The Lewis Model of Development with

Unlimited Labour Supply
The Lewis Model of Development with Unlimited Labour Supply!
An eminent development economist Arthur Lewis put forward his model of “Economic
Development with Unlimited Supplies of Labour” which envisages the capital accumulation
in the modern industrial sector so as to draw labour from the subsistence agricultural sector.
Lewis model has been somewhat modified and extended by Fei and Rains but the essence of
the two models is the same. Both the models (that is, one by Lewis and the other modified
one by Fei-Ranis) assume the existence of surplus labour in the economy, the main
component of which is the enormous disguised unemployment in agriculture.
Further, they visualise ‘dual economic structure’ with manufacturing, mines and plantations
representing the modern sector, the salient features of which are the use of reproducible
capital, production for market and for the profit, employing labour on wage-payment basis
and modern methods of industrial organisation.
On the other hand, agriculture represents the subsistence or traditional sector using nonreproducible land on self-employment basis and producing mainly for self-consumption with
inferior techniques of production and containing surplus labour in the form of disguised
unemployment.
As a result, the productivity or output per head in the modern sect is much higher than that in
agriculture. Though the marginal productivity in agriculture over a wide range is taken to be
zero, the average productivity is assumed to be positive and equal to the bare subsistence
level.
Lewis’ Model of Development with Surplus Labour:
In the labour-surplus models of Lewis and Fri-Ranis, the wage rate in the modern industrial
sector is determined by the average productivity in the agriculture. To this average productivity is added a margin (Lewis fixes this margin at 30%) which is required for furnishing
an incentive for labourers to transfer themselves from the countryside to the urban industries
as well as for meeting the higher cost of urban living.
In this setting, the model shows how the expansion in the industrial investment and
production or, in other woods, capital accumulation outside agriculture will generate
sufficient employment opportunities so as to absorb all the surplus labour from agriculture

the demand for labour or marginal productivity curve of labour will shift outward. the stock of capital assets in the modern sector will increase. say to MP3 position. In this new equilibrium situation profit or surplus accruing to the capitalist class will be equal to WQ2E which is larger than the previous WQ1D. the modern sector will employ OL1 labour at which marginal product of labour equals the given wage rate OW. 44. at the wage rate OW. On the basis of the principle of profit maximisation. average product in agriculture by) 30%. When the demand curve for labour is MP3 employment of labour will rise to OL3. that is. the demand for labour is given by the marginal productivity curve MP1. OL1 amount of labour will be employed in the modern sector. The new surplus or profits of WQ2E will be further invested with the result that capital stock will increase and the demand or marginal productivity curve for labour will further shift upward. So long as surplus labour exists in the economy any amount of labour will be available to the modern sector at the given wage rate OW.e. With a given initial amount of industrial capital. As a result of the increase in the stock of industrial capital. Now. Lewis assumes that all wages are consumed and all profits saved and invested. With MP2 as the new demand curve for labour and the wage rate remaining constant at OW.and elsewhere.1 OS represents the real wages which a worker would be getting in the subsistence sector. The process of expansion and capital accumulation in the modern sector and the absorption of labour by it is explained by the accompanying Fig. wage in the modern sector will be OWQ1L1 and WQ1D will be the capitalists’ surplus. the profits earned will go on being reinvested and the expansion of the modern sector will go . which will remain constant. OS is the average product per worker in the subsistence sector. In this way.e. When the capitalists will reinvest their profits for setting up new factories or expanding the old ones. With this the total share of labour i. for instance from MP1 to MP2 in our diagram. OW is the wage rate fixed in the modern sector which is greater than OS (i..

