Policy Making in the Generalized Harris-Todaro Model

Abstract

In the previous chapter we presented a simple treatment of the Generalized Harris-Todaro (GHT) model. However, we did not provide a treatment for policy making in that framework. Recall that in the important papers of Bhagwati and Srinivasan ((1974)(1975)) on the HT model optimal policies were developed to reduce or eliminate unemployment and also to rank these policies in terms of welfare.¹ They established that the first best policy was a uniform wage subsidy in both sectors financed by lump-sum taxes. This policy removed the distortions and the economy arrived at a first best solution where DRS = DRT = FRT. The second best policies were a wage subsidy to manufacturing and a production subsidy to agriculture which resulted in the following condition: DRT ≠ FRT = DRS. These policies could not be ranked in terms of welfare due to the well known theories of the second best.² In all this analysis there is only one representative consumer whose marginal rate of substitution is given by DRS.