lewiss model and its application in the reality

This sectoris often characterized by low productivity and limited opportunities for higher wages.Lewis argues that the wage differential between the agricultural and industrialsectors ac

HO CHI MINH CITY CAMPUS

-*** -DEVELOPMENT ECONOMICS

MID-TERM REPORT

Major: International Business Economics

LEWIS’S MODEL AND

ITS APPLICATION IN THE REALITY

Lecturer: Le Hang My Hanh

Ho Chi Minh City, September 2023

CHAPTER 1 GENERAL INTRODUCTION TO LEWIS’S MODEL 2

1.1 General background of Arthur Lewis 2

1.2 Introduction to Lewis’s model 2

1.3 Definitions 3

CHAPTER 2 DESCRIPTION AND CRITICISM OF LEWIS’S MODEL 4

2.1 Description of Lewis’s model 4

2.2 Criticisms of the Lewis’s model 7

CHAPTER 3 APPLICATIONS OF LEWIS’S MODEL IN THE REALITY 10

3.1 Applications in China 10

3.2 Applications in Vietnam 12

CONCLUSION 14

REFERENCES 15

In development economics, many models have been put forward to explain rationally for developing economies One of the most famous models is the two-sector economic model of Arthur Lewis - the Saint Lucian economist who won the Nobel Prize in Economics in 1979 Lewis's model showed the natural movement of labor between the traditional agricultural sector and the modern industrial sector, which is very visible in developing countries The model has explained the root reasons for this shift; however, it also has some limitations for some agriculture, especially monsoon Asian countries

Therefore, to learn more about Lewis's model as well as its strengths and shortcomings, the authors wrote this paper based on studies on the model and its applications in several developing economies, including China and Vietnam

The content of this report includes 3 main chapters:

- Chapter 1: General introduction to Lewis’s model

- Chapter 2: Description and criticisms of Lewis’s model

- Chapter 3: Applications of Lewis’s model in the reality

CHAPTER 1 GENERAL INTRODUCTION TO LEWIS’S MODEL 1.1 General background of Arthur Lewis

Arthur Lewis, born on January 23, 1915, was a prominent economist and social theorist from the Caribbean He made significant contributions to the fields of development economics and economic history In recognition of his contributions to economics, Arthur Lewis was awarded the Nobel Memorial Prize in Economic Sciences in 1979 for his studies of economic development and his construction of an innovative model relating the terms of trade between less developed and more developed nations to their respective levels of labor productivity in agriculture He was the first person of African descent to win a Nobel Prize in a field other than peace or literature Lewis continued to be actively involved in academia and policy work until his death in 1991

1.2 Introduction to Lewis’s model

Lewis's model, or Lewis’s dual-sector model, is an economic framework developed by economist Arthur Lewis in the late 1940s The model aims to explain the process of economic development in developing countries, particularly the structural transformation from a traditional agrarian economy to a modern industrialized economy

In Lewis's dual-sector model, the initial stage involves a situation where the majority of the workforce is employed in the traditional agricultural sector This sector

is often characterized by low productivity and limited opportunities for higher wages Lewis argues that the wage differential between the agricultural and industrial sectors acts as a pull factor, attracting surplus labor from the agricultural sector to migrate to urban areas and seek employment in the industrial sector As more workers move from the agricultural sector to the urban industrial sector, the industrial sector experiences an increase in the labor force The process of rural-to-urban migration continues as the industrial sector expands and offers employment opportunities The migration is driven by the expectation of higher wages and better living conditions in urban areas compared to the rural agricultural areas This creates a self-reinforcing

cycle where the growing industrial sector attracts more labor, leading to further industrial expansion and economic development

Although Lewis's model has been subject to various criticisms and refinements over the years, it remains a notable contribution to the understanding of economic development and has influenced subsequent theories and policies in the field of development economics

1.3 Definitions

Before going deeply into the explanation of the model, there are some definitions

to understand

Structural-change theory: The hypothesis that underdevelopment is due to underutilization of resources arising from structural or institutional factors that have their origins in both domestic and international dualism Development therefore requires more than just accelerated capital formation

