Dual-Sector Model (developing economies)

Sir William Arthur Lewis (23 January 1915 – 15 June 1991) published in 1954 what was to be his most influential development economics article, Economic Development with Unlimited Supplies of Labour (Manchester School). In this publication, he introduced what came to be called the dual sector model, or the "Lewis model".

Lewis combined an analysis of the historical experience of developed countries with the central ideas of the classical economists to produce a broad picture of the development process. In his theory, a "capitalist" sector develops by taking labour from a non-capitalist backward "subsistence" sector. 

The "subsistence" sector was defined by Lewis as "that part of the economy which is not using reproducible capital". It can also be adjusted as the indigenous traditional sector or the "self employed sector". The per head output is comparatively lower in this sector and this is because it is not fructified with capital. The "Dual Sector Model" is a 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 labour, promotes industrialization and stimulates sustained development.

In the model, the subsistence agricultural sector is typically characterized by low wages, an abundance of labour, and low productivity through a labour-intensive production process. 

Lewis defined the "capitalist" sector as "that part of the economy which uses reproducible capital and pays capitalists thereof". The use of capital is controlled by the capitalists, who hire the services of labour. It includes manufacturing, plantations, mines etc. The capitalist sector may be private or public.

In contrast to the "subsistence" sector, the capitalist manufacturing sector is defined by higher wage rates as compared to the subsistence sector, higher marginal productivity, and a demand for more workers. Also, the capitalist sector is assumed to use a production process that is capital intensive, so investment and capital formation in the manufacturing sector are possible over time as capitalists' profits are reinvested in the capital stock. 

Improvement in the marginal productivity of labour in the agricultural sector is assumed to be a low priority as the hypothetical developing nation's investment is going towards the physical capital stock in the manufacturing sector.

The subsistence sector is governed by informal institutions and social norms so that producers do not maximize profits and workers can be paid above their marginal product. At an early stage of development, the "unlimited" supply of labour from the subsistence economy means that the capitalist sector can expand for some time without the need to raise wages. This results in higher returns to capital, which are reinvested in capital accumulation. In turn, the increase in the capital stock leads the "capitalists" to expand employment by drawing further labour from the subsistence sector. 

Assumptions

1. The model assumes that a developing economy has a surplus of unproductive labor in the agricultural sector.
2. These workers are attracted to the growing manufacturing sector where higher wages are offered.
3. It also assumes that the wages in the manufacturing sector are more or less fixed.
4. Entrepreneurs in the manufacturing sector make profit because they charge a price above the fixed wage rate.
5. The model assumes that these profits will be reinvested in the business in the form of fixed capital.
6. An advanced manufacturing sector means an economy has moved from a traditional to an industrialized one.

Given the assumptions of the model (for example, that the profits are reinvested and that capital accumulation does not substitute for skilled labour in production), the process becomes self-sustaining and leads to modernization and economic development.

The primary relationship between the two sectors is that when the capitalist sector expands, it extracts or draws labour from the subsistence sector. This causes the output per head of labourers who move from the subsistence sector to the capitalist sector to increase. Since Lewis in his model considers overpopulated labour surplus economies he assumes that the supply of unskilled labour to the capitalist sector is unlimited. This gives rise to the possibility of creating new industries and expanding existing ones at the existing wage rate. A large portion of the unlimited supply of labor consists of those who are in disguised unemployment in agriculture and in other over-manned occupations such as domestic services, casual jobs, petty retail trading. Lewis also accounts for two other factors that cause an increase in the supply of unskilled labour, they are women (confined to) the household and population growth.

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 of land. As a result, the agricultural sector has a quantity of farm workers who are not contributing to agricultural output since their marginal productivities are zero. 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. (The term surplus labour here is not being used in a Marxist context and only refers to the unproductive workers in the agricultural sector.) Therefore, due to the wage differential between the capitalist and subsistence sector, workers will tend to transition from the agricultural to the manufacturing sector over time to reap the reward of higher wages. However, even though the marginal product of labor is zero, it still shares a part in the total product and receives approximately the average product.

