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ARTHUR LEWIS

TWO-SECTOR
MODEL
Immanouel A. Rafanan

Who is Arthur Lewis?


Lewis

is a St. Lucian Economist


Jan 23 1915: Birth Date
1940: Earned his Ph.D degree
at the London School of Economics
1954: Published Economic Development
with
Unlimited Supplies of
Labor
1963: Was knighted for his contribution to
economics
1979: He received the Nobel Prize
June 15 1991: Lewis died, he was 76 years
old.

Two-Sector Model (Lewis


Model)
Explains

the growth of a developing economy


in terms of a labour transition between two
sectors, the Capitalist Sector and the
Subsistence Sector.

theory of development in which surplus


labor from Traditional Agricultural Sector
is transferred to the Modern Industrial
Sector whose growth over time absorbs the
surplus labor, promotes industrialization and
stimulates sustained development.

Traditional Agricultural
Sector
That part of the economy which is not using
reproducible capital
The per head output is comparatively lower in this
sector and this is because it is not fructified with
capital

Typically characterized by:


Low Wages
Abundance of Labor
Low Productivity
Labor Intensive Process

Modern Industrial Sector


That part of the economy which uses
reproducible capital and pays capitalists
thereof
Profits are reinvested in the capital stock
May be private or public

Typically characterized by:


Higher Wages
Higher Marginal Productivity
Demand for More Workers
Capital Intensive

Assumptions
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.

Assumptions
Entrepreneurs

in the manufacturing sector


make 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.

An

advanced manufacturing sector means


an economy has moved from a
traditional to an industrialized one.

Implications
Since

the agricultural sector has a


limited amount of land to cultivate,
the marginal product of an
additional farmer is assumed to be
zero as the law of diminishing
marginal returns has run its course
due to the fixed input, land. As a
result, the agricultural sector has a
quantity of farm workers that are not
contributing to agricultural output

Implications
This

group of farmers that is not


producing any output is termed
surplus labour since this cohort
could be moved to another sector
with no effect on agricultural output.
Therefore, due to the wage
differential between the agricultural
and manufacturing sectors, workers
will tend to transition from the
agricultural to the manufacturing

Implications
Therefore,

due to the wage


differential between the agricultural
and manufacturing sectors, workers
will tend to transition from the
agricultural to the manufacturing
sector over time to reap the reward
of higher wages.

Implications
If

a quantity of workers moves from


the agricultural to the manufacturing
sector equal to the quantity of
surplus labour in the agricultural
sector, regardless of who actually
transfers, general welfare and
productivity will improve.

Implications
Total

agricultural product will


remain unchanged while total
industrial product increases due
to the addition of labour, but the
additional labour also drives down
marginal productivity and wages in
the manufacturing sector.

Implications
Over

time as this transition


continues to take place and
investment results in increases in the
capital stock, the marginal
productivity of workers in the
manufacturing will be driven up by
capital formation and driven down by
additional workers entering the
manufacturing sector.

Implications
Eventually,

the wage rates of the


agricultural and manufacturing
sectors will equalize as workers
leave the agriculture sector for the
manufacturing sector, increasing
marginal productivity and wages in
agriculture whilst driving down
productivity and wages in
manufacturing.

Implications
The

end result of this transition


process is that the agricultural wage
equals the manufacturing wage, the
agricultural marginal product of
labour equals the manufacturing
marginal product of labour, and no
further manufacturing sector
enlargement takes place as workers
no longer have a monetary incentive
to transition

Surplus Labour and Growth of


Economy

ONPMis

the total product of labor. It is


divided between the OWPM (payments
to labor in the form of wages) and the
NPW (capitalist surplus).

Surplus Labour and Growth of


Economy

The

growth of the capitalist sector and


the rate of labor absorption from the
subsistence sector depends on the use
made of capitalist surplus. When the
surplus is reinvested, the total product
of labor will rise.

Surplus Labour and Growth of


Economy

The

marginal product line shifts upwards


to the right, that is toN1
Assuming wages are constant, the
industrial sector now provides more
employment. Hence employment rises
byMM1.

Surplus Labour and Growth of


Economy

The

amount of capitalist surplus goes up


fromWNPtoWN1P
This amount can now be reinvested and
the process will be repeated and all the
surplus labor would eventually be
exhausted

Surplus Labour and Growth of


Economy

When

all the surplus labor in the subsistence


sector has been attracted into the capitalist
sector, wages in the subsistence sector will
begin to rise, shifting the terms of trade in
favor of agriculture, and causing wages in
the capitalist sector to rise.

Surplus Labour and Growth of


Economy

When

all the surplus labor is exhausted, the


supply of labor to the industrial sector
becomes less than perfectly elastic. It is now
in the interests of producers in the
subsistence sector to compete for labor as
the agricultural sector has become fully

Surplus Labour and Growth of


Economy

It

is the increase in the share of


profits in the capitalist sector which
ensures that labor surplus is
continuously utilized and eventually
exhausted.

Surplus Labour and Growth of


Economy

Real

wages will tend to rise along


with increases in productivity and the
economy will enter into a stage of
self-sustaining growth with a
consistent nature.

Criticisms
Economic

development takes place


via the absorption of labor from the
subsistence sector where
opportunity costs of labor are very
low. However, if there are positive
opportunity costs, e.g. loss of crops
in times of peak harvesting season,
labor transfer will reduce agricultural
output.

Criticisms
Absorption

of surplus labor itself may


end prematurely because
competitors may raise wage rates
and lower the share of profit.
The Lewis model underestimates the
full impact on the poor economy of a
rapidly growing population.
Lewis seems to have ignored the
balanced growth between agriculture
and industry.

Criticisms
Possible

leakages from the economy


seem to have been ignored by Lewis.

The

transfer of unskilled workers


from agriculture to industry is
regarded as almost smooth and
costless, but this does not occur in
practice because industry requires
different types of labor.

Empirical Test & Practical


Application
Empirical

evidence does not always


provide much support for the Lewis
model.
Theodore Schultzin an empirical study of a

village inIndiaduring the influenza epidemic


of 191819 showed that agricultural output
declined, although his study does not prove
whether output would have declined had a
comparable proportion of the agricultural
population left for other occupations in
response to economic incentive.

Empirical Test & Practical


Application
The

Lewis model was applied to the


Egyptian economy by Mabro in 1967.
Despite the proximity of Lewis's assumptions

to the realities of the Egyptian situation


during the period of study, the model failed
firstly because Lewis seriously
underestimated the rate of population growth
and secondly because the choice of capital
intensiveness in Egyptian industries did not
show much labor using bias and as such, the
level of unemployment did not show any
tendency to register significant decline.

Empirical Test & Practical


Application
The

validity of the Lewis model was


again called into question when it was
applied to Taiwan
It was observed that, despite the

impressive rate of growth of the economy


of Taiwan, unemployment did not fall
appreciably and this is explained again in
reference to the choice of capital intensity
in industries in Taiwan. This raised the
important issue whether surplus labor is a
necessary condition for growth.

Empirical Test & Practical


Application
This

model has been employed quite


successfully inSingapore. Ironically
however it has not been employed in
Sir Arthur Lewis' home country ofSt.
Lucia

~The End