QUESTION-1

“The development economists made distinction between Economic Growth and Economic
Development which were earlier considered as synonymous. Developing countries have the
dual challenge of boosting the growth of its economies while maintaining a minimum
standard of development of the country. Whereas, in case of the developed economies,
Growth is their main cause of concern.”

Interpret the above statement in your own words considering your opinion on Economic
Growth and Economic Development highlighting the evidences of different developing and
developed economies.

Economic Growth

Often used interchangeably, Economic growth and Economic development are altogether
different but related concepts. Economic Growth could be termed as an increase in the
amount of goods and services being produced in an economy during a specific period of time
due to various reasons like increase in the quality of resources (by education etc.), increase in
the quantity of resources & improvements in technology or in another way an increase in the
value of goods and services produced by every sector of the economy. Economic Growth is
usually measuring in term of countries’ GDP (Gross Domestic Product) i.e. increase in total
income earned in the country in a given year or GNP/GNI (Gross National Product/Gross
National Income) i.e. the total income earned by a country's citizens. Economic Growth is a
necessary condition for economy of country but its not sufficient in itself.

Economic Development

Economic Development, on the other hand, refers to an increase in living standards,

improvement in self-esteem needs and freedom from oppression as well as a greater choice. It
refers to such action by policymakers which eventually promote the health, health, political,
and social well-being of a specific area. It leads to development and improvement in literacy
rates, life expectancy, unemployment, and poverty rates. Such actions can also involve
multiple areas including development of human capital, critical infrastructure, regional
competitiveness, environmental sustainability, social inclusion, safety, and other initiatives
within an economy. Economic development leads to the economic growth of a country. It is
usually associated with rising incomes and related increases in consumption, savings, and
investment.
Differences and relationship

Economic Growth is a relatively narrower concept than economic development. Economic

Growth could be termed as a normative concept since it could apply in the context of people's
sense of morality i.e. right and wrong or good and bad. Economic Growth is more concerned
with market productivity and rise in GDP whereas economic development is a policy
intervention endeavour with aims of economic and social well-being of people. As pointed
out by Amartya Sen, Economic growth could be considered to be one aspect of the process of
economic development. Economic growth and development are a two-way relationship. The
first chain consists of economic growth benefiting human development with the rise in
economic growth, families and individuals will likely increase expenditures with increase in
incomes, which in turn leads to growth in human development.

Concisely, the relationship between human development and economic development can be
explained in three ways. First, increase in average income leads to improvement in health and
nutrition (known as Capability Expansion through Economic Growth). Second, it is believed
that social outcomes can only be improved by reducing income poverty (known as Capability
Expansion through Poverty Reduction). Lastly, social outcomes can also be improved with
essential services such as education, healthcare, and clean drinking water (known as
Capability Expansion through Social Services). With regard to idea of economic growth and
overall development, there are some widely debated issues were some state that negative
effect of growth on low income groups, stressing the need for new approaches to economic
development that will allow the poor to benefit more from economic growth than they do at
present. Others are more optimistic, believing that the benefits of current models for growth
will eventually 'trickle down' to poorer groups in society, if they are not already doing so.

However, the corelation between the Economic Development and Economic Growth is hard
to measure since in developing countries where the capacity to gather and analyses data is
often very weak, Poverty and income distribution are hard to measure. There is also
controversy about the mechanisms by which economic growth may reduce poverty, the
timing of these and the policy implications.

Measures & Factors of economic development

To measure the economic development, we usually take into consideration the

  GDP per capita,
 Literacy Rates
 Levels of literacy and education standards,
 Levels of healthcare e.g. number of doctors per 1000 population
 Quality and availability of housing
 Levels of environmental standards
 Life expectancy

Human Development Index (HDI) is another method to measure the development which
takes into account all these factors which affect productivity and could lead to Economic
Growth. HDI combines the Life Expectancy Index, Education Index (Mean and expected
years of schooling) & Income Index (GNI at PPP). These factors lead to the creation of more
opportunities in the sectors of education, healthcare, employment and the conservation of the
environment. It implies an increase in the per capita income of every citizen.
Factors affecting economic growth in developing countries
 Savings & Investments: - Higher savings often lead to more funds for investment
which helps the economic growth.
 Infrastructure: - Infrastructure is another factor that affects the economy since
availability of factors such as transport and communication help in determining the
overall growth of economy.
 Corruption: - Levels of Corruption i.e. what percentage of tax rates are actually
collected and spent on public services is another factor affecting growth
 Inwards investment: - Inward investment could help a developing country to procure
raw materials which their economy needs for development for example USA has
invested in many African countries to help export raw materials, that its economy
needs. This flow of foreign aid and investment. Targeted aid, can help improve
infrastructure and living standards.
 Educational standards and labour productivity. Basic levels of literacy and
education can determine the productivity of the workforce.

