Unbalanced growth strategy: - Weebly
Unbalanced growth strategy:
In the last two decades a lot has been discussed about the strategies which can be adopted by underdeveloped countries in the initial stages of economic development. Among these discussions the debate on balanced growth versus unbalanced growth is an important one. Economists like Arthur Lewis, Rodan, and Ragnar Nurkse have advocated the strategy of balanced growth for underdeveloped countries. But criticizing this strategy Hirschman published his ’strategy of economic development’ in 1958, in which he has strongly advocated the strategy of unbalanced growth.
Unbalanced growth strategy:
According to the unbalanced growth strategy the creation of the deliberate and preplanned imbalances in the economy is the best way to achieve economic growth in underdeveloped economy. Hirschman regards development as a chain of disequilibria that must be kept alive. If the economy is to be kept moving ahead, the task of development policy is to maintain tensions, disproportions and disequilibria. In other words imbalances and tensions should be created in an economy for attaining an accelerated economic development. Hirschman believes that underdeveloped countries are not capable of developing the different sectors simultaneously because of the paucity of resources and necessary infrastructure. So he argues that investment should be made in the strategic industries or leading sectors of the economy. Such an investment will create more investment opportunities and pave the way for further economic development.
To make the above argument clear Hirschman divides the economy into two parts, namely, 1, social overhead capital(SOC) and 2. Directly productive activities (DPA). SOC refers to power, transport and communication, financial institutions, education etc. These services have occupied a central place in development. Without SOC, primary and secondary sectors cannot develop. Giving priorities to develop SOC will create imbalances and stimulate investment in DPA. This may bring about some balance between SOC and DPA in the economy. But the strategy requires that more should be invested again in the SOC sector. This will once again create imbalances in the economy and encourage DPA. Thus according to Hirschman, “development via excess capacity of SOC” is an important way of achieving rapid development of an underdeveloped economy.
Another way of creating the imbalances in the economy, according to Hirschman, is to make investment first of all in DPA. If investment is first made in DPA industries run into difficulties because of shortage of SOC. This will stimulate and encourage investment in SOC.
As investment in DPA expands still more activities which expand SOC will be encouraged and stimulated. This technique of encouraging and stimulating economic development and planning of the economy is known as” development via shortage of Social overhead capital”.
The two techniques of unbalanced growth mentioned above will speed up economic development. Each type of imbalance builds up certain pressures in the economy for making investments and thereby increases productivity and output. However the question of deciding what kind of imbalance is likely to be most effective is an important problem of economic planning.
Linkage effects:
The establishment of a project leads to the establishment of project lead to the establishment of projects which use its products or the projects which supply essential things needed by it. This is called ’Linkage effects’. The modern production system has innumerable stages right from the production of raw materials to the production of final consumer goods. Investment in a particular stage of production stimulates investment both in subsequent stages of production and the earlier stages of production. Accordingly two types of linkages effects are distinguished by Hirschman. That investment which encourages investment in the subsequent stages of production is referred to as”forward linkage effect”. That investment which encourages investment in the earlier stages of production is called”backward linkage effect.” Every investment has generally these two effects. But the magnitude of linkage effects of every investment will not be the same. To make the policy of imbalanced growth effective, the emphasis should be laid on those projects which can ensure the maximum total linkage. The task of finding out the projects with greatest total linkage is not an easy one. Such projects can be described only on the basis of empirical studies conveying input-output analysis.
Generally, linkage effects will be weak in underdeveloped countries on account of the pre-dominance of the primary sector, existence of imperfectly competitive market conditions and other socio-economic conditions. All this indicates that the underdeveloped countries should not take investment decisions taking into consideration the linkage effects existing in developed countries. Every country has to find out the linkage effects in the light of its own special characteristic features. This type of study is an important part of economic planning. On the whole, the examination of linkage effects is useful to adopt the most effective unbalanced growth technique.
Balanced growth technique:
Arthur Lewis, Ragnar Nurkse, Rosenstein Rodan and several other economists have advocated the technique of balanced growth for underdeveloped countries. Balance growth implies that there should be simultaneous development of agriculture, Industry, trade and commerce. For this, balance is required between demand and supply. This is nothing but balanced sectoral development. Secondly, it implies balanced regional development. Thirdly, it implies balance in the balance of payment of a country and this may also be called ’external balance’.
