1.2 Lewis’ Dual Economy Model and the turning point
The Lewis Model (Lewis, W. A. ,1954) and its extended theory by Rains and Fei (Ranis, G., & Fei, J. C. ,1961) is one of the most famous theoretical frameworks for structural transformation in economic development. It explains the idea of a dual economy that views economic development as the transformation of two sectors, from a “traditional” (agriculture) sector to a “modern” (industry) sector. The modern or industry sector is defined as the capitalist sector "that part of the economy which uses reproducible capital and pays capitalists thereof", while the traditional or agriculture sector is defined as the subsistence sector "that part of the economy which is not using reproducible capital" (Lewis, W. A.,1954).
The subsistence agricultural sector is characterised by low wages, low productivity close to zero and an abundance of labour through a labour intensive production process. In contrast, the capitalist industrial sector is characterised by higher wage rates and higher marginal productivity and a shortage of workers through capital intensive and technologically advanced production processes. This indicates that it is possible for producers or capitalists in developing countries to make great profits from overall economy growth over time by using their savings to reinvest. Hence, it encourages them to expand industrial production and raise employment by capital accumulation.
During this transformation, the traditional sector is viewed as a supplier of labour for the modern sector, with an unlimited labour supply at the subsistence wage. As this transformation will end at one point, the turning point called the Lewis Turning Point (Figure 1), wages in both the traditional and modern sector get equated with the disappearance of the excess supply of labour, and an urban-rural integration in the labour market will have been formed. Once the economy has crossed the Lewis turning point, the industrial sector needs to raise wages in order to retain employment, so profits and investments decrease. The Lewis turning point is relatively a long-term process which can be mainly assessed in two ways: the numerical criteria, namely when agricultural surplus of labour becomes exhausted (surplus of labour is defined as zero marginal product for agricultural labour). Secondly, the price criteria, namely a significant increase in real wages in the modern sector.
The Lewis model combines the processes of economic growth and structural transformation, especially the labour transfer process which is an experience that developed countries have gone through. However, there are several flaws in the Lewis model. Firstly, it ignores the importance of the agriculture sector and the associated development of agricultural and industrial development. If the agricultural sector maintains low productivity then the overall output reduction may cause an increase in food prices, causing profits to fall. Secondly, it indicates the absence of labour-saving technological progress, meaning that the modern industry sector’s capital accumulation can bring a fixed percentage of labour force growth. Thus, the faster the capital accumulation, the more employment opportunities will be created. With the development of the industrial sector, capitalists will tend to use capital-intensive technology to gain greatly increase of yields and profits, resulting in the stability or even reduction of labour.
Source: Kwan (2007).
1.3 The role of Capital market in the process of industrialisation
So why isn’t all the supply of labour from the traditional sector immediately absorbed by the modern sector? The answer is that the scale of the modern sector is limited by the supply of capital (Ray, D., 1998).
Compared to spatially dispersed agriculture, capital intensity is much higher in the spatially concentrated industry sector where capital accumulation can be more easily realised. As capital accumulation through capital markets provide the fuel for industrialisation, capital accumulation as well as an increasing share of industry will contribute to economic development.
For developing countries, capital accumulation plays more important role than for developed countries where other factors such as human capital and disembodied technology seem to be more and more important according to recent studies ( and ). For developing countries, there is a lack in capital accumulation in perfect markets(low level of wealth and limited capital markets)but an abundance of labour (low labour costs and low supply elasticity).
With the main function of finance, resource-collocation, risk-pricing and institutional innovation, capital markets are an important mechanism for industrialisation. Macroscopically, capital markets promote the adjustment of industrial structure, regional structure and improve the rural financing environment facilitating rural industrialisation. Microcosmically, capital markets finance capitalists with the required capital to promote technological innovation and transition. With capital markets, capitalists may be able to reinvest to seek maximum returns, countries may also benefit from investments to develop industry and infrastructure.
From the experience of developed countries, a well-developed capital market tends to attract more foreign capital through investment securities. This implies that a well-developed capital market is an important prerequisite for developing countries to use foreign investment rationally to industrialise and make the transition from developing to developed.
Furthermore, for the agricultural sector, faced with the absence of a well-developed capital market, small farmers may not able to gain access to finance and credit so they cannot use capital intensive or advanced technologies for the industrialisation of agriculture. Thus, to shift from agriculture to industry, it is important for developing countries to address the capital accumulation of the capital market imperfections.
- Evidence
2.1 Empirical and theoretical arguments for developed countries and developing countries
Thanks to the Industrial Revolution, Britain, Germany, the United States and Japan experienced rapid economic growth. Many economists have studied the role of industrialisation, and there is ample, powerful supporting evidence. Rodrik, D. (2009) finds that the rapid economic convergence in the European periphery during the 1950s and 1960s and the development of East Asian countries since the 1960s was strongly based on industrial manufacturing and the structural change from traditional agricultural sectors to more modern industrial sectors. Furthermore, older articles confirm the contribution of manufacturing with more recent articles emphasising the importance of manufacturing in developing countries, rather than in developed countries, in the period 1950–1973, with a less significant effect in the period after 1973 (Szirmai, A.,2012).
