Chapter Four:

Structural Change and Dualistic

Economy
Lecture Note: Dev’t Economics
By Dr. Teshome Adugna
 4.1 Rostow’s Stages of economic growth
• In Modernization theory, problems that held back the
industrialization of poor countries were related to the
“irrational” way in which resources were allocated in a
traditional society.
• Traditional societies became modern by rationalizating
resource allocation, and by the elimination of cultural,
institutional and organizational roadblocks that did not allow
countries to develop.
Cont.
• Positivist evolution implied that all societies would pass
through the same set of stages that the western society had
passed: from a traditional to a modern society.
• W. Rostow identified five stages of modernization:
1) The traditional society,
2) Preconditions for take-off,
3)Take-off,
4) The drive to maturity, and
5) The age of high mass consumption.
Cont.
• Traditional Society:
• The economy is dominated by subsistence activity where output
is consumed by producers rather than traded
• Economic change and improvement are not sufficient to increase
output per capita.
• Resource allocation is determined very much by traditional
methods of production.
• Most of the economy is oriented toward producing primary
products
– i.e. Agriculture, Fuel, Forestry, Raw materials
• Majority of people live and work in rural sectors
• Literacy is low
• Any trade is carried out by barter where goods are exchanged
directly for other goods
Cont.
• Transitional Society: The pre-condition to take off
• Transition society has some sort of association with cultures.
Such cultures include various transfers of more developed
nations’ values, attitudes, institutions, best practices, technology,
foreign aid, foreign direct investment etc
• The economic transitions are accompanied by the evolution of
new political and social institutions that support the
industrialisation
• Development of Physical and social infrastructure has begun in a
small but important way.
• Increased specialization generates surpluses for trading.
• As incomes, savings and investment grow entrepreneurs emerge.
External trade also occurs concentrating on primary products.
Cont.
• Takeoff Society:
• At this stage, nations experience an accelerated growth rate.
• Improvement in production leads to expansion of supporting
and related industries
• Capital stock is very active and dynamic
• Some key sectors generate sufficient capital to finance further
growth
• Nations need to obtain foreign exchange to finance many
developmental projects
• Export typically accounts for a very high percentage of the
annual flow of total foreign currency earnings
• Physical and social infrastructure have been developed to
sustain steady development
Cont.
– Industrialisation increases, with workers switching from
the agricultural sector to the manufacturing sector.
– Growth is concentrated in a few regions of the country and
in one or two manufacturing industries.
– The level of investment reaches over 10% of GNP.
Cont.
• Technological Maturity:
• The economy is effectively applying modern technology to
the full range of its economic activities
• Unskilled labor and capital-intensive industries are
replaced by more skilled labor as well as more advanced
technology-intensive industries
• Productivity and wages increase very rapidly.
Technological innovation is providing a diverse range of
investment opportunities.
• The economy is producing a wide range of goods and
services and there is less reliance on imports.
Cont.
• High Mass Consumption:
– Per capita income has increased to levels that provide
purchasing power beyond that of basic necessities
– The economy is geared towards mass consumption. The
consumer durable industries flourish.
– The service sector becomes increasingly dominant.
– Consumers start shifting their attention from the quantity of
products to the quality of products in order to augment
quality of life
Cont.
• According to Rostow development requires substantial
investment in capital.
• For the economies of LDCs to grow the right conditions for
such investment would have to be created.
• If aid is given or foreign direct investment occurs at stage 3
the economy needs to have reached stage 2.
• If the stage 2 has been reached then injections of investment
may lead to rapid growth.
 Then what was Rostow’s argument?

• The following was the major argument of Rostow’s stage of

economic growth.
– All advanced countries already through the take-off stage.
– LDCs still in the traditional or "pre-conditions" stage.
– LDCs only need to follow certain set of rules to move into
take-off stage.
– Principal strategy for development: Generate high levels of
domestic and foreign saving to generate sufficient
investment to accelerate economic growth. (But how?)
 Limitations

• Many development economists argue that Rostows’s model

was developed with Western cultures in mind and not
applicable to LDCs.
• In reality policy makers are unable to clearly identify stages as
they merge together. Thus as a predictive model it is not very
helpful.
• Saving and investment are NECESSARY but not
SUFFICIENT conditions for growth.
• The importance of external, international influences.
 4.2 Labour Surplus and Migration models
• Theoretically, migration is defined simply as a process of personal
movement from one area to another.
• Rural-to-urban migration in particular is the process of rebalancing
economic resources (human and physical ones) in order to set up a new
stage of economic development.
• Economists consider rural-to-urban migration as a process of labor
movement from less-developed to more advanced areas.
• Industrialization always takes place in urban areas, and as soon as it
starts, the labor force in urban areas becomes scarce, and it needs to be
supplemented by labor from rural areas.

