Networks and Misallocation: Insurance, Migration, and the Rural-urban Wage Gap

We provide an explanation for the large spatial wage disparities and low male migration in India that is based on the existence of caste-based rural insurance networks and missing insurance markets. Our model highlights the trade-off between consumption-smoothing provided by the surplus-maximizing network and the income gains from migration. This gives rise to the predictions, which we verify empirically, that relatively-wealthy households within the caste benefit less from the network and will be more likely to migrate. Structural estimates of the model show that even small improvements in formal insurance decrease the spatial misallocation of labor by substantially increasing migration. ∗We are very grateful to Andrew Foster for his help with the structural estimation and for many useful discussions that substantially improved the paper. Scott Weiner provided outstanding research assistance. Viktoria Hnatkovskay and Amartya Lahiri graciously provided us with the NSS wage data. Research support from NICHD grant R01-HD046940 and NSF grant SES-0431827 is gratefully acknowledged. †University of Cambridge ‡Yale University