Lewis Theory of Economic Development

Imran RafiqShafqat SahiWaqar AbbasRehan HashmiRehan Khan

Economic Development

Economic development is a process which entails a gradual transformation of basically a subsistent agrarian economy into a highly productive and self sustained industrial economy.

Why Transformation

Natural Limits of Land Fertility

No prospects of increase in employment level in agriculture

Lewis Model of Transformation

Traditional subsistent agri sector has zero marginal production of labor.

Highly productive urban industrial sector with high marginal production of labor.

Effects

Industrial sector attracts labor from agri sector.

Profits generated by industrial sector results in expansion of industry.

Expansions ultimately absorb all of the surplus agri labor.

Agri sector wage rate start increasing.

Pitfalls

Capitalist profits may not be re-invested. Capitalist profits may be re-invested in labor

saving and capital intensive technology. Constant wage rate in manufacturing sector

is questionable. Assumption of full employment in urban area. Application of diminishing returns.

Conclusion

Dropping “the assumption that the supply of labor was fixed” Lewis was able to solve two problems that had troubled him.

– First, “What determines the relative prices of steel and coffee?” – What explained the rising share of profits in nineteenth century

Britain, for the first 50 years of the industrial revolution. An ‘unlimited supply of labor’ will keep wages down, producing cheap

coffee in the first case and high profits in the second case. It is the national economy model that leads to the Lewis

Model – However, problems related to the world economy and hence to

the issue of why some nations became rich while others remained poorer was more fundamental to Lewis’s life work.

Misperception: Lewis saw industrialization as the key to development and that he underplayed the role of agricultural.

Conclusion

His main concern in the national economy model was not industrialization.

– It was, to understand the process by which a community which was previously saving and investing 4 - 5 % of its national income, converts into an economy where voluntary saving is running at 12-15 % approx.

– ‘Why do they [backward countries] save so little’, the … answer is not ‘because they are so poor’…. The answer is ‘because their capitalist sector is so small’

Overpopulation which at first appears to be a disadvantage can become an advantage in the process of development

– It is possible to vitalize the capitalist sector however small it might initially be, if unlimited labor is available at a constant real wage,

– The capitalist surplus will rise continuously, and annual investment will be a rising proportion of the national income

Conclusion

The theory proposes a division of the economy into two sectors

– Capitalist and a non-capitalist sector– The model is intended to work equally well whether the

capitalists are agriculturalists or industrialists.– The non-capitalist sector serves for a time as a reservoir

from which the capitalist sector draws labor. In the world economy model, it shows how the

persistence of surplus labor on a world scale can limit the possibilities for development in a particular country

Lessons Learned

A rise in productivity in the subsistence sector could tend to push up wages in the capitalist sector but this would only happen if the subsistence producers were allowed to keep the benefit of the increased production

It is not profitable to produce a growing volume of manufactures unless agricultural production is growing simultaneously.

– This is also why industrial and agrarian revolutions always go together, and why economies in which agriculture is stagnant do not show industrial development

Not that overpopulated underdeveloped countries needed to industrialize.

– It was that a process of accumulation could start with capitalist enterprise, be it in the agricultural, mining, manufacturing, tourist or other service sector.

– Once initiated the productivity of the entire economy and notably the agricultural sector could be transformed leading to self sustaining development.