For developed countries, as seen in Figure 1, the manufacturing real value added ratio of the U.S., Germany, Italy, France, U.K and Japan grew more slowly between 1970 and 2010, when compared to China and Korea. This reflects the declining share of manufacturing’s contribution to GDP in advanced economies. It is interesting to note that similar to Engel’s law (as per capita incomes rise, spending on agricultural goods as a share of household income declines), it may reflect the development of standards of living, as people can purchase food, clothing and other basic goods at a lower price.
Figure 1 Manufacturing Real Value Added Ratio to Real GDP, 1970-2010
Source: Atkinson, R. D., Stewart, L. A., Andres, S. M., & Ezell, S. J. (2012).
For developing countries, Szirmai, (2011) finds a significant positive empirical correlation of 0.74 between the degree of industrialisation and per capita income in developing countries. It is interesting to see that the poorer countries are those with, the lower shares of manufacturing (and the higher shares of agriculture), and the richer countries are those who have a higher degree of industrialisation.
2.2 China’s development through industrialisation
“China, which has emerged as the archetype of this growth strategy since the 1970s, travelled a well-worn path,” Rodrik (2013). With a large agricultural population, the dual economy structure in China is very obvious.
Figure2 shows the development of China’s industrialisation from 1970 to 2010 with a concentration of about 40% -50%. This indicates that the main engine of growth is from secondary industries, but looking at the economic structure, it can be seen that there is still a big gap between China and developed countries with regard to tertiary industries.
Figure2 value added (% of GDP) by sector
Source: World Bank Data
Showing changes in the industrial structure, Figure 3 shows that the proportion of secondary and tertiary industry employment, as a percentage of total employment, has increased significantly, indicating that the employed population quickly transferred from a mainly agricultural population to secondary and tertiary industries. However, the agricultural industry still occupies a dominant position of employment.
Figure3 shares of employment (%) by sector
Source: World Bank Data
As seen in the figures above, China's economic development seems to fit the theoretical description before the arrival of the Lewis’ turning point. 30 years of sustained economic growth was driven by rapid industrial expansion and huge accumulation of capital in the agricultural sector, which has become an important source to finance for the development of industry. The large amount of agricultural labour also made an important contribution. Additionally, consistent with Lewis’ model, the transformation of agricultural labour has been accompanied by a growing income gap between urban and rural areas, increasing the cost of industrial enterprises and hindering industrial expansion.
It is also interesting to note that the recent emergence of a "labour shortage" phenomenon in China, raises domestic and foreign economists’ concerns and discussions about whether China's economy is at the Lewis turning point.
Compared with other advanced Asia countries’ turning points (Japan around 1960, Minami, (1968), Korea around 1970, Moo‐Ki, (1982), China is far behind. For China, it is more complicated. Das, M., & N'Diaye, M. P. M. (2013) find that the Lewis Turning Point in China will emerge between 2020 and 2025, while Krugman, P. (2013) conclude that China has hit the Lewis turning point and is running out of surplus agriculture labour.
China will reach the Lewis turning point, but whether that is now or at some future point in time is a point of much debate, to which there is no definite answer. Confirming the Lewis turning point suggests that the increase of labour market efficiency and the demographic dividend cannot be a major force in promoting economic development after that point and a new phase of economic development needs to find new impetus.
Furthermore,for the role of capital markets, finance controlling limits the growth of Chinese development, especially in rural areas. The backward rural finance and urban modern finance credit cannot truly reflect the market supply and demand for capital. Thus, financial inhibition has slowed the process of industrialisation.
2.3 Cities in Africa development without industrialisation:
While most Asian countries have developed with structural transformation, McMillan and Rodrik (2011) finds that the structural transformation has made a negative contribution to overall growth in Africa. However, thanks to the rich natural resource exports, cities in Africa have experienced the urbanisation without industrialisation. Furthermore, they may even be in the process of premature de-industrialisation (Figure4 ).
Additionally, this economic growth may not last in the long term. The new competitive pressures of globalisation are challenging. Relying mainly on the unstable and falling prices of primary product exports such as coffee, cocoa and minerals, African economies, in an unstable international market and climatic conditions, are very fragile and weak.
To maintain farer economic growth, industrialisation will probably be a key engine for Africa. In reality, with a lack of capital accumulation and capital market imperfections, African countries should implement policies to attract foreign investment into the manufacturing sector to diversify products so that volatility will reduce with wider trade openness. Hence, to sustainably develop, African countries cannot rely on traditional technologies and methods to produce primary goods and industrialisation may be an effective strategy.
Figure4 Urbanization and Natural Resource Exports in Africa, 1960-2000.
Source: Jedwab, R. (2013).
- Conclusion
The implementation and progress of industrialisation have not only positive effects on economic and human development, but also has negative effects on the natural environment and human society. Industrialisation in developing countries is the main catalyst to start economic development, but this should be rapid industrialisation.
Increased soil erosion and desertification, causes environmental pollution and a broken ecological balance. For developing countries, it is important not whether to industrialise, but how to achieve industrialisation.
Words: 2579
Reference
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