Lewis’TheoryofUnlimitedSuppliesofLabour

THELEWISTHEORY

Two Sector Economy. Prof. W. Arthur Lewis has developed a very systematic theory of EconomicDevelopmentwithUnlimited Supplies of Labour.1 Like the classical economists, he believes that inmany underdeveloped countries an unlimited supply of labour is available at a subsistence wage.Economic development takes placewhen capital accumulates as a result of thewithdrawal of surpluslabour from the “subsistence” sector to the “capitalist” sector. The capitalist sector is that part of theeconomywhichusesreproduciblecapitalandpayscapitalistsfortheusethereof.’Itemployslabourforwages inmines, factories, and plantations for earning profit. The subsistence sector is that part of theeconomywhich does not use reproducible capital. In this sector, output per head is lower than in thecapitalistsector.

Lewisstartshistheorywiththeassertionthattheclassicaltheoryofperfectlyelasticsupplyoflabouratasubsistencewageholds true in thecaseofanumberofunderdevelopedcountries.Sucheconomiesareover-populatedrelatively tocapitalandnatural resourcesso that themarginalproductivityof labour isnegligible, zero or even negative. Since the supply of labour is unlimited, new industries can beestablishedorexistingindustriesexpandedwithoutlimitatthecurrentwagebydrawinguponlabourfromthe subsistence sector. The current wage is what labour earns in the subsistence sector, i.e., thesubsistence wage. The main sources from which workers would be coming for employment at thesubsistencewageaseconomicdevelopmentproceedsare“thefarmers,thecasuals,thepettytraders,theretainers(domesticandcommercial),womeninthehouseholdandpopulationgrowth.”Butthecapitalistsector also needs skilled workers. Lewis argues that skilled labour is only a “quasibottleneck, atemporarybottleneck”whichcanberemovedbyprovidingtrainingfacilitiestounskilledworkers.

1.’ThisisthetitleofanarticlepublishedbyW.A.LewisintheManchesterSchool,May,1954.ReprintedinAggrawalandSingh,op.cit..pp.400-449.Also“UnlimitedLabour”Furthernotes:TheManchesterSchool.Jan.,1958.

Capitalist Surplus. Now the question is what determines the subsistence wage at which the surpluslabour is available for employment in the capitalist sector? It depends upon the minimum earningsrequired for subsistence.Tobeprecise, thewage level cannotbe less than the averageproductof theworkerinthesubsistencesector.Itmay,however,behigherthanthis,ifthefarmersaretopayrentorfoodcostsmore or if they feel that psychic disutilities of leaving home are large. Though “earnings in thesubsistencesectorsetafloortowageinthecapitalistssector,”yetinpracticecapitalistwagesaremorethan30percent2higherthansubsistencewagesdueto:

(a )asubstantial increase in theoutputof thesubsistencesectorwhichbyraisingreal incomemightinduceworkerstoaskforahighercapitalistwagebeforeofferingthemselvesforemployment;

(b) ifwith thewithdrawalof labour from thesubsistencesector, totalproduct remains the same, the

average product and hence the real income of those remaining behind will rise and the with drawnworkersmightinsistonahigherwageinthecapitalistsector;

(c)thehighcostoflivingandsomehumanitarianconsiderationmaymovetheemployerstoraisethereal wage, or governmentmay encourage trade unions and support their wage-bargaining efforts. Thesupplyoflabouris,however,consideredtobeperfectlyelasticattheexistingcapitalistwage.

2.Inthe1958article,Lewisestimatedagapof50percent.Infact,thesizeofthismargincannotbepreciselystatedandwillvarywithlocalcircumstances.

CapitalFormationDependsonCapitalistSurplus.Capitalistsaimatprofitmaximisation.Itistheywhosaveandautomaticallyinvestwhattheysave.Sincethemarginalproductivityoflabourinthecapitalistsector ishigher than thecapitalistwage, this results in capitalist surplus.This surplus is reinvested innewcapital assets.Capital formation, takesplaceandmorepeopleareemployed from the subsistencesector.Thisprocesscontinuestillthecapital-labourratiorisesandthesupplyoflabourbecomesinelasticandthesurplus labourdisappears.Thuscapital formationdependson thecapitalistsurplus.TheLewistheory can be explained with the help of Fig. 1. The horizontal axis measures the quantity of labouremployedandtheverticalaxis,itswageandmarginalproduct.OSrepresentsaveragesubsistencewageinthesubsistencesector,andOWthecapitalistwage.AtOWwageinthecapitalistsector,thesupplyoflabourisunlimited,asshownbythehorizontalsupplycurveoflabourWW.Inthebeginning,whenON1labourisemployedinthecapitalistsector,itsmarginalproductivitycurveisP1L1andthetotaloutputofthissectorisOP1O1N1.OutofthisworkersarepaidwagesequaltotheareaOWQ1N1.TheremainingareaWP1Q1showssurplusoutput.This is thecapitalistsurplusor totalprofitearnedbythecapitalistsector.Whenthissurplusisreinvested,thecurveofmarginalproductivityshiftsupwardstoP2L2-Thecapitalist surplus and employment are now larger than before beingWP 2Q2 andON 2respectively.FurtherreinvestmentsraisethemarginalproductivitycurveandthelevelofemploymenttoP3L3andON

