GOHRAM BALOCH

04092014001

Criticisms of the Lewis Model

Although the Lewis two-sector development model is simple and roughly reflects the
historical experience of economic growth in the West, four of its key assumptions do not fit
the institutional and economic realities of most contemporary developing countries.

First, the model implicitly assumes that the rate of labor transfer and employment creation
in the modern sector is proportional to the rate of modern-sector capital accumulation.

The contemporary sector will expand more quickly and more jobs will be created, the faster the
pace of capital accumulation. But what if, according to the Lewis model's underlying
assumption, capitalist gains are instead reinvested in more sophisticated labor-saving capital
equipment? (We are obviously assuming here that capitalist gains are really reinvested in the
local economy rather than being moved overseas as a type of "capital flight" to be added to the
deposits of Western banks.) The bottom, modern-sector figure of Figure 3.1a is reproduced in
Figure 3.2, but this time the labor demand curves don't move evenly outward; instead, they cross.
In order to reflect the fact that capital stock additions embody labor-saving technical progress,
demand curve D2 (KM2) has a greater negative slope than demand curve D2 (KM1). This is
because KM2 technology requires significantly less labor per unit of output than KM1
technology does.

We notice that total wages (0WMEL1) and employment (L1) are stable even though total output
has increased greatly (i.e., 0D2EL1 is significantly bigger than 0D1EL1). Profits from the
additional output are distributed to capitalists in full. Due to the fact that all additional income
and output growth are distributed to a small number of capital owners while income and
employment levels for the vast majority of workers remain largely unchanged, Figure 3.2 serves
as an example of what some might refer to as "antidevelopment" economic growth. Despite an
increase in overall GDP, aggregate social welfare, as measured, for example, by more evenly
distributed gains in income and employment, would either remain the same or hardly improve.

The second questionable assumption of the Lewis model is the notion that surplus labor
exists in rural areas while there is full employment in the urban areas.

The majority of recent studies suggests that rural areas have minimal labor surplus. However,
development economists today generally concur that Lewis's assumption of rural surplus labor is
untrue. It is true that there are some seasonal and geographical exceptions to this rule (e.g., at
least until recently in some regions of China and the Asian subcontinent, some Caribbean
islands, and isolated regions of Latin America where land ownership is very unequal).

The third dubious assumption is the notion of a competitive modern-sector labor market
that guarantees the continued existence of constant real urban wages up to the point where
the supply of rural surplus labor is exhausted.

. Prior to the 1980s, an observable characteristic of urban labor markets and wage determination
in almost all developing countries was the propensity for these wages to increase significantly
over time, both in absolute terms and relative to average rural incomes, despite rising levels of
open modern-sector unemployment and low or no marginal productivity in agriculture.
Institutional elements like union negotiating strength, public service pay scales, and the hiring
practices of multinational businesses frequently work against competition in emerging nations'
contemporary labor markets.

The fourth concern with the Lewis model is its assumption of diminishing returns in the
modern industrial sector. Diminishing returns.

Stage of production where output increases at a decreasing rate as more units of variable input
are added. Yet there is much evidence that increasing returns prevail in that sector, posing
special problems for development policymaking that we will examine in Chapter 4
We study the Lewis model because it enables students to engage in the discussions, since many
development professionals still think about development in this way, either overtly or implicitly.
The concept is also commonly seen as being applicable to current events in China, where labor
has been progressively transferred from agriculture to industry, as well as to a few other nations
with comparable growth patterns. Lewis's tipping point, when manufacturing salaries begin to
climb, was largely attributed to China's pay rises beginning in 2010. (See the case study for
Chapter 4).

The Lewis two-sector model is still useful as an early conceptual representation of the
development process, but when we consider the laborsaving bias of most modern technological
transfer, the existence of significant capital flight, the widespread nonexistence of rural surplus
labor, the increasing prevalence of urban surplus labor, and the tendency for modern-sector
wages to rise quickly even where substantial open unemployment exists, we must acknowledge
that it is no longer accurate.