In the discussion of development technique balance is taken to mean ‘sectoral balance’. ‘External balance’. Balanced growth is not development of different sectors of the economy at the same rates of development. Balanced growth implies as Arthur Lewis has said growth in the proportions dictated by the different rates of growth of demand. This means that incomes generated by the growth of different sectors should be distributed on products produced in these sectors. So, in considering balance we have to take into consideration income elasticity of demand. Nurkse has pointed out that taking due account of this income elasticity of demand, selecting those rates of growth for the different sectors of the economy which would bring about a balance between new aspects and new incomes is the problem of balanced growth technique. Allocation of investment among different sectors so as to bring about balance between demand and supply is the gist of balanced growth technique.
To indicate the necessity of sectoral balanced growth. Arthur Lewis has described the interrelationships between the agricultural and industrial sectors as follows. Let us suppose that modernization advances in the field of agriculture. If the industrial sector also expands in the appropriate proportion, at the same time, the demand for the increased supply of agricultural product increases and the labourers released from the agricultural sector also get employment opportunities in the industrial sector. Otherwise the effects will be bad, because the labourers released from the agricultural sector will remain unemployed, as agricultural output increases; it results in a fall in prices of agricultural products, which will lead to a fall in farm income. In this situation agricultural development also cannot continue.
Economic development which gives importance to industrial development and which ignores agricultural development will face a lot of difficulties. Expansion of industries and rise in incomes of the people in urban areas bring about rise in the demand for both raw materials and food products. As agricultural production remains unchanged, the increasing demand for food and raw materials remain unsatisfied. As a result of this, prices of food products rise, bringing about a rise in other prices and ultimately strengthen inflationary forces in the economy. In this situation workers agitate for higher wages. This is not favourable to industrial development. Moreover, the demand for industrial products does not expand since the income of the farmers does not increase. If there are no opportunities for exporting their products to other countries. Industries will not be producing according to the new productive capacity. As a result of this, industrialists suffer losses. Hence, the simultaneous development pf agriculture and industry is an essential pre-requisite to the doctrines of balanced growth.
The doctrine of balanced growth not only implies the balance between agriculture and industry, but also balances among all the sectors of the economy- agriculture, industry, trade, commerce and other services. Growth which implies a balance between demand and supply of all these various sectors is known as,” growth with sectoral balance”. Thus a properly integrated growth of agriculture, industry, power, trade and commerce and other services, export and import can be called “Balanced growth”.
Critical appraisal:
According to Hagen complete balance among different sectors of the economy is impossible and unnecessary. The adoption of balanced growth techniques depends upon several conditions. The doctrine of balanced growth runs into difficulties because of the deficiency of capital in the underdeveloped countries. The simultaneous development of different sectors requires huge amount of capital investment and less developed countries cannot mobilize necessary capital in the early stages of development, because of the existence of vicious circle of poverty which results in low income, low savings and low investment. In this condition, Singer holds that it would be better for the underdeveloped country to utilize its limited capital resources in certain strategic sectors.
Prof. Fleming has shown that the feasibility of the technique of balanced growth is based on certain conditions like, easy availability of capital, effectively checking the demand for workers for higher real wages, readiness of surplus labour existing in the field of industry, profitability of investment in one-sector of industry depending on the growth of some other industry existence of scope for economies of scale which accompany large-scale organisation in basic industries etc.
It should be noted that the underdeveloped countries will be having sectoral imbalance before setting their foot on the road to development. It is universally agreed that the ultimate aim of underdeveloped countries is to overcome this imbalance. The main point of discussion is whether maintaining deliberately planned imbalance through out is good for achieving development or attempting to maintain balance throughout is good for promoting development. While unbalanced growth technique lays stress on the linkage effects, the balanced growth technique emphasizes the existence of interrelationship among different investments. Presently, it is widely admitted that both these techniques are necessary in formulating development policies and programmes.
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Rostow’s theory or classification of stages:
Many economists think that economic development takes place by certain well-defined stages. However, different economists have classified stages differently. But, in the study of economic development, stages of economic growth presented by W.W. Rostow have acquired great importance.
Rostow’s classification of stages:
W.W.Rostow has classified the following five stages of economic growth:
1. Traditional Society
2. Pre-conditions for the take-off
3. Take-off into self-sustained growth
4. Drive to maturity
5. Age of high mass consumption
Rostow has explained these stages with historical references and has also indicated the date for the crucial stage of economic growth for several countries.
