3.

Growth Models and

Theories of development
Cont’d
Lewis’ Theory of Unlimited
Supply of Labour
Assumptions of the Lewis Model:

Lewis model makes the following assumptions:

(i)There is a dual economy i.e., the economy is characterized by a traditional,
over-populated rural subsistence sector furnished with zero MPL, and the
high productivity modern urban industrial sector.

(ii) The subsistence sector does not make the use of 'Reproducible Capital',
while the modern sector uses the produced means of capital.

(iii) The production in the advanced sector is higher than the production in
traditional and backward sector.

(iv) According to Lewis, the supply of labor is perfectly elastic. In other

words, the supply of labor is greater than demand for labor.
The followings are the sources of unlimited supply of labor in UDCs.

(i) Because of severe increase in population more than required number of labors
are working with lands, the so called disguised unemployed.
 
(ii) In UDCs so many people are having temporary and part time jobs, as the shoe-
shines, loaders, porters and waiters etc. There will be no fall in the production even
their number are one halved.

(iii) The landlords or feudals are having an army of tenants for the sake of their
influence, power and prestige. They do not make any contribution towards
production, and they are prepared to work even at less than subsistence wages.
 
(iv) The women in UDCs do not work, but they just perform house-hold duties.
Thus they also counted as unemployed.

(v) The high birth rate in UDCs leads to growth of unemployment.

• The Lewis Theory
(I) Two Sector Economy or Dual Economy:

• Two sector economy: “subsistence” sector and “capitalist “sector.

• The subsistence sector is that part of the economy which does not use reproducible
capital.In this sector, the output per head is quite low as compared to the capitalist
sector. The average productivity of labour is low and people are generally backward,
illiterate, and unskilled. Thus, there are less similarities between the two sectors and
the development is lopsided.
• The capitalist sector is that part of the economy which uses reproducible capital and
pays capitalists for the use thereof. The use of capital is controlled by capitalist sector
which hires the services of the labourers. It may be either private or public. The
average wages are quite high. The people are generally advanced, literate,
sophisticated and skilled in the capitalist sector. They employ labourers for wages in
mines, factories and plantations etc. for earning profits. The output per head is high.
• He believes, like the classical theory, that in many LDCs an unlimited supply of labour is
available at a subsistence wage.
• Under the above circumstances, the main problem is to provide
gainful employment to the unlimited supplies of labour. It requires
greater attention in development and expansion of subsistence
sector.
• In his own words, “The central problem in the theory of economic
development is to understand the process by which a community,
which has previously, earning and investing 4 or 5 per cent of its
national income or less, converts itself into an economy, where the
voluntary savings are running about 12 to 15 per cent of the national
income or more”.
• Thus, it is clear that gainful employment can be provided to unlimited
labour force when rate of investment is at least 12 to 15 per cent of
the national income. In order to provide employment to the
unlimited supply of labour or surplus labour new industries can be set
up or existing industries expanded without limit at the current wage
rate by drawing up labour from the subsistence sector or the
subsistence wage.
• According to Lewis, the capitalist sector needs skilled workers for its
expansion and the supply of this type of labour cannot be regarded
unlimited in these countries. In this connection, Lewis argued that
skilled labour is only a quasi bottleneck/a temporary bottleneck which
can be removed by providing training facilities to unskilled labour.
(II) Capitalist Surplus:

• Now, how the unlimited supply of labour is converted into capitalist

surplus which is an essential prerequisite of growth. The main
objective of capitalists is to maximize their profits.
• The capitalist surplus is the difference between the marginal
productivity of labour and the capitalist wage. The capitalist sector
starts drawing labour from the subsistence sector on account of
higher wages.
• Though the wages have been assumed constant, yet Lewis says that
the urban wages are at least 30% higher than average rural income to
induce the workers to migrate from their home areas.
• Their contribution to output is also higher despite higher wages. In
this way surplus is generated in the capitalist sector. Lewis termed
this surplus as the ‘capitalist surplus’. The capitalist surplus is
reinvested in the new capital assets by the entrepreneurs. It leads to
capital formation in the economy. This investment creates new jobs
for the unemployed labourers withdrawn from the subsistence
sector. The supply of labour is supposed to be perfectly elastic at the
capitalist wage rate. Thus, the labourers continue to be available at
the existing capitalist wage rate.
• Thus the circular process of surplus generation, increased investment
and increased demand for labour continues to steer the system out of
the state of underdevelopment.
• In short, the process of economic development continues till the
capital labour ratio rises and the supply of labour becomes inelastic,
and surplus labour disappears. Thus the capitalist formation depends
on the capitalist surplus.
Diagrammatic Representation:
• In the diagram, quantity of labour employed is shown on axis-OX and
the marginal productivity has been shown on axis-OY. OS is the wage
rate in the subsistence sector and OW is the wage rate in capitalist
sector.
• The supply of labour is unlimited, as shown by the horizontal supply
curve of labour WW. At the start when OE1 labour is employed in the
capitalist sector, its marginal productivity curve is A’D1 and the total
output of this sector is OA’b’E1. Out of this labourers are paid wages
equal to the area OWB’E1. The remaining area WA’B1 shows surplus
output. This is the capitalist surplus or total profit earned by the
capitalist sector.
• As this surplus is reinvested, the curve of marginal productivity shifts
upward to A2D2. The capitalist surplus and employment are now
larger than before being WA2B2 and OE2 respectively reinvestment
raises the marginal productivity curve and the level of employment to
A,3D3 and OE3 so on, till the entire surplus is absorbed in the capitalist
sector. After this, the supply curve will slope from left to right
upwards like an w ordinary supply curve, and wages and employment
will continue to rise.
• According to Lewis, the technical progress may be recognized as
capital saving device and labour saving device. In both ways, the
technical progress tends to enhance profits or capitalist surplus and
employment in the capitalist sector.
• Profit as the Main Source of Capital Formation:

