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Economic Development With Unlimited Supplies of Labour

This is the third article in a three part series to coincide with Nobel Laureate Week .

WORLD WAR TWO affected people of all races, creeds and geographical land masses. Its aftermath led to three occurrences which influenced the writings of Sir Arthur. These included decolonization, racial tensions and questions surrounding the role of government.

The end of the war spurred debate on what ideological consensuses should be invented to avert a recurrence of war. Consequently issues such as racial justice, political independence, economic growth and the re-distribution of wealth were topical in the mid 1950’s to 1970’s. Sir Arthur sought to contribute to this debate through his writings and musings by using economic theory to provide solutions to these pertinent issues.

One of Sir Arthur’s most famous pieces is “Economic Development with Unlimited Supplies of Labour”. This paper was published in 1954 and was an attempt by Sir Arthur to adapt existing economic theory to the realities of developing countries, which had received little attention at that time. The piece sought to explain how societies can spur growth and development through the use of two characteristics of developing countries at the time, namely, a large subsistence sector and a small capitalist or entrepreneurial sector. Where the capitalist sector uses reproducible capital and pays for this use while the subsistence sector consisted of low skill persons who could, if they moved over to the capitalist sector earn wages paid at some premium above the current subsistence earnings .

Having defined these actors, Sir Arthur focused on the interplay between them, whereby an initial capital injection by the capitalist sector, geared towards investments, generates returns which are then reinvested and thereby fuel a positive feedback loop, as the returns are continually reinvested. He pointed out that returns on an investment and its effect on raising the stock of capital drives the need for more labour from the subsistence sector. To the extent that policy makers could encourage this virtuous cycle he posited that they could address the high unemployment in the region and raise wages. Giving this thinking Sir Arthur sought to underscore why it was that some countries experienced high growth and development and others remained mired in poverty despite most societies having this combination of capitalist and subsistence sectors. In addition to this a central question is what was the source of this initial capital injection needed to start this cycle. The piece points out that the capital stock of a country is tied to its economic development, since development raises national earnings and that from this pool of earnings comes national savings. The banking system in turn stores and un-lends this savings resulting in capital. The point was nuanced somewhat by the fact that the increase in savings due to growth occurred more so in the top echelon of income earners who derived their incomes from investments and were not salaried. Sir Arthur therefore noted that the success of absorbing surplus labour and raising wages was tied to the presence of an entrepreneurial class of persons who had a requisite amount of savings and skills to invest. The piece then focuses on how the divergences in economic fortunes could be tied to whether there was an enabling environment to allow this class to flourish.

In addition to having an entrepreneurial class, economic growth would be stronger in countries which adapts to and facilitates the assimilation of technological change while ensuring functioning capital markets. This assimilation of technology in his view creates increasing opportunities for capital to be invested profitably and consequently raise national income which serves to increase the level of capital which can then be reinvested by the entrepreneurial class. Sir Arthur focused heavily on the earnings received by this class given that the income they received from their business was significantly more than that of the earnings of salaried workers. The national earnings and subsequent savings of a nation which can then serve as the capital stock for reinvestment was largely tied to ensuring the success of the entrepreneurial class. This stems from the fact that capital grows faster than the rate of consumption as capitalist can reinvest surpluses and therefore quickly compound their returns, furthermore under the assumption of an unlimited supply of labour this rate of growth does not diminish over time. Perhaps ahead of his time Sir Arthur realized that economic development favours net savers and therefore alters the distribution of income which can lead to income inequality. An economy’s development therefore often lie in the hands of persons who receive profits or rents.

Having defined the role and contribution of the capitalist sector a more precise explanation as to how his framework facilitates better social outcomes can be expounded upon. The first channel for better social outcomes is that as more labour is absorbed into the capitalist sector societal earnings are raised as these persons now earn wages which are higher than subsistence. This higher earnings grows the middle class allowing for the enterprising class to sell more goods and services which in turn fuel gains in national