1. Traditional Society:
According to W.W.Rostow, in the traditional society the knowledge and the fruits of modern science are either absent or it is not used and hence the level of productivity is low. The economic activities in such a society are carried on with simple tools and implements. In a society of this kind, about 75% of the labour force would be engaged in food production. The landlords have the most honored place in society. The economic activities are determined by traditional customs. Family plays an important role in economic life. Savings arising in society is generally spent on unproductive items. On the whole, the traditional society is one which is caught up in the low level equilibrium trap.
2. Pre-conditions for take-off (Transitional society):
Many changes should take place in society to alter the low productivity situation and take the economy along the path of progress. A few changes occur in political, economic and social fields in the traditional society. These changes generally occur gradually. The idea that economic progress and a rise in productivity are possible, people are filled with new enthusiasm for achieving these. This is an important feature of this stage. In the economic field, enterprising men come forward and innovate. Utilization of savings for productive purposes will take place. Profit motive begins to stimulate economic activities. Competition and contract slowly take the place of traditional customs and conventions. New industrial units adopting modern techniques of production come into existence. The society based on rural self-sufficiency will undergo certain changes and will have national and inter-national relations. During this transitional stage the importance of agriculture begins to decline and the importance of industry and service sector begins to increase. Important changes take place in the field of agriculture resulting in increase in agricultural productivity. The agricultural sector’s capacity to supply food products to the growing population and raw-materials to industries increases. This is one of the important developments of this stage. SOC should be established, which depends on the role of the government. The establishment of effective government is one of the pre-conditions for the take-off. Thus a variety of changes occur in this stage, all of which create an atmosphere favourable to development and prepare the ground for the take-off stage.
3. Take-off stage:
The duration of the take-off stage is about 2 or 3 decades. During this short period, obstacles to steady growth are overcome and the economy starts moving on the road to self-sustained growth. According to Rostow’s description this stage has chiefly the following features:
a. Assuming an annual rate of growth of population as 11/2percent and capital-output ratio as 3:1 the rate of investment should be over 10% of net national income.
b. One or two substantial manufacturing sectors with a high growth rate should be established these sectors will guide and stimulate other enterprises. This sector may be called ‘leading sector’.
c. Take-off requires the emergence of new political, economic, social and institutional frame-work conducive to economic development. People should welcome modern ideas.
The society which has the above features can be said to have reached the stage of ’take-off’ into self-sustained growth with the take-off stage.
4. Drive to maturity:
Following take-off comes the stage of what Rostow has called ’drive to maturity’. The modernization process which grows out of the previous two stages of growth becomes complete when the economy reaches the stage of maturity. The different parts of the economy will be reorganized in such a way so as to obtain the advantages of the existing state of technology. The leading sectors spread to all sectors of the economy, that means as Rostow, says, the take-off stage spreads through-out the nation the modern ideas and modern methods of production spread to all parts of the economy. Some changes occur in the characteristic of industrial leadership and in the structure of labour force. In this stage experienced specially trained industrial leaders acquire greater prominence than the hereditary industrial leaders, and skilled workers, white collar workers together become a large part of the labour class. Trade union’s strength grows incomes of workers rise.
5. Age of high mass consumption:( Post Maturity stage)
After a country reaches the stage of maturity, second thoughts arise about the modern industrial civilization itself. People begin to re-think about the basic aims and values of human life. The question of the objectives for which the newly developed efficient economic machinery should be used arises. Rostow suggests four objectives which the advanced nations are trying to harmonize. Achieving a prominent place in the world and engaging in military enterprises is one objective. Establishing a welfare state, providing high standards of living to the common people is the third objective. Reducing the working hours for labourers and thereby securing them greater leisure and lightening the burden of their work constitute the fourth objective.
After reaching the stage of ‘high mass consumption’ the question, ‘what next’, arises. This question is related to world peace and world economic prosperity.
Appraisal of Rostow’s analysis:
Rostow’s study of stages is not merely descriptive; his aim is to throw light on the problem of development and to construct a theory of economic growth on the basis of history. He himself has pointed out that his explanation has deep roots in the ‘dynamic theory of production’. Each stage presents some problems. Nations which move along the path of development have to solve these problems and move to a still higher stage of development.
Rostow’s analysis of the stages of economic growth has occupied an important place in the study of economic growth. His concept of ‘take off’ stage has become popular in a very short span of time. The concept has attracted the attention of scholars, statesman, administrators and others interested in development. His idea that economic growth would become automatic after reaching the take-off is perhaps one of the causes for its popularity.
