Urban unemployment, rural labor monopsony, and optimal policies

Using a dual-economy model with urban unemployment and rural labor monopsony, this paper shows that the first-best optimum can be achieved by different rates of wage subsidies, in which the subsidy to rural wage is adjusted upward in accordance with the amount of exploitation by rural producers. It is also shown that the policy of either import substitution or export promotion has merit, depending on whether the distortion of urban unemployment exceeds that of rural labor monopsony or not. The theoretical results obtained in this paper justify the observation of the policies adopted in many countries.