• It is clear from the above analysis of Lewis model with unlimited supply of labour
that profits constitute the main source of capital formation. The greater the
share of profits in national income, the greater the rate of savings and capital
accumulation.
• Thus with the expansion of the modern or capitalist’s sector, the rate of saving
and investment as percentage of national income will continuously rise. As a
result, rate of capital accumulation will also increase relatively to national
income. It is of course assumed that all profits or a greater part of the profits is
saved and automatically invested.
• This rise in the share of profits in national product is due to the assumptions of
the model that wage rate remains constant and prices of the products produced
by the capitalist sector do not fall with the expansion in output.
• To quote Lewis himself, “If unlimited supplies of labour are available at constant
real wage rate, and if any part of the profits is reinvested in productive capacity,
profits will grow continuously relatively to the national income”.
A Critical Appraisal of Lewis Model:
• Lewis model neglects the importance of labour absorption in
agriculture:
• A grave weakness of the models of Lewis and Fei-Ranis is that they
have ignored the generation of productive employment in
agriculture. No doubt, Lewis in his later writings and Fei-Ranis in their
modified and extended version of Lewis model have envisaged an
important role for agricultural development so as to sustain industrial
growth and capital accumulation. But they visualise such an
agricultural development strategy that will release labour force from
agriculture rather than absorbing them in agriculture.
• Assumption of adequate labour-absorptive capacity of the modern
Industrial sector:
• An important drawback of Lewis model is that it has neglected the
importance of agricultural growth in sustaining capital formation in the
modern industrial sector. When as a result of the expansion of capitalist
modern sector, transfer of labour from agriculture to industry takes place,
the demand for food-grains will rise.
• If the output of food-grains does not increase through agricultural
development to meet the additional demand for food-grains, prices of
food-grains will rise. With the rise in prices of food-grains wages of
industrial labour will increase. Rise in wages will lower the share of profits
in the industrial product which in turn will slow down or even choke off the
process of capital accumulation and economic development
• The Assumption of Constant Real Wage Rate in the Modern Sector:
• The assumption of constant real wages to be paid by the urban
industrial sector until the entire labour surplus in agriculture has been
drawn away by the expanding industrial sector is quite unrealistic.
The actual experience has revealed a striking feature that in the
urban labour markets where trade unions play a crucial role in wage
determination there has been a tendency for the urban wages to rise
substantially over time, both in absolute terms and relative to
average real wages even in the presence of rising levels of urban
open unemployment. The rise in wages, as explained above, seriously
impairs the development process of the modern sector.
• It neglects the labour-saving nature of technological progress:
• A serious lacuna of the Lewis model from the viewpoint of
employment creation is its neglect of the labour-saving nature of
technological progress. It is assumed in the model, though implicitly,
that rate of employment creation and therefore of labour transfer
from agriculture to the modern urban sector will not be proportional
to the rate of capital accumulation in the industrial sector.
• Accordingly, the greater the rate of growth of capital formation in the
modern sector, the greater the creation of employment opportunities
in it. But if capital accumulation is accomplished by labour-saving
technological change, that is, if the profits made by the capitalists are
reinvested in more mechanised labour-saving capital equipment
rather than in existing types of capital, then employment in the
industrial sector may not increase at all.
• Lewis model has been reproduced in Fig. 44.2. With a modification
that profits made are reinvested in labour-saving capital equipment
due to the technological change that has taken place. As a result of
this, marginal productivity curve does not shift uniformly outward but
crosses the original marginal productivity curve from above. It is
evident from Fig. 44.2, that with the constant wage rate OW, the
employment of labour does not increase even though marginal
productivity curve has shifted.
• It will be observed from Fig. 44.2 that though employment of labour
and total wage (OWQL) have remained the same, the total out­put has
increased substantially, the area OEQL is much greater than the area
ODQL. This illustration points to the fact that while the industrial
output and profits of the capitalist class can increase, the
employment and incomes of labour class remain unchanged.
• Lewis Model Ignores the Problem of Aggregate Demand:
• A serious factor which can slow down or even halt the expansionary process in Lewis
model is the problem of deficiency of aggregate demand. Lewis assumes, though
implicitly, that no matter how much is produced by the capitalist or modern sector, it will
find a market.
• Either the whole increment in output will be demanded by the people in the modern
sector itself or it will be exported. But to think that entire expansion in output will be
disposed of in this manner is not valid. This is because a good part of the demand for
industrial products comes from the agricultural sector.
• If agricultural productivity and therefore incomes of the farming population do not
increase, the problem of shortage of aggregate demand will emerge which will choke off
the growth process in the capitalist industrial sector. However, once an allowance is
made for the increase in agricultural productivity through a priority to agricultural
development, the basic foundations of Lewis model crumble down.
• This is because a rise in agricultural productivity in Lewis model will mean a rise in wage
rate in the modern capitalist sector. The rise in the wage rate will reduce the capitalist’s
profits which in turn will bring about a premature halting of the expansionary process.