Tariff-induced capital inflow and welfare in the presence of unemployment and informal sector

Abstract

The co-existence of rural–urban migration and persistent urban unemployment is a common feature in developing countries. In this paper we draw on the Harris–Todaro model and extend it to include an urban informal sector where the product of the informal sector is used as an industrial input in the urban formal sector. We derive and contrast various welfare effects of tariff-induced capital inflow. Also, we analyze the welfare implications of employment subsidy as the policy instrument in the presence of international capital mobility.