The limitations of the analytical frame-work of Rostow’s stages theory and the criteria for the take-off especially as offering a mode of prognosis have been set forth by several economists like Kuznets, Caircross and others. The gist of their criticisms is as follows:
1. That conceptionally the term ‘leading sector’ is vague.
2. Historically the identification of the take-off periods for the several countries as given by Rostow is open to dispute and
3. Analytically the sequence of features of the transitional and the take-off stages may not occur in the order they are supposed to but may overlap.
It has been pointed out that ‘leading sector’ idea is not precise. Leadership of a sector depends upon the origin of its growth in an autonomous impulse and upon the magnitude of its direct and indirect contributions of the country’s economic growth. The identification and chronology of leading sectors requires specification and evidence which are said to be lacking in Rostow’s discussion.
Leading sector is obviously a phenomenon pertaining to a part of the economy. So, the take-off becomes only a sectional concept. But, the other features of the take-off mentioned by Rostow investment of over 10% of the national income is a phenomenon pertaining to the entire economy and not to every section of it. So, the ‘take-off’ concept according to this becomes a concept applicable to the overall economy. Rostow has not given co-ordinated view of this ambiguity in the concept of the ‘take-off’.
Another objection to Rostow’s analysis is that it does not give the due importance to the effects of historical heritage, time of entry, into the process of modern economic growth, degree of backwardness and such other relevant factors on the characteristics of the early phase of modern economic growth in the different traditional countries.
The concept of ‘self-sustained growth’ is criticized as being misleading oversimplification. It is held that no growth can be considered as purely self-sustaining. Economic growth is always a struggle. To say, that after the ‘take-off’ growth becomes automatic conceals the complex issues involved in achieving development of the developing countries.
Big Push theory:
Big-push theory is advocated by Prof. Rosenstein Rodan. The under-developed countries suffer from vicious circle of poverty, low savings and investments and other obstacles to development. The advocates of the theory of the ‘big push’ are of the opinion that initially a big push is needed to break the vicious circle of poverty, and free the economy from the low level equilibrium trap and remove the obstacles to development. They also argue that proceeding bit by bit in isolated and small way does not produce sufficient impact on growth.
The theory of Big Push is based on the following four arguments.
1. Indivisibility in the production function
2. Complementarity of demand
3. Indivisibility in the supply of savings and
4. Psychological indivisibility
1. Indivisibility in the production function:
While explaining the ‘indivisibility in the production function’ interrelationships among different enterprises should be taken into consideration. This argument emphasizes the importance of SOC (Social Overhead Capital) in developing countries. Transport, communication. Electricity and other items of social over head capital require huge capital investment and have long gestation period. Moreover, they are enterprises deserving high priority. The social overhead capital which required huge investment creates favourable climate for the establishment of other industries. The benefits of SOC cannot be derived without the establishment of other industries. Therefore production function is said to be indivisible. For example: if an electric power generating station is established, the industry producing electric goods and the industry utilizing electric power should be set up. If a huge irrigation project is established, supplying fertilizers, a modern agricultural implement becomes necessary. Since the interrelationships among firms in an expanding industry and interrelationships among different industries in a developing economy are close, the cluster of enterprises should be regarded as an indivisible whole complex. It means the entire development of the production structure be regarded as a part of the ‘Big Push’.
2. Complementary of Demand:
The necessity of the big push is also explained on the basis of the Complementarity of demand. The Complementarity of demand requires simultaneous setting up of interdependent industries in developing economies. The main idea here is that since individual investment projects have high risk because of uncertainity as to whether their products will find a market investment decisions are interdependent. Thus different investment decisions have to be taken on the basis of the Complementarity of demand. Moreover the income generated from the establishment of a project will create the demand for certain goods. To meet this demand necessary investment will have to be made in industries producing these goods. On the whole, the main idea of complimentary of demand is that goods produced by different industries should meet the demand created by the generation of income from different industries. Interrelated investment decisions necessarily cover many enterprises. Therefore, it is said that huge investment is required and this constitutes the ‘big push’.
3. Indivisibility in the supply of savings:
Huge investments require huge amount of savings. It is not easy to achieve this in developing countries, because of the existence of the vicious circle of poverty. Here the main question is how to break this vicious circle of poverty. The big push is said to be the weapon to break this vicious circle, because, the relation between the national income and national savings has this characteristic. If income increases by a small amount, the marginal rate of savings also increases by a small amount, if income increases significantly savings also increases significantly. The existence of this relationship between the increase in income and the increase in savings is an important point supporting the big push theory.
