lewis model and its application in the reality

This theory posits the existence of a dual economy, comprising a traditional agricultural sector with surplus labor and a modern industrial or urban sector.. The surplus labor in agricul

HO CHI MINH CITY CAMPUS

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ECONOMIC DEVELOPMENT MID-TERM REPORT

Major: International Business Economics

LEWIS’ MODEL AND ITS APPLICATION IN THE REALITY

Ho Chi Minh City - September 2023

CHAPTER 1: INTRODUCTION TO LEWIS’ MODEL THEORY OF

ECONOMIC DEVELOPMENT 1

1 Introduction to Lewis’ Model 1

1.1 Overview of Lewis’ Model: 1

1.2 Principles and Concepts 1

1.3 Assumptions of the Lewis’s model: 3

1.4 Movement of labor: 3

CHAPTER 2: CHINA CASE STUDY 5

2.1 China's Economy Before the Reform Era: A Historical Overview 5

2.2 China Reform Era: Transformative Measures 6

2.2.1 The Shift from Agriculture to Industry and Services 6

2.2.2 Government Policies and Reforms Influencing Structural Transformation 7

2.3 Results and Key Findings 9

2.3.1 China's GDP growth and industrial output 9

2.3.2 Contributions of manufacturing and services sectors 11

2.3.3 Regional disparities in economic development 12

CHAPTER 3: FINDINGS AND CRITICISM 14

REFERENCE 17

CHAPTER 1: INTRODUCTION TO LEWIS’ MODEL THEORY OF

ECONOMIC DEVELOPMENT

1 Introduction to Lewis’ Model

1.1 Overview of Lewis’ Model:

The Lewis Theory, also known as the "Lewis Model" or "Lewis Theory of Economic Development," is an economic model developed by the British economist Sir Arthur Lewis This theory was proposed in the mid-20th century and has had a significant impact on the understanding of economic development, particularly in the context of developing countries

This theory posits the existence of a dual economy, comprising a traditional agricultural sector with surplus labor and a modern industrial or urban sector The surplus labor in agriculture, not needed for subsistence farming, is seen as a crucial resource that can be mobilized to fuel the growth of the modern sector As labor migrates to the industrial sector, wages rise in both sectors, and capital accumulation occurs, contributing to economic development

The Lewis Model underscores the importance of government policies and investments

in infrastructure, education, and healthcare to facilitate this labor transition and address income disparities While the model has faced criticisms and adaptations due to its simplifications, it remains a relevant and influential tool for understanding and guiding economic development in developing economies worldwide

1.2 Principles and Concepts

Arthur Lewis put forward a development model of a dualistic economy, consisting of rural agricultural and urban manufacturing sectors

Lewis' model seeks to provide a framework for understanding how relatively poor countries can develop economically It begins by assuming that one of the characteristics shared by poor countries is that their economies tend to consist largely of a "subsistence sector" in which the supply of labor is very large and the amount of capital invested per worker is very low

Subsistence sector: The agricultural section of the economy A traditional, overpopulated, rural subsistence sector characterized by zero marginal labor productivity It is characterized by:

 Low wages

 An abundance of labor

 Low productivity through a labor-intensive production process

The Lewis model describes a path whereby a developing economy can foster the growth

of a new "capitalist sector" which will employ a growing share of the excess labor available from the subsistence sector Over time, this capitalist sector can come to eclipse the subsistence sector, causing the overall economy to grow

Capitalist sector: The manufacturing section of the economy A high-productivity modern, urban industrial sector into which labor from the subsistence sector is gradually transferred It is characterized by:

 Higher wage rate

 Higher marginal productivity

 A demand for more workers

1.3 Assumptions of the Lewis’s model:

The model assumes that a developing economy has a surplus of unproductive labor in the agricultural sector

These workers are attracted to the growing manufacturing sector where higher wages are offered

It also assumes that the wages in the manufacturing sector are more or less fixed Entrepreneurs in the manufacturing sector make a profit because they charge a price above the fixed wage rate

The model assumes that these profits will be reinvested in the business in the form of fixed capital