Structural transformation: The process of transforming an economy in such a way that the contribution to national income by the manufacturing sector eventually surpasses the contribution by the agricultural sector More generally, a major alteration

in the industrial composition of any economy

Surplus labor: The excess supply of labor over and above the quantity demanded

at the going free-market wage rate In the Lewis two-sector model of economic development, surplus labor refers to the portion of the rural labor force whose marginal productivity is zero or negative

Production function: A technological or engineering relationship between the quantity of a good produced and the quantity of inputs required to produce it

CHAPTER 2 DESCRIPTION AND CRITICISM OF LEWIS’S MODEL 2.1 Description of Lewis’s model

According to the Lewis model, the underdeveloped economy is divided into two sectors: a traditional, overpopulated, rural subsistence sector with zero marginal labor productivity—a situation that allows Lewis to classify this as surplus labor in the sense that it can be withdrawn from the traditional agricultural sector with no loss of output—and a modern, urban industrial sector with high marginal labor productivity into which labor from the subsistence sector is gradually transferred The model's major focus is on the process of labor transfer as well as the increase of production and employment in the contemporary sector Labor transfer and modern-sector employment growth are both caused by output growth in that industry The rate of industrial investment and capital accumulation in the contemporary sector determines the rate of this expansion Such investment is made possible by the excess of modern-sector profits over wages, assuming that capitalists reinvest all of their profits Finally, Lewis assumed that the level of pay in the urban industrial sector was constant, determined as a certain premium above a fixed average subsistence level of wages in the traditional rural sector At a fixed urban salary, the supply curve of rural labor to the contemporary sector is thought to be perfectly elastic

Figure 1 The Lewis Model of Modern-Sector Growth in a Two-Sector Surplus Labor Economy

Figure 1 illustrates the Lewis model of modern-sector growth in a two-sector economy Consider first the traditional agricultural sector, which is depicted in the two right-hand diagrams of Figure 1b The upper graphic depicts how subsistence food production varies as labor inputs rise It is a typical agricultural production function in which the total output or product (TPA) of food is defined by changes in the amount of the single variable input, labor (LA), given a set amount of capital, KA, and unchanging traditional technology, tA The average and marginal product of labor curves, APLA and MPLA, are displayed in the lower-right diagram and are derived from the total product curve shown above As Lewis is presenting an underdeveloped economy in which the majority of the population lives and works in rural regions, the quantity of agricultural labor (QLA) available is the same on both horizontal axes of the right-hand side of the picture and is expressed in millions of workers

Lewis holds two beliefs regarding the conventional sector First, there is surplus labor in the sense that MPLA is zero, and second, all rural employees partake equally

in output, therefore the rural real pay is determined by the average rather than the marginal product of labor This might be thought of metaphorically as passing around the family rice bowl at dinnertime, from which each individual eats an equal share Assume that LA agricultural laborers produce TPA food, which is distributed evenly as

WA food per person As demonstrated in the bottom diagram of Figure 1b, the marginal product of these LA employees is zero; thus, the surplus-labor assumption applies to all workers in excess of LA

Figure 1a's upper-left figure depicts the total product (production function) curves for the modern industrial sector Once again, output of manufactured goods (TPM) is a function of a variable labor input, LM, for a given capital stock, KM, and technology,

tM On the horizontal axes, the amount of labor utilized to create an output of, say, TPM1, with capital stock KM1, is indicated in thousands of urban workers, L1 The Lewis model allows for the modern-sector capital stock to rise from KM1 to KM2 to KM3 as a result of industrial capitalists reinvesting profits As a result, the total product curves in Figure 1a will shift higher from TPM(KM1) to TPM(KM2) to

TPM(KM3) The process of generating capitalist profits for reinvestment and growth is depicted in the lower-left diagram of Figure 1a The modern-sector marginal labor product curves are derived from the TPM curves in the upper diagram Under the premise of perfectly competitive labor markets in the modern sector, these marginal product of labor curves represent the actual labor demand curves This is how the system works

