Udviklingsøkonomi - grundfag

Lecture 09

Two-sector dual-economy models

Lewis model with extensions by Ranis and Fei

Interplay between agriculture and industry

1

Basic premises here

Accepting the’modern’ capitalist society as the end goal

Development taken to = economic growth

Developemnt is tehrefore transformation from traditional to modern

Capital accumulation and savings the key to growth

Focus on the class of capitalist and entrepreneurs that invest and create the modern society

Clear rationale for development aid

2

Lewis 2-sector model of development with unlimited supply of labour

Capitalist-sector

”Modern sector, industry”

Use capital

Employes workers

Profit oriented (wage=MP)

W. Arthur Lewis, 1958

Subsistence-sector

”traditional sector, agriculture”

Does not use capital

Use family labour

Wage not equal to MP

Surplus labour

Due to rural surplus labour the capitalists can hire (unlimited) amount of labour at a wage equal to the subsistence wage plus a markup

3

Surplus production of food

Two central assumptions:

1. Traditional sector has surplus labour

2. Traditional sector pays the average product (income sharing)

Capitalists invest their profits. This increases the amount of capital in the formal sector and pushes upwards the marginal product curve

MP of rural labourAs surplus labour disappears,

the rural marginal product will increase

The Lewis model in Basu’s extensionAn alternative representation of

the Lewis modellen

w

Løn

og m

argi

nal p

rodu

kt

A1

L1

At the end (to the right of LT) , wages in both sectors increase together

LT0M 0R

MP of urban labour

Total labour force

Critique:

Is the entire profit invested?

Rural wages may stay low for a long time!

Neglect of agriculture – can it deliver the required food???

A2

B1 B2

L2

n

4

Labour force in traditionel/modern sector

Lewis model and policy

• Savings and investment – strengthen the capitalists

• Wage / income policy – modesty required

• Price policy – avoid interventions that damage industry

• Agricultural policy – neglect agriculture as long as there is surplus labour

• Industrial policy - provide support, for example through subsidies and trade protection

5

Discussion:

Distributional implications?

Who will demand indstrial goods?

Is labour really in ”surplus”?

6

Ranis-Fei

Lewis model overlooks the importance of agriculture

There is a risk of neglecting agriculture, becauseFalling agricultural

surplus: too little production

Terms of trade may change to the benefit of agriculture

(there are also distribution and poverty arguments for a rural focus)

3 phases

A surplus labour (MPL=0)

B Disguised unemployment, underemployment (MPL< W)

C Commercialisation of the ”traditional sector” (MPL= wage)

7

8

Intuition behind the Ranis-Fei model

After a while, as labour leaves agriculture: Food production will fall For a given food demand, and

assuming away imports, this will lead to

Declining terms of trade for industry

Rise in modern sector wage (w*) This slows down industrial growth

9

Ranis-Fei – discussion

When labour leaves agriculture, the rural average product (AVPL) will rise, so then why does the rural wage, w not increase?

Weakness of the model If the rural wage were to rise, this would be a problem for the

industrialisation scenario; would put upwards pressure on the industrial wage (w*) (also in phase A with surplus labour)

Solutions: either

1. Tax agriculture to reduce agricultural surplus and avoid rise in w, w*, or

2. Invest in agriculture, expand production to avoid the terms of trade go against industry

10

Policy discussion – rural versus urban

Example Rural growth in China Constant agricultural

problems in the Soviet

Is heavy taxation of the agricultural surplus a good idea?

Short run – it is good for industry

Long run Reduced investment in

agriculture Rural stagnation Industrial terms of trade is

worsened Worse prospects for

industrialisation

Conclusion: Stimulation of agriculture is required

How?

•Decent prices

•Investment

•Infrastructure

•New technologies