4. Psychological indivisibilities:
It is essential to make people development minded. This effort is indivisible, because unrelated and bit by bit efforts cannot make sufficient impact on growth. A favourable climate for development can be created only when investment of a minimum size or speed is made in an underdeveloped economy. This argument also strengthens the theory of big push.
On the basis of the above chain of arguments, it can be said that a big push or a large comprehensive programme is needed in the form of a high minimum amount of investment to launch underdeveloped on the path of progress.
Critical Appraisal:
The theory of big push assigns a major role to the government in the development activities of the underdeveloped countries. The governments have inevitably to play a leading role in the fields of SOC and Labour training programmes. For, in these fields the social marginal net product will be greater than the private marginal net product. For instance, it does not appear profitable to private entrepreneur to invest for providing training to labourers. But the investment by government in this proves socially beneficial and hence profitable. In several public utility enterprises the social marginal and net product is generally higher than private marginal net product. So, in these enterprises the government naturally has to play a predominant role. Government intervention and measures would also be needed to mobilize large savings needed for the ‘Big Push’. According to Prof. Ellis, this undue importance to the government is a defect of the ‘big push theory’.
Another main defect of the ‘big push’ theory according to prof. Ellis is that it emphasis the importance of a high level of investment in industry and does not give due importance to the primary sector.
Prof. Ellis has also pointed out that the advantages of the big push had been exaggerated.
Again, several Underdeveloped countries have specialized in producing primary products. The big push theory does not apply to the development of this sector.
On these grounds it can be said that the theory of ‘big push’ is not realistic. Prof. Ellis has said,” economic development of many advanced countries cannot be said to be the result of crash programmes”. However, the industrial revolution which took place in the developed countries indicates that the big push is necessary to achieve rapid economic development.
Critical minimum effort thesis:
Almost all the underdeveloped countries have the similar characteristic features. The most pressing problem of underdeveloped countries is to break the vicious circle of poverty. According to Leibenstein, critical minimum effort is the only way to break the vicious circle of poverty and release the forces of growth. It is the contention of Leibenstein that in general conditions of underdevelopment, in order to achieve sustained secular development, the initial stimulants should be of a critical minimum size. Why is critical minimum effort needed in developing economy? Leibenstein has answered this question with the help of the following four reasons:
1. To correct internal diseconomies
2. To correct external diseconomies
3. To overcome income depressing forces which come with growth generating forces and
4. To strengthen income-generating forces.
1. In underdeveloped countries the firms will not be having economies of scale. In these countries expanding productive units to the required optimum size is an important task. For this a certain magnitude of investment and other efforts are necessary. Since modern industrial units are generally large scale units, the required effort to build up these should also be a big effort. Since many industrial units are to realize the economies of scale.
2. since external diseconomies are existing in underdeveloped countries and since external economies are essential for development, a critical minimum effort is said to be necessary. All those factors which bring down production cost of all firms in an industry can be called external economies of scale of a firm depend upon its internal organisation and the cost of goods and services it gets from other firms. Every firm has to grow up to a particular size for achieving economies of scale. Huge investment is required for balanced growth. From the point of view of technology, capital investment in social overhead capital and other large-scale industries should be big because these cannot be divided into small units. Critical minimum amount of investment will be high in places having technological indivisibility. In underdeveloped countries special efforts are necessary for creating external economies. Technological knowledge, enterprise, skilled labour etc are deficient in underdeveloped countries. To overcome these deficiencies special social cost should be incurred. It is also difficult to provide necessary social overhead capital immediately. That means firms will have to work for sometime without getting necessary facilities. Moreover, since the gestation period of different interrelated industries are different, some firms may have to incur losses for sometime. Taking these into consideration Leibenstein argues that critical minimum effort is necessary for overcoming external diseconomies existing in underdeveloped countries.
