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New tools to understand the economies of poor countries

In 1954, Sir William Arthur Lewis put forward an argument that standard economic models are less relevant to poor countries. Their economies are in transition, from mainly traditional subsistence agriculture to a more modern industrialised economy. He said different tools are needed to explain how this transformation takes place. His work was one of the first contributions to the discipline of development economics, which developed in the 1950s and 1960s.

In his highly influential article - 'Economic Development with Unlimited Supplies of Labour', Lewis first set out his analysis of the way poor countries with surplus labour transform their economic structures. He later received the Nobel Prize for his work on the Lewis model also known as the two-sector model or dualism.

Lewis explains that many poor countries are characterised by a dual (or two-sector) economy consisting of a large, traditional (subsistence agricultural) sector and a small, modern (industrial) sector. Lewis rejects the neo-classical economics view that the quantity of labour is fixed and instead argues that there is an unlimited supply of labour (because of population pressures) in many poor countries. This keeps wages low. The traditional sector provides a large pool of cheap labour for the modern sector: this leads to high profits and growth in the modern sector.

In the Lewis model, countries in transition are characterised by:

• A 'dual' economy: modern industries exist alongside primitive technologies, modern towns alongside poor villages.
• An unlimited supply of unskilled labour, which includes the underemployed, the unemployed, women in the household and temporary increases in population.
• A 'subsistence' farming sector characterised by low wages, an unlimited pool of labour and low productivity because of the labour intensive production process.
• A 'capitalist' manufacturing sector characterised by higher wages, higher productivity and a need for more workers.
• Wage levels in the modern sector that only need to be slightly higher than earnings in the subsistence sector to attract workers (because of the unlimited supply of labour).
• The presence of surplus labour meant that farm workers can be removed from agricultural production without reducing agricultural output (because the extra output by having an extra farm worker or working an extra hour in the traditional sector is very low).

Lewis explains how the transition to a more modern economy occurs:

• Technological advances and capital formation in the modern sector result in increased profits (not higher wages).
• Profits are used to increase investment; this fuels further growth and employment in the sector.
• Eventually a turning point is reached when there is no surplus labour left.
• The dualistic nature of the economy then ends, with wages rising to reflect productivity.
  

Once the transition is complete, employers can keep wages low by encouraging immigration or exporting capital (outward foreign investment). Assessing the position of poor countries with surplus labour in international trade and investment, Lewis concludes:

• Inward foreign investment tends not to raise wages in the recipient country unless it raises productivity in sectors producing for the domestic market.
• The relatively low labour productivity in agriculture in poor countries makes it hard for them to benefit from international trade. Any benefits from increasing exports tend to go to consumers in the importing countries.
• Poor countries will benefit from policies designed to protect their economies from foreign competitors.

Original work by:
W Arthur Lewis

Further Information
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Source(s)
'Economic Development with Unlimited Supplies of Labour', The Manchester School, 22.2, pages 139-191, by W Arthur Lewis, 1954

June 2007

See also
Sir William Arthur Lewis (1915 - 1991): A brief biography and further links to his work, from Wikipedia

An autobiography on the official website of the Nobel Foundation

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