3andsoon,tilltheentiresurpluslabourisabsorbedinthecapitalistsector.Afterthis,thesupplycurveWWwillslopefromlefttorightupwardslikeanordinarysupplycurve,andwagesandemploymentwillcontinuetorisewithdevelopment.

Thus,capitalisformedoutofprofitsearnedbythecapitalists.AccordingtoLewis,iftechnicalprogressiscapital-saving, itmaybeconsideredasan increment incapital, and if it is labour-saving, itmaybeconsidered as an increment in the marginal productivity of labour. As such, he does not make anydistinctionbetween thegrowthof technical knowledge and thegrowthofproductive capital and treatsthemasa“singlephenomenon”withtheresultthattechnicalprogresstendstoraiseprofitsandincreaseemploymentinthecapitalistsector.

Role of the State and Private Capitalists. “The central problem in the theory of economicdevelopment,” according to Lewis, “is to understand the process by which a community which waspreviously saving and investing 4 or 5 per cent of its national income or less converts itself into aneconomywherevoluntarysavingisrunningatabout12to15percentofnationalincomeormore.Thisisthe central problem because the central fact of economic development is rapid capital accumulation(includingknowledgeandskillswithcapital).Inunderdevelopedcountrieswithsurpluslabour,only10percentofthepeoplewiththelargestincomesavewhoreceiveabout40percentofthenationalincome.

Thewageandsalaryclasseshardlysave3percentofthenationalincome. But the dominant classes consisting of landlords, traders,moneylenders, priests, soldiers, princes are engaged in prodigalconsumption rather than in productive investments. It is, therefore,the state capitalist and indigenous private capitalists who createcapital out of profits earned. “The indigenous private capitalist isbound up with the emergence of new opportunities, especiallysomething that widens the market, associated with some newtechnique which greatly increases the productivity of labour, andhence thecapitalist surplus.Thestatecapitalist,on theotherhand,canaccumulatecapitalevenfaster thantheprivatecapitalist,sincehe can use for this purpose not only the profits of the capitalistsector, but also what he can force or tax out of the subsistencesector.”Thus,onceacapitalistsectorhasemergeditisonlyamatterof time before it becomes sizable. If the opportunities for usingcapital productivity increase rapidly, the surplus will also growrapidly,andthecapitalistclasswithit.CapitalFormationthroughBankCredit.Butcapitaliscreatednotonlyoutofprofits, it is also createdoutofbankcredit. In anunderdevelopedeconomywhichhasabundantidleresourcesandshortageofcapital,creditcreationhasthesameeffectoncapitalformationasprofits. It will raise output and employment. Credit- financed capital formation, however, leads toinflationaryriseinpricesforsometime.Whenthesurpluslabourisengagedinthecapitalistsectorandpaidoutofcreatedmoney,prices risebecause incomeincreaseswhileconsumergoodsoutput remainsconstant.Thisisonlyatemporaryphenomenon,forassoonascapitalgoodsstartproducingconsumptiongoods,pricesstartfalling.InthewordsofLewis,“Inflationforthepurposeofcapitalformationisaverydifferent kettle of fish. It is self-destructive. Prices begin to rise but are sooner or later overtaken byrisingoutput,andmay,inthelaststage,enduplowerthantheywereatthebeginning.”Theinflationaryprocessalsocomes toanend“whenvoluntary savings increase toa levelwhere theyareequal to theinflatedlevelofinvestment.”Ascapitalformationistakingplaceallthetime,outputandemploymentrisecontinuouslyandsodoprofit.Sincehigherprofitleadtohighersaving,atimewillcomewhensavingsincreasesomuchthatnewinvestmentscanbefinancedwithoutrecoursetobankcredit.

Thisanalysisalsoappliestothegovernmentwhichreceivesbacktheinflationfinancedmoneyintheformof taxes.Secondly , when national income increaseswith rising output, it is not required to resort todeficit financing.Given abundant labour and scarce physical resources, the effect of capital formationeitherthroughtaxationorcreditcreationisthesameonoutput.Sincebackwardeconomiesarefacedwithunlimitedsuppliesoflabour,theLewistheoryisprimarilyconcernedwiththisproblem.

