8. Structural transformation

Question 1

What is the Lewis model aimed at doing?

Answer 1

Putting a positive spin on transformation between agriculture and urban development

Question 2

What is structural transformation and policy aimed at doing?

Answer 2

How to encourage unproductive labour into higher productivity sectors

Question 3

What are some of the general processes in economic development?

Answer 3

• 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

Question 4

What is structural transformation?

Answer 4

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

Question 5

What explains cross-country income disparities?

Answer 5

Caselli 2005 Development accounting shows sectoral productivity differences explain more than half of cross-country income disparities

Question 6

How does structural transformation effect relative wages?

Answer 6

The convergence of regional wages which reduces inequality

Question 7

Why is structural transformation matter?

Answer 7

• Income disparities decrease with structural transformation
• Transformation can also be an important source of growth

Question 8

How can structural transformation be a source of growth?

Answer 8

Resources move out of sectors with low (relative and absolute) productivity into sectors with high (relative and absolute) productivity

Question 9

Which paper uses development accounting?

Answer 9

Caselli 2005

Question 10

What does the Caselli 2005 paper?

Answer 10

This paper finds that cross-country income differences are due to:

1. Much lower productivity in agriculture
2. Much higher shares of employment in the low-productivity sector
3. Slightly lower productivity in non-agriculture

Question 11

What are some empirical regularities/ stylised facts that we see in empirical studies of development?

Answer 11

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

Question 12

What are some of the causes of moving from agriculture to manufacturing to services?

Answer 12

• Non-homothetic preferences
• Differential productivity growth across sectors (Lewis model)

Question 13

What are non-homothetic preferences?

Answer 13

Low income elasticities of demand for food and agriculture and high income elasticities of demand for services

Question 14

When was the Lewis model created?

Answer 14

1954, it’s one of the earliest and best-known models of structural change

Question 15

What are the two sectors the model features?

Answer 15

• A modern capitalist sector
• A traditional subsistence agricultural sector

Question 16

Give a brief overview of the model?

Answer 16

• 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

Question 17

What type of returns do we have to labour and what does this imply?

Answer 17

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

Question 18

What is fixed in the short-run in the modern sector?

Answer 18

Capital and technology

Question 19

What type of labour supply do modern sector firms face?

Answer 19

Perfectly elastic supply of labour as there is surplus labour in the agricultural sector

Question 20

How do modern sector firms maximise profits?

Answer 20

By employing workers until MP_LM=W_M

Question 21

As we leave the short run, what does Lewis assume is done with profits?

Answer 21

The profits get invested moving K up which moves the marginal product of labour higher

Question 22

How do firms respond in the Lewis model to increased marginal product of labour?

Answer 22

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.

Question 23

What is the Lewis turning point?

Answer 23

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

Question 24

What does the Lewis turning point predict will happen?

Answer 24

• 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

Question 25

Explain the Lewisian turning point?

Answer 25

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.

Question 26

Why do many think that China has reached a Lewis turning point?

Answer 26

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

Question 27

What are some common critcisms of the Lewis model?

Answer 27

• 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)

Question 28

What are some policy interventions that can encourage structural transformation?

Answer 28

• 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)

Question 29

What is the rate of growth in output expansion in the modern sector determined by?

Answer 29

The speed with which this expansion occurs is determined by the rate of industrial investment and capital accumulation in the modern sector

Question 30

What allows the modern sector to grow through investment?

Answer 30

Such investment is made possible by the excess of modern-sector profits over wages on the assumption that capitalists reinvest all their profits.

Question 31

What did Lewis assume about the level of urban wages?

Answer 31

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.

Question 32

Why do wages in the urban sector not rise in the urban sector despite growing profits?

Answer 32

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.

Question 33

What is sometimes called antidevelopmental economic growth?

Answer 33

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

Question 34

When would antidevelopmental growth occur?

Answer 34

If profits were reinvested in labour saving technologies and therefore shift the demand curve up and do not move the quantity of labour used

Question 35

What is the conclusion to draw about the lewis model?

Answer 35

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.