1.4 Movement of labor:

When the capitalist sector expands, it extracts or draws labor from the subsistence sector This causes the output per head of laborers who move from the subsistence sector to the capitalist sector to increase

Since Lewis in his model considers overpopulated labor surplus economies he assumes that the supply of unskilled labor to the capitalist sector is unlimited This also gives rise

to the possibility of creating new industries and expanding existing ones at the existing wage rate

The capitalist sector gives a slightly higher wage than the subsistence wage in order to compensate labor for the friction of moving and induce labor to leave the traditional way

of life

This wage is called the “subsistence plus wage” and it is according to Lewis, usually

30% higher than the subsistence wage

It is worth mentioning that in the Lewis Model, the rate of accumulation of industrial capital and, therefore, the absorption of surplus labor depends upon the distribution of income With the aid of the classical assumption that all wages are consumed and all profits saved, Lewis shows that the share of profits and therefore rate of saving and investment will rise continuously in the modern sector and capital will continue to be expanded until all the surplus labor has been absorbed The rising share of profits serves

as an incentive to reinvest them in building industrial capacity as well as a source of savings to finance it

End of growth process:

The process of economic growth is linked to the growth of capitalist surplus, that is profit As long as the capitalist surplus increases, the national income also increases raising the growth of the economy

The increase in capitalist surplus is linked to the use of more and more labor which is assumed to be in surplus in the case of this model This process of capital accumulation does come to an end at some point

CHAPTER 2: CHINA CASE STUDY 2.1 China's Economy Before the Reform Era: A Historical Overview

Throughout the twentieth century, China was a surplus labor economy par excellence Even at the time of liberation (1st October 1949) - almost all of the arable land was in use, and in the next half century, the rural population and labor force more than doubled

In the 1980s the increase was absorbed mainly by rural industrialization outside the planning system, but as urban reforms progressed the main absorption of the growing rural labor force was through rural-urban migration

In the early 1950s, agriculture contributed to around 50% of the country's GDP This heavy reliance on agriculture was indicative of a pre-industrialized economy with limited diversification The rural sector was marked by traditional farming practices, limited mechanization, and low agricultural productivity China faced challenges such as land fragmentation, food shortages, and a lack of modern infrastructure in rural areas

Industrialization in China was in its infancy during this period The industrial sector was relatively small and underdeveloped , primarily consisting of state-owned enterprises focused on heavy industries Light industries and modern manufacturing were relatively underrepresented, and there was limited technological advancement in this sector Furthermore, rural areas in China faced challenges such as limited access to education, healthcare, and basic infrastructure The income disparities between urban and rural areas were significant, reflecting the divide between the relatively more developed urban centers and the predominantly agrarian rural regions Under central planning, China was compartmentalized into an ‘invisible Great Wall’ between rural and urban areas Despite

it having been a peasant-led revolution, there was a large rural-urban divide in incomes (Knight and Song, 1999) The disbanding of the communes in the early 1980s and the restoration of incentives raised peasant incomes but, as urban reforms advanced, the ratio

of urban to rural household income per capita grew, and it reached a peak of 3.32 in

2009 This reflects in part the unbalanced nature of political influence, however latent it might have been (Knight et al., 2006)

2.2 China Reform Era: Transformative Measures

2.2.1 The Shift from Agriculture to Industry and Services

One of the key principles of the Lewis Model is the shift of surplus labor from the agricultural sector to the industrial and services sectors In China's case, this transition has been a central driver of its economic growth

As millions of rural laborers moved to cities in search of better job opportunities, China's industrial and manufacturing sectors experienced explosive growth Cities like Shenzhen and Guangzhou in the Pearl River Delta region became manufacturing powerhouses, producing a wide range of goods for both domestic consumption and export

Simultaneously, the services sector also expanded rapidly, encompassing finance, technology, retail, and more This diversification of the economy further mirrored the Lewis Model's predictions, as surplus labor found employment in both manufacturing and services

2.2.2 Government Policies and Reforms Influencing Structural Transformation

China's remarkable economic transformation has been significantly shaped by a series

of government policies and reforms These initiatives have played a pivotal role in orchestrating the structural transformation from an agrarian-based economy to a diversified and industrialized one