•
Cont.
• For the purpose of our discussion, we classify the different
theoretical frameworks in which internal migration has been
modeled into two types:
– the first type covers the dual economy models which
emerged in the 1950s ; and
– the second type covers the Harris-Todaro models
developed in the 1970s .
• Lewis model, internal migration removed ‘disguised
unemployment’ from rural areas and enabled the transition to
a modern economy. In Todarian models, the focus is on
explaining the existence of unemployment in urban areas and
its link with internal migration.
 Lewis rural -urban migration model
• The first theoretical work involving rural to urban migration is
the Lewis (1954) model of development which tries to explain
the transition from a stagnating economy based on a
traditional rural sector to a growing economy driven by the
development of a modern urban sector.
• Lewis viewed development process as a structural change
involving transformation of primarily agricultural economy to
an industrial one.
• Lewis assumes that rural economies initially present a specific
context in which there is ‘surplus labor’ in the agricultural
sector, so that marginal productivity in that sector is close to
zero.
Cont.
• The engine of development is industry and development
requires rapid growth of industry. The growth of industry
depends on three things:
1. Capital accumulation and investment in industry
2. Availability of labor to industry
3. Availability of food to industrial workers
 Lewis Model: Main Assumptions

• Two-Sectors (two goods): Agriculture and Industry.

• Diminishing marginal productivity of labor in both sectors.
• Dual Economy: Underdeveloped economies are characterized
by dualism which is coexistence of traditional and modern
sectors.
• Interaction between agriculture (traditional sector/rural) and
industry (modern sector/urban) in the development process.
• Role of capital investment in industry, rural-urban migration,
and agricultural surplus in the development process.
Cont.
• Traditional sector is characterized by:
– backward or traditional technology and low capital intensity.
– The production is normally organized on the basis of family
labor with overall output distributed not in the form of wages
and profits, but in the form of shares that accrue to each family
member.
– Producers in this sector maximize family income and not profit.
• Modern sector on the other hand is characterized by:
– advanced technology and relatively high-capital intensity.
– Producers in this sectors are profit maximizes.
• Given these assumptions, the agricultural sector is able to supply a
perfectly elastic labor force to the modern industrial sector.
Cont.
• The figure 4.1 below show that labor supply is infinitely
elastic, which ensures a constant low wage OW fixed below
the labor productivity trend OP but significantly above the
average product (or income) OWa in peasant agriculture.
• So that OW/OWa>1 is the ratio of the industrial wage to
income level in peasant agriculture.
• Given OP=MPL in capitalist industry and employment level
in industry equal to OL, total industrial product amounts to
OPEL and wage bill to OWEL, so that the capitalist surplus
amounts to OPEL – OWEL=WPE.
 Figure 4.1: Lewis urban wage determination

wage
p

E
w Ls  

pL ( k )
w A

O L Employment
Cont.
• In figure 4.2, the capitalist surplus expands continuously as
extra surplus labor is absorbed into industrial wage
employment at a constant low wage OW.
• On the other hand, shifts in the industrial output curve P(K) is
directly determined by shifts in the industrial capital stock
( investment), assumed to be a direct constant proportion of
capitalist surplus (profits).
• That is, expansion in the capitalist surplus supplies the savings
to finance the growth of capital stock (productive capacity) to
absorb surplus labor in agriculture, which, in turn, increases
the capitalist surplus and, hence, enlarging further the capital
stock and growth rate of industry.
 wage
p3 L s

p2
p1
w2
p
w1
E Ls  
w
pL ( k 3) pL ( k 4 ) pL ( k 5 )
pL ( k 2 )
w pL ( k ) p L ( k 1)
A

O L L1 L 2 L 3L 4 L 5 L 6 Employment

Figure 4.2: Industrial capital accumulation and labor absorption in

Lewis’s Dual Economy Model
Cont.
• After L surplus labor in agriculture is fully exhausted;
4

consequently, the labor supply curve becomes positively

sloped.
• This indicate that additional labor supply to industry is only
feasible at higher wage rates (reflected in shifts of the wage
rate curves from OW to OW1 to OW2).
 Lewis Model: Criticism

• Does surplus labor really exist?

