LEWIS MODEL OF ECONOMIC DEVELOPMENT

Arthur Lewis explained the economic development process in the classical framework that assumes that an unlimited supply of labour eases economic development. Lewis states that economy has two sectors, the capitalist and the subsistence sector in his analysis of the economy and its interconnections (Islam & Yokota, 2008). He argued that the capital segment grows by absorbing an unlimited supply of labour from the subsistence segment. The unlimited labour supply ensures a constant wage in the sector, and capital accumulation is achieved by the reinvesting all the surplus profits over wages. According to Lewis, the capitalists’ capital accumulation is the key to development in the developing nations. The Lewis model also hypothetically explains the existence of disparity between the poor and the rich; and economic growth in the developing nations without hinting at Marxism. The model has drawn to itself much attention from policymakers and economists in less developed nations as it appears to explain the economic development structural process in the developing nations (Wu 2008). Most less developed countries are still facing difficulties in economic development through capital formation in the economy. Although the Lewis model has been shown to fit the development of low-income and emerging nations, some of its elements are hindered in developing economies like China.

The Lewis Model of Development

The most important aspect of the Lewis model is the two divisions of the economy: a rural, subsistence sector, and an urban, industrial, and capitalist sector. Lewis contends that the subsistence sector is mostly based on the natural resources and products such that the marginal productivity of labour is nil or very low. That implies that there exists a ‘disguised unemployment’ underemployment, a possible pool of labour supply to the capitalist division. The labour could be reduced without lowering output (Cai 2015). Moreover, other factors affect a rich supply of labour, including high population growth owing to low mortality and high birth rates, workers released from different forms of casual jobs, wives and daughters released from domestic work, and unemployment produced by growing efficiency. Consequently, the supply of labour is more than demand. The labour market is thus in favour of capitalists, and they can thus maintain a constant wage. Lewis, in his model, assumes that labour supply is ‘unlimited’ on the basis that the capitalist can have an adequate supply of labour at the same wage.

The level of wage in the capitalist division is established by that which is in the subsistence division. That is so because the capitalist sector wage is less compared to the consumption in the subsistence sector, peasants do not leave the land to go seek employment in the capitalist. Lewis states that the capitalist wage is about 30% more compared to subsistence incomes (Cai 2015). The difference is deemed necessary to induce the change from the subsistence segment to make up for the high cost of living in the capitalist area or the psychological transfer cost. Since the marginal product of labour is nil or negligible, the wage in the subsistence area is constant at a subsistence level. Consequently, the capitalist sector wage also remains constant. Although it is higher compared to the subsistence sector’s wage, due to a little inducement, it is not more than a subsistence level in urban life.

In the capitalist, labour is employed to a level at which the marginal product is equivalent to the wage not to reduce the surplus of the capitalist. Since the supply of labour is more than the demand, and the wage is constant at the subsistence level, the profits are maximized. The capitalists, who are profit-minded, are supposed to reinvest all of the profits to develop more capital at a maximized rate (Wu 2008). Capital expansion results in new employment. The accumulation of capital increases, but the wage remains constant so that the surplus increases. Full investment and an unlimited supply of labour ensure that both employment and capital accumulation increases at a maximized rate.

As the capitalist sector absorbs significant labour, it continues to expand. The process goes on until the surplus of labour vanishes. From that point, the extraction of more labour from the subsistence division increases the marginal productivity of labour in the sector. Therefore, labour transfer comes with a loss of food production.

Nevertheless, before the exhaustion of the surplus of labour, the increase in income in the subsistence sector may happen and impact the expansion of the capitalist segment. This is explained in the model using the terms of trade between the capitalist and subsistence sectors on the supposition that their products that are exchanged are different. First, the altering of the absolute population number by labour transfer will result in two situations: due to the decrease of the absolute number of the population in the subsistence sector, although there is surplus labour and the productivity does not increase, the average production per person may perhaps rise (Zhang et al. 2004). Such an increase in earnings in the subsistence sector leads to an increase in wages in the capitalist sector. Another situation is that as the capitalist division enlarges relative to the surplus of the supply of products of the subsistence sector, it leads to a higher price of the subsistence goods. Consequently, the terms of trade go against the capitalist segment, and the profits of the capitalists decrease. Secondly, if there is a growth of agricultural sector efficiency, through the introduction of new technology or competent farming rotation, it directly increases the average income per person in the sector, and the capitalist workers’ wage will indirectly increase (Zhang et al. 2004).

Lewis, then, expanded his theory outside one nation. Using the classical framework that supposes that all nations have a surplus-labour, he proposes that the capitalist may evade holding up the capital accumulation by importing labour, or through exporting of capital to, nations in which surplus labour is still accessible at a subsistence wage.

Practical Application of the Lewis Model

A lot of methodological issues arise in the application of the Lewis model to real-life experiences of industrialization. One of these is about the choice of the right experiential equivalents of the theoretical dual sectors of the Lewis economy (Zhang et al. 2004). There is significant ambiguity even regarding the theoretical depiction of the dualism, with the researcher as well as Lewis using different terms to convey it. Irrespective of such diverse hypothetical terms of dualism chosen, there is no ideal match between the terms and the practical equivalents that might be selected in regards to the accessibility of data and other possible considerations. Another methodological issue is about the kind of labour to be examined. The Turning Point prediction of the model concerns the unskilled labour wages that can be transferred easily from the old to the contemporary sector (Wu 2008). Consequently, not all manufacturing sector labour, a part of which use highly skilled labour, fits in the purview of the Lewis model. However, it is not always easy to differentiate unskilled labour within the modern sector because of definitional and data problems.