Difference in growth between Developing and Developed economies

It is usually seen through statistics that most developed countries are usually those with the
highest GDP per capita. Clearly this doesn’t showcase the whole picture due to the fact that
growth in GDP per capita could result from growth in the incomes of richer groups in society,
with incomes of poorer groups remaining largely unchanged. This growth overlaps with
spending patterns skewed towards the rich excluding the poor. This indicates that growth in
growth in per capita GDP doesn’t necessarily leads to a reduction in poverty or to broader
social and economic development. In many countries economic growth could be associated
with increasing levels of poverty and divide between rich and poor rather than the reverse.

All Developed countries do not exhibit all these characteristics in equal measure. For
example, in some countries (or regions within them). in which, for example, crime and
employment levels appear to be quite high, or highlighting the fact that not everyone has
access to good public services, housing and so on. Some of these points are clearly open to
debate. For instance, crime levels in the rural areas of many developing countries where most
people live are often much lower than in some of the urban population centres of developed
countries.

Economic growth without development

Dependency theorists argue that poor countries have sometimes experienced economic
growth with little or no economic development initiatives; for instance, in cases where they
have functioned mainly as resource-providers to wealthy industrialized countries. It is
possible to have economic growth without development. i.e. an increase in GDP, but most
people don’t see any actual improvements in living standards. Such instances are listed
below: -

 There could be a situation where the benefits of economic growth are not equitably
distributed amongst different groups of society. Economic Growth may enable higher
incomes for people making them able to buy more food. However, this doesn’t
necessarily improve everyone’s living standards. Such Economic Growth process could
just avoid the poorer section of the society since they can’t take part in this process of
growth. Equitable distribution of the benefits of economic growth among different groups
of society is a key issue among economy. Moreover, a country may witness increase in
GDP, but the benefits of growth may be syphoned into the bank accounts of politicians.

 In case of countries like India there is a significant increase in GDP due to fact of
substantial expenditure on Military goods. If such expenditure is at expense of health care
 and education, it can lead to lower living standards. Further increase in economic growth
may enable more money to be spent on education. However, there is no guarantee that the
proceeds of growth will be used to improve education standards. There is often a weak
correlation between GDP and literacy rates.

 Economic growth can also have a negative impact on the environment. For example, An
Unsustainable growth and higher output could cause more pollution. If higher growth
involves cutting down forests then this could have adverse environmental consequences
in long-term. However, without proper regulation, it can also lead to environmental and
health problems. This is an example of where growth leads to a decline in living standards
for many since such growth does not take into account the depletion of natural resources
which might lead to pollution, congestion & diseases.

 Economic Growth could also affect the standard of living where such growth and
development also focus on improvements in infrastructure and transport. This may be
important for regions which may be cut off from the main areas of economic growth.
However, it can also cause an increase in congestion. This means people will spend
longer in traffic jams. GDP may increase but they have lower living standards because
they spend more time in traffic jams. If a state-owned industry increases output, this is
reflected in an increase in GDP. However, if the output is not used by anyone then it
causes no actual increase in living standards

QUESTION-2

“The difference between IHDI (Inequality-adjusted Human Development Index) and HDI is
the overall loss to human development due to inequality. In fact, one of the shortcomings of
HDI is that it does not include gender dimensions.”

Elaborate in your own words how IHDI is an improvement over HDI and the relevance of
Gender Empowerment Measure (GEM) and Gender Development Index (GDI). Also explain
in your words why GEM and GDI were failures and thus replaced by Gender Inequality
Index (GII)?

Human Development Index (HDI) represents a national average of human development

achievements in the three basic dimensions making up the HDI: health, education and
income. It serves as a frame of reference for both social and economic development. HDI
could be used to summarize the long-term growth and progress of country in these
dimensions.

