Unemployment, rural–urban migration and environmental regulation

• Date: 01 May 2018
• Published date: 01 May 2018
• DOI: http://doi.org/10.1111/rode.12360
• Author: Karlygash Kuralbayeva

REGULAR ARTICLE

Unemployment, rural–urban migration and

environmental regulation

Karlygash Kuralbayeva

Department of Geography and

Environment, and Grantham Research

Institute, London School of Economics

Correspondence

Karlygash Kuralbayeva, Department of

Geography and Environment, London

School of Economics.

Email: k.z.kuralbayeva@lse.ac.uk

Funding information

Financial support by the Global Green

Growth Institute (GGGI), the Grantham

Foundation for the Protection of the

Environment and the UK Economic and

Social Research Council (ESRC) through

the Centre for Climate Change Economics

and Policy

Abstract

This paper develops a general equilibrium model that

incorporates specific features pertaining to developing

countries: a large informal sector and rural–urban migra-

tion. A calibrated version of the model is used to study the

effects of energy tax changes and a reduction in agricul-

tural-sector energy subsidies on labor market outcomes.

The results indicate that the incidence of energy taxes is

partly shifted on to the rural sector through rural–urban

migration. The results thus highlight the importance of

modeling the features particular to developing countries

and the economic general equilibrium effects when assess-

ing the impact of environmental taxation in those countries.

1

|

INTRODUCTION

A large number of studies have analyzed the incidence of carbon taxes in developed countries, and

a subset of these studies have looked at how carbon tax policies affect unemployment. Nonethe-

less, general equilibrium studies of environmental taxation, based on unique institutional and eco-

nomic characteristics of developing countries, are limited. Special features of developing

economies, which include “dual”economies with modern and traditional sectors, or three-sector

economies with a traditional rural sector and an urban sector (characterized by both a formal and

informal sector), suggest that models from studies of developed countries are not appropriate to

examine the employment and wage impacts of green tax policies. The policy guidelines derived

from existing studies in developed countries are likely to be misleading for developing countries,

as they do not take into account economic conditions that are specific to developing countries.

-------------------------------------------------------------------------------------------------------------------------------------

This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and reproduction

in any medium, provided the original work is properly cited.

©2017 The Authors. Review of Development Economics Published by John Wiley & Sons Ltd.

DOI: 10.1111/rode.12360

Rev Dev Econ. 2018;22:507–539. wileyonlinelibrary.com/journal/rode

|

507

This paper develops a dual economy model, which is an extension of Satchi and Temple

(2009) to analyze the effects of energy taxes in general equilibrium. The model features three sec-

tors: urban formal, urban informal,

1

and rural agricultural. The search and matching frictions fol-

lowing Pissarides (2000) form a distinction between formal, or “regulated,”jobs and informal, or

“unregulated,”jobs. This entails that workers in the informal sector search for jobs in the formal

sector, with the unemployment rate being defined as the proportion of the population that is self-

employed in the informal sector. The income of the unemployed comprises unemployment benefits

and income from self-employment in the informal sector.

I solve the model numerically and choose parameter values to match some key aspects of labor

markets in Mexico. I find that modeling key features of developing countries, namely rural–urban

migration, can lead to qualitatively different conclusions about the incidence of higher energy taxa-

tion on poverty in developing countries. As in the simplified version of the main model, even

though agricultural workers do not pay energy or labor taxes, they still bear the burden of environ-

mental taxation through reduced wages. A potential explanation for this wage reduction is as fol-

lows: (a) when unemployment benefits and income from self-employment in the informal sector

are fixed in real terms, the urban sector reduces demand for labor due to higher energy taxes and

the agricultural sector absorbs some of the increased number of unemployed people; or (b) when

unemployment benefits are proportional to the after-tax income of urban workers and labor taxes

are evaded in informal sector, as environmental taxation imposes a heavy tax burden on the unem-

ployed, the unemployed try to escape the brunt of higher taxation by either searching for jobs

more intensively or migrating into the urban area, which pushes wages down in the rural area.