With the many choices possible regarding each of the three issues, including empirical counterparts, type of wage, a type of labour, it is evident what a confusing variety of likely combinations a researcher as to deal with in choosing the empirical strategy for the application of the Lewis model. Another issue concerns the marginal product (Wu, 2012). Different from the wage that is evident, marginal product is invisible and should be estimated assuming a production function and applying econometrics techniques, an undertaking fraught with numerous theoretical and computational issues. Most scholars are reluctant to the idea of the production function. Even if the idea is permitted, most issues remain concerning its specification and estimation.

Relevant empirical studies on China’s Growth

Two schools of thoughts have governed the debate over the growth of China. At first, the debate was over the reform speed, that is, whether the fast growth of China was attributable to its incremental and gradual changes or its fast and widespread changes (Shen 2003). The accrued evidence from east of Europe began to indicate that gradual-changing economies did poorer compared to the fast-changing ones. Vietnam offered a new example of a country in which fast reforms resulted in economic growth rates similar to those of China (Wu 2012). Due to this indication, debate shifted on to one of inferring the type of  economic change in China.

The first economic reforms in China were introduced in the backward rural agricultural sector that has surplus labour before extending to the urban industries. The reform series made the most of dualistic economy of China and thus assisted it in undertaking its economic takeoff (Tridico 2010). However, the economic shift that happened in the already urbanized and industrialized Soviet economies resulted in economic recessions. Consequently, the dualistic economy facilitated the growth of economies like Vietnam and China, despite the speed of development, in their shift from central development. The growth route of China is more applicable to a dualistic account, like the Lewis dualistic model than other theories.

China’s Dualistic Economic Development

In China, before the economic reforms of 1978, the countryside agricultural division was operated as communal lands and the government determined wages. Profit seeking was only permitted in the city industrial division. During the economic improvements of 1978, the dualistic structure was not brought to an end (Ding 2012). Rather, the urban sector was allowed to advance more by building an active service segment and another TVEs’ class. Therefore, China’s dualistic economic organization entails the agricultural sector in the rural areas and the industrial sector mainly in urban areas. The impact of agriculture to the GDP of China decreased from about 40% in 1960 to about 10% in 2009 (Islam & Yokota 2009), while the contribution of industrial production increased from 60% to about 91% in the same era. Besides, the industrial sector expands at a more rapid speed than the agrarian division. That shows that growth of the economy in China is motivated more by the industrial segment compared to the agricultural one.

Sectoral labour allocation in China

China’s economy is characterized by a labour surplus, and most of the extra-labour is employed in the agricultural area. Before the economic developments of 1978, movement of labour was government controlled using the “Hukou method.” Gollin (2014) argues that the ordinary yearly rural-urban immigration rate between 1949 and 1985 was 0.24%, which is much lesser than the normal rate of the world of 1.84% between 1950 and 1990. However, the restriction of the labour movement was relaxed since 1980a to accommodate the labour demand  in the manufacturing division. Nonetheless, the introduction of the one-child strategy during the 1970s was more severely imposed, especially in urban regions. That decelerated the expansion of the labour force born in the city and provoked the scarcity of labour in the capitalist sector (Gollin 2014). Lately, the government has restricted the mobility of labour, and an increasing number of rural workers have moved to urban areas and cities. Consequently, n 2009, the relative employment rate in the agricultural sector decreased from 70% in 1978 to 38% in 2009 (Gollin 2014). Equally, the employment rate in the capitalist sector increased rapidly to 62% of the total employment. It is important to note that despite relaxation of the restrictions on the mobility of labour; most of the migrants are only permitted into urban areas temporarily.

Conclusion

The Lewis model has been shown to fit the development of low-income and emerging nations, although not all of its elements apply. Having examined the Lewis dualistic model for the Chinese economy, it is evident that the economic growth in China is mainly connected to the expansion of the capitalist division. That is inspired by fast capital growth and employment growth. The labour reorganization from the agricultural to the non-agricultural sector has made a constructive net impact on the fast-economic development in China.

References

Cai, F. 2015, Understanding the past, present, and future of China’s economic development: based on a unified framework of growth theories. China Under Xi Jinping.33-62.

Ding, S. 2012, China’s Remarkable Economic Growth. Oxford Scholarship Online. http://www.myilibrary.com?id=359480.

Gollin, D. 2014, The Lewis Model: A 60-Year Retrospective. Journal of Economic Perspectives. 28, 71-88.

Islam N., & Yokota K. 2008. Lewis growth model and China’s industrialization. Asian Economic Journal. 22, 359-396.

Islam, N., & Yokota, K. 2009, China’s Industrialization Viewed from the Lewis Growth Model. In Islam, N. 2016, Resurgent China, Palgrave Macmillan.

Shen, X. 2003, China’s economic growth and the development of popular understanding and knowledge. Sustaining China’s Economic Growth in the Twenty-First Century.

Tridico, P. 2010, Growth, Inequality and Poverty in Emerging and Transition Economies. Transition Studies Review. 16, 979-1001.

Wu, Y. 2008, productivity, efficiency and economic growth in china. Basingstoke, Palgrave Macmillan.

Wu, Y. 2012. Understanding economic growth in China and India a comparative study of selected issues. Singapore, World Scientific Pub. Co.

Zhang, X., Mount, T. D., & Boisvert, R. N. 2004. Industrialization, urbanization and land use in China. Journal of Chinese Economics and Business Studies. 2, 207-224.