Segmented Labor Markets and Structural Transformation
Working draft (PDF), September 2026 · Online appendix (PDF). Presented at the North American Meeting of the Urban Economics Association (Chicago, 2026) and the Dutch Urban Economics and Trade Workshop (2025, 2026).
Most urban growth this century will occur in developing economies. Whether this urbanization translates into sustained economic development depends on how quickly workers gain access to productive formal employment. I develop a dynamic spatial general equilibrium model with three types of labor markets: rural, urban informal, and urban formal. Migrants enter an informal queue, and formalization depends on informal labor congestion and the economy's ability to move informal workers into formal employment. I quantify the model for Ethiopia using novel geospatial and microdata. The speed of transition from informal to formal labor markets emerges as a key determinant of long-run structural transformation, economic growth and welfare: improvements to formalization raise the long-run urban formal labor share by 26 pp and real GDP by 13.1 percent relative to the baseline, while leaving the urban population share largely unchanged. The formalization rate also shapes both the effectiveness of economic policies and national resilience to climate shocks and conflict. Cities become engines of structural transformation not when workers arrive, but when labor markets absorb them into productive employment.