We are here not interested in validity of all the assumptions. It is of course assumed that all profits or a greater part of the profits is saved and automatically invested. and if any part of the profits is reinvested in productive capacity. the share of profits in national product will rise. With the aid of classical assumption that all wages are consumed and all profits saved. In our view the basic premise of these models is wrong and that makes it unrealistic and irrelevant for framing a suitable development strategy to solve the problem of surplus labour and unemployment. therefore. Thus with the expansion of the modern or capitalist’s sector. the absorption of surplus labour depends upon the distribution of income. It is also evident from above that share of capitalist’s profits depends on the share of the capitalist sector in the national product. explicitly or implicitly. The greater the share of profits in national income. Profit as the Main Source of Capital Formation: It is clear from the above analysis of Lewis model with unlimited supply of labour that profits constitute the main source of capital formation. It is worth mentioning that in Lewis Model. the rate of saving and investment as percentage of national income will continuously rise. As a result. As the capitalist or modern sector expands. To quote Lewis himself. 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. the rate of accumulation of industrial capital and. . profits will grow continuously relatively to the national income”.on absorbing surplus labour from the subsistence sector until all the labour surplus is fully absorbed in productive employment. A Critical Appraisal of Lewis Model: The validity and usefulness of the labour-surplus model of Lewis for developing countries like India depend of course on the extent to which their underlying assumptions are valid for the economies in question. 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 labour has been absorbed. the greater the rate of savings and capital accumulation. The basic premise of the model is that industrial growth can generate adequate employment opportunities so as to draw away all the surplus labour from agriculture in an over-populated developing country like India where population is currently increasing at the annual rate of around 2 per cent. “If unlimited supplies of labour are available at constant real wage rate. made in this model. This rise in the share of profits in national product is due to the assumptions of the model that wage rate remains constant and prices of the products produced by the capitalist sector do not fall with the expansion in output. rate of capital accumulation will also increase relatively to national income.

These immigrants to the urban areas have been mainly employed in petty trade. the industrial sector must expand sufficiently to provide employment opportunities for the released workers … labour reallocation must be rapid enough to swamp massive population increases if the economy’s centre of gravity is to be shifted over time.This premise has been proved to be a myth in the light of generation of little employment opportunities in the organised industrial sector during over fifty years of economic development in India. domestic service and casual work in which the disguised unemployment and poverty exist as acutely as in agriculture. Lewis model neglects the importance of labour absorption in agriculture: A grave weakness of the models of Lewis and Fei-Ranis is that they have ignored the generation of productive employment in agriculture. the generation of adequate employment opportunities and as a result the absorption of surplus labour from agriculture in the expanding industrial sector has not proceeded as predicted by Lewis model. For instance. the organised industrial employment increased by only 3 millions which is too meagre to make any significant impact on the urban unemployment situation. Latin American and African countries. In this process each sector is called upon to perform a special role: productivity in the agricultural sector must rise sufficiently so that smaller fraction of the total population can support the entire economy with food and raw materials. No doubt. simultaneously. as envisaged by Lewis and Fei-Ranis. In may be pointed out here that migration of some workers from the rural to the urban areas in India has occurred as shown by the slight increase in the degree of urbanisation noticed in the various censuses but these immigrants to the urban areas have not been absorbed into the modern high-productivity employment.” . This is evident from the statistical data about meagre increase in employment in the organised sector. as things are stand. far from providing a solution to the labour-surplus problem in agriculture. thus enabling agricultural workers to be released. the traditional sector of the economy is simply moving from the countryside into the cities in apparent contrast to the Lewis model. Lewis in his later writings and Fei-Ranis in their modified and extended version of Lewis model have envisaged an important role for agricultural development so as to sustain industrial growth and capital accumulation. in the 30 years (1951-81) of industrial development in India during which fairly good rates of industrial production had been achieved. But they visualise such an agricultural development strategy that will release labour force from agriculture rather than absorbing them in agriculture. Thus to quote Fei and Ranis: “In such a dualistic setting the heart of the development problem lies in the gradual shifting of the economy’s centre of gravity from the agricultural to the industrial sector through labour reallocation. Thus. Thus.

Rise in wages will lower the share of profits in the industrial product which in turn will slow down or even choke off the process of capital accumulation and economic development. When as a result of the expansion of capitalist modern sector. Thus Sara S. An important drawback of Lewis model is that it has neglected the importance of agricultural growth in sustaining capital formation in the modern industrial sector. The employment potential of industrial sector is so little that far from withdrawing labour currently employed in agriculture. Indeed. .” Assumption of adequate labour-absorptive capacity of the modern Industrial sector: Another related shortcoming of development models of Lewis. it does not seem to be possible for the organised industries and services. even to absorb the new entrants to the labour force. Fei and Ranis is their assumption that the growth of industrial employment (in absolute amount) will be greater than the growth in labour force (which in India at present is of the order of about 8 million people per year). adopting proper agricultural technologies and making appropriate institutional reforms in the pattern of land ownership. a good amount of employment opportunities can be generated in agriculture itself by capital accumulation in agriculture. transfer of labour from agriculture to industry takes place. If the output of food-grains does not increase through agricultural development to meet the additional demand for food-grains. on the basis of existing capital-intensive technologies. prices of food-grains will rise. Because only then the organised industrial sector can absorb surplus labour from agriculture. the demand for food-grains will rise. Even about the African countries most of which do not suffer from the Malthusian problem of over-population but are currently faced with acute urban unemployment (especially of what is known as “Unemployment of School Leavers” majority of which have migrated from the villages to the urban. Berry remarks about the African experience: “Most students of the problem of rising African urban unemployment agree that the solution to the problem lies in raising incomes and employment opportunities in agriculture so as to ensure a new market equilibrium with more people productively employed in agriculture.areas) the expert opinion has veered round to the view of seeking solution of labour-surplus problem within agriculture.We have shown above that employment potential of organised industrial sector is so little that labour reallocation between agriculture and industry and “smaller fraction of the total population being employed in agriculture” is just not possible in labour-surplus developing countries like India. With the rise in prices of food-grains wages of industrial labour will increase.

