sector.

Finally, better living conditions must be provided, if not directly, then by promoting growth of the
sector on the fringes of urban areas or in smaller towns where the population will settle close to its
new area of work, away from the urban density.

Promotion of the informal sector outside the urban areas may also help redirect the flow of rural-
urban migration

Governments will have to abandon their hostility toward the informal sector and adopt a more
positive and sympathetic posture.
The business development procedures must be eased

Because access to skills plays an important role in determining the structure of the informal sector,
governments should facilitate training in the areas that are most beneficial to the urban economy.

In this way, the government can play a role in shaping the informal sector so that it contains
production and service activities that provide the most value to society.

Specifically, such measures might promote legal activities and discourage illegal ones by providing
proper skills and other incentives.

It could also generate taxes that now go unpaid.

Economics Revision notes - Unit 5 16

 Women in the Informal sector
In some regions of the world, women predominate among rural-urban migrants and may even
comprise the majority of the urban population.

Though historically many of these women are simply accompanying their spouses, a growing
number of women in Latin America, Asia, and Africa migrate to seek economic opportunity

With the exception of the export enclaves of East Asia and a few other cities, where everything from
computers to clothing and running shoes are manufactured, only a small minority of these migrants
is able to find employment in the formal sector, which is generally dominated by men.

As a consequence, women often represent the bulk of the informal-sector labor supply, working for
low wages at unstable jobs with no employee or social security benefits.

From street vendors and domestic workers to subsistence farmers and seasonal agriculture
workers, women make up a disproportionate percentage of workers in the informal sector
The increase in the number of single female migrants has also contributed to the rising proportion of
urban households headed by women, which tend to be poorer, experience tighter resource
constraints, and retain relatively high fertility rates.
The changing composition of migration flows has important economic and demographic implications
for many urban areas of the developing world

Working in this informal, or grey economy, as it’s sometimes called, leaves women often without any
protection of labor laws, social benefits such as pension, health insurance or paid sick leave.

They routinely work for lower wages and in unsafe conditions, including risk of sexual harassment.

The lack of social protections has long-term impact on women.

For example, fewer women receive pensions globally, and as a result, more elderly women are now
living in poverty. Even in developed economies, such as in France, Germany, Greece and Italy,
women’s average pension is more than 30 per cent lower than men’s
Though historically, many of these women were simply accompanying their spouses, a growing
number of women in Latin America, Asia, and Africa migrate to seek economic opportunity.

Most of the women find employment in informal economy. As a consequence, women often
represent the bulk of the informal-sector labor supply, working for low wages at unstable jobs with
no employee or social security benefits.

The increase in the number of single female migrants has also contributed to the rising proportion of
urban households headed by women, which tend to be poorer, experience tighter resource
constraints.
The changing composition of migration flows has important economic and demographic implications
for many urban areas of the developing world.

Because members of female-headed households are generally restricted to low-productivity

informal-sector employment and experience higher dependency burdens, they are more likely to be
poor and malnourished and less likely to obtain formal education, health care, or clean water and
sanitation, often remaining effectively excluded from government services.

Economics Revision notes - Unit 5 17

 Dropout rates among children from households headed by women are much higher because the
children are more likely to be working to contribute to household income.
While the slow, or even negative, growth of formal sector employment opportunities, combined with
a rapid and significant growth in the urban labor force, economic stabilization and restructuring
programmes, and the quest for increased flexibility and deregulation of the economy have had
detrimental effects on men and women alike, women have been increasingly pushed into informal
activities.
For example, the reduction in public sector jobs has affected women more than men, because of
their concentration in temporary and lower level jobs; the decline in formal sector wages, has forced
many women to turn to remunerated, most often informal work; attitudes and cultural norms
constitute other powerful barriers to women's entry into the (formal) labor market.

Women as microentrepreneurs

Many women run small business ventures or microenterprises that require little or no start-up
capital and often involve the marketing of homemade foodstuffs and handicrafts.

Though women’s restricted access to capital leads to high rates of return on their tiny investments,
the extremely low capital labor ratios confine women to low-productivity undertakings.
Characteristics of women entrepreneurs

1. The use and investment in social networks;

2. A greater reluctance to take risks; and

3. A tendency to diversify in order to minimize risks.

4. With the growing role of female microentrepreneurs, women will need to rely on the success of
these strategies, looking at the constraints they face:

5. Lack of access to productive resources due to discriminations in property ownership and in

employment;

6. Lack of time because of unequal gender division of labor in unpaid productive and reproductive
activities;

7. Lack of skills due to lower levels of literacy and formal education;

8. Lack of access to labor as a result of norms of gender hierarchy and separation; and

9. Lack of access to markets due to their exclusion from the most lucrative markets.

Providing women entrepreneurs with sustainable access to microfinance

The mechanisms developed since the mid-1970s to provide women micro-entrepreneurs with
access to financial services are extremely diverse, offering alternatives to the formal banking
system, while incorporating the advantages of informal savings and credit systems.

The features that most programmes have in common are:

close targeting of the most needy borrowers;

decentralized loan delivery and management systems through intermediary institutions or

parallel banking system;

Economics Revision notes - Unit 5 18

 group formation to ensure financial discipline; and

support systems to enhance productivity.

Mechanisms providing women with access to financial services

Social programmes, run by commercial banks, which provide borrowers with incentives from the
government.

Most commercial bank schemes have failed to reach large numbers of poor borrowers, let alone
women.

Women's participation in formal small-scale enterprise lending programmes rarely exceeds 20

percent.

Intermediary programmes, generally run by NGOs offering micro-businesses a link to the formal
banking system (for example: Women's World Banking; the original activities of SEWA;

Production Credit for Rural Women, Nepal;

Institute for the Development of the Informal Sector, Peru).

