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Economic Development, Urban Underemployment, and Income Inequality

  • James E. Rauch

The evolution of inequality in permanent income is investigated during the course of a less developed country's transformation from a primarily agricultural to a primarily urban-industrial economy. The source of inequality is market luck in obtaining employment in the protected urban "formal sector" versus employment in the unprotected urban "informal sector." It is shown that with development the log variance measure of inequality in this country tends to follow an "inverted U": it rises when urbanization is low and consequent pressure on the land keeps rural incomes low, making agents willing to incur high risks of "underemployment" in the urban informal sector, and eventually falls after urbanization and consequently rural incomes has increased sufficiently to allow agents to make better than even bets in the industrial sector. These results in combination with new empirical evidence suggest that rather than being an unimportant artifact of the design of inequality indices, inverted-U behavior of inequality may be driven by the important social phenomenon of mass urban underemployment.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3758.

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Date of creation: Jun 1991
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Publication status: published as Canadian Journal of Economics, vol. 26, pp. 901-918-(November 1993)
Handle: RePEc:nbr:nberwo:3758
Note: ITI IFM
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  1. Robinson, Sherman, 1976. "A Note on the U Hypothesis Relating Income Inequality and Economic Development," American Economic Review, American Economic Association, vol. 66(3), pages 437-40, June.
  2. Braulke, Michael, 1983. "A Note on Kuznets' U," The Review of Economics and Statistics, MIT Press, vol. 65(1), pages 135-39, February.
  3. Greenwood, Jeremy & Jovanovic, Boyan, 1988. "Financial Development, Growth, And The Distribution Of Income," Working Papers 88-12, C.V. Starr Center for Applied Economics, New York University.
  4. Banerjee, Biswajit, 1983. "The Role of the Informal Sector in the Migration Process: A Test of Probabilistic Migration Models and Labour Market Segmentation for India," Oxford Economic Papers, Oxford University Press, vol. 35(3), pages 399-422, November.
  5. Tidrick, Gene M, 1975. " Wage Spillover and Unemployment in a Wage-Gap Economy: The Jamaican Case," Economic Development and Cultural Change, University of Chicago Press, vol. 23(2), pages 306-24, January.
  6. Eaton, Jonathan, 1987. "A Dynamic Specific-Factors Model of International Trade," Review of Economic Studies, Wiley Blackwell, vol. 54(2), pages 325-38, April.
  7. Harris, John R & Todaro, Michael P, 1970. "Migration, Unemployment & Development: A Two-Sector Analysis," American Economic Review, American Economic Association, vol. 60(1), pages 126-42, March.
  8. Rauch, James E., 1991. "Modelling the informal sector formally," Journal of Development Economics, Elsevier, vol. 35(1), pages 33-47, January.
  9. Fields, Gary S, 1979. "A Welfare Economic Approach to Growth and Distribution in the Dual Economy," The Quarterly Journal of Economics, MIT Press, vol. 93(3), pages 325-53, August.
  10. Knight, J B, 1976. "Explaining Income Distribution in Less Developed Countries: A Framework and an Agenda," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 38(3), pages 161-77, August.
  11. Greenwood, J. & Jovanovic, B., 1990. "Financial Development, Growth, And The Distribution Of Income," University of Western Ontario, The Centre for the Study of International Economic Relations Working Papers 9002, University of Western Ontario, The Centre for the Study of International Economic Relations.
  12. Papanek, Gustav F. & Kyn, Oldrich, 1986. "The effect on income distribution of development, the growth rate and economic strategy," Journal of Development Economics, Elsevier, vol. 23(1), pages 55-65, September.
  13. Moore, Robert E., 1990. "Measuring inequality change in an economy with income growth : Reassessment," Journal of Development Economics, Elsevier, vol. 32(1), pages 205-210, January.
  14. Becker, Gary S & Tomes, Nigel, 1979. "An Equilibrium Theory of the Distribution of Income and Intergenerational Mobility," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1153-89, December.
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