8. Structural transformation Flashcards
What is the Lewis model aimed at doing?
Putting a positive spin on transformation between agriculture and urban development
What is structural transformation and policy aimed at doing?
How to encourage unproductive labour into higher productivity sectors
What are some of the general processes in economic development?
- A steady accumulation of physical and human capital over time
- Rural-urban migration and urbanisation
- Population growth - first increasing, then decreasing with family size
- Structural transformation
What is structural transformation?
The reallocation of economic activity across agriculture, manufacturing and services. Usually associated with a reallocation of resources from low-productivity, labour intensive sectors to higher-productivity, capital and knowledge intensive sectors
What explains cross-country income disparities?
Caselli 2005 Development accounting shows sectoral productivity differences explain more than half of cross-country income disparities
How does structural transformation effect relative wages?
The convergence of regional wages which reduces inequality
Why is structural transformation matter?
- Income disparities decrease with structural transformation
- Transformation can also be an important source of growth
How can structural transformation be a source of growth?
Resources move out of sectors with low (relative and absolute) productivity into sectors with high (relative and absolute) productivity
Which paper uses development accounting?
Caselli 2005
What does the Caselli 2005 paper?
This paper finds that cross-country income differences are due to:
- Much lower productivity in agriculture
- Much higher shares of employment in the low-productivity sector
- Slightly lower productivity in non-agriculture
What are some empirical regularities/ stylised facts that we see in empirical studies of development?
As a country’s income per-capita increases we observe:
- A declining share of agriculture
- An increasing share of services
- A hump-shaped share of manufacturing
What are some of the causes of moving from agriculture to manufacturing to services?
- Non-homothetic preferences
- Differential productivity growth across sectors (Lewis model)
What are non-homothetic preferences?
Low income elasticities of demand for food and agriculture and high income elasticities of demand for services
When was the Lewis model created?
1954, it’s one of the earliest and best-known models of structural change
What are the two sectors the model features?
- A modern capitalist sector
- A traditional subsistence agricultural sector
Give a brief overview of the model?
- The agricultural sector acts as a reservoir containing an unlimited supply of labour
- When the marginal productivity of labour has been driven down to 0, labour can drain away from the sector without reducing output
- Profits in the modern sector are re-invested in capital allowing even higher profits by drawing even more labour from the agricultural sector
What type of returns do we have to labour and what does this imply?
Diminishing marginal returns to labour, when the marginal product reaches 0, there is no value to employing more labour and any additional workers become surplus labour
What is fixed in the short-run in the modern sector?
Capital and technology
What type of labour supply do modern sector firms face?
Perfectly elastic supply of labour as there is surplus labour in the agricultural sector
How do modern sector firms maximise profits?
By employing workers until MP_LM=W_M
As we leave the short run, what does Lewis assume is done with profits?
The profits get invested moving K up which moves the marginal product of labour higher
How do firms respond in the Lewis model to increased marginal product of labour?
Wage hasn’t changed, so more productivity from reinvesting is going to increase profits, capitalists therefore want to bring in more labour. Given the models assumption of infinite pool of labour, this theoretically would happen again and again drawing in more and more labour. This is how the modern sector sweeps up surplus labour and therefore develops by taking the excessive labour in agriculture that has zero marginal product and making it more productive.
What is the Lewis turning point?
The Lewis turning point represents a point where all surplus labour has been absorbed by the modern sector. Thereafter, additional workers can be withdrawn from the agricultural sector only at a higher cost of lost food production because the declining labour-to-land ratio means that the marginal product of rural labour is no longer zero
What does the Lewis turning point predict will happen?
- Increasing agricultural sector wages as additional workers moving to the modern sector will n longer by surplus labour but have +MP
- Agricultural sector total product will begin to fall
- Modern sector growth will slow as ‘cheap’ labour dries up
Explain the Lewisian turning point?
You are going to hit a point when you exhaust all surplus labour in the agricultural sector and then to attract people to the modern sector you must now take productive labour from agriculture which is going to impact the wage rate in both the modern sector and agriculture sector. No longer just attracting workers who had had zero marginal product. This slows down modern sector growth as reinvestment slows because the wage rate rises.
Why do many think that China has reached a Lewis turning point?
Zhang et al 2011 provide evidence for rising real wages in rural areas suggesting an end to cheap labour available to China’s more modern sectors
What are some common critcisms of the Lewis model?
- Surplus agricultural labour (does it actually exist?)
- Capital investments (unlikely to invest in same tech, more capital intensive may require less labour)
- The modern sector (requires constant real wage rate and assumption of full employment in modern sector)
- Homogeneity of labour (differences in skills)
What are some policy interventions that can encourage structural transformation?
- Broadening access to education
- Infrastructure
- Improving agricultural productivity (technology, less labour intense)
- Land tenure (encourages investment in agriculture, less labour)
- Industrial policies (aimed at attracting FDI, SEZs for example)
What is the rate of growth in output expansion in the modern sector determined by?
The speed with which this expansion occurs is determined by the rate of industrial investment and capital accumulation in the modern sector
What allows the modern sector to grow through investment?
Such investment is made possible by the excess of modern-sector profits over wages on the assumption that capitalists reinvest all their profits.
What did Lewis assume about the level of urban wages?
Lewis assumed that the level of wages in the urban industrial sector was constant, determined as a given premium over a fixed average subsistence level of wages in the traditional agricultural sector. At the constant urban wage, the supply curve of rural labour to the modern sector is considered to be perfectly elastic.
Why do wages in the urban sector not rise in the urban sector despite growing profits?
The supply of rural labour is assumed to be unlimited or perfectly elastic, as shown by the horizontal labour supply curve WM. Lewis assumes that at urban wage WM above rural average income WA, modern-sector employers can hire as many surplus rural workers as they want without fear of rising wages.
What is sometimes called antidevelopmental economic growth?
All the extra income and output growth is distributed to the few owners of capital, while income and employment levels for the masses of workers remain largely unchanged
When would antidevelopmental growth occur?
If profits were reinvested in labour saving technologies and therefore shift the demand curve up and do not move the quantity of labour used
What is the conclusion to draw about the lewis model?
When we take into account the labour-saving bias of most modern technological transfer, the existence of substantial capital flight, the widespread nonexistence of rural surplus labour, the growing prevalence of urban surplus labour, and the tendency for modern-sector wages to rise rapidly even where substantial open unemployment exists, we must acknowledge that the Lewis two-sector model—though valuable as an early conceptual portrayal of the development process of sectoral interaction and structural change and a description of some historical experiences, including some recent ones such as China—requires considerable modification in assumptions and analysis to fit the reality of most contemporary developing nations.