3. Economic development depends basically on the attitude of the people. Generally growth incentives will not be strong in underdeveloped countries. The existing incentives can stimulate only those profitable activities which can maintain the existing level of national income and cannot bring about a rise in the national output. These are known as “zero sum incentives”. The incentives which can stimulate profitable activities and bring about a rise in national output are called “positive sum incentives”. If positive sum incentives are to come into existence, income generating forces should be stronger than the income depressing forces, Leibenstein feels that more creation of positive sum incentives is not sufficient to solve all the problems of development because sometimes growth stimulating activities may reduce the level of income. For example, public health programme reduces death rate. As a result of this population increases at a rapid rate, and results in higher population growth rate. Investment which transfers surplus labour from agricultural sector to the non-agricultural sector creates food supply problem. Investment of capital required for increasing agricultural production sufficiently can only solve this problem. The growth effort which overcomes the income depressing forces can be regarded as the critical minimum effort.
4. Breaking the cultural and age-old institutional structures which are preventing the underdeveloped countries from developing is a great task. This is dependent on the attitude of the people. Economic growth requires special type of human response to motivation and incentives which are created by economic and social environment. One of the pre-requisite of economic growth is the transformation of attitudes of the people from the traditional outlook and motivations towards enterprising activities such as profit making, risk bearing etc. According to Leibenstein, a critical minimum effort is necessary to change the attitude of the people. Proceeding bit by bit is isolated and small way or small efforts cannot change the attitudes imbibed by the people since immemorial. It requires a critical minimum effort. The change should not only be brought about quickly but it should also be widely dispersed. People should believe that these newer values are profitable, honorable and long enduring. To bring about such changes a critical minimum effort is needed.
These four reasons indicate the nature and necessity of critical minimum effort to achieve rapid economic development. In conclusion, it can be said that the ‘critical minimum effort thesis’ is a definite and clear theory of economic development. This thesis indicates a critical minimum effort needed to reach a critical minimum effort is needed to reach a critical level of per capita income. After reaching this level of per capita income underdeveloped countries get themselves transformed as self advancing on the path of progress. This thesis is helpful to understand the problems of underdeveloped countries, which are making efforts to become developed economies.
(Criticisms of big push theory can be applied to this theory also)
Arthur Lewis Labour surplus theory:
Prof. W. Arthur Lewis has developed a very systematic theory of “economic development with unlimited supplies of labour”. Like the classical economists. He believes that in, many underdeveloped countries an unlimited supply of labour is available at a subsistence wage. Economic development takes place when capital accumulates as a result of the withdrawal of surplus labour from the ‘subsistence’ sector to ‘capitalist’ sector. The capitalist sector is,” that part of the economy which uses reproducible capital and pays capitalist for the use thereof”. It employs labour for wages in mines, factories and plantations for earning profits. The subsistence sector is that part of the economy which does not use reproducible capital. In this sector, output her head is lower than in the capitalist sector.
Lewis starts his theory with the assertion that the classical theory of perfectly elastic supply of labour at a subsistence wage holds true in the case of a number of underdeveloped countries, such economies are over populated relatively to capital and natural resources so that the marginal productivity of labour is negligible. Since the supply of labour is unlimited, new industries can be established or existing industries expanded without limit at the current wage by drawing upon labour from the subsistence sector. The current wage is what labour earns in the subsistence sector that is the subsistence wage. The main sources from which workers would be coming for employment at subsistence wage as economic development proceeds are, “the farmers, the casual labour, petty traders, etc”. But the capitalist sector also needs skilled workers, Lewis argues that skilled labour is only a ‘quasi bottleneck’ (temprarory bottleneck) which can be removed by providing training facilities to unskilled workers.
Now the question is what determines the subsistence wage at which the surplus labour is available for employment in the capitalist sector? It depends upon the minimum earnings required for subsistence. To be precise, the wage level cannot be less than the average product of the worker in the subsistence sector It, may, however, be higher than this , if the farmers are to pay rent or food costs more or if they feel that psychic disutilities of leaving home are large. Though earnings in the subsistence sector a floor to wage in the capitalist sector,” yet, in practice capitalist wages are more than 30% higher than subsistence due to:
a. a substantial increase in the output of the subsistence sector which by raising real income might induce workers to ask for a higher capitalist wage before.
b. if with the withdrawal of employment from the subsistence sector total product remains the same, the average product and hence the real income of those remaining behind will rise and the withdrawn workers might insist on a higher wage in the capitalist sector.
c.The high cost of Living and some humanitarian consideration may move the employers to raise the real wage.
Capitalists aim at profit maximization. It is they who save and invest. Since the marginal productivity of labour in the capitalist sector is higher than the capitalist wage, this results in capitalist surplus. This surplus is reinvested in new capital assets. Capital formation takes place and more people are employed from the subsistence sector. This process continues till the capital-labour ratio rises and the supply of labour becomes inelastic and surplus labour disappears.
