The political economy of endogenous dual-sector model: public goods, labor markets and tax rates

Purpose - This paper studies the political economy of the endogenous urban–rural divide in two dimensions: labor market and provision of public goods. Design/methodology/approach - This paper gives a dual-sector model endogenously depending on the consumption of public goods (club goods), the number of rural–urban migrants and the tax rate (transfer payments). Findings - According to the research findings in this paper, the constraints on the participation of rural residents portray the rural residents' bargaining power, and in the game between the urban elites and the rural residents, tax rates depend on the preferences of the urban elites and the constraints urban elites and the rural residents jointly face. Therefore, the urban elites have to set tax rates deviating from the most preferred ones. The model in this paper can explain a series of empirical findings and yield new theoretical findings for empirical testing. Originality/value - Significantly, the paper finds that the increase in agricultural productivity will lead to industrialization, accompanied by the disintegration of the dual-sector model. However, though the increase in industrial productivity can accelerate industrialization, it will further expand the urban–rural divide.