HDI combines the life Expectancy Index which includes Average life expectancy compared
to a global expected life expectancy, Education Index which includes mean & expected years
of schooling and Income Index which takes into account Gross National Income (GNI) at
Purchasing power parity (PPP). The HDI is arithmetic mean of the three component indices
However like all averages, it conceals disparities in human development across the
population within the same country. While the HDI does not capture all the dimensions of
well-being, it is a very useful tool which can be used to question national policy choices. For
example, question how two countries with the same level of income per capita can have
different HDI

Inequality-adjusted Human Development Index (IHDI) takes into account problem faced by
HDI and therefore takes into account not only the average achievements of a country on
health, education and income, but also how those achievements are distributed among its
citizens by “discounting” each dimension’s average value according to its level of inequality.
Thus, the IHDI is distribution-sensitive average level of human development. Two countries
with different distributions of achievements can have the same average HDI value. Under
perfect equality the IHDI is equal to the HDI, but falls below the HDI when inequality rises

How IHDI is an Improvement over HDI

 HDI has been constantly criticized for its narrow focus and non-inclusion of critical
dimensions such as political freedom, employment, environment. A nation can skew the
HDI due to possibility of substitution between different dimensions i.e. a poor
performance in one dimension could be compensated for by good performance in another.
Moreover, HDI fails to measure inequality in the distribution of human development
within a country. Human Development is a broad concept which cannot be captured
through a single mean.
 The difference between the IHDI and HDI is the overall loss to human development due
to inequality. The IHDI captures the inequality in distribution of the HDI dimensions. The
IHDI allows a direct link to inequalities in different dimensions. It can help in developing
policies towards inequality reduction. These indication about inequality leads to better
understanding of inequalities across population and their contribution to the overall
 human development cost since IHDI is the level of human development when the
distribution of achievements across people in the society is accounted for.
 IHDI shows if inequality is getting better or worse. By analysing the trend in the IHDI
one can assess the course of the overall development of the economy. Moreover, IHDI is
more through in its calculations due to the fact that it could be obtained by computing
inequality for each dimension and then across dimensions, which further implies that it
can be computed by combining data from different sources. IHDI provides a direct link to
inequalities in dimensions of the HDI and the resulting loss in human development. The
IHDI and its components can be useful as a guide to help governments better understand
the inequalities across population and how they cause overall loss in the level of human
development due to inequality.

Relevance of Gender Empowerment Measure (GEM) and Gender Development Index

(GDI)
Gender Development Index (GDI) is used to measures gender gaps in human development
achievements by looking for disparities between women and men in three basic dimensions
of human development i.e. health, knowledge and living standards using the same component
indicators as in the Human Development Index (HDI). GDI is the like a ratio of the HDI
which is calculated accounting for females and males separately but with a similar
methodology to HDI. It measures dimensions such as whether both genders have equal
opportunities for participation in political and economic decision-making, equal access to
basic social services, including education and health, equal reward for equal work and many
more related to equality between both the genders.

Gender Empowerment Measure (GEM) is used to measure relative female representation in

economic and political power. It considers gender gaps in political representation, in
professional and management positions in the economy, as well as gender gaps in incomes.
GEM is used as a measure of inequalities between men’s and women’s opportunities in a
country. It gives indicators to explain ways in which the inequalities are associated with three
components of development: education, employment and political participation. Further
exploration on this concept is done through three interrelated dimensions: agency, resources
and achievements
Why is GII Better?
The Gender Inequality Index (GII) is a new measure of these inequalities built on the same
framework as the HDI and the IHDI — to better expose differences in the distribution of
achievements between women and men in these three dimensions: reproductive health,
empowerment and the labour market. GEM and GDI were considered failures due to various
reasons and therefore were eventually replaced by GII. Reasons for such changes were
because: -
 Some relevant dimensions of gender inequalities are lacking.
The first criticism made of the GDI and GEM were that they were limited to economic and
political dimensions. They failed to reflect certain sociological manifestations of gender
inequality, such as participation in community or family decisions, in physical integrity, etc
Moreover GDI did not reflect measures that were required in countries with high
unemployment, high levels of poverty and inequality. Similarly, for GEM to be useful it must
be created out of institutions which empower the poor and look at exclusion and inclusion in
those institutions in order to use the right tools for engendering a change in gender relations
but ultimately were not efficient in doing so

High GDI values for high HDI countries may suggest that gender inequalities are too small to
have a noticeable impact on their human development. But in reality, there are some subtle
gender inequalities (educational choices, quality of education, access to employment and
training, promotion, pay, etc.), which the GDI is too crude to pick up, and which may have a
substantial impact on human development of developed countries

 These indicators didn’t measure gender inequality as such.