• Limited role of agriculture in the development process
• Wage determination in agricultural sector
• How to transfer agricultural surplus from agriculture to
industry:
(i) agricultural taxation;
(ii) agricultural pricing policy?
 Harris-Todaro Model
• Harris and Todaro (1970) presented a static framework version
of the Todaro model in which the interaction between the rural
and urban sectors is more detailed.
• This model tried to observe the relationship between urban
employment and unemployment with rural-urban migration.
 Critical Assumptions
• Two-Sectors (two goods): Rural and Urban. Rural sector
produces agricultural goods and the urban sector produces
manufactured goods.
• Marginal product of labor in both agriculture and
manufacturing is positive and depends on the amount of labor
employed in both the sectors. Diminishing marginal
productivity.
• Producers in both sectors are profit maximizes.
• Full employment in the rural sector.
• In the urban sector, employers must pay at least the mandated
minimum wage. Introduces the possibility of unemployment in
the urban sector (source of inefficiency).
• Migration is positively related to the urban-rural real income
differential.
Cont.
• Todaro rural-urban migration is shown in the figure 4.3 below.
The model assume that there is only two sector, rural
agricultural and urban manufacturing sector. The demand for
labour( the marginal product of labour curve) in Agricultural
is given by the negatively slope line AA’.
• Labour demand in manufacturing is given by MM’. The total
labour force is given by line OAOM.
• In a neo-classical, flexible, wage, full employment market
economy, the equilibrium wage would be established at
wA = wm* ,withOA O workers in agriculture and Om L
*
m m

workers employed in urban manufacturing. All available

workers are therefore employed.
 Figure 4.3 : The Harries –Todaro Migration Model

A M

Manufacturing wage rate

q'
Agricultural wage rate

z w m

w
A E
w *

A
q w *

w **

A
M' A'
L
O L L*A L
O
* m

A m
A m

Lus
Cont.
• But what of urban wages are institutionally, determined as
assumed by Todaro at a level of wm ,which is above wm . If for
*

the moment we continues to assume that there is no

unemployment,OmL workers would get urban jobs and the
m

rest,OA L ,would have to settle for rural employment ofOA w

**

m A

Ow
*

A
A

wage(below the free-market level wm ofw ). Sowmnow we have

**

an urban-rural real wage gap of - ,with

OmL were free to migrate then
institutionally fixed. If rural workers
m

despite the availability of only jobs, they are willing to

take their chance in the urban job lottery.
Cont.
• If their chance(probability) of securing one of these favoured
jobs is expressed by the ratio of employment in
manufacturing Lm ,to the total urban
kk labour pool,Lus,then the
expression:
L
w  ( w )................4.1
m

L
A m

us

• The equation 4.1 shows the probability of urban job success

L
necessary to equate agricultural income m
( w ) ,thus
L between job
m

causing a potential migrant to be indifferent

us

locations.
• The locus of such points of indifference is given by the qq '
curve in above figure.
Cont.
• The new unemployment equilibrium now occur as
z
point ,where the urban-rural m A
wis OA- L ,
actual wagewgap A

workers are still in the agricultural sector andOmLm of these

workers have modern(formal) sector jobs payingw wages.
- OLm m ,are either unemployed or engaged in low
m

The rest,OLm A

income informal-sector activities.

• This explain the existence of urban unemployment and the
private economic rationality of continued rural to urban
migration despite this high unemployment.
 Characteristics of Todaro model
• To sum up, the Todaro Migration model has four
basic characteristics.
 Migration is stimulated primarily by rational economic consideration of
relative benefits and costs, mostly financial but also psychological.
 The decision to migrates depends on expected rather than actual urban-rural
wage differential where the expected differentials is determined by the
interaction of two variables, the actual urban-rural wage differential and the
probability of successfully obtaining employment in the urban sector.
 The probability of obtaining an urban job is directly related to the urban
employment rate and thus inversely related to the urban unemployment rate.
 Migration rate in access of urban job opportunity growth rates are not only
possible, but also rational and even likely in the face of wide urban-rural
excepted income differentials. High rate of urban unemployment are
therefore inevitable outcome of the serious imbalance of economic
opportunities between urban and rural area in most underdeveloped
countries.
 Policy Implications of Todaro model

