Human capital accumulation by low skilled workers with borrowing constraints a welfare analysis based on the lucas rural urban migration model

HUMAN CAPITAL ACCUMULATION BY LOW-SKILLED WORKERS WITH BORROWING CONSTRAINTS – A WELFARE ANALYSIS BASED ON THE LUCAS RURAL-URBAN MIGRATION MODEL XU YIQIN (M.S PEKING UNIVERSITY) A THESIS SUBMITTED FOR THE DEGREE OF DOCTOR OF PHILOSOPHY DEPARTMENT OF REAL ESTATE SCHOOL OF DESIGN AND ENVIRONMENT NATIONAL UNIVERSITY OF SINGAPORE AUGUST, 2012 Declaration I hereby declare that this thesis is my original work and it has been written by me in its entirety I have duly acknowledged all the sources of information which have been used in the thesis This thesis has also not been submitted for any degree in any university previously Xu Yiqin 21 August 2012 ii iii Acknowledgement Acknowledgements I would like to express my gratitude to all those who helped me during the writing of this thesis I gratefully acknowledge the help of my supervisor, Prof Fu Yuming, who has offered me valuable suggestions in the academic studies In the preparation of the thesis he has spent much time helping me to write thesis and provided me with inspiring advice Without his patient instruction, insightful criticism and expert guidance, the completion of this thesis would not have been possible My heartfelt thanks also go to Prof Liao Wen-Chi who gave me considerable help by means of suggestion, comments and criticism I am also pleased to acknowledge my classmates for their invaluable assistance throughout the preparation of the original manuscript They graciously made considerable comments and sound suggestions to the outline of this paper I should finally like to express my gratitude to my beloved parents who have always been helping me out of difficulties and supporting without a word of complaint iv v Abstract Human capital accumulation by individual workers and urbanization are two central factors underlying sustained economic growth (Lucas, ”On the Mechanics of Economic Development,” Journal of Monetary Economics, 1988, 22, 3-42 [72]; Jones and Romer, ”The New Kaldor Facts: Ideas, Institutions, Population, and Human Capital,” American Economic Journal: Macro-economics, 2010, 2(1), 224245 [14]) The persistent incentive for human capital accumulation depends crucially on spillover effects derived from close proximity to human capital in an urban context (Lucas, ”Life earnings and rural-urban migration,” Journal of Political Economy, 2004, 112(1), S29-S59 [73]; Lucas, ”Trade and the Diffusion of the Industrial Revolution,” American Economic Journal: Macroeconomics, 2009, 1(1), 1-25 [74]) This dissertation builds on the work of Lucas (2004) to study the incentive for rural (low-skilled) workers to migrate to the urban sector and to invest in human capital accumulation Our focus is on the role of financing constraints, which in reality discourage human capital accumulation by low-skilled workers but are omitted in Lucas (2004) Workers must allocate time to learning in order to accumulate human capital, forgoing employment income Absent borrowing constraints, low-skilled workers can smooth their consumption by borrowing from future employment income, which is expected to grow with human capital When the financing constraint is binding, the low-skilled workers must lower current consumption to finance learning and thus face a reduced incentive for human capital accumulation due to vi the greater opportunity cost of learning We solve the dynamic model in Lucas (2004) subject to a borrowing constraint We show that the lifetime utility of low-skilled workers is reduced when they are unable to borrow from future income to smooth consumption during the period of unemployment devoted to human capital accumulation We use the model to study several stylized facts and rural-urban migration policy issues for an economy in transition from a low-skilled economy to a high-skilled economy First, we show that, when low-skilled workers are unable to borrow from future income, the saving rate of rural household will rise in response to the opening of the urban sector to rural migrants and the attendant opportunities for profitable human capital accumulation This increased saving rate is necessary for financing the initial period of unemployment in cities in order for new migrants to catch up in human capital accumulation In contrast, absent the borrowing constraint, the rural saving rate will be negative in response to the opening of the urban sector, as low-skilled workers attempt to smooth consumption in anticipation of higher future income Second, we show that a rise in rural-urban migration cost in the presence of a binding borrowing constraint for low-skilled workers reduces their incentive to migrate to cities to accumulate human capital Consequently, rural-urban migration, human capital accumulation and economic growth all slow down and rural-urban income disparity widens Third, we show that the urban government can help to mitigate the borrowing constraint faced by low-skilled workers by subsidizing their migration to cities and financing the subsidy with increased future income-tax revenue produced by an expanded highskilled urban workforce Such a subsidy program is self-financing and will raise not only the lifetime welfare of the low-skilled migrants but also the rate of rural-urban migration, human capital accumulation, and economic growth We use numerical analysis to quantify the impact of the borrowing constraint, rural-urban migration cost, and the self-financing migration subsidy programs vii Finally, we apply the results of the model to shed lights on China’s recent experience of urbanization and economic development We observe a significant rise in rural household saving rate (above the urban household saving rate) in the late 1990s when the urban housing and labor markets are liberalized to allow rural workers the freedom to live and work in cities This phenomenon, not well explained by the previous studies, is consistent with the predictions of our model In addition, we document evidence from extant literature regarding the lagging urbanization, lagging human capital accumulation, and widening rural-urban income gaps in China in relation to income growth These features are consistent with a rural-urban migration (and human capital accumulation) process constrained by a lack of financing and high opportunity costs of human capital accumulation for low-skilled migrants We discuss the causes for the high opportunity cost of human capital accumulation for low-skilled migrants Furthermore, we use the insights from our model to argue that the welfare implications of many rural-urban migration policy issues currently debated in China can be better understood from the point of view of mitigating the financing constraint for human capital accumulation by low-skilled migrant families For instance, the urban low-income housing benefits should be extended to rural migrant families to encourage their human capital accumulation in cities for the benefit of the whole economy viii ix Contents Declaration ii Acknowledgement iv Abstract vi Introduction 1.1 Motivation of this research 1.2 Stylized facts 1.3 Statement of this research 1.4 Structure of this thesis 12 China’s urbanization experience 14 2.1 Urbanization history in China 14 2.2 Characteristics of rural-urban migration 16 2.2.1 Regulated rural-urban migration x 17 References [1] Mahmudul Anam Rural-urban wage differential, rent seeking, and a justification for free trade Journal of Urban Economics, 26(3):328 – 334, 1989 [2] Steven Barnett and Ray Brooks China: Does government health and education spending boost consumption? 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