Relationship between the two sectors = impact 0f shifting supply of labourers: If a quantity of workers moves from the subsistence to the capitalist sector equal to the quantity of surplus labour in the subsistence sector, regardless of who actually transfers, general welfare and productivity will improve (because only surplus labour has shifted). Total agricultural product will remain unchanged while total industrial product increases due to the addition of (surplus agricultural) labour, but the additional labour also drives down marginal productivity and wages in the manufacturing sector. 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. Eventually, the wage rates of the agricultural and manufacturing sectors will equalize as (no longer surplus) workers leave the agriculture sector for the manufacturing sector, increasing marginal productivity and wages in agriculture whilst driving down productivity and wages in manufacturing. 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.

The model assumes rationality, perfect information and unlimited capital formation in industry. These do not exist in practical situations and so the full extent of the model is rarely realised. However, the model does provide a good general theory on labour transitioning in developing economies.

Surplus labour can be used instead of capital in the creation of new industrial investment projects, or it can be channeled into nascent industries, which are labour-intensive in their early stages. Such growth does not raise the value of the subsistence wage, because the supply of labor exceeds the demand at that wage, and rising production via improved labour techniques has the effect of lowering the capital coefficient. Although labour is assumed to be in surplus, it is mainly unskilled. This inhibits growth since technical progress necessary for growth requires skilled labor. But should there be a labor surplus and a modest capital, this bottleneck can be broken through the provision of training and education facilities. The utility of unlimited supplies of labour to growth objectives depends upon the amount of capital available at the same time. Should there be surplus labour, agriculture will derive no productive use from it, so a transfer to a non-agriculture sector will be of mutual benefit. It provides jobs to the agrarian population and reduces the burden of population from land. Industry now obtains its labour. Labour must be encouraged to move to increase productivity in agriculture. To start such a movement, the capitalist sector will have to pay a compensatory payment determined by the wage rate that people can earn outside their present sector, plus a set of other amounts includes the cost of living in the new sector and changes in the level of profits in the existing sector. The margin capitalists may have to pay is as much as 30 per cent above the average subsistence wage.

The point at which the excess labor in the subsistence sector is fully absorbed into the modern sector, and where further capital accumulation begins to increase wages, is sometimes called the Lewisian turning point. It has recently been widely discussed in the context of economic development in China.

The Lewis turning point is a situation in economic development where surplus rural labor is fully absorbed into the manufacturing sector. This typically causes agricultural and unskilled industrial real wages to rise. Shortly after the Lewis point, an economy requires balanced growth policies.

Typically, reaching the Lewis turning point causes an increase in the wage bill and the functional distribution favoring labor. However, in some cases such as in Japan from 1870 to 1920, agricultural labor productivity increased significantly and produced a labor surplus, dampening the rise in real wages.

According to a study by Zhang and Yang, China reached the Lewis point in 2010; cheap labor in the country has rapidly decreased and real agricultural wages have substantially increased. Despite its large population, in the early 2010s China faced labor shortages, and real wages nearly doubled since 2003. Such rapid rise in wages for unskilled work is a key indicator of reaching the Lewis point. However, other journals such as the China Economic Review claim that China has not reached the Lewis point, comparing the effect of the Lewis point in China to the Japanese experience. A 2013 working paper by the International Monetary Fund predicts the Lewis point in China to "emerge between 2020 and 2025".

In their 2017 book Artificial Intelligence and Economic Theory: Skynet in the Market, Tshilidzi Marwala and Evan Hurwitz used Arthur Lewis theory to understand the transition of the economy into the Fourth Industrial Revolution where much of the production in the economy is automated by artificially intelligent machines. In this regard, they identified an equilibrium point, i.e. Lewis turning point, where automating human labor does not result in additional economic benefit.

Surplus labour and the growth of the economy .
Capital accumulation .
Criticism .
Empirical tests and practical application of the Lewis model .

Economics .

Middle income trap .

Development economics .
Technological dualism .
Fei–Ranis model of economic growth .
Social dualism .

Democratic Socialism in US ..   

Dual-Sector Model (developing economies) ..

Economies of Nations ..