Unit 4 Macro: Lewis Turning Points

Lewis turning points are the defining feature of Arthur Lewis’ Dual-Sector Model, devised in 1954.

Source: tradingeconomics.com

The model assumes an economy contains two distinct sectors. Firstly, there is the capitalist sector, characterised by:

1. A capital-intensive manufacturing process, relying on the use of reproducible capital
2. Higher average wages
3. Higher marginal and average productivity
4. Higher demand for labour

Contrasting this, there will also be a subsistence or agricultural sector in an economy.

This involves:

1. A labour-intensive production process
2. Low dependency on capital
3. Low marginal and average productivity
4. Low average wages

At an early stage in a country’s development, the subsistence sector is very large. As the main limit on agricultural production is likely to be land, not labour, there comes a point where the marginal productivity of every new farmer or labourer is zero. These workers are considered to be surplus labour. As a result, these workers will move to the capitalist sector over time. Because they are surplus labour, this means that the workforce in the capitalist sector can be increased without wages rising. Early on in development, the Lewis Model assumes that this source of labour is effectively unlimited.

Because marginal productivity is high, an increase in workers available without an increase in wages (which Lewis assumes to be fixed because of the assumption that labour from the subsistence sector is unlimited) means profits will increase. These profits are assumed to be re-invested. This investment leads to growth within the sector, causing the capitalist PPF to shift outwards.

Although the surplus labour from the subsistence sector is assumed to be unlimited initially, eventually it will run out, meaning moving additional labour from agriculture to manufacturing requires a decrease in the output of agriculture. As such, capitalist employers are now competing for labour, causing wages to start to rise as capital accumulation rises (assuming all profits are used to purchase capital). This point is the Lewis turning point of the title.

The model has been criticised primarily on the basis of the assumptions it makes. Firstly, it assumes that capital is the main factor contributing to long run growth, like other exogenous growth theories. For a developing economy, there may be some truth to this concept, but even in this situation capital investment is evidently not the only factor causing growth: improved government policies, for example, could improve human capital (as opposed to the fixed capital used in the model), leading to increased growth.

Secondly, the model assumes that all profits will be re-invested. This is often untrue; it may be in the short run interests of a company not to invest (as this increases costs and so decreases profits), meaning particularly if a company is poorly managed, investment will not happen to the same extent, limiting the effects on long run growth.

A final key criticism is that the model assumes that there are a large number of unproductive agricultural workers. This may be the case at certain times of the year, but the number of workers required for agriculture varies seasonally – at harvest, those workers who were previously unproductive may become productive. As such, transferring workers to the manufacturing sector may in fact cause a reduction in agricultural output, even if those workers are unproductive and so seem surplus for much of the year.

Empirical evidence supports the model to some extent – India, for example, saw agriculture as a share of employment fall from 74% in 1972 to 57% in 2000, while services and industry grew from 26% to 43% (ISI). Indian investment has also risen considerably and growth has remained high, facts that support the Lewis Model. However, certain countries buck this trend; Egypt, for example, has managed to achieve relatively high growth recently (more than 5% since 2006), despite investment decreasing almost continually from 1960 levels as a percentage of GDP (from 36% to 8% in 2011, IMF) and agriculture rising as a percentage of total employment between 2002 and 2008 (from 27.5% to 31.6%). As a result, though the model is a useful tool for understanding some aspects of growth, it is clearly limited in its accuracy.

Mark Austen and Max Goswami-Myerscough