Examine the difference between the Lewis and Todaro models of economic development. Discuss the view that neither model adequately explains the process of development in contemporary less developed countries.

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Macroeconomic Analysis

Essay 7: Examine the difference between the Lewis and Todaro models of economic development.   Discuss the view that neither model adequately explains the process of development in contemporary less developed countries.

The Lewis Model

Consider this question

“If an economy is a traditional backward economy then how does the economy transform itself into a modern industrial economy?”

Looking at this question, eminent economist and Nobel Prize winner Sir Arthur Lewis set about creating the first duel sector model of economic growth.     His model compares the traditional sector versus the modern sector, or in simpler terms the rural agricultural sector versus the urban manufacturing sector.

First of all let me state what the characteristics are of such a backward rural economy according to Lewis.

  • The economy is essentially a subsistence economy.  That is production is primarily for self-consumption.

  • There is no saving and no capital accumulation in the economy.

  • The economy is not market based but rather the emphasis is on families supporting themselves and trading among other families.   Or to put it more formally, organisation of production is family based, not market based.  

  • The most important of Lewis’s assumptions that he makes about rural economies is that there exists “a surplus labour supply”.  To put this assumption into context imagine that there are 10 brothers and sisters working on their family farm and together they produce 150 units.    Now, as the family own the land it therefore means all the family work there.  But the reality of it is they could probably produce as much output with only six of them working there.  So in reality there is a surplus of labour.   To make this point more mathematically you can say that the marginal product of labour is equal to zero, or if it is equal to anything then it is negligible.   Wage is equal to Average product in this case so in the farm scenario above each family member gets 15 products.  And so therefore wage is higher than marginal product of labour.

If nothing happens to this economy then this will repeat year after year.   Something has to happen for this economy to become a modern industrial economy.   Capitalists will need to invest from the industrial sector and in Lewis’s model this sector is assumed to located in the urban economy.

Now let me address the assumptions Lewis makes about the Urban industrialised economy.

  • Production, in this case, is primarily for profit.

  • Output of production is market based, not family based in the formal sector.  That is, firms hire employees from the market on the basis of knowledge, experience, availability etc… rather than because they are related to someone who can give them a job. [Although undoubtedly this can still be the case, it’s just not so much of a factor.]  

  • In order to maximise profits, capitalists will employ labour only up to the point where wage equals marginal product of labour.

  • Finally, there is a diminishing product of labour with a given amount of capital.

To explain that last point further let’s just assume that the capitalist sector can get all the labour it wants from the agricultural sector.   Lewis says because there is surplus labour in the agricultural sector you can therefore get all the labour you want at a fixed wage.   If this is the case then as more labour is employed the marginal product of labour goes down.  For example if there is one machine, and one man can produce 200 units of output from it, then by adding a second worker you may be able to produce 380 units of output and finally by adding a third worker you can produce 480 units of output.  You can see that by the time the third worker is added you are receiving much less than you would expect for a lot more in wage.  Therefore firms will only hire up to the point where the marginal product of labour equals the wage.

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Figure 1 Production Possibility Frontier for the Urban sector

Assuming capitalists do not consume their profit but rather want to reinvest in order to gain more we can see that from the PPF above, reinvesting shifts the PPF from N1, to N2.  

Employment in this case raises from M1 to M2 as well.   In fact, this will keep on until there is no surplus labour in the economy and eventually the capitalists will have to start paying higher wages in order to get more labour.

Now the majority of the people work ...

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