It was stated that GDI and GEM did not measure gender equality as such, but instead some
combination of absolute levels of achievement and a penalty for inequality. The main
criticism regarding the GDI and GEM is that they are not a measure of gender inequality as
such, because they include absolute levels of women’s well-being. They were calculated with
the implicit assumption that gender differences in earned incomes are a good representation
of gender differences in access to nutrition, housing, and clothing.

 Skewed Perception of the Measures

The GDI and GEM didn’t realistically capture the gender gaps in development and
empowerment in the Third World. It was argued that these indices had been developed from a
northern perspective, and did not incorporate the perspective of the south. Nearly all
indicators in the GEM arguably reflect a strong urban elite bias and use some indicators more
relevant to developed countries. Alternatively, GDI and GEM were developed at the national
level and for major States. The results for India were based on a range of different variables
and the computed scores differed significantly from those prepared by UNDP

 Effect of Income Disparity in computation

These measures used to combine the absolute and relative achievements. Thus, a country
with low absolute income scores poorly, even with perfect gender equity. The GDI used to
adjust the HDI for gender inequalities, thereby measuring both total achievements and
disparities though usually it was often misinterpreted as reflecting only the latter. These
measures required extensive imputations for filling the missing data. With income the most
important driver of the wedge between the HDI and the GDI, this imputation was particularly
problematic.

 GII incorporated the developing world perspective

If in the developing world, gender inequality in family, identity, health and access to
economic resources are the main concerns, in the OECD countries discrimination in politics,
family, employment and incomes used to be the main concerns. Even though differences
existed, similarities could also be observed between them. So, it was stated that gender
inequality in the family concerns the OECD as much as the developing countries.
Discrimination in the family dimension appeared to be a crucial issue for both. Even though
extent of this discrimination was different from OECD to developing countries, it was found
to be a crucial issue for women all around the world. Whatever the level of development,
inequalities within the household, and therefore in the private sphere, used to be one of the
most notable manifestations of gender discrimination. GII was successful in incorporating
this perspective in its computation to provide a better picture of the disparity.

Therefore, overall Advantages of GII were: -

 The GII covers a limited number of indicators, but covers as many dimensions of
gender equality as possible through its database. Also, it was available for over 109
countries.
 The GII allows comparisons between not only the countries, but also over different
time periods.
 Its interpretation is easy: the higher the GII is, the stronger gender inequalities are;
  The GII was not built on a predefined economic model; therefore, it was more
perceptible to change
 GII minimizes statistical biases and problems related to multicollinearity and
measurement error. Also, The GII is a relative measure which measures gender
inequalities. It includes appropriate weights determined endogenously and no
unintended weights.

QUESTION-3

“Every economic activity can have some impact on the environment and every environmental
chain can have an impact on the economy.”

Discuss how the environment and economy are interlinked? Further explain, in what ways the
problem of Free Riding can occur and how can cause damage to an environmental asset?

It should be noted that Economics action by us can have some effects on the environment.
Moreover, even environmental changes could impact the economy. The economy being
referred to comprises of: -

 Population of economic agents,

 Institutions formed by such agents which comprises od firms and government and the
linkages between agents and the institutions.

Environment comprises of the biosphere of the existence which includes all the life on the
surface of the earth, our atmosphere, all the flora and fauna and the geosphere. Different Life
forms, material resources and energy are all part of this environment. These constitutes parts
of the environment interact with each other

Interlinkage between Environment and Economy

The economy consists of 2 sectors i.e. Production sector and consumption sector. Between
these 2 sectors, the exchange of goods & services and Factors of production takes place
The Economy has 2 sectors- Production sector and consumption sector. Exchange of goods
and services and factors of production between these two sectors takes place. The
environment is the above diagram consists of 3 interlinked factors i.e. Energy & Materials
(E1) Waste & Sink (E2), Amenity (E3) and Global Life Support System (E4). The
Production sector could extract energy resources (such as Oil, Gas) as well as the material
resources (such as iron ore) from the environment. Then their resources these are
transferred into outputs, out of which we derive useful outputs and waste products. There
some recycling of resources might take place within the production sector by the loop R1
and within the consumption sector by the loop r2.

