Trade, Urbanization and Capital Accumulation in a Labor Surplus Economy

Along the global trend of economic development, it is often observed rapid industrial transformation accompanied by contitual rural-urban migration. In many developing countries there are yet abundant supplies of “surplus labor.”We construct a small open, dynamic framework to examine how the existence of this large supply of rural, unskilled labor a¤ects trade, urbanization, capital accumulation, factor returns, sectoral and aggregate output and social welfare, as well as to explore why the processes of urbanization and economic development are rather divergent in di¤erent economies. We …nd that in a surplus-labor economy commonly adopted trade policies may reduce capital accumulation, urbanization and aggregate output. Under reasonable factor intensity assumptions, a reduction in migration barriers enhances capital accumulation, inducing urbanization and increasing aggregate output. Our numerical results indicate that import tari¤s in the presence of capital barriers can generate strong intertemporal distortions which delay urbanization and economic development. Trade and capital barriers are crucial for the presence of abundant rural surplus labor, whereas di¤erent trade/investment environments and policies may lead to very divergent processes of urbanization and economic development. While a reasonable migration discounting can generate a large urban-rural wage gap, locational no-arbitrage can cause irresponsiveness of the real unskilled wage in urban areas to parameter and policy changes. Keywords: Surplus Labor and Urban Development, Capital Barriers and Accumulation, International Trade. JEL Classi…cation Numbers: O41, F16, R23. Acknowledgment: We are grateful for comments and suggestions by Spiros Bougheas, Carsten Kowalczyk, Kei-Mu Yi, Zhihong Yu, and seminar participants at Chinese U-Hong Kong, Nottingham, UC-Riverside, the Midwest International Trade Meeting, CES-ifo Globalization Conference, ATW 2010, IEFS China, May, 2010, 2010 Taipei International Conference on Growth, Trade and Dynamics, and APTS, June, 2010. Correspondence: Eric Bond, Department of Economics, Vanderbilt University, Nashville, TN 37235, U.S.A.; (Tel) 615-322-2388; (Fax) 615-343-8495; (E-mail) [email protected].