Question

Consider structural changes models.
a. What are the stylized facts of structural transformation of Hollis B. Chenery and his

colleagues identified as patterns of development?
b. In the Lewis Two-Sector model, the economy consists of two sectors: a traditional, overpopulated rural subsistence sector characterized by zero marginal labor productivity and a high-productivity modern urban industrial sector into which labor from the subsistence sector is gradually transferred.

i. What are the main assumptions of the model.
ii. Explain in details the process of labor transfer and the growth of output and employment in the modern sector. (Hint: Use graphs to help your discussion. Make sure to label the axis.)

Answer 1

Part(a): Structural transformation and patterns of development

According to Hollis B. Chenery and his colleagues, there is no set marker or point of identification of development of a nation's economy in comparison to itself in the previous years or at the international level. The best way to measure economic development or growth was by analysing the real per capita gross national product or real gross domestic product (GDP).

Per capita income as a measure of economic development does not provide the entire picture according to Chenery as it does not include market transactions and environmental costs such as pollution, loss of resources, degradation etc. It also does not take into account the quality of life and distribution of income.

It is not just capital and accumulation of wealth that characterises a strong economy, but various other changes at an economic and social level changes that transform an economy into one that is structurally sound. These changes include literacy, distribution of income, urbanisation, international trade, growth and distribution of population etc.

Signs of development according to Chenery are:

• Shift from agriculture based to an industry based economy.
• Change in consumption pattern from essentials to manufactured and luxury goods.
• Migration of people from rural to urban areas.
• Decline in the rate of population growth.
• Reduction in the size of a family.

(i).Assumptions of Lewis Two- Sector Model:

• Marginal productivity of labour is negligible.
• Quicker the rate of capital accumulation, quicker the growth of modern economy.
• There is high availability of labour in the rural areas, while there is almost full employment in urban areas.
• Increase in capital of modern sector would increase the productivity of labour thereby increasing the total output, whereas it would not be applicable in the case of traditional sector.

(ii). Modern sector is small and is capital intensive where as traditional sector is large and has large amount of labour. There is high capital accumulation in the modern sector, while in the traditional sector there is negligible amount of capital accumulation. The law of diminishing marginal product suggests that adding of more of a material needed for input results in less benefit to the output process.

Wages in traditional sector= Total output produced/ total amount of labor.

Amount of labour is large in traditional sector, hence, the wages are less in relation to the modern sector. Thus, there is a transfer or migration of labor from the traditional to the modern sector. An increase in the capital in a modern sector would result in an increase in output whereas it would have little to no effect on the output in the traditional sector. According to Lewis, the best way to grow a under-developed or developing economy is to transfer capital to the modern sector. He also pointed out that more investment in the modern sector would lead to inequality in distribution income and increase in income-- which means the economy is growing. The economy would stabilize at some point when the marginal product of labor in the traditional sector matches the marginal product of labor in the modern sector due to increased capital accumulation.