Role of the Environment in Economy

Environment plays a key role in the economy. Firstly, it acts as a provider of resources and
raw materials for the production cycle and secondly, it acts as a receptor of the waste
products generated from the production. Such waste might be a direct result of Production or
consumption cycle. For example, whenever an individual puts of garbage whenever they head
out for an outing, they are contributing to such forms of wastes. The next role of the
environment to be considered is with regard to amenities (marked as E3). The environment
acts as a supplier of amenities, educational and spiritual values to the society. For e.g. People
may derive pleasure from existence of biosphere and wilderness in Himachal Pradesh,
However, some people may have attached a spiritual and spiritual and cultural value to same
environment. However, choosing or using environment for one purpose might affect its
ability to provide us the services for another. e.g. using a mountain region as a source of
minerals may reduce its amenity value
Environment as a global support system
Environment can also act as a global life support system for the people by helping us in: -

 Maintenance of atmospheric composition suitable for life

 Maintenance of temperature and climate
 Recycling of water and nutrients

Economic development of an economy can also be affected by some external resources such
as environmental degradation due to the fact that such degradation could result in imposition
of high costs on developing countries by expense on health services or reduction in overall
productivity or efficiency of the resource. The sustainable solution to this problem with
regard to these environmental problems is by working towards enhancement of productivity
or efficiency of the resources and improving living conditions among the poor. Achieving an
environmentally sustainable growth without exploitation of the resources provided to us
could be a tantamount to the process of economic development.

As discussed in earlier, unsustainable growth and higher output could cause more pollution.
If higher growth involves cutting down forests then this could have adverse environmental
consequences in long-term. Without proper regulation and taking into account environmental
costs associated with various economic activities, it can also lead to environmental and health
problems and such growth leads to a decline in living standards for many since it does not
take into account the depletion of natural resources. Development economists agree that
environmental considerations should form an integral part of policy initiatives.

For an example damaging the soil, water supplies, and forests resulting from an unsustainable
method of production can greatly reduce long-term national productivity but paradoxically
can show up as having a positive impact on the Gross National Income (GNI) figures. It is
thus very important that the long-term implications of environmental quality be considered in
economic analysis. Rapid population growth and expanding economic activities in an
unsustainable method for the developing world are likely to do extensive environmental
damage unless steps are taken to mitigate their negative consequences

The problem of Free Riding

It is stated that the environmental assets are to be considered as a pure public good if such
consumption is non-excludable or non-rivalry. The fear of ‘Free riding’ results due to the
reason that everyone benefits form such public goods & services and no one can be excluded
form deriving the benefits from these resources. ‘Free Rider’ could be termed as someone who
conceals their preferences for the goods & services available in order to enjoy the benefits
without paying for the resources. The free rider problem can crop up when the resource is
shared by all and free to all. Like air. If a community sets voluntary pollution standards that
encourage all residents to cut back on carbon-based fuels, many will respond positively. But
some will refuse to make any change in their habits. If enough follow the standards, the air
quality will improve and all the residents will benefit equally, even the free riders.

However, once a good is provided to public, free-riders will either derive benefit from these
resources without contributing to paying for that good or will contribute less than other nations.
Free riding therefore implies that the market may think if it such public goods are being
handled without considerations with the assumption that they don’t have to pay for the benefits
derived from such goods. If everyone expects someone else to pay for the clean-up and as a
result no one pays, a free rider problem exists. Therefore, market would provide lesser of such
public goods than it is socially desired and therefore misallocating resources away from the
environmental assets to private goods where the conditions of rivalry and exclusive use holds
good.