EndoftheGrowthProcess.The theoryshowsthat“ifunlimitedsuppliesof labourareavailableataconstant realwage, and if any part of the profit is reinvested in productive capacity, profitwill growcontinuouslyrelativelytothenationalincomeandcapitalformationwillalsogrowrelativelytonationalincome.”But theprocessofgrowthcannotgoon indefinitely, if as a result of capital accumulationnosurpluslabourisleft.Itmayalsostopifdespitetheexistenceofsurpluslabour,realwagesrisesohighasto reduce the capitalist profit to the level where they are all consumed and nothing is left, for netinvestment.Thismayhappeninanyoneofthefourways:

(a ) if the capitalist sector expands so rapidly that it reduces absolutely the population in thesubsistencesector,theaverageproductivityoflabourrisesinthelattersectorbecausethereareveryfewpeopletosharetheproductandsothecapitalistwagerisesintheformersector(inthediagramSSandWWwillshiftupwardsandreduceprofit);

(b)ifasaresultoftheexpansionofthecapitalistsectorrelativelytothesubsistencesector,thetermsoftradeturnagainsttheformerwithrisingpricesofrawmaterialsandfood,thecapitalistswillhavetopayhigherwagestotheworkers;

(c ) if the subsistence sector adopts new techniques of production, real wages would rise in thecapitalistsectorandsoreducethecapitalistsurplus;and

(d),iftheworkersinthecapitalistsectorimitatethecapitalistwayoflife;andagitateforhigherwagesand if successful in raising theirwages, thecapitalist surplusand the rateofcapital formationwillbereduced.

In Open Economy. When capital accumulation is adversely affected by any of these factors, it cancontinuebyencouragingmassimmigrationorbyexportingcapitaltosuchcountriesaspossessabundantlabouratsubsistencewage.Boththesepossibilitiesare,however,ruledoutbyLewishimself.

First , mass immigration of unskilled labour is not possible because trade unions in the high-wagecountriesopposeit.Theyfearthatlabourimportswouldbringdownwagestothesubsistencelevelofthepoorestcountry.

Second,theeffectofcapitalexportsistoreducethecreationoffixedcapitalathomeandhencetoreducethedemandforlabourandwagesinthecapital-exportingcountry.Butthereductioninwagesisoffsetifcapitalexportscheapenthethingswhichworkersimportbecausetheirrealwageswillrise.Ontheotherhand,thereductioninwagesisfurtherencouragedifcapitalexportsraisethecostofimportedthingsastherealwagesofworkerswillfall.Sotheeffectofcapitalexportscannotbeassessedwithdefiniteness.

ACRITICALAPPRAISAL

TheLewistheoryisapplicabletooverpopulatedunderdevelopedcountriesundercertainsetconditions.Its applicability is, therefore, circumscribed by its assumptions which are the basis of criticismsdiscussedbelow:

1.WageRatenotConstant intheCapitalistSector.The theoryassumesaconstantwage rate in thecapitalist sectoruntil the supplyof labour isexhausted from, the subsistencesector.This isunrealisticbecausethewageratecontinuestoriseovertimeintheindustrialsectorofanunderdevelopedeconomyevenwhenthereisopenunemploymentinitsruralsector.

2.NotApplicableifCapitalaccumulationisLabourSaving.Lewisassumesthatthecapitalistsurplusisreinvested in productive capital but according to Reynolds,3 if the productive capital happens to belaboursaving,itwouldnotabsorblabourandthetheorybreaksdown.ThisisshowninFig.2wherethecurveP2L2hasagreaternegativeslopethanthecurveP1L1,therebyshowinglabour-savingtechnique.WiththeshiftingofthemarginalproductivitycurveupwardsfromP1L1toP2L2,thetotaloutputhasrisen

substantially from OP 1Q1N1to OP2Q1N1. But the total wage billOWQ1N1andthelabouremployedON1remainunchanged.

3. Skilled Labour not a Temporary Bottleneck. Given an unlimitedsupplyoflabour,Lewisassumestheexistenceofunskilledlabourforhistheory.Skilled labour is regardedasa temporarybottleneckwhichcanberemovedbyprovidingtrainingfacilitiestounskilledlabour.Nodoubtskilled labour is in short supply in underdeveloped countries but skill-formationposesaseriousproblem,asittakesaverylongtimetoeducateandtrainthemultitudesinsuchcountries.

4.LackofEnterpriseandInitiative.TheLewistheoryisbasedontheassumption thatacapitalistclassexists inunderdevelopedcountries. Infact,theentireprocessofgrowthdependsontheexistenceofsuchaclasswhich has the necessary skill to accumulate capital. In reality, such countries lack capitalists withnecessaryenterpriseandinitiative.