• Urban bias in the development policy aggravates the urban

unemployment problem.
• Faster job-creation in the urban formal sector is insufficient
solution to the urban unemployment problem.
• Providing wage subsidy to the urban formal may increase
urban unemployment.
• Optimal policy requires either a mix of wage subsidy to the
urban formal sector and restriction on migration or wage
subsidy to both the urban formal sector and agriculture.
 4.3 Kalder’s Growth Law
• Kaldor’s analysis of development hinges on four fundamental
concepts:
– increasing returns in the manufacturing sector;
– effective demand-constrained growth;
– the agriculture-industry relationship; and
– internal-external market relations.
• In terms of development policies, Kaldor believed that:
– economic development requires industrialization;
– this in turn presupposes an ‘agriculture revolution’;
– entering into the global market with a temporary stage of
protection for newly established industries;
– this must be accompanied by export-led growth policies.
Cont.
• Kaldor developed four ‘empirical laws’:
– the first law is Manufacturing Sector as the Engine of
Growth’
• He found evidence that manufacturing industry is the
engine of growth for every country at every stage of
growth.
– the second law is the more the output of the manufacturing
sector grows the greater is the increase of productivity in
the system as a whole.
Cont.
• There are three external reasons:
– first, because the growth of manufacturing provides
capital goods and hence technical advances embodied in
them as input for other sectors;
– second, because an increase in output and employment in
the manufacturing sector reduces the employment in
agriculture but not its output; and
– third, because greater activity in the manufacturing sector
produces greater turnover per worker in the distribution
sector.
• The third law, the industry-agriculture relation.
• The last law is export growth increase economic growth.
4.1 Dualism, center-periphery models and
the process of cumulative causation
Dualism
• Dualism may be characterized by the coexistence of a modern
sector and a traditional sector within the framework of the
same economic system.
• In other ward, dualism refers to economic and social division
in the economy. such as;
– Difference in technology between sector or regions
– Difference in the degree of geographic development
– Difference in social custom and attitudes between an indigenous and
an imported social system.
• Dualism in all its aspects is a concomitant of the growth of a
money economy.
Cont.
• Basically, therefore a dual economy is characterised by
– A difference in social custom between the subsistence and
exchange sectors in the economy.
– A gap between the level of technology in the rural
subsistence sector and the industrial monetized sector.
– A gap in the level of per capita income between region of
the country.
• There are three types of dualism
– Geographic dualism
– Social dualism
– Technological dualism
 Technological Dualism
• The major cause of labour employment problem is the
existence of technological dualism.
• Technological dualism refers to the use of different production
function in the advanced and traditional sectors.
• In this interpretation, dualism is associated with structural
unemployment or technological unemployment. This is a
situation in which productive employment opportunity are
limited, not because of lack of effective demand, but also
because of resource and technological restraint in the two
sector(traditional and modern sectors).
• The figure below show the fixed combination of capital and
labour.
Cont.
• The line OE joining the points a,b,c, etc., representing the
expansion path of the sector and its slop is equal to a constant,
relatively capital intensive factor ratio.
• If the actual facor endowment is the right of line OE-say, at
point F-there must then be some unemployment of labour in
this sector.
• To produce an output of q1, the sector will use OK1 units of
capital and OL1 units of labour ; even though OL2 units of
labour are available, the excess supply of labour will have no
effect on production techniques and L1L2 units of labour will
remain in excess supply, regardless of the relative factor prices
of capital and labour.
Capital

K a

L1 L2
labour
 Centre-Periphery Model

• According to the centre-periphery model, the world is

comprised of the two sectors-the centre and the periphery-in
which production structure are very different from each other.
• In the periphery, backward sector(with low productivity and
backward production) coexist with the modern sectors and
high productivity levels.
• The periphery also tend to export a small range of products
and to benefit from very few linkage(horizontal or vertical).
• At the centre, on the other hand, production structure are
modern throughout and cover a wide range of capital,
intermediat and consumer goods.
Cont.
• The difference in the productivity result in an international
division of labour, with the periphery producing and exporting
primary product and a core specialization in manufactures.
The lower export price for periphery state.
• This would lead to a transfer of income from the periphery to
the centre.
• Finally, the income elasticity of demand was higher for
manufactures than for primary products. Therefore, whenever
the periphery grew faster than the centre, it would import more
and incurs recurrent trade deficit.
• Protection is needed to counter this.
 The process of cumulative causation
• A major component of the foundation of the neo-classical
system of economics thought is the notion that free market
economics tends to move to wards “equilibrium” to stay in
equilibrium once established and return to “equilibrium” if
temporarily dislodged by some “shock” emanating from
outside the system.
• Far from a market system generating forces that will return it
to equilibrium when disturbed, the new argument maintains, it
is more likely to generate a process of cumulative causation
that will carry it further and further away from equilibrium.
Cont.
• Cumulative causation refers to the unfolding events connected
with a change in the economy. These change apply to a whole
set of variable as a consequence of the multiplier effect.
• Thus, the location of a new factory may be the basic of more
investment, more jobs both in that factory and in ancillary and
service industries in the area, and have a better infrastructure
which would, in turn attract more industry.
• The figure below illustrate cumulative causation as envisaged
by G.Myrdal(1957).
 New Industry
More job