Tragedy of Commons

This could cause the tragedy of commons which is a result when it is either impossible or
expensive to deny access to the environmental assets. In a condition consumption by an
individual surpasses the consumption of the same resource by another, but both of the have
equal legal access to such asset, then both of them have an equal incentive to capture as much
benefit as that asset provides to them both and have an incentive to capture as much benefit
that assets provides as soon as possible before the other person captures them. Both cases may
lead over-exploitation of such assets than it is desired for the common good of the society and
thereby cause depletion of the asset. This is particular in global warming and the environment.
If a group of states agree to cut their carbon emissions, other states may not have any incentive
to join in the agreement. They will not have not damage their economy with carbon-control
policies, while still enjoying the benefits (a decrease in carbon-emissions to help global
warming) produced by those nations who are working toward it.

Solution to free-riding

Since this problem arises due to non-exclusion, it can be solved by the intervention of a third
party i.e. The Government. The Government can therefore assign the well-defined property
rights to either of two parties who possess open legal access to such environmental assets.
Whether or not the problem is to set up limit over usage of assets both the parties must be
confronted with several contingencies for such a case. For example, Mandatory production
standards are designed to prevent companies from damaging a public good such as air or water.
Emission taxes that create financial incentives for industries to reduce known pollutants, for
example, from oil and coal production, are used to reduce negative externalities. The
government can also force a company that causes an environmental problem to clean it up, thus
solving the free rider problem. The government however must keep in mind that higher
production costs due to regulation may be passed on to households in the form of higher prices,
which eventually can harm the economy. Legislation and its enforcement increase the size and
cost of government. As a result, they should also perform cost-benefit analysis to determine
appropriate levels of environmental regulation.

Communities can also work together in this regard. Communities can turn their public resource
into a private or club resource, charging dues to make sure everyone who uses it contributes to
it. They can impose a small fee on everyone. This will limit over-consumption and, over time,
may even spur altruistic Behavior. That is, many people may like the idea of making a small
contribution to a resource that they use

QUESTION-4

“The existence of Dualism in an economy can create discrepancies between the superior and
inferior elements in a society. However, if a dual economy which is marked by presence of
unlimited labour supply can be converted into an asset which can pave the way for
development in a UDC”

Explain your understanding of the above mentioned statement.

Dualism is a way of conceptualizing the existence of two separate but symbiotic sets of
economic processes or markets within the same political or national social framework. The
existence of these two opposite economies creates a problem known as the problem of
dualism Under dualism, two sectors, i.e., modern or advanced sector and traditional or
backward sector exist and operate side by side.

Dualism may be of various types. Technological Dualism, as Benjamin Higgins mentions it

in his book ‘Economic Development’, indicates the applications of different production
functions in the advanced sector as well as in the traditional sector. Under this dualism,
advanced sector is capital-intensive and backward sector is labor-intensive. Since in
Underdeveloped countries, like India, usual predominantly inputs are land and labour, they
tend to be labour intensive W. Arthur Lewis stated that the urban economy took the
advantage of labor from rural areas by holding down their urban wages until the rural
surplus was exhausted. Lewis propounded an economic growth model with unlimited
supply of labour which could be converted into an asset for economic development in the
dual or two sector economy with special reference to such underdeveloped countries

Theory of Unlimited labour for economic development

He stated that in the subsistence sector which uses little or no capital but where the
prevailing level of labour input is very large, the marginal product of labour will be small
or even 'zero’, depending on the man-land ratio due to large population growth &
unlimited labor supply. For example, if 10% laborers are needed in an employment &
instead 20% are working then remaining 10% are actually unemployed. Their MPL will be
zero.

However, the actual 'wage' or reward received by self-employed labor will be significantly
greater than its marginal product. This is explained by the lack of alternative employment
on the one hand and the prevailing rules of income formation on the other. According to
him the capitalist sector can recruit as much labour as it wishes at a constant wage rate.
This wage will exceed the 'wage' in the subsistence sector. He propounded that in such
situation, the capitalist will employ labour up to the point where the marginal product of
labour just equals this constant wage; for this is the amount of employment at which the
employer's profit is maximised. This amount will, however, be less than the available
supply of labour, the rest will continue to work unproductively in the subsistence sector.
This is usually taken to imply that surplus labour should be taken off agriculture and put to
'productive' use in construction projects or similar activities to accelerated economic
development

Assumptions

Two Sectors of economy

He was working based on assumption that with a spontaneous growth of population in
such country, there may be unlimited supply of labor due to the dualistic in nature of the
economy. For this to work he stated that there should a division of economy into a
“Dual/Two sector economy”. The two sectors could be (1) Capitalist sector & (2) The
Subsistence sector. He assumed that in these two co-existing economic sectors, wage rates
are high in capitalist (industrial) sector & low in subsistence (agricultural) sector and labor
supply tends to be perfectly elastic at the subsistence rates of wages.

