Environmental sustainability of poverty reduction in a small Open dualistic economy: The case of wage subsidy policies and industrial pollution under sector-specific capital

This chapter is the first attempt to examine the circumstances under which rural and urban wage subsidies as policies for reducing urban unemployment decrease pollution and improve welfare in a dual developing economy. In a specific-factor model of a small open Harris-Todaro economy with polluting urban manufacturing, an urban wage subsidy may decrease pollution in a realistically relevant situation where a dirty input is complementary to capital. GDP is likely to increase if rural technology exhibits strong diminishing returns to labor and if the urban population ratio is high. Welfare improves if, in addition, consumers' preferences shift toward a clean (rural) good as pollution increases. An urban wage subsidy could be consistent with environmental protection in increasing manufacturing employment and reducing urban unemployment while they work in opposite directions in improving welfare. The optimal labor market policy under a given pollution tax is characterized by the uniform urban and rural wage subsidies.