It was suggested in chapter 7 that general equilibrium models with market-clearing solutions did not correspond to the observed imbalances and shortages of foreign exchange associated with the balance of payments problems of many developing countries. This observation can be made a fortiori about labour markets. In the general equilibrium model of earlier chapters, labour was treated as a single homogeneous factor of production which moved freely between sectors so that in the equilibrium solution to the model there was full employment and a single wage rate. In fact, labour is not a homogeneous commodity and labour markets frequently fail to clear in the simple manner suggested by general equilibrium models. Urban unemployment is a widely observed phenomenon in developing countries, yet – as in many fully industrialised countries – formal sector wage rates remain well above their market-clearing level. In rural areas unemployment is less obvious, but there is extensive evidence of what is commonly described as either surplus labour or under-employment. (See, for instance, the discussion of the continuing role of surplus labour in the recent history of Chinese agriculture in Taylor, 1988.) In both urban and rural areas, there are substantial wage differentials between formal and informal sectors, between large firms and small, and between different geographical regions.

The way in which these divergences from market-clearing equilibrium models is normally handled in the cost-benefit literature is to analyse the social value of labour in a dual economy model.