TOPIC 6: Structural-Change and Lewis Two-Sector Models of DevelopmentTheoretical Context* Early economic growth models, like Rostow's stages and Harrod-Domar, often implicitly assumed the presence of conducive attitudinal and institutional conditions (e.g., integrated markets, skilled workforce, efficient government) in underdeveloped nations. However, these are often lacking, along with complementary factors such as managerial competence and skilled labor.* There was also insufficient focus on reducing the capital-output ratio ($$c$$), which is an alternative strategy for raising growth (as seen in Equation 3.7), by increasing the efficiency of investment.### Structural-Change Models Overview* Structural-change theory examines how underdeveloped economies transition from traditional subsistence agriculture to more modern, urbanized, and industrially diverse manufacturing and service economies.* It utilizes neoclassical price and resource allocation theory and modern econometrics to explain this transformation.* Two prominent examples are: * The

Structural-change theory

The hypothesis that underdevelopment results from underutilization of resources due to structural or institutional factors, stemming from both domestic and international dualism. It implies that development requires more than just accelerated capital formation.

Structural transformation

The process of altering an economy such that the manufacturing sector's contribution to national income eventually surpasses that of the agricultural sector. More generally, it signifies a major alteration in the industrial composition of an economy.

Lewis two-sector model

A development theory positing that surplus labor from the traditional agricultural sector shifts to the modern industrial sector. The modern sector's growth then absorbs this surplus labor, promotes industrialization, and stimulates sustained development.

Surplus labor

The excess supply of labor beyond the quantity demanded at the prevailing free-market wage rate. In the Lewis model, it specifically refers to the portion of the rural labor force whose marginal productivity is zero or negative.

Production function

A technological or engineering relationship detailing the quantity of a good produced based on the quantity of inputs required.

Average product (AP_L)

Total output or product divided by total factor input (e.g., average product of labor AP_L = \text{Total Output} / \text{Total Labor Used}).

Marginal product

The increase in total output resulting from the addition of one extra unit of a variable factor of production (e.g., labor or capital). In the Lewis model, surplus labor is defined as workers with zero marginal product.

Self-sustaining growth

Economic growth that continues over the long term, supported by saving, investment, and complementary private and public activities.

Patterns-of-development analysis

An empirical approach to identify characteristic features of the structural transformation process an economy undergoes as it develops from a traditional agricultural economy to a modern industrial one.

Traditional, rural subsistence sector (Lewis Model)

Characterized by abundant, surplus labor with zero or near-zero marginal productivity, meaning adding more labor does not increase total output.

Modern, urban industrial sector (Lewis Model)

Characterized by high productivity and a need for labor, offering higher wages than the traditional sector to attract workers.

Phase 1 (Lewis Model)

Modern sector draws on an unlimited supply of labor from the traditional sector without increasing wages, as long as surplus labor exists, allowing for rapid industrial expansion.

Phase 2 (Lewis Model)

Surplus labor in the traditional sector is exhausted. The marginal product of labor in agriculture starts to rise, and the modern sector must offer higher wages, leading to rising labor costs.

Phase 3 (Lewis Model)

The economy has successfully transformed, with the modern sector dominating. Growth becomes self-sustaining, driven by higher wages, increased consumption, and continued investment.