5.MultiplierProcessdoesnot operate inLDC.Again, the theory assumes that capital accumulationtakesplacewhenthecapitalistclasscontinuestoreinvestprofits.It,therefore,presupposestheoperationof the“investmentmultiplier”which isnotapplicable tounderdevelopedcountries.4For ifprofits arereducedsomehoworthepricesofwagegoodsrise,theprocessofcapitalformationwillstopbeforeallthesurpluslabourisabsorbed.

3.LloydG.Reynolds,“WagesandEmploymentinaLabour-SurplusEconomy,”A.E.R..September,1956.

4.SeeChapteron“KeynesianTheoryofDevelopment.”

6.One sidedTheory. This is a one-sided theory because Lewis does not consider the possibility ofprogressintheagriculturalsector.Astheindustrialsectordevelopswiththetransferofsurpluslabour,thedemandforfoodandrawmaterialswillrisewhichwill,inturn,leadtothegrowthoftheagriculturalsector.

7.NeglectsTotalDemand. Lewis does not study the problem of aggregate demand.He assumes thatwhateverisproducedinthecapitalistsectoriseitherconsumedbyitselforisexported.Hedoesnotevenanalysethepossibilityofthecapitalistsectorsellingitsproductstothesubsistencesector.Incase,itsohappens,thegrowthprocessmaycometoahaltmuchearlierthroughunfavourabletermsoftradeorthesubsistencesectoradoptingnewtechniquesofproductiontomeettheexpandingrawmaterialdemandofthecapitalistsector.

8.Mobility ofLabournot soEasy.Higher capitalistwagewill not lead to themovement of surpluslabourfromthesubsistencesectortothecapitalistsector.Peoplearesointenselyattachedtotheirfamilyandlandthattheydonotliketoleavetheirkithandkin.Moreover,differencesinlanguageandcustom,theproblemsof congestion,housingandhighcostof living in the capitalist sector stand in thewayofmobilityoflabourtothissector.Thisisthemainweaknessofthetheory.

9.MarginalProductivityofLabournotZero.Schultzdoesnotagreethatthemarginalproductivityof

labour in overpopulated underdeveloped countries is zero or negligible. If itwere so, the subsistencewagewouldalsobezero.Thefactisthateveryworkerreceivesthesubsistencewage,maybeinkind,ifnotincash.Itis,therefore,difficulttofindouttheexactnumberofsurpluslabourerswhoaretomovetothecapitalistsector,theirnumberhardlyexceeding5percent,asisnowgenerallyaccepted.

10. Productivity falls withMigration of Labour from the Subsistence Sector. Lewis assumes thatwhenthesurpluslabouriswithdrawnfromthesubsistencesectortothecapitalistsector,theagriculturalproductionremainsunaffectedinthesubsistencesector.Butthefactisthatwithdrawalofworkersfromthe farms will reduce output. As pointed out by Schultz, “there is no evidence for any poor countryanywherethatwouldsuggestthatatransferofevensomefraction,say5percentoftheexistinglabour-forceoutofagriculture,withotherthingsbeingequal,couldbemadewithoutreducingitsproduction.”

11.LowIncomeGroupsalsoSave.Itisnotcorrecttosaythatonly10percentofthepeoplewiththelargest incomesave. Infact,people,with lowincomesalsosavedue tosocial reasonsandevensmallfarmers save for capital accumulation in underdeveloped countries,whereas high income groups savelessbecausetheyspendmoreundertheinfluenceofthedemonstrationeffect.

12.Inflation,notSelf-Destructive.Lewis’sview that inflation for thepurposeofcapital formation isself-destructive is difficult to believe in the face of acute shortage of consumer goods. Production ofconsumer goods fails to increase rapidly due to structural rigidities. On the other hand, the marginalpropensitytoconsumeofthepeopleisnearunity,sothatallincreasesinincomeleadtoinflationaryriseinprices.

13. Inefficient Tax Administration. Lewis’s contention that taxation will mop up increasing incomecannot be accepted because the tax administration in underdeveloped countries is not so efficient anddevelopedastocollecttaxessufficientenoughforcapitalaccumulation.

Conclusion.Despitetheselimitations,theLewistheoryhasthemeritofexplaininginaveryclearcutwaytheprocessofdevelopment.Thistwosectortheoryhasgreatanalyticalvalue.Itexplainshowlowcapitalformationtakesplaceinunderdevelopedcountrieswhichhaveplethoraoflabourandscarcityofcapital.Hisstudyoftheproblemsofcreditinflation,populationgrowth,technologicalprogress,andinternationaltradegivesthetheoryatouchofrealism.

