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Economic growth and labor supply

Outline and Evaluate the value of the Lewis Model to Understanding Growth in a Labour Surplus Economy.

This essay discusses on dual sector Lewis model, which focuses on the migration of labour between two sectors. Two sectors described in the Lewis model are capitalist sector and subsistence sector. One is rural agricultural sector and other is urban manufacturing sector. The characteristics of subsistence sector are low wage and unlimited supply of labour (Lewis 1954). On the other hand, there is labour shortage in capitalist economy and hence, wage rate is higher. Capitalist or the industrial sector absorbs the surplus labour of the rural sector for sustainable development. Wage rate in the Lewis model is determined by the average productivity in the agriculture. Moreover, Lewis model tells that surplus labour disappears from the traditional sector with the integration of the traditional economy with modern industrial economy.  

In the subsistence sector or the D sector has unlimited supply of labour. Hence, the wage rate in this sector is less than the wages in C or the industrial sector. The modern sector develops absorbing labour from traditional sector. In the agricultural sector, marginal products become zero after a certain point; recruiting labour beyond that point causes total output to fall. Hence, the surplus labour exists in the traditional sector, as shifting one unit of labour does not reduce output of that sector. On the other hand, wage rate is high due to shortage of labour. Bargaining power of workers through trade union keeps the wage rate at higher level (Athukorala, Prema?chandra and Zheng 2017). However, according to Lewis, wages in the industrial sector remains constant and the capitalists earn surplus. The surplus labour migrates to the modern industrial sector in search of job. The disguised unemployed workers get job in the industrial sector. Consequently, output in the modern sector expands and surplus generated. The surpluses are further reinvested in the economy. As industrial sectors have both backward and forward linkages, output growth in one sector leads to the increase in demand in the other related sectors. In the view of Naudé (2013), speed of expansion depends on the rate of investment and capital formation in the economy and in that sector. Although wage is constant in the urban areas, this is higher compared to the rural wage. Higher wage induces agricultural workers to migrate to the urban areas in search of jobs. In this way, a modern sector expands with increment in employment to restore economic growth. Greater employment implies greater aggregate demand, further increase in national output and growth of the economy.

Figure 1: Production function in the traditional sector

(Source: created by author)

The above figure shows that the traditional sector employing labour more than up to the highest point of the total production curve. At the highest point of the total productivity curve, marginal product of labour is zero. Further increase in labour in the production process, reduces total output due to inefficiency of the labour and absence of resource. Hence, after point L1, transfer of any labour improves productivity of the traditional sector and the employment of that worker can improve productivity of the scarce sector (Lewis, Ethan and Peri 2014). This migration of labour leads to autonomous expansion in the demand, government purchases and the expansion of different sectors of the economy.

Discussion on the sectors of the model

Two sectors in the Lewis model are capitalist (C) and the subsistence sector (D). The characteristics of the traditional D sector are low wage, unlimited supply of labour and existence of the small-scale industries along with agricultural sectors. Existence of disguised unemployment or the surplus labour is significant feature of this sector. Market is less competitive due to absence of product differentiation and the market meets only the local community needs. Another feature is that the marginal productivity (MP) of labour is less than the subsistence wage level.


On the other hand, the capitalist (C) or the modern sector is characterised by shortage of labour and hence higher wage for labour. However, wage is fixed at a level as assumed by Lewis. Other important features are free and competitive market. Demand is greater for the specialised labour. This modern sector expands absorbing surplus labour of the D sector. Generally large scale industries and MNCs operate in this sector. Surpluses generated in this sector are reinvested for capital formation and expansion of the sector. Labour in this sector is employed at the point MP = real wage (Yang et al. 2016).

Developing countries are traditionally agricultural based economies. In the view of Fei and Ranis, three stages can occur due to migration of labour in a developing economy. At stage 1, MPL = 0 < SW (Ratha, Soonhwa and Seyed 2015). Marginal productivity of labour is less than the subsistence level of wage at this stage when disguised unemployment exists in the agricultural sector in absolute terms. At stage II, when the modern sector starts to absorb the surplus labour, subsequently the wage rate in that sector starts to rise. At this stage, 0 < MPL <WS and surplus labour starts to shrink. At the stage III, when rate of migration in the modern sector increases due to higher wage, labour supply in the agricultural sector falls below L1. Marginal productivity of the labour becomes greater than subsistence wage and hence, wage rate in the traditional sector starts to rise (Ehrenberg, Ronald and Robert 2016). As the wage rate raises in the traditional D sector, standard of living of the workers increases and leads to the rising aggregate demand for the consumer goods and several industrial products. Rising demand for industrial products causes expansion of the C sector. Deficit of labour in the C sector is thus filled by the D sector through migration of labour.

On the other, with increasing congestion of workers in the urban areas, demand for food and agricultural products increases. The workers buy the food at market price. Initially, demand for agricultural product is locally bound and from the stage II of turning point, the demand from products rises from urban areas and for export to the international market. Third stage is the Lewis turning point, when agricultural labour are commercialised. Hence, agricultural sector expands also along with the modern industrial sector. However, a wage gap exists between skilled and unskilled workers in the urban area.  