Most programmes have succeeded in reaching somewhat better-off women, and SEWA decided to
set up its own poverty-oriented bank, because its members encountered too many difficulties in
their dealings with banking procedures, application forms, opening hours and attitudes of male bank
clerks.

Parallel programmes that provide financial services alongside other development and social
programmes via non-bank institutions (for example: Working Women's Forum, India; Progreso,
Peru;

BRAC, Bangladesh; Small Business Scheme of the National Christian Council of Kenya).

Many of these programmes have succeeded in reaching women clients, heavily supported by
donors.

Poverty-oriented development banks, generally started as intermediary or parallel programmes and

then officially registered as banks (for example: SEWA Bank, India; Grameen Bank, Bangladesh).
They have adapted delivery systems and loan conditions to meet the specific needs of female
clients.

Community revolving loan funds, similar to ROSCAs, with government and donor grants or loans
(for example: Partnership for Productivity, Kenya).

These funds offer limited but useful services to women.

If well managed, they can be sustainable.

The major risk is erosion of funds due to default and inflation.

Savings and credit cooperatives and unions providing special schemes for women members (for
example: Cooperative Union, Gambia).

Participatory methods help ensure that these organizations meet the real needs of members. They
mobilize their own capital and are more or less democratic.

Cooperatives can, however, be formalistic and financial services are not always readily available.

Successful microfinance institutions characteristics

Economics Revision notes - Unit 5 19

 1. Offering primarily short-term working-capital loans;

2. Having a turnaround time for loan approval of less than 2 weeks;

3. Providing services close to borrowers' home or work;

4. Charging interest rates significantly above the rate of inflation, and

5. Having lower salary levels than financially less viable programmes.

Importance of microfinance on women micro entrepreneurs

Impact assessments provide evidence of the positive effects of micro-finance on the livelihood of
poor women, especially in Asia:
A study from Bangladesh confirms improvements in women's physical mobility, economic security,
ability to make own purchases, freedom from family domination and violence, political and legal
awareness and public participation, as a result of a more stable integration into microfinance circuits

A study of Grameen Bank suggests that women participants in credit programmes are more
conscious of their rights, better able to resolve conflicts, and have more control over decision
making at the household and community levels

credit to women has positive effects on the schooling of girls, it increases women's asset holdings
(except land) and is a significant determinant of total household expenditure
a study in Sri Lanka found that loans contributed to women's independent income, giving them
more bargaining power in their relation with male family members

Enhanced women's empowerment, such as increased self-confidence, and better cooperation with
neighbors has also been observed in Thailand

International studies on impact of microfinance on women entrepreneurs

The findings for Africa give a less clear picture, in that there is a positive impact on self-confidence
but little proof of increased access to credit, intra-household decision making and individual assets
ownership

In Latin America, a study in Ecuador found a significant increase in hourly income for women and in
efficiency and productivity of their enterprises

Negative impact of microfinance on women microentrepreneurs

However, some studies have also detected negative impacts on women's income and employment,
such as increased work loads and higher social pressure to ensure loan repayment.

Also, a positive impact on non-participants, such as the welfare and education of children, cannot
be automatically assumed
Moreover, women often employ daughters and daughters-in-law as unpaid employees thereby
increasing their workload.

Finally, participation in credit schemes can lead to indebtedness that is unmanageable, simply
because there are no sufficiently profitable income-earning activities in which to invest.

In this situation, women may end up being even more dependent that they were before.

Access to and control over financial resources

Economics Revision notes - Unit 5 20

 About 63% of women's loans are actually invested by male relatives, while women bear the formal
responsibility for repayment in a Bangladesh programme

a study of 151 Grameen Bank loans to women found that 12% surrendered the entire loan to male
family members
another study in Bangladesh discovered that of 140 loans made by ACTIONAID to women, about
50% were used for men's productive activities

a survey of loans to women borrowers in the Grameen Bank, Save the Children Fund and BRAC
registered a loss of direct control over loan use (Ackerly, 1995)

an assessment of K-REP confirmed that men try to control income from women's enterprises;

Recommendations for policy makers

To effectively address the constraints faced by female entrepreneurs in their access to

microfinance, support services are required at many levels.

At the policy level the following actions may be considered:

surveys to determine the needs, demands and debt capacity of women;

legal reforms to abolish gender differences in commercial and civil law;

allowing non-bank financial institutions to take savings;

setting of realistic capital requirements for non-bank financial institutions; and

gender-sensitization of policy makers.

At the institutional level:

1. supply side measures should address constraints relating to track-record requirements, size
requirement, equity requirement, etc., and include

2. the creation of separate, gender-based parallel structures to be developed into self-sustaining

financial institutions;

3. the creation of gender-specific windows in financial institutions; and

4. the gender sensitization of existing financial institutions for the adoption of financial services
that meet the needs of female microentrepreneurs and that accommodate their reproductive
and productive roles.

Direct support measures can address constraints on the demand side, such as:

helping women satisfy the requirements made by financial institutions through the provision of
education, enterprise development and training;

dissemination of sensitization information about financial sector institutions and available

microfinance services, and

support to group-based savings and credit organizations, such as women's associations.

Governments, the social partners and other civil society organizations should adhere to the
following points:

Economics Revision notes - Unit 5 21

 1. respect and enforce basic principles for sustainable microfinance, such as the "Micro and small
enterprise guiding principles for selecting and supporting intermediaries" of the Donors' Working
Group on Financial Sector Development;

2. coordinate their activities and exchange their experiences in the area of microfinance and
gender;

3. Allow for the participation of clients, especially female entrepreneurs, in the design and offering
of financial services to micro and small enterprises.

Economics Revision notes - Unit 5 22