The issue of rural economic diversification as a critical component of rural transformation in less developed economies, has assumed considerable importance in the development dialogue since the seventies. Given the failure of the industrialisation led development strategies to "trickle down" to the rural poor, a need was felt for restructuring the development strategy of the fifties. The agricultural-rural sector was to be regarded as having greater flexibility in absorbing labour and generating extenstive growth, rather than as a sector passively supplying labour to an urban based industrial sector. While the labour absorption capacity of agriculture in the aggregate appeared to be limited, it was the creation of non-agricultural activities, in particular rural small-scale manufacturing enterprises, that was more crucial in the restructured strategy. An issue which came to be much debated in this context was: Is the process of rural diversification primarily agricultural-rural induced or did the impulses lie outside the rural economy? Our study also addresses this question in an attempt to examine structural transformation of employment, spatially, over the period 1971-91 in Kerala. This state is unique in many respects among the states of India, one of which is its settlement pattern, characterised by a rural-urban continuum. Applying the "continuous method" to study spatial change in the occupational structure across rural, small towns and large urban units (comprising of cities/big/medium towns and agglomerations), we find that economic diversification in general and manufacturing in particular, has been fairly rapid in rural areas. Within the latter, some rural settlements, numbering about 128 villages, were transformed into urban areas during 1971-91. An examination of certain socio-economic characteristics of these villages, which can be used as proxies for "agricultural-rural" and "urban" linkages reveals that, in fact, both types of linkages play a dominant role in economic diversification depending on the location of the village visa-vis large urban units. In other words higher agriculture linked indicators are associated with highly diversified "isolated" villages while urban linkages determine the growth of non-agricultural activities in extensions/ outgrowths of urban agglomerations