Structural Change and Development: Critiquing the Lewis Model, Study notes of Development Economics

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• Lecture 4: Structural changeLecture 4: Structural change Readings: „Todaro: chapter 3 „Roland: chapter

Structural change „^ Industrial revolution:th^ ‰^19 century Britain^ ‰^ Millions of people left countrysideTo textile factories steam engine steel mills‰^ To^ textile factories, steam engine, steel mills^ ‰^ Followed by Germany, US (late 19

th) ‰^ Extraction of oil: manufacturing products, car industry ‰^ China since 1978 following a similar path „ How did they change from agriculture to manufacturing?

Lewis model „^ Nobel prize in 1979p „^ Most important and used model in 60s-70s „^ 2 sectors:^ ‰^ Traditional: no new technologies, productivity very low^ ‰^ Modern „^ Traditional sector:^ ‰^ Marginal product of labor = 0‰^ Marginal product of labor = 0^ ‰^ Surplus of labor^ ‰^ Possible to withdraw people from traditional sector without any fall in output „^ Modern sector:^ ‰^ Wage necessary to attract people from traditional sector: very low^ ‰^ Huge profits: reinvested in firm: more K (Solow-type growth)^ ‰^ At higher levels of K, firms more productive: can afford to pay higher wages (but don’t need to) „^ Until?„^ Until?

Lewis model „^ Until surplus of labor is absorbedp^ ‰^ Traditional sector: MPL>0: incomes increase^ ‰^ Modern sector: wage necessary to attract increase (firms can afford it) „^ Growth „^ Policy implication?

Dual economy - South AfricaNatal-Transkei

Natal

Dual economy - South Africa „^ Illustrates well the dual economy: the traditional and

y modern sectors: ‰^ Natal: private property rights, functioning legal systems, markets,commercial agriculture and industrycommercial agriculture, and industry ‰^ Transkei: communal property in land and all-powerful traditionalchiefs until recentlyI^ li^ ti^ f L^

i^ d l^ h^

T^ k i i t^ N t l „^ Implication of Lewis model: change Transkei into Natal „^ However this was man-made not the natural process of„^ However, this was man-made, not the natural process ofeconomic growth

Brief history of Transkeith^ „^ In 19^ century: densely populated, attracted settlersy

y p p^

„^ Initially created demand for goods: Black Africans(Xhosa):^ ‰^ Adopted plows^ ‰^ Wanted private property, which weakened the chiefs^ ‰^ Dug irrigation ditches^ ‰^ Built fences „^ Slow weakening of extractive political and economicinstitutions burgeoning economic progressinstitutions, burgeoning economic progress

Brief history of Transkei „^ In South Africa, the dual economy:

,^

y ‰^ Was not an inevitable outcome of the process of development ‰^ But created by the stateE t^ ti^ th h d it

li^ it „^ Extractive growth had its limits:^ ‰^ No creative destruction^ ‰^ 80% population could not use their talents: barred from skilledworkers, businessmen, entrepreneurs, engineers, or scientists^ ‰^ 1970s: GDP growth = 0 „^ The dual economy ended in 1994„^ The dual economy ended in 1994^ ‰^ But not the natural course of economic development^ ‰^ Empowerment by Blacks who managed to organize and rise up

Structural change „^ Dual economy may not be a passing stage

y^ y^ p

g^ g „^ Structural change: not inevitable „^ Extractive political institutions may block:^ ‰^ Fear of creative destruction1960s 70s: foreign aid to build modern sector = failure„^ 1960s, 70s: foreign aid to build modern sector = failure

Import substitution strategy „^ Developing countries specialize in exports of primaryp^ g^

p^ p^

p^ y commodities (raw + agricultural) „ Terms of trade declining ‰^ Ratio of export prices to import prices ‰^ (because demand for manufactured goods increase as worldeconomy develops) ‰^ Prebisch-Singer hypothesis ‰^ Developing countries kept in poverty by industrialized countries „ Solution:„ Solution: ‰^ Protect infant industries ‰^ In import substitution sectors, or export sectors

Import substitution strategy „^ Experience:p^ ‰^ Import substitution worked in Germany, failed in Brazil, India^ ‰^ Export promotion worked in Japan, South Korea, Taiwan, Singapore, Hong-Kong;working in China now „^ Good or bad?^ ‰^ In the light of inclusive vs extractive political and economic institutions?

Foreign aid „^ Initial idea of foreign aid:

g ‰^ Related to structural change ‰^ Encourage local industries in developing countries ‰^ 1950s, 60s ‰^ Mixed results „ 1980s: structural adjustment policies, Washingtonconsensusconsensus

Washington consensus „^ Privatization „^ Trade Liberalization „^ Fiscal discipline „^ Consensus in the 1990s „^ Also called structural adjustment policies „^ Implemented as conditions for loans to country in crisis by World Bank andIMF „^ Good or bad?^ ‰^ In the light of inclusive vs extractive political and economic institutions?