2.2.2.1 The Four Modernizations and Economic Reforms

At the heart of China's economic transformation were the "Four Modernizations" initiated by Deng Xiaoping in the late 1970s These encompassed the modernization of agriculture, industry, national defense, and science and technology These reforms signaled a shift away from centralized planning towards a more market-oriented economy

In agriculture, the Household Responsibility System allowed farmers to lease or transfer land, providing them with greater incentives to increase productivity This reform led to

a reduction in the agricultural workforce and encouraged rural-to-urban migration 2.2.2.2 Special Economic Zones (SEZs) and Foreign Investment

The creation of Special Economic Zones, notably exemplified by Shenzhen, was a pivotal moment in China's economic transformation SEZs offered favorable conditions for foreign investment, including tax incentives and reduced bureaucratic red tape Multinational corporations flocked to these zones, leading to technology transfers and significant foreign direct investment

Foreign trade and export-oriented policies were also aggressively promoted China's accession to the World Trade Organization (WTO) in 2001 further opened up its economy to global trade, contributing to a surge in exports and trade surpluses

2.2.2.3 Rural-Urban Migration and Labor Market Reforms

The Chinese government recognized the need to absorb surplus labor from the agricultural sector into more productive urban employment Policies were implemented

to facilitate rural- -urban migration This involved the relaxation of hukou (household to registration) restrictions, enabling rural migrants to access social services in urban areas

Additionally, labor market reforms were introduced to provide greater flexibility for employers and employees These reforms aimed to encourage the growth of the industrial and services sectors by making it easier to hire and fire workers, contributing

to the movement of labor from agriculture to urban industries

2.2.2.4 "Go West" Policy and Regional Development

China's economic growth had primarily been concentrated along the eastern coastal regions, such as Guangdong, Shanghai, and Beijing, while the western provinces, including Xinjiang, Tibet, and parts of Sichuan and Yunnan, lagged behind in terms of

economic development This stark regional imbalance raised concerns about social stability and equitable growth

To address regional disparities in development, particularly between the coastal and western regions, the Chinese government launched the "Go West" policy in the early 2000s This initiative involved significant investments in infrastructure, education, and healthcare in less-developed western provinces It aimed to boost economic activity in these regions and alleviate pressure on overcrowded coastal cities

2.2.2.5 Technological Advancements and Innovation

Government support for science and technology played a crucial role in China's economic transformation Investments in research and development, the establishment

of high-tech industrial parks, and initiatives like "Made in China 2025" aimed to boost innovation and move China up the value chain in manufacturing

2.3 Results and Key Findings

2.3.1 China's GDP growth and industrial output

China's GDP growth has consistently surpassed global averages, positioning it as one of the world's economic powerhouses Once one of the poorest countries in the world four decades ago, with a GDP per capita of only RMB 385 (about US$156) in 1978, China is now the world’s second-largest economy , with an annual growth rate averaging 8.5 percent over the past 40 years, and GDP per capita of RMB 59,660 in 2017 (about US$8,830 as converted using the average exchange rate of 2017), marking a monumental shift in the country's economic landscape This remarkable expansion aligns closely with the predictions of the Lewis Model, which posits that the absorption of surplus labour into the industrial sector would lead to rapid economic growth

Manufacturing has been one of the cornerstones of China's economic transformation China has earned the moniker of the "world's factory," and its manufacturing output reflects this title Statistical data from NBS underscores the pivotal role of manufacturing

in China's economic landscape In 1978, the manufacturing sector contributed just over 40% to China's GDP By 2020, this figure had surged to nearly 30 trillion USD, constituting approximately 28% of China's GDP

The growth of various industries within manufacturing, such as electronics, automotive, and textiles, exemplifies the Lewis Model's emphasis on industrialization For instance, the automotive industry has witnessed remarkable expansion In 1978, China produced approximately 200,000 vehicles; by 2020, this number had skyrocketed to over 25 million vehicles, making China the world's largest automotive market