CHAPTER

Fei-RanisTheory

INTRODUCTION

JohnFei andGustavRanis in an article entitled “ATheory of EconomicDevelopment ” analyse “thetransition process through which an underdeveloped economy hopes to move from a condition ofstagnation to one of self-sustained growth.” Their theory is an improvement over Lewis’s theory ofUnlimitedSupplies ofLabour becauseLewis failed to present a satisfactory analysis of the growthofagricultural sector. The analysis that follows is based on the original article and the subsequentmodifications1madebytheauthorsintheirtheoryofthedevelopmentofadualeconomy.

THETHEORY

The theory relates to an underdeveloped labour-surplus and resource-poor economy inwhich the vastmajorityof thepopulationisengagedinagricultureamidstwidespreadunemploymentandhighratesofpopulation growth. The agrarian economy is stagnant, people are engaged in traditional agriculturalpursuits.Non-agriculturalpursuitsexistbut theyarecharacterisedbyamodestuseofcapital.There isalso an active and dynamic industrial sector. Development consists of the re-allocation of surplusagriculturalworkers,whosecontributiontooutputiszeroornegligible,totheindustrialsectorwheretheybecomeproductiveatawageequaltotheinstitutionalwageinagriculture.2

1.JohnG.H.FeiandGustavRanis,“ATheoryofEconomicDevelopment,”AER,Vol.51,September1961;DevelopmentofLabourSurplusEconomy,1964;and“Agrarianism,DualismandEconomicDevelopment,”inTheTheoryandDesignofEconomicDevelopment(eds.)I.AdelmanandF.Thorbecke,1966.

ASSUMPTIONS

Inpresentingtheirtheoryofeconomicdevelopment,FeiandRanismakethefollowingassumptions:

1.There is a dual economydivided into a traditional and stagnant agricultural sector and an activeindustrialsector.

2.Theoutputoftheagriculturalsectorisafunctionoflandandlabouralone.

3.Thereisnoaccumulationofcapitalinagricultureexceptintheformoflandreclamation.

4.Landisfixedinsupply.

5.Agriculturalactivityischaracterisedbyconstantreturnstoscalewithlabourasavariablefactor.

6. It is assumed that themarginal productivity of labour becomes zero at some point. If populationexceedsthequantityatwhichthemarginalproductivityoflabourbecomeszero,labourcanbetransferred

totheindustrialsectorwithoutlossinagriculturaloutput.

7.Theoutputof theindustrialsector isafunctionofcapitalandlabouralone.Landhasnoroleasafactorofproduction.

8.Populationgrowthistakenasanexogenousphenomenon.

9.Therealwageintheindustrialsectorremainsfixedandisequaltotheinitiallevelofrealincomeintheagriculturalsector.Theycallittheinstitutionalwage.

10.Workersineithersectorconsumeonlyagriculturalproducts.

Given these assumptions,Fei andRanis analyse thedevelopmentof alabour-surplus economy into three phases. In the first phase, thedisguised unemployed workers, who are not adding to agriculturaloutput,aretransferredtotheindustrialsectorattheconstantinstitutionalwage. In the second phase, agricultural workers add to agriculturaloutput but produce less than the institutional wage they get. Suchworkers are also shifted to the industrial sector. If the migration ofworkerstotheindustrialsectorcontinues,apointiseventuallyreachedwhenfarmworkersproduceoutputequaltotheinstitutionalwage.Thisbegins the third phase which marks the end of the take-off and thebeginning of the self-sustained growth when farm workers producemore than the institutional wage they get. In this phase, the surpluslabour is exhausted and the agricultural sector becomescommercialised.

2.Beforestartingthismodel,studentsshouldfirstreadtheLewisModelinthepreviouschapter.

Fig.1(A)showsthefunctioningoftheagriculturalsectorwhereagriculturalgoodsareproducedbytheapplicationoflabour(L)andland(Z).Labourismeasuredonthehorizontalaxisandlandontheverticalaxis.TherayORshowsthestageofproduction.ThecurveABCistheproductioncontourofagriculturalgoods.AssuminglandtobefixedatOZ,labourON1producesthemaximumoutput.ThetotalproductivityoflabourisrepresentedbyTPcurveinFig.1(B).IfmorelabourisemployedbeyondN1withlandOZ,productionwouldnotincrease.ThisisbecausethetotalproductivityoflabourbecomesconstantbeyondpointMontheTPcurve.AssumingthatON2isthetotallabourforce,engagedinagricultureON1 is thenon-redundantlabourandN1N2istheredundantlabourforce.N1N2numberofworkersdonotmakeanypositivecontributiontooutputandtheirmarginalphysicalproductivityapproacheszerobeyondpointMontheTPcruve.Suchworkersaredisguisedunemployed.

Economic development takes placewhen theseworkers are shifted from the agricultural sector to theindustrialsectorinthreephases.ThisisillustratedinFig.2(A),(B)and(C)wherePanel(A)depictstheindustrialsectorandpanels(B)and(C)theagriculturalsector.