Usage of Capitalist Surplus

He stated that in the subsistence sector which uses little or no capital but where the
prevailing level of labour input is very large, the marginal product of labour will be small
or even 'zero’, depending on the man-land ratio due to large population growth &
unlimited labor supply. He stated that the capitalist surplus could be reinvested in the new
capital which leads to capital formation in the economy. Such investment creates new jobs
for the unemployed withdrawn from the subsistence sector. Over time as this this shit
continues and investment results in increases in the capital, the MPL 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 eventually 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.

Role of banks and savings

He also stressed the importance of financial management at personal and institutional level
emphasizing that creation of bank credit will give rise to inflationary increase in prices.
However, he stated that that inflationary pressures will not continue forever. Though such
situation may increase price level in the short run but when the capital goods industries
starts producing consumer goods, the problem is tackled.

On a personal level, he stated that saving tend to play a crucial role in the economic
development. He made an assumption that savings generated in the capitalist sector and in
the subsistence sector. The capitalist sector invests all its savings for its further expansion.
He stated that in absence of savings, if capitalist do capitalists do not re-invests a major
portion of (savings) profits, neither the total production nor the opportunity of employment
increases. It because of such increased savings, capitalist sector economy expands.

Since this process of economic growth cannot go on forever. It comes to an end when
there is no surplus labor. According to Lewis, growth process comes to an end because of
the following reasons-:

 Increased demand for laborer’s after surplus labor is exhausted, tends to raise
wages.

 MPL rises in subsistence sector, with the use of new techniques of production over
time, laborers may demand higher wages.

 Trade unions may force the capitalist sector to increase the wages.

On account of the above factors, the surplus generated because of unlimited supply of
labor in UDCs start decreasing and ultimately it vanishes. The rate of capital formation is
reduced & economic growth is checked.

Criticisms

Difficulty in transferring the labor: - Transfer labor from the subsistence Sector to the
capitalist sector by offering them an incentive of a little higher wage is a difficult process.
Lewis ignored the cost involved in training these unskilled workers. Moreover, the cost of
training rises as more and more labor is transferred and mobility of labor may be very low
due family affection, difference in language, caste, religion etc. affecting it adversely.

One sided Theory: - It works on assumption that disguised unemployment exists in the
agriculture sector. Also, it does not take into account improvement in agricultural sector,
since development of both is complimentary to each other. When such labor is transferred
the share of agricultural output falling to each one left in the agricultural sector will rise.
This means the institutional wage will go on rising with every transfer and also wages paid
in the capitalist sector.
Savings: - It is also wrong to assume that people always squander away their savings and
that savings are done by capitalist sector alone. Saving can also be found in middle- &
low-income groups. They save to make their future secure.

Wrongful assumption: - This theory is criticised on the ground that it perpetuates unequal
distribution of income It is also wrong to assume that a capitalist will always re-invest
their profits. They can indulge in un-productive pursuits. They can use their profits for
speculative purposes.

Partially Valid Assumptions: - Every underdeveloped country does not have surplus
labour in the subsistence sector. As such, the model does not apply to countries which are
sparsely populated. This may be true in respect of overpopulated countries like India &
China but may not be incorrect for many UDCs of West Africa, Latin America, etc. which
are sparsely populated. Further the model assumes that, besides labor, there is unlimited
supply of entrepreneurs in the capitalist sector. This is not true in the case of many of the
underdeveloped countries.

Problems of Aggregate Demand: - In analyzing the problems of dual economy model,

Lewis ignored the problems of aggregate demand. He assumes that whatever is produced
by the capitalist sector is either consumed by it or is exported. He failed to take note of the
demand for products of the capitalist sector by the subsistence sector.

Problem of Inflation: - Inflation is not liquidating, as has been assumed by Lewis,

Experience of various, countries show that if once prices start rising, it, becomes difficult to
control them.