Helping Great Ideas: Harris and Todaro

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This week’s GEM helping hand is extended to the 1970 article by John Harris and Michael Todaro (hereafter H&T), “Migration, Unemployment, and Development: A Two Sector Analysis”. H&T were moved up in the planned order of game subjects in order to emphasize that the Helping Hand is about enriching great ideas. H&T’s contribution certainly qualifies. It was honored as one of the “Top 20” articles published during the first century of the American Economic Review. There is little doubt that the paper deserves recognition. But, as is characteristic of many ideas that the profession recognizes as laudable, most economists – even those on the AER selection committee – have little grasp of the full power of the H&T model. Given the GEM Project’s helping hand, however, the H-T idea blossoms and becomes an essential component of rational-behavior macro theory.

Original Great Idea

Starting with a basic model with point-of-hire labor homogeneity, H&T posit two venues of economic exchange: subsistence agriculture and an industrial enclave. Assumed production heterogeneities cause the more capital-intensive sector to pay wage rents, the existence of which implies the industrial jobs are rationed. (Arthur Lewis’s growth model, featured two weeks ago, is easily recognized.) Further positing that high-wage job search is mutually exclusive with holding a low-wage job, H&T investigate rational labor transfer between the two venues. They plausibly demonstrate that workers’ searching for a rent-paying job invest in spells of unemployment that are increasing in the size of the wage premium and the perceived likelihood of obtaining rent-paying employment. Optimizing labor behavior yields continuous-equilibrium unemployment in excess of market-centric frictional joblessness.

Given modern macro rules of engagement, the H&T paper is unlikely to have been published by today’s American Economic Review. It is a minor miracle that an article that derives its critical results from the assumption of meaningful wage rigidity is remembered today with anything but scorn. After all, prohibiting the consequential use of assumed MWR is what much of the 30-year macro wars were about. My guess is that H&T get a pass from microfoundations police who closely patrol the literature today because the authors made clear that their analysis was restricted to elaborating on Sir Arthur Lewis’s respected, Nobel-prize-winning two-sector model explaining how economies break out of subsistence. Mainstream DSGME theory cannot handle the subsistence question, encouraging mainstream gatekeepers to treat it as a sui generis issue.

GEM Helping Hand

The GEM Project demonstrates that confining H&T labor transfer to Lewis-class modeling has buried its substantial power to explain behavior in highly specialized economies. From the perspective of the generalization of rational exchange from the marketplace to information-challenged workplaces, it becomes clear that evidence-consistent modeling of labor markets has been badly compromised by the absence of rational sectoral transfer.

Informed by microfounded MWR, the H&T analysis takes a much more robust role in linking the marketplace and highly specialized workplace venues of rational exchange. The H&T mechanism now governs two-way flows that are central to optimizing labor-market activity in modern economies. The prime example of such market activity, which the mainstream general-market-equilibrium theory cannot accommodate, is the class of joblessness that reflects the time-varying queue of rational workers seeking employment, for which they are qualified, that pays wage rents. Exchange generalization identifies the subset of reservation-wage unemployment  associated with the inter-venue, two-way labor transfer motivated by continuous-equilibrium MWR and the consequent rationing of rent-paying jobs. (For elaboration, see the website’s e-book, chapter 6.) The optimizing decision to join the good-job-seeking queue is governed by perceived high-wage employment growth and wage-rent size, a process that is rooted in the original H&T great idea and little influenced by match technology. It substantially alters the textbook narrative by making market labor supply to the highly-specialized-establishment venue elastic. Moreover, if workers can compete effectively for rent-paying jobs while being employed in the low-wage sector, queue-related unemployment is partly disguised, greatly expanding the actual labor pool available to rent-paying firms.

In another significant example, rational two-way labor transfer in GEM modeling permits the effective introduction of job downsizing into macro modeling. By definition, downsizing involves the permanent loss of a rent-paying job. (See the website’s e-book, chapter 5.) Rational workers’ response to that class of unemployment includes extended periods of price discovery as they attempt to identify their true opportunity costs, often featuring short-duration jobs paying market wages before they settle into more long-lasting positions. Job downsizing an important, policy-relevant phenomenon, necessary to adequately explain available labor-market evidence. The phenomenon is inherently excluded in New Keynesian market-centric DSGE theory.

Is the Game Worth the Candle?

It is a pleasure to work with a rational-behavior macro model that features microfounded MWR. It is especially enjoyable to work through the existing literature, enriching great ideas that have been shortchanged by mainstream NK thinking. I recognize that, given the need to publish, authors are stuck with the task of working within the market-centric general-equilibrium model class that many know, at least deep down, to be a deeply flawed description of highly specialized economies. The H&T labor-transfer mechanism vividly illustrates that unhappy state of affairs. Restricted to filling out the Lewis growth model, it has garnered honors but has little relevance to most of the great macro issues of the day. The arbitrary restriction to explicating subsistence economics has been lifted by the Project’s micro-coherent, stabilization-relevant, generalized-exchange macroeconomics. H&T governance of the optimizing labor flows between the large-establishment and small-establishment venues critically contributes to modern descriptions of labor-market behavior. H&T labor-transfer goes from being a good idea playing a heavily proscribed role to a great idea on a much bigger stage. It is worth a pile of metaphorical candles.

Cumulative score: Worth it: 3, Not worth it: 0. As the score builds, keep in mind the major objection of mainstream theorists to generalized-exchange macroeconomics: Adding a second (workplace) venue of rational exchange is too much work. Its benefits are not worth the effort.

Blog Type: New Keynesians Chicago, Illinois

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