It is assumed in the model.Thus. 44. seriously impairs the development process of the modern sector. that is. Accordingly. With a modification that profits made are reinvested in labour-saving capital equipment due to the technological change that has taken place. It neglects the labour-saving nature of technological progress: A serious lacuna of the Lewis model from the viewpoint of employment creation is its neglect of the labour-saving nature of technological progress. marginal productivity curve does not shift uniformly outward but crosses the original marginal productivity curve from above. during the period 1966-1979. that rate of employment creation and therefore of labour transfer from agriculture to the modern urban sector will not be proportional to the rate of capital accumulation in the industrial sector. if no allowance is made for agricultural growth. The Assumption of Constant Real Wage Rate in the Modern Sector: The assumption of constant real wages to be paid by the urban industrial sector until the entire labour surplus in agriculture has been drawn away by the expanding industrial sector is quite unrealistic. As a result of this. that with the constant wage rate OW.2. The actual experience has revealed a striking feature that in the urban labour markets where trade unions play a crucial role in wage determination there has been a tendency for the urban wages to rise substantially over time. the greater the rate of growth of capital formation in the modern sector.2. It is evident from Fig. both in absolute terms and relative to average real wages even in the presence of rising levels of urban open unemployment. the employment of labour does not increase even though . Lewis model has been reproduced in Fig. The rise in wages. then employment in the industrial sector may not increase at all. the expansion of modern sector and capital accumulation is bound to be halted. the greater the creation of employment opportunities in it. if the profits made by the capitalists are reinvested in more mechanised labour-saving capital equipment rather than in existing types of capital. neglect of agriculture in the development strategy pursued in India since the Second Plan virtually resulted in stagnation in the industrial sector. though implicitly. Thus. But if capital accumulation is accomplished by labour-saving technological change. as explained above. 44.

though implicitly. 44. If agricultural productivity and therefore incomes of the farming population do not increase. However. the basic foundations of Lewis model crumble down. The rise in the wage rate will reduce the capitalist’s profits which in turn will bring about a premature halting of the expansionary process. labouring class has not received any benefit from it. Lewis Model Ignores the Problem of Aggregate Demand: A serious factor which can slow down or even halt the expansionary process in Lewis model is the problem of deficiency of aggregate demand. the area OEQL is much greater than the area ODQL. Either the whole increment in output will be demanded by the people in the modern sector itself or it will be exported. But to think that entire expansion in output will be disposed of in this manner is not valid. employment has lagged far behind. This is because a rise in agricultural productivity in Lewis model will mean a rise in wage rate in the modern capitalist sector. Although GNP has increased.marginal productivity curve has shifted. . It is not just theoretical illustration but has been actually borne out by the experience of industrial development of several developing countries. It will be observed from Fig. the total output has increased substantially. This is because a good part of the demand for industrial products comes from the agricultural sector. Lewis assumes. the problem of shortage of aggregate demand will emerge which will choke off the growth process in the capitalist industrial sector. the employment and incomes of labour class remain unchanged. that no matter how much is produced by the capitalist or modern sector. it will find a market. This experience shows that while industrial output has significantly increased.2 that though employment of labour and total wage (OWQL) have remained the same. This illustration points to the fact that while the industrial output and profits of the capitalist class can increase. once an allowance is made for the increase in agricultural productivity through a priority to agricultural development.

. The model makes a systematic and penetrating analysis of the growth problem of dual economies and brings out some of crucial importance of such factors as profits and wages rates in the modern sector for determinating the rate of capital accumulation and economic growth. It underlines the importance of intersectoral relationship (i. .e. It clearly points out the role of capital accumulation in raising the level of output and employment in labour-surplus developing countries.Conclusion: Despite several limitations and drawbacks Lewis model retains a high degree of analytical value. the relationship between agriculture and the modern industrial sector) in the growth process of a dual economy.