Improved
External infrastructure
Population economies
outflow
More Ancillary
skilled industry
labour
Rise in Increased
demand government
revenue

Increased More service More wealth

investment industries
Cont.
• Expansion of one region may have either favourable or
unfavourable effect on other regions. Myrdal calls these
“spread effect” and “backwash effects” respectively .
• Given the coexistence of the spread effects and backwash
effect, tree possibility may emerge;
– If the two kind of effects balance each other, the current
special pattern of income distribution will persist .
– If the spread are stronger than the backwash effect, the
process of cumulative causation will lead to the
development of new economic centre, and hence
convergence.
Cont.
– In the case in which backwash effect outweigh spread
effect market forces will lead to polarization or divergence
• Inverted U shape of the growth of the economy and regional
inequality. Initially when the economy grow, the inequality
became higher, if the economy continue to grow, the regional
inequality begin to decline.
 4.5 Theories of dependency and unequal
exchange
• Dependency theory is based on the notion that resources are
flowing from a "periphery" of poor and underdeveloped states
to a "core" of wealthy states, enriching the latter at the expense
of the former.
• It is a central contention of dependency theory that poor states
are impoverished and rich ones enriched by the way poor
states are integrated into the "world system".
• These theories attempts to explain the perpetuation and widening of
the difference between centre and periphery.
• Dependency refers to a situation in which the economy of certain
countries in conditioned by the development and expansion of
another economy in which the former is subjected.
Cont.
• The dependency and unequal exchange relation is related to
the characteristics of trade; but there are many other important
dimensions to the argument.
– The dependency on foreign exchange
– The dependency on foreign technology
– The decline in terms of trade
– The impact of neo-colonialism influence in developing
countries.
 Form of dependency
• There are different forms of dependency can be
distinguished, as they have evolved historically;
– Colonial dependency
– Financial-industerial dependency
– Technological-industerial dependency
 Limitation of dependency theory
• Some free-market economists said that dependency theory
leads to:
– Corruption. Free-market economists hold that state-owned
companies have higher rates of corruption than privately owned
companies.
– Lack of competition. By subsidizing in-country industries and
preventing outside imports, these companies may have less incentive
to improve their products, to try to become more efficient in their
processes, to please customers, or to research new innovations.
– Unsustainability. Reliance of industries on government support may
not be sustainable for very long, particularly in poorer countries and
countries which largely budget out of foreign aid.
Cont.
– Domestic opportunity costs. Subsidies on domestic industries come out
of state coffers and therefore represent money not spent in other ways,
like development of domestic infrastructure, seed capital or need-based
social welfare programs. At the same time, the higher prices caused by
tariffs and restrictions on imports require the people either to forgo
these goods altogether or buy them at higher prices, forgoing other
goods
 Unequal exchange
• The unequal exchange was introduced by Emmanuel in 1972.
• Exchange is unequal between rich and poor countries because
wage are lower in poor countries and lower than if the rate of
profit in poor countries was not as high as in rich countries.
• In other words, exchange is unequal in relation to a situation
where wages would be equalized
• In order to explain the above idea with suitable diagram, let
us take two countries and call them “centre”(c) and
“periphery” (p). Assume that prices in the two countries are
based on a percentage mark-up (r) on unit labour cost, so that
 L
p  w ( ) (1  r )
O
c c c c

and
L
p  w ( ) (1  r )
O
p p p p

• Where w is the money wage rate and wL/O is wage per unit of
output. Now assume for institutional reasons wc  wp and that
the mark-up or rate of profit equalizes between the two
countries.
Cont.
• In the centre, the given rate of profit (r )wage rate ( wc )gives a
constant price ( pc )
• In the periphery, at a give wage rate ( wp ) there is a positive
relation between the rate of profit and terms of trade(P) given
by upward sloping line ( wp )
• An increase in the periphery wage shifts the periphery
rightward to w giving a new terms of trade, p2 at the same
1

rate of profit.
• Unequal exchange is measured as the difference between the
actual terms of trade p and what it would be if wages were
1

higher in the periphery and the rate of profit was lower at r

1
 r ( wp ) w 1

(r ) ( wc )

r 1

p1 p2 Terms of trade