WA denotes the average amount of real subsistence income in the traditional rural sector in the lower diagrams of Figures 1a and 1b As a result, WM in Figure 1a represents the actual wage in the modern capitalist sector The horizontal labor supply curve WMSL shows that the supply of rural labor is expected to be unlimited or perfectly elastic at this wage In other words, Lewis thinks that if the urban wage WM

is higher than the rural average income WA, modern-sector companies can hire as many excess rural workers as they wish without concern of wage inflation Given a fixed supply of capital KM1 in the early stages of modern-sector expansion, the demand curve for labor is dictated by labor's diminishing marginal product and is depicted in the lower-left diagram by the negatively sloping curve D1(KM1) Because profit-maximizing modern-sector businesses are supposed to hire laborers until their marginal physical product equals the real wage (i.e., the point F of intersection of the labor demand and supply curves), total modern-sector employment equals L1 TPM1,

or total modern-sector output, is given by the area enclosed by the points 0D1FL1 The proportion of total output paid to workers in wages would thus be equal to the area of the rectangle 0WMFL1 The entire profits accruing to capitalists would be the balance

of output depicted by the area WMD1F Lewis believes that all profits will be reinvested, therefore the entire capital stock in the modern sector will expand from KM1 to KM2 Because of the increased capital stock, the total product curve of the modern sector shifts to TPM(KM2), causing the marginal product demand curve for labor to grow This outward movement in the labor demand curve is depicted by line D2(KM2) in the bottom half of Figure 1a With L2 people now working, a new equilibrium modern-sector employment level will be established at point G Total

output rises to TPM2 or 0D2GL2, while total wages and profits climb to 0WMGL2 and WMD2G, respectively These greater (WMD2G) gains are reinvested once more, boosting the total capital stock to KM3, moving the total product and labor demand curves to TPM(KM3) and D3(KM3), respectively, and elevating the level of modern-sector employment to L3

This pattern of self-sustaining modern-sector growth and job expansion is expected to continue until all surplus rural labor is absorbed by the new industrial sector Following that, additional workers can be withdrawn from the agricultural sector only at a larger cost of lost food production since the lowering labor-to-land ratio means that rural labor's marginal product is no longer zero This is referred to as the "Lewis turning point." As modern-sector salaries and employment continue to rise, the labor supply curve becomes more favorably sloped The economy will have undergone structural transition, with the balance of economic activity shifting from traditional rural agricultural to contemporary urban industry

2.2 Criticisms of the Lewis’s model

The Lewis two-sector development model is straightforward and broadly corresponds to the experience of economic growth in the West throughout history, but four of its key principles are inconsistent with the institutional and economic circumstances of the majority of modern developing countries

According to the Lewis model, the frequency of modern-sector labor transfer and employment creation is corresponding to the rate of modern-sector capital accumulation This indicates that the faster the pace of capital accumulation, the faster the current sector's growth rate and the rate of new employment creation However, if capitalist earnings were to be reinvested in more advanced labor-saving capital equipment, the labor demand curve shifts less than proportionately to capital increases Figure shows the relationship of the labor demand curves D2(KM1) and D2(KM2) D2(K )M2

has a higher negative slope than D2(KM1) to represent the fact that KM2 technology needs substantially less labor per unit of output than KM1technology As a result, even though overall output has increased significantly, employment has remained steady

Profits are accrued to capitalists for all excess output This is what some may term

"anti-developmental" economic growth, because the bulk of the advantages of growth

go to a tiny number of people, while the rest of the population sees little change in income or employment This assumption, however, may not hold accurate if capital increase is accompanied by labor-saving technological advances

Figure: The Lewis Model Modified by Laborsaving Capital Accumulation: Employment Implications

The second questionable assumption of the Lewis model is that developing nations have two types of labor markets: surplus labor markets in rural regions and full employment markets in urban areas However, most recent evidence does not support this theory In reality, there is little surplus labor in rural regions, and many individuals have moved from rural to urban areas in search of jobs The Lewis model's assumption

of rural surplus labor is based on the idea that agricultural production in developing nations is low However, agricultural production has grown in many developing nations in recent years, reducing the demand for rural labor Most development economists, however, believe that the Lewis model's assumption of surplus labor in rural regions is typically inaccurate

The Lewis model's third assumption is that the modern-sector labor market is competitive and assures steady real urban wages until the supply of rural surplus labor