LetustakePanel(C)wherethelabourforceintheagriculturalsectorismeasuredfromrighttoleftonthe

horizontal axis ON and agricultural output downward from O on theverticalaxisOY.ThecurveOCX is the totalphysicalproductivitycurve(TPP)3oftheagriculturalsector.ThehorizontalportionCXofthecurveshows that the total productivity is constant in this region so that themarginalproductivityofMN labour iszero.ThusMN labour is surplusand its withdrawal to the industrial sector will not affect agriculturaloutput. If, however, it is presumed that the entire labour force ON isengagedintheagriculturalsector,itproducesNXtotalagriculturaloutput.AssumingthattheentireoutputNXisconsumedbythetotal labourforceON,therealwageisequaltoNX/ONortheslopeoftherayOX.Thisistheinstitutionalwage.

Theallocationprocess in threephasesduring the take-off isdepicted inPanel(B)oftheFig.2wherethetotallabourforceismeasuredfromrightto left on the horizontal axisONand the average output on the verticalaxisNV.ThecurveNMRU represents themarginalphysicalproductivityoflabour(MPP)intheagriculturalsector.NWistheinstitutionalwageatwhichtheworkersareemployedinthissector.

3.ItistheinvertedOTPcurveFig.1(B)

In Phase I, NM workers are disguised unemployed. Their marginalphysicalproductivityiszero,asshownbyNMportionoftheMPPcurveinPanel(B)orCXportionoftheTPPcurveofPanel(C).ThisredundantlabourforceNMistransferredtotheindustrialsectorshownasOMinPanel(A)atthesameinstitutionalwageOW(=NW).

InPhaseII,theMPPofagriculturalworkersMKispositiveintherangeMRontheMPPcurveNMRUbutislessthantheinstitutionalwageKR(=NW)theyget,asshowninPanel(B).Sotheyarealsodisguisedunemployedtosomeextentandareshiftedtotheindustrialsector.Butthenominalwageintheindustrialsectorwillnotequaltheinstitutionalwageinthisphase.Thisisbecauseagriculturaloutputdeclineswiththetransferoflabourtotheindustrialsector.Asaresult,thereisashortageofagriculturalcommoditiesleadingtoriseintheirpricesrelativetoindustrialgoods.Thisleadstotheworseningofthetermsfortheindustrialsector,therebyrequiringariseinthenominalwageintheindustrialsector.Thenominalwagerises above the institutionalwageOW toLH andKQ. This is shown by the upwardmovement of thesupplycurveoflabourfromWTtoHandQ,asMLandLKlabourgraduallyshiftstotheindustrialsectorinPanel (A).Themovementon thesupplycurveof labourWTW tfromTupward is “theLewis turningpoint.”

WhenPhaseIIIbegins,agriculturalworkersstartproducingagriculturaloutputequal to the institutionalwageandultimatelymorethantheinstitutionalwagetheyget.Thismarkstheendofthetake-offandthebeginningoftheself-sustainedgrowth.ThisisshownbytherisingportionRUoftheMPPcurveinPanel(B)which is higher than the institutionalwageKR(=NW).Consequently,KO of labourwill be shiftedfromtheagriculturalsectortotheindustrialsectoratarisingnominalwageaboveKQinPanel(A)ofthefigure.This leads to theexhaustionof thesurplus labour in theagriculturalsectorwhichbecomesfullycommercialised.AccordingtoFeiandRanis,“The‘exhaustionofthelaboursurplus’mustbeinterpreted

primarilyasamarketphenomenonratherthanasaphysicalshortageofmanpower,itisindicatedbyanincreaseintherealwageatthesourceofsupply.”

Fei andRanis point out that as agriculturalworkers are shifted to the industrial sector, there begins asurplus of agricultural commodities. This leads to the total agricultural surplus (or TAS) in theagriculturalsector.Theexcessportionoftotalagriculturaloutputovertheconsumptionrequirementoftheagricultural labour force at the institutionalwage is the TAS. The amount of TAS is a function of thenumberofworkersshiftedtotheindustrialsectorineachphaseofthedevelopmentprocess.TheTASismeasuredinPanel(C)ofthefigurebytheverticaldistancebetweenthelineOXandtheTPPcurveOCX.InPhaseIwhenNMlabouristransferred,theTASisBC.InphaseII,asMLandLKworkersareshiftedtotheindustrialsector,DEandFGamountsofTASarise.“TASmaybeviewedasagriculturalresourcesreleasedtothemarketthroughthereallocationofagriculturalworkers.Suchresourcescanbeshiphonedoffbymeansoftheinvestmentactivitiesof thelandlordclassand/orgovernmenttaxpolicyandcanbeutilisedinsupportofthenewindustrialarrivals.”

