Poverty Reduction during the Rural-Urban Transformation - The Role of the Missing Middle

As countries develop, they undergo a structural transformation from agriculture to manufacturing and services as well as a spatial transformation from rural to urban. Historically, this process has been far from uniform across countries, with some fostering rural diversification out of agriculture and others undergoing rapid agglomeration in mega cities. This paper examines whether the nature of these transformations (rural diversification versus agglomeration in mega-cities) affects the rate of poverty reduction. Using cross-country panel data for developing countries spanning 1980-2004, it is found that migration out of agriculture into the missing middle (rural nonfarm economy and secondary towns ) is strongly associated with poverty reduction, while expansion of mega-cities is not. Migration to the missing middle leads to more inclusive growth patterns, while agglomeration in mega cities widens income inequality, even though it also generates faster economic growth, as predicted by the new economic geography. These findings bear on the longstanding debate about the appropriate balance of public investment in both portable (education, health) and non-portable (infrastructure) public goods across space.