Lewis' model of economic development: Indian context

Arthur Lewis was a well-known economist with contributions in the field of development economics. In 1954, he wrote ‘Economic development with unlimited supplies of labour’ for which he won the Nobel Prize in 1979.

He proposed the theory of economic development in his book which gives an idea for development in the developing economies in terms of labour transitions between two sectors, the capitalist sector and the subsistence sector. The theory has the following assumptions:

1.     Agriculture (or the subsistence sector) has a surplus of unproductive labour.

2.     Workers are attracted to the growing manufacturing sector.

3.     Wages in the manufacturing sector are more or less fixed.

4.     Entrepreneurs in the manufacturing sector make a profit.

5.     Profits will be reinvested in the business.

6.     The advanced manufacturing sector means the economy has moved from a traditional to an industrialised one.

So, Lewis’s argument keeps one notion at the centre, i.e. there is a substantive labour force disguisedly employed in agriculture (the subsistence sector). By this, he meant that the marginal productivity of some of the labour is 0. These are the labourers whose productivity, according to Lewis, doesn’t add to the economy. The subsistence sector, he argues, can thus provide labourers to be absorbed by the developed sector aligned according to the capitalist principles. This forms the basis for further development.

According to him, if the surplus labourers from agriculture are incentivised with a little greater wages, they can be brought to the developed sector. This developed sector will then earn a profit which will be further utilised in absorbing more labourers. This process will continue until the surplus-labour gets totally exhausted. This point of time, when surplus-labour will get exhausted, can also be understood as when wages in both sectors will become equal or both sectors will become competitors to each other.

This is very relevant for overpopulated economies which are defined as the economies having a marginal product of labour below the subsistence level of wages. Now, why such a situation of overpopulated economies exist, needs an understanding of the infrastructure in such economies, i.e. the tenancy and share-cropping.

This model has helped the developing economies in directing their goals for development. Many academicians have analysed this model's relevance in several countries. Before analysing its relevance for India, here is the graphical representation of Lewis’ theory:

Here, the horizontal axis shows the labour and vertical axis shows the marginal product. W1 represents the subsistence wage, i.e. wage in the subsistence sector. The W represents industrial wages, i.e. the wages that will be offered by the alternative sector to attract these labours. NQ is the Marginal Productivity line initially. When OM labours are absorbed, NWP is the profit which when gets invested brings more labour moving the Marginal Productivity line to N1P’Q1.

While Lewis’ analysis was too simplistic, it was revised by Renis and Fei. According to them, with the movement of labourers from subsistence sector, the subsistence wage increases because in agriculture (the subsistence sector) wages are calculated by average productivity rather than marginal productivity. So as some labourers with marginal productivity equal to zero move to the developed sector, the total productivity in the subsistence sector remains the same and gets divided into a lesser number of people. This is the argument behind the increase in wages.

So, Renis and Fei proposed that W1 keeps shifting upward with more and more labour absorption until it gets equal to the industrial wage. At this point, both sectors become competitors.

Some of the major criticisms of Lewis’ model are as follows:

 i.       The assumption that "marginal productivity of some labourers in the subsistence sector is 0" was too simplistic an assumption without any empirical evidence at that time. Later it was found that marginal productivity, though substantially low, was not equal to zero. Theodore Schultz analysed these results by observing the influenza hit area of India in 1918-19. This means the total product will be affected upon moving the labourers out of the subsistence sector.

ii.      Lewis thought it would be quite easy to induce the labour force and thus ignored the complicated factors influencing the migration patterns. The skill requirements in the new industry can be different and may require training of the labours before being absorbed. This would increase the cost of labour transitions.

iii.       He didn’t give any answer to what would happen if enterprises would invest in labour-saving instead of labour-intensive technologies after getting profit. This can turn the results opposite and people can get unemployed.

Now, coming to the Indian context, the theory is still relevant. As most of the labourers here in agriculture are disguisedly employed, their transition would benefit all, increasing the overall productivity. Due to tenancy and share-cropping still in practice in large parts of the country, whole family gets involved in the field making it difficult to determine an individual’s productivity. But recent figures suggest that even after out-migration from villages in large numbers, the agricultural GDP has increased. This means the labour transition would not affect the overall food productivity of the country.

This has happened because of the use of traditional patterns in agriculture had left scope for bringing modern technologies to it, thus increasing the productivity along with reducing labour dependency of the sector.

According to the FICCI report of 2015, almost 50% of the labour force is still employed in the agriculture sector, thus providing an opportunity for economic development according to Lewis’ model. The wage differences in the sectors that led to huge migrations are still in existence. This simply means that there is still scope for bringing agricultural labourers out of their sector to secondary (i.e. industrial) or tertiary (i.e. service) sectors.

The increase in small and medium enterprises which are also absorbing a large labour force from agriculture can be seen as an alternative to the industrial sector. The alternative is required because for a labour transition to happen, there are some capital requirements. While, in the case of many small and medium enterprises, the surplus from agriculture can serve as inputs. This will also solve migration issues if dealt with wisely. To take an example, we can think of jute bag production in the vicinity of the village itself. Clusters of villages can be formed where such production activities can be carried out. This will prove a huge leap towards the economic development of rural areas.