Structural Change Theory stresses on the process on which underdeveloped

economies transform from traditional subsistence agriculture to a more modern,

urbanized and industrialized economies. The two well-known examples of structural
change approach are

(1) Lewis two sector model and

(2) Patterns of development by Chenery and coauthors.

LEWIS TWO SECTOR MODEL

In the mid 1950’s W. Arthur Lewis formulated the Lewis two sector model.

The Lewis two-sector model on structural change is one of the best known
structural development theory that focuses on structural transformation of countries
from a subsistence economy to a more industrialized economy.

Lewis emphasized that underdeveloped economies consists of two sectors:

(1) a traditional, overpopulated rural subsistence sector with surplus labor; a zero
marginal labor productivity and

(2) a high productivity modern sector to which surplus labour is transferred.

Lewis assumes that the faster the rate of capital accumulation the higher the growth
rate of the modern sector. He also assumes the level of wages in the industrialized is a
given premium in comparison with the fix average level of wages in traditional
subsistence economy.

Lewis has provide two assumptions about the traditional sector, (1) surplus labor exist in
rural areas with zero marginal product while (2) all rural workers shares equally in the
output which was determined by the average not by the marginal product.

Criticisms on Lewis Model

The four key assumptions in the Lewis two sector model do not fit the institutional and
economic realities of most developing countries.
The model assumes that the faster capital accumulation leads to higher growth on
modern sector with regards to labor transfer and employment creation. However if the
capitalist profits are invested in a more labor saving capital equipment rather than
human capital, total output would grow substantially, GDP would rise but income and
employment levels for the masses of workers would remain unchanged.

Most research indicates that there is a little surplus labor in rural areas which is
contradictory to the assumption of Lewis stating the surplus labor in rural sector with
zero marginal product. Developmental economists of today also agree that Lewis’s
notion that surplus labor exist in rural sector is completely invalid.

The assumption that a competitive modern sector labor market guarantees a continued
existence of constant real urban wages up to the point where rural surplus labor is
exhausted remains questionable with the fact that urban wages continues to rise even
with the presence of rising levels of modern sector unemployment and zero marginal
productivity in agriculture and institutional factors such as multinational corporations
tends to negate competitive forces in the modern sector labor markets.

Other assumption suggests that diminishing returns prevail in the modern sector
however evidence suggest that increasing returns prevail rather than diminishing
returns.

Structural Change and Patterns of Development

The best known model of structural change is the empirical work of the Hollis B.
Chenery and his colleagues, which examines the patterns of development for a number
of developing countries during the post war period. Patterns of development analysis
focus on the sequential process on which underdeveloped economy is transformed to
replace the traditional subsistence economy as the engine of economic growth. In the
patterns of development, in addition to the accumulation of capital both physical and
human, a set of interrelated changes in the economic structure of the country is required
in the transition from a traditional to modern. This involve all economic functions such as
transformation of production and changes in the consumer demand, international trade,
and resource use in socioeconomic factors such as urbanization and growth and
distribution of the country’s population. Empirical structural change analysis emphasized
the domestic and international constraint of development. Under the domestic
constraints is the country’s resource endowment, physical and population size and
institutional constraint such as government policies and objectives. International
constraints include access to external capital, technology and international trade.
Differences in the development levels among countries are due to the domestic and
international constraints faced by the country. The extent that developing countries have
access to the opportunities presented by the industrialized countries, developing
countries can make the transition at even faster rate than that of the industrialized
countries.