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
Key Definitions
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: 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.
Interpreting the Lewis Two-Sector Model
To interpret the Lewis two-sector model, consider the following:
Dual Economy: The model begins with an economy divided into two distinct sectors:
Traditional, rural subsistence sector: Characterized by abundant, surplus labor with zero or near-zero marginal productivity. This means adding more labor to this sector does not increase total output, or might even decrease it.
Modern, urban industrial sector: Characterized by high productivity and a need for labor. As this sector grows, it offers higher wages than the traditional sector, attracting workers.
Labor Transfer: Development occurs as labor is gradually transferred from the traditional surplus sector to the modern industrial sector. This transfer is driven by:
Wage differential: The modern sector pays a constant institutional wage (often slightly above subsistence), which is still higher than the marginal product in the traditional sector.
Capital accumulation: Profits generated in the modern sector are reinvested into expanding its capital stock, which increases the demand for labor in this sector.
Stages of Growth: The model suggests distinct phases:
Phase 1 (Unlimited Supplies of Labor): The modern sector can draw on an unlimited supply of labor from the traditional sector without increasing wages, as long as surplus labor exists. This allows for rapid industrial expansion.
Phase 2 (Turning Point): Eventually, the surplus labor in the traditional sector is exhausted. The marginal product of labor in agriculture starts to rise, and the modern sector must begin to offer higher wages to attract workers, leading to rising labor costs.
Phase 3 (Self-Sustaining Growth): The economy has successfully transformed, with the modern sector dominating. Growth becomes self-sustaining, driven by higher wages, increased consumption, and continued investment.
Implications: The model highlights the importance of industrialization and capital accumulation as drivers of economic development, provided there is an initial pool of underemployed labor that can be productively reallocated.
Based on the provided notes, to prepare for your test, you should focus on understanding graphs and charts related to production functions and the Lewis two-sector model itself. Specifically, this would include:
Production Function Graphs: These typically show total output as a function of labor input. You'll need to understand how to derive and interpret:
Total Product Curve: Illustrating how total output changes with increasing labor.
Marginal Product Curve: Showing the additional output from each extra unit of labor. The concept of "surplus labor" directly relates to the portion of this curve where marginal product is zero or negative.
Average Product Curve: Representing total output divided by total labor used.
Lewis Two-Sector Model Diagrams: While not explicitly detailed as a graph type, the description of labor transfer, wage differentials, and capital accumulation strongly implies a need to understand conceptual diagrams showing:
The supply and demand for labor in both the traditional and modern sectors.
How the constant institutional wage in the modern sector attracts labor from the traditional sector.
The movement of labor from the subsistence sector (with zero or near-zero marginal product) to the modern sector as industrialization progresses, and how this affects overall output and wages in the different phases of growth described in the model.