Begin with a dual sector economy with a rural traditional subsistence sector and an urban modern capitalist sector. Assume for simplicity that the subsistence sector is the agriculture sector and the capitalist sector is the industrial sector. The Lewis model posits that this economy will develop if it mobilizes resources to industrialize.
1) Disguised Unemployment.
An unlimited supply of labour exists in the agricultural sector. Labour is disguisedly unemployed, that is, there is an excess supply of labour with a zero MPL. Basically, there is so much labour in agriculture that each additional unit of labour adds nothing to agricultural output.
Above is the agricultural sector’s production function. Between 0 to L* each additional unit of labour increases total output. After L* each additional unit of labour adds nothing to total output.
2) Constant Real Wage.
Agriculture’s surplus labour is available at a constant real wage to the industrial sector. Agricultural workers will migrate to industry if the real wage in industry is higher than what workers can get by cultivating their own land in the agriculture sector. Because labour supply exceeds demand at this real wage, the real wage in industry remains constant.
Industrialization Resultantly, the industrial sector will make high profits by employing disguisedly unemployed workers from agriculture, and this allows the economy to develop. Industrial profits are re-invested to make more labour-intensive machinery so the industry MPL curve shifts right and more labour is transferred from agriculture to industry. Again profits are re-invested to make more labour-intensive machinery so the industry MPL curve shifts right and more labour is transferred to industry. After the agricultural surplus labour runs out, agriculture’s wage must rise and consequently industry’s wage must rise to attract more labour so industry profits begin to fall, less can be re-invested for capital accumulation and industry’s MPL curve shifts right by less and less each time and eventually stops.
Recommendations for Development Many policy recommendations arise from the Lewis model:
1) Savings and Investment.
An LDC must raise its savings rate to allow domestic investment to rise and kick-start the industrialization process. Lewis posits that an LDC needs an investment between roughly 12% to 15% of its GDP to be able to grow and develop.
2) External Finance.
A capitalist class must exist to invest but LDCs may have a small capitalist class or none at all. LDCs must then either use foreign savings or government spending to invest in industry.
3) Intersectoral Terms of Trade.
Lewis asserts that LDCs must keep food prices low otherwise high food prices will cause wages to rise, capitalists’ profits to fall and less capital accumulation. So LDCs must keep developing the agricultural sector to ensure productivity is high and food prices are low.
Criticisms There are many criticisms of the Lewis model:
1) Re-Invested Profits.
Industrial profits might not be re-invested into domestic industry, MNCs may repatriate profits and invest abroad.
2) Capital-Intensive Machinery.
Profits may be re-invested to make capital-intensive machinery for industry, so industry does not require much labour from agriculture. Rich industrial capitalists make more profit whilst disguised unemployment remains in agriculture, so income distribution worsens.
3) Seasonal Unemployment.
Maybe the agricultural workers are just seasonally unemployed, they may still be crucial for agriculture during harvest times. If these workers leave agriculture, domestic food supply may fall and the population starves. For example, in India there are so many Zebu cows roaming the streets it seems like they are useless and being kept alive for religious reasons but they are in fact the axis of agriculture, they are crucial for the agricultural season and are simply seasonally unemployed the rest of the time.
4) Income Inequality.
Profits flow into the hands of capitalists so income distribution worsens and skews further towards the rich.
5) Capitalist vs. Non-Capitalist Sector.
Lewis is commonly misinterpreted in such a manner that industry has been prioritised over agriculture. It must be stressed that Lewis focused on a capitalist and non-capitalist dual sector model. A capitalist hires labour to work with machinery to make output for profit. Both industry and agriculture have capitalists, the capitalist sector is not synonymous with the industrial sector. Both agriculture and industry must be developed.