There is also the average agricultural surplus (or AAS). The AAS is the total agricultural surplusavailableperheadtoworkersallocatedtotheindustrialsector.Itisasifeachallocatedworkercarrieshisownsubsistencebundlealongwithhim.TheAAScurveisdepictedasWASOcurveinPanel(B)ofthefigure.InPhaseI,theAAScurvecoincideswiththeinstitutionalwagecurveWA.InPhaseII,whenMKworkersaretransferredtotheindustrialsector,theAASbeginstofallfromAtoSinPanel(B)whileTASisstillrisingfromBCtoDEtoFGinPanel(C).

InPhaseIII,AASdeclinesmorerapidlyfromStoOinPanel(B)andTASalsodeclinesasshownbythenarrowingoftheareafromFGtowardOinPanel(C)belowPhaseIIIofPanel(B).ThedeclineinbothAASandTASisduetotheriseinMPPofagriculturalworkersbymorethantheinstitutionalwagewhichultimatelyleadstothetransferoftheremainingsurpluslabourtotheindustrialsector.

Fei and Ranis call the boundary between Phase I and II as the “shortage point” when shortages ofagriculturalgoodsbeginasindicatedbythefalloftheAAS(theportionASofWASOcurve)belowtheminimuminstitutionalwage(NW).AndtheboundarybetweenphaseIIandIIIasthe“commercialisationpoint”whichsignifies thebeginningofequalitybetweenMPPand the institutionalwage inagriculture.ThustheLewisturningpointcoincideswiththeshortagepointofFeiandRanis,andtheincreaseintheindustrialwageisspeededupatthecommmercialisationpoint.

They show that if agricultural productivity is increasing, the shortage point and the commercialisationpointcoincide.ThisisbecausewiththeincreaseinagriculturalproductivitytheriseinMPPenablestheoutputtorisetotheleveloftheinstitutionalwagemorequickly.ItmaybeviewedastheshiftingofMRUcurveupward to the left inFig. 2(B).On theother hand, theAAS increaseswith the increase in totalphysicalproductivityThismeansthattheASOcurveinFig.2(B)shiftsupwardtotheright.Iftheriseinproductivity issufficient, theMRUandASO curves inFig.2(B)will so shiftupward that the shortagepointAand thecommercialisationpointR coincideandPhase II is eliminated.So far as the industrialsectorisconcerned,theincreaseinagriculturalproductivityhastheeffectofraisingtheindustrialsupplycurveaftertheturningpoint.ThiscanbeviewedastheshiftingoftheWTW1curvedownwardtotherightbelowpointTinFig.2(A).

AccordingtoFeiandRanis,“Theeconomicsignificanceoftheequalitybetweenourturningpointandthe

commercialisation point is that, after the turning point, the industrial supplycurveoflabourfinallyrisesasweenteraworldinwhichtheagriculturalsectoris no longer dominated by non-market institutional forces but assumes thecharacteristics of a commercialised capitalist system.” In other words, theeconomicsignificanceoftheeliminationofthesecondphaseis that itenablestheeconomytomovesmoothlyintoself-sustainedgrowth.

BalancedGrowth.FeiandRanishavefurthershownthat theirmodelsatisfiestheconditionsofbalancedgrowthduringthetake-offprocess.Balancedgrowthrequiressimultaneousinvestmentinboththeagriculturalandindustrialsectorsof the economy. This is illustrated in Fig. 3 wherePP is the initial demandcurveforlabourandS1S1theinitialsupplycurveoflabour.TheyintersectatawhereOMlabourforceisemployed in the industrial sector.At this level of employment, the industrial sector is getting a profitequaltotheareaS1Pa.Thisprofitisthetotalinvestmentfundavailabletotheeconomyduringthetakeoffprocess.ApartofthisfundisallocatedtotheagriculturalsectortherebyraisingagriculturalproductivityandshiftingthesupplycurveoflabourintheindustrialsectordownwardtotherightfromS1S1toS2S2.The remaining part of the investment fund is allocated to the industrial sector, thereby shifting theindustrialdemandcurveupwardtotheright,fromPPtoP1P1.TheS2S2andP1P1curvesintersectata1lyingonthebalancedgrowthpathS1a3.Ata1the industrialsectorabsorbsML labour forcewhichhasbeen released by the agricultural sector as a result of rise in agricultural productivity following theallocationof investment fund to it. InFig.3,ML labour forceabsorbed in the industrial sectorexactlyequalsthelabourforceMLreleasedfromtheagriculturalsectorinFig.2(B).