Consequence of migration of labor

In the view of Nathan (2014), as labour and capital are complementary to each other, surplus labour and low capital reduce investment in the agricultural sector. Economic benefit in the economy is realised when employment increases, investment in the economy rises to expand different sectors in the economy. Increase in employment in one hand expands the output a sector by using additional labour in production process. Additional labour is productive as far as marginal productivity is rising to complement capital. Migrant labour contributes to the flexibility of labour market in a labour surplus developing country. Young migrants are better educated and skilled compared to workers nearly retirement. Any sector can use human capital in more efficient way with young workers. In the words of Lewis (2013), young workers contribute to the economy in terms of productivity, taxes and social contributions in comparison to the benefits they receive from government. Young people can be easily motivated and encouraged for innovation in the product market. Innovation enhances marginal productivity of capital or labour.

Economic growth of Chinese economy over the periods 1965 -2009 can be attributed to the development of non agricultural sector, which is driven by rapid migration of labour and capital formation. China has a Lewisian Dualistic economic development over a long period of time. Chinese economy was agrarian economy predominantly. Surplus labour existed in that sector with low productivity. During 1978, rural liberalisation released labour from rural economy to promote market economy. Economic activities increase with the expansion of labour as seen in the Chinese economy. Increase in supply of labour makes labour market competitive in the market economy to make wage rate at competitive level. Workers want to get themselves employed at minimum wage where there is surplus labour in the economy. Low wage induces firms to employ more labour. As a result, non agricultural sector develops rapidly. Chinese economy envisaged rapid economic growth since 1990 due to increase in total factor productivity (Ercolani and Zheng 2011). When productivity of one sector boosts, ability of this sector swells to supply in the international market after meeting domestic needs. As a result export increases to enhance the export sector. A structural change occurs in the economy. Economic reform of China facilitated the economic transition. GDP grows as a result of increasing economies of scale. Rise in employment reduces poverty level of the developing economy.


As described earlier, third turning point leads to the commercialisation of the agricultural sector. Commercialisation raises the demand for food products in the urban market. However, accumulation of labour results in the unemployment in the sector due to existence of skill gap. However real wage of the existing employees increases.

Conclusion

This above essay has described that migration of labour leads to the greater trade in products and services by expanding non agricultural sector of the economy. This paper has examined the impact of the Lewis model on the economy. Transition of an economy starts with the migration of labour from traditional agriculture based economy to the modern industrial economy. Modern sector expands by absorbing surplus labour of the agricultural or traditional sector. Surplus workers move to the urban economy in search of jobs in the industrial sector for higher wage. Wage level in the urban sector decreases with increase in labour supply. Wage rate in the agricultural sector also increases due to commercialisation of the agriculture. Both the agricultural and industrial sector develops with absorption of surplus labour. However, there is argument regarding equalisation of wages as the wage gap exists in the labour market due to presence of skilled and unskilled labour. Surplus labours in the tradition economy are employed in the modern sector and for first few units output rises rapidly. Structural changes occur in the economy due to transition from agricultural to industrial economy.

References

Athukorala, Prema?chandra, and Zheng Wei. "Economic Transition and Labour Market Dynamics in China: An Interpretative Survey of the ‘Turning Point’Debate." Journal of Economic Surveys (2017).

Ehrenberg, Ronald G., and Robert S. Smith. Modern labor economics: Theory and public policy. Routledge, (2016).

Ercolani, Marco, and Wei Zheng. "An Empirical Analysis Of China’S Dualistic Economic Development: 1965–2009". Mitpressjournals.Org. https://www.mitpressjournals.org/doi/pdf/10.1162/ASEP_a_00108 (2011).

Lewis, Ethan, and Giovanni Peri. Immigration and the Economy of Cities and Regions. No. w20428. National Bureau of Economic Research, (2014).

Lewis, W. Arthur. "Economic Development with Unlimited Supplies of Labor". The Manchester School (1954). 22: 139–91.

Lewis, W. Arthur. Theory of economic growth. Vol. 7. Routledge, (2013).

Nathan, Max. "The wider economic impacts of high-skilled migrants: a survey of the literature for receiving countries." IZA Journal of Migration 3, no. 1 (2014): 4.

Naudé, Wim. "Entrepreneurship and economic development: Theory, evidence and policy." Browser Download This Paper (2013).

Ratha, Dilip, Soonhwa Yi, and Seyed Reza Yousefi. "Migration and development." Routledge Handbook of Immigration and Refugee Studies 1, no. 3 (2015): 260.

Yang, Jin, Hui Wang, Songqing Jin, Kevin Chen, Jeffrey Riedinger, and Chao Peng. "Migration, local off-farm employment, and agricultural production efficiency: evidence from China." Journal of Productivity Analysis 45, no. 3 (2016): 247-259.

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