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This paper considers an economy where labor is indivifible and agents are identical Although the discontinuity in labor supply at the individual leve! disappears as a result of aggregation, it is shown that indivisible labor has strong consequences for the aggregate behavior of ~he economy. It is also shown that optimal allocations involve lotteries over employmem and cor~umption. *I am indebted to Ed Prescott for his guidance. I ha~,e benefited from conversatio~ with John Geaneakoplos. Vittorio Grilii, Rol:ert King, Glenn MacDonald, Rodolfo Manuelli, Walter Oi, and the comments of an anonymous referee. Financial support from the Social Sciences and Humanities Research Council of Canada and NSF Grant No. S~S-85!0861 is gratefully acknowledged.

Structural transformation refers to the reallocation of economic activity across the broad sectors agriculture, manufacturing and services. This review article synthesizes and evaluates recent advances in the research on structural transformation. We begin by presenting the stylized facts of structural transformation across time and space. We then develop a multi-sector extension of the one-sector growth model that encompasses the main existing theories of structural transformation. We argue that this multi-sector model serves as a natural benchmark to study structural transformation and that it is able to account for many salient features of structural transformation. We also argue that this multi-sector model delivers new and sharper insights for understanding economic development, regional income convergence, aggregate productivity trends, hours worked, business cycles, and wage inequality. We conclude by suggesting several directions for future research on structural transformation.

2 Technically we should assume a small endowment of the nonagricultural good that is always consumed to avoid the fact that instantaneous utility is lowered when c increases from zero to a small positive amount. We ignore this for simplicity. 3 There are theoretical reasons to believe that a value close to a is appropriate. Models with endogenous fertility suggest that output per capita will be close to subsistence levels for economies that have not begun the process of industrialization. See Hansen and Prescott (forthcoming) and Oded Galor and David Weil (2000).