“The central problem in the theory of economic development “ according to Lewis,” is to understand the process by which a community which was previously saving and investing 4 to 5% of its national income or less converts itself into an economy where voluntary saving rate is about 12 to 15%. This is the central problem because the central fact of economic development is rapid capital accumulation”. In underdeveloped countries with surplus labour, only 10% of the people with the largest income save who receive about 40% of the national income. The wage and salaried classes hardly save 3% of the national income. It is, therefore, the state capitalist and indigenous private capitalist is bound up with the emergence of new opportunities, which widens markets, technology that enhances labour productivity and further increases capitalist surplus.
But capital is created not only out of profits; it is also created out of bank credit. In an underdeveloped economy, which has abundant idle resources and shortage of capital, credit creation has the same effect on capital formation as profits.
End of growth process
The theory shows that, “ if unlimited supplies of labour are available at a constant real wage, and it any part of profits is reinvested in productive capacity, profits will grow continuously relatively to the national income and capital formation will also grow”. But the process of growth cannot go on indefinitely, if as a result of capital accumulation, no surplus labour is left. It may also stop if, despite the existence of surplus labour, real wages rise so high as to reduce the capitalist profits to the level where they are all consumed and nothing is left for net investment. then capital accumulation is adversely affected. Capital accumulation can continue by encouraging mass immigration or by exporting capital to such countries which possess abundant labour at subsistence wages. Both these possibilities are ruled out be Lewis because; mass immigration of unskilled labour is not possible because trade unions oppose it. The effect of capital exports is to reduce the creation of fixed capital at home and hence to reduce the demand for labour and wages in the capital exporting country. But the reduction in wages is offset if capital exports cheapen the things which workers import because of their real wages will rise. On the other hand, the reduction in wages is further encouraged if capital exports raise the cost of imported things as the real wages of workers will fall. So the effect of capital exports cannot be assessed with definiteness.
Critical Appraisal:
The Lewis theory is applicable to overpopulated underdeveloped countries under certain set conditions. Its applicability is, therefore, circumscribed by its assumptions which are the bases of criticism discussed below:
1. Wage rate not constant in the capitalist sector:
The theory assumes a constant wage rate in the capitalist sector. Until the supply of labour is exhausted from the subsistence sector. This is unrealistic because the wage rate continues to rise over time in industrial sector of an underdeveloped economy even when there is open unemployment in its rural sector.
2. Not applicable if capital accumulation is labour saving:
Lewis assumes that the capitalist surplus is reinvested in productive capital. But according to Reynolds, if the productive capital happens to be labour saving, it would not absorb labour and the theory breaks down.
3. Skilled labour not a temporary bottleneck:
Given an unlimited supply of labour, Lewis assumes the existence of unskilled labour for his theory. Skilled labour is regarded as a temporary bottleneck which can be removed by providing training facilities to unskilled labour. No doubt skilled labour is in short supply in underdeveloped countries but skill formation poses a serious problem, as it takes a very long time to educate and train the multitudes in such countries.
4. Lack of enterprise and initiative:
Lewis’s theory is based on the assumption that a capitalist class exists in underdeveloped countries. In fact the entire process of growth depends on the existence of such a class which has the necessary skill to accumulate capital. In reality, such countries lack capitalists with necessary enterprise and initiative.
5. One sided theory:
This is a one-sided theory because Lewis does not consider the possibility of progress in the agricultural sector. As the industrial sector develops with the transfer of surplus labour, the demand for food and raw-materials will rise, which will, in turn lead to the growth of the agricultural sector.
6. Inefficient tax administration:
Lewis’s contention that taxation will mop up because the tax administration in underdeveloped countries is not so efficient and developed as to collect taxes sufficient and developed as to collect taxes sufficient enough for capital accumulation.
7. Low income groups also save:
It is not correct to say that only 10% of the people with the largest income save. In fact, people with, low incomes also save due to social reasons and even small farmers save for capital accumulation in underdeveloped countries. Whereas high income groups save less because they spend more under the influence of the demonstration effect.
Conclusion:
Despite these limitations the Lewis theory has the merit of explaining in a very clear cut way the process of development. This two sector theory has great analytical value. It explains how low capital information takes place in underdeveloped countries which have high labour and scarcity of capital. His study of problems of credit, inflation, population, growth, technological progress, and international trade gives the theory a touch of realism.
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