Thus as investment funds are continued tobe allocated toboth sectors through time, the economywillmoveonthebalancedgrowthpath.Butthereiseverylikelihoodfortheactualgrowthpathtodeviatefromthe balanced-growth path from time to time. “Such a deviation, however, will call into playcountervailingequilibrating forceswhich tend tobring itback to thebalanced-growthpath.Theactualpathis,infact,likelytobeoscillatingaroundthebalanced-growthpath.”Forexample,ifasaresultofoverinvestment in the industrial sector, the demand curve for labour shifts toP2P 2and intersects thesupplycurveoflabour8282ata2,theactualgrowthpathwillbeabovethebalanced-growthpath.Thiswillleadtoshortageofagriculturalgoods,todeteriorationofthetermsoftradeoftheindustrialsectorand to rise in thewage rate in this sector.Thiswilldiscourage investment in the industrial sectorandencourage investment in the agricultural sector and thereby bring the actual path to the level of thebalanced-growthpatha3.

ACRITICALAPPRAISAL

The Fei-Ranis model is an improvement over the Lewis model. The Lewis model ignores thedevelopmentofagricultural sectorandconcentratesexclusivelyon the industrial sector.TheFei-Ranismodel shows the interaction between the two sectors in initiating and accelerating development.Moreover,itsexplanationoftheLewisturningpointismorerealistic.Butthemajormeritofthetheoryisthatitshowstheimportanceofagriculturalproductsincapitalaccumulationinunderdevelopedcountries.

Despitethesemerits,themodelisnotfreefromcriticismwhicharediscussedbelow:

1.SupplyofLandnotFixed.FeiandRanisbeginwith theassumption that thesupplyof land is fixedduringthedevelopmentprocess.Inthelongrun,theamountoflandisnotfixed,asthestatisticsofcropacreageinmanyAsiancountriesreveal.Forinstance,theindexnumberofareaundercrops(base1961-62)inIndiarosefrom82in1950-51to107.3in1970-71.

2. Institutional Wage not above the MPP. The model is based on the assumption of a constantinstitutionalwagewhichisabovetheMPPduringphasesIandIIofthedevelopmentprocess.Thereisnoempiricalevidencetosupportthisassumption.Infact,inlaboursurplusunderdevelopedcountries,wagespaidtotheagriculturalworkersaremuchbelowtheirMPP.

3.InstitutionalWagenotConstantintheAgriculturalSector.Thetheoryassumesthattheinstitutionalwage remains constant in the first two phases even when agricultural productivity increases. This ishighlyunrealisticbecausewithageneralriseinagriculturalproductivity,farmwagesalsotendtorise.For instance, the daily real wage rates (at 1966 prices) of agricultural workers for various farmoperations inPunjabduring theperiodof thegreenrevolution(1967-72) increasedby41.7percent to55.2percent.4

4.ClosedModel.AccordingFeiandRanis, thetermsof trademoveagainst theindustrialsector inthesecondphasewhenagriculturaloutputdeclinesandpricesofagriculturalcommoditiesrise.Thisanalysisisbasedontheassumptionofaclosedeconomywhereforeigntradedoesnotexist.Butthisassumptionisunrealisticbecauseunderdevelopedcountriesarenotclosebutopeneconomieswhichimportagriculturalcommoditieswhenshortagesarise.

4.M.L. Jhingan, “Surpluses Pertaining since theGreenRevolution and their contriubution to Industrialisation—AStudy of Punjab,” IJAE.,ConferenceNumber,July-September,1979.

5.CommercialisationofAgricultureLeadstoInflation.Accordingtothetheory,whentheagriculturalsectorentersthethirdphase,itbecomescommercialised.Buttheeconomyisnotlikelytomovesmoothlyinto self-sustained growth because inflationary pressures will start. When many workers shift to theindustrial sector, the agricultural sector will experience shortage of labour. In the meantime, theinstitutionalwagealsoequals theMPPofworkersand theshortagesofagriculturalproductsarise.Allthesefactorswilltendtocreateinflationarypressureswithintheeconomy.

6.MPPnotZero.FeiandRanisobservethat“withafixedamountofland, therewillbesomesizeofpopulationwhichislargeenoughtorenderMPPzero.”ButSchultzdoesnotagreethatinlabour-surpluseconomiestheMPPiszero.Accordingtohim,if itwereso,theinstitutionalwagewouldalsobezero.Thefactisthateveryworkerreceivesaminimumwage,maybeinkind,ifnotincash.ThusitiswrongtosaythattheMPPiszerointheagriculturalsector.

Conclusion.However,theselimitationsdonotunderminetheimportanceoftheFei-Ranismodelfortheeconomic development of labour-surplus countries. It systematically analysis the development processfromthetake-offtoself-sustainedgrowth,throughtheinteractionoftheagriculturalandindustrialsectorsofanunderdevelopedeconomy.