I also find that fixing the energy tax in the agricultural sector while increasing the energy tax

imposed in the urban area results in a higher reduction in the earnings of rural-sector workers than when

energy taxes change universally in the economy. This is because the former policy is associated with a

relatively higher burden on the urban sector than the latter, resulting in a higher outflow of labor into

the rural area, which leads to a higher decline in the earnings of workers in the agricultural sector. Fur-

thermore, simulations of the model with energy subsidies in the agricultural sector also suggest that

higher energy subsidies to protect the incomesof rural workers from the adverse effects of environmen-

tal taxation in the urban area can be counter-productive. Specifically, a higher level of energy subsidy

provision to the rural sector is associated with a larger decline in earnings of rural workers when the

urban sector is subject to environmental regulation. Intuitively, larger subsidies create more budgetary

pressure and less room for the government to reduce payroll taxes, which ultimately determines whether

such a reduction in labor taxes can offset the adverse effects of higher energy taxes on labor productiv-

ity and thus lead to a reduction in unemployment. If unemployment is reduced by less, more people

migrate to the rural area,pushing wages down and increasing the incidence of poverty.

Finally, the results indicate that the energy intensity of the urban sector is important for the size

of the potential double-dividend effects, and consequently for how rural sector wages are affected

by environmental regulation. If the urban sector is highly labor-intensive, declines in energy

demand due to higher energy taxes impose a smaller tax burden and the effects of environmental

regulation are less pronounced. As a result, the prospects for a sizable reduction in unemployment

are much lower in the economy, resulting in a larger inflow of workers into the rural area and

therefore a larger decline in agricultural wages. Conversely, with a lower energy intensity of the

agricultural sector and relatively higher energy intensity of the manufacturing (urban) sector, envi-

ronmental regulation is associated with a higher reduction in payroll taxes and consequently higher

employment, leading to lower migration and a decline in rural sector wages.

This paper makes two main contributions. First, it demonstrates the importance of modeling spe-

cial features of developing countries when analyzing the tax incidence of carbon taxes in developing

508

|

KURALBAYEVA

countries. Looking only at the effects of environmental regulation on the sector that is subject to reg-

ulation would underestimate the potential adverse spillover effects on other sectors of the economy

through migration patterns. For instance, the reduction in agricultural-sector wages due to urban-sec-

tor taxation can be sizable and comparable with the effects of regulation on incomes of the unem-

ployed. Simulations of the benchmark model under the assumptions that incomes of the unemployed

are proportional to the after-tax urban wage and that labor taxes are evaded in the informal sector sug-

gest that a doubling of the energy tax rate from its baseline value reduces the income of the unem-

ployed by 4.48 percent and rural-sector incomes by 2.77 percent. Therefore, the effects of

environmental regulation in developing countries have to be analyzed using a different theoretical

framework than conventional models suggest. Even though the focus of this paper is on the effects of

energy taxes, similar issues arise with analyzing other tax incidences in developing countries.

Second, the paper develops a tractable framework that incorporates features that are specific

to developing countries. This framework highlights an important rural–urban migration channel

through which environmental regulation can yield other dividends that are important in assess-

ing the overall welfare effects of regulation in developing countries. For instance, in many

developing countries facing large rural–urban migration, the inability of city authorities to offer

housing and basic public services to these migrants leads to the formation of slums, deteriora-

tion of living conditions, congestion, and environmental risks. In such circumstances, a larger

rural population associated with higher energy taxes could be beneficial and could offset the

costs of environmental taxation in terms of lower rural wages. I do not perform welfare analy-

sis in this paper, but this simple framework can be extended to study the welfare effects of

green tax reforms in developing countries by taking these general equilibrium effects into

account. Another potential extension of the model could be to allow workers to have different

productivity levels, which would facilitate studying the distributional implications of green tax

policies.

The rest of the paper is organized as follows. Section 2 presents the structure of the model.

Section 3 explains the parameterization of the model. Section 4 discusses the simulation results. In

Section 5, I test the sensitivity of the baseline results to changes in the values of some parameters,

as well as the functional form of the production function. Section 6 considers three extensions to

the core model: the first allows payroll taxes paid by employees; the second makes an explicit dis-

tinction between the unemployed and the self-employed in the urban sector; and the third endoge-

nizes the job destruction rate. Section 7 concludes.

2

|

MODEL

The paper develops a general equilibrium search model in the style of Diamond, Mortensen and

Pissarides (DMP: Diamond, 1971; Mortensen and Pissarides, 1994), with a large informal secto r

and potential for rural–urban migration, in a setting with a polluting production factor and environ-

mental taxes.

2

The economy comprises two regions/sectors: urban and rural/agricultural, denoted

by mand a, respectively. The urban sector is characterized by search and matching frictions, which

mean that unemployment exists in equilibrium.

3

This in turn partitions the urban sector into infor-

mal (unregistered, assumed to be self-employed) and formal (registered) production activities, and

I use the term “unemployed”to refer to self-employment in the informal sector. The size of the

population is normalized to 1 and can be decomposed as follows:

KURALBAYEVA

|

509