Structural Transformation and the Rural-Urban Divide

Development of an economy typically goes hand-in-hand with a declining importance of agriculture in output and employment. Given the primarily rural population in developing countries and their concentration in agrarian activities, this has potentially large implications for inequality along the development path. We examine the Indian experience between 1983 and 2010, a period when India has been undergoing such a transformation. We find a significant decline in the wage differences between individuals in rural and urban India during this period. However, individual characteristics such as education, occupation choices and migration account for at most 40 percent of the wage convergence. We use a two-sector model of structural transformation to rationalize the rest of the rural-urban convergence in India as the consequence of two factors: (i) differential sectoral income elasticities of demand along with productivity growth; and (ii) higher labor supply growth in urban areas. Quantitative results suggest that the model can account for 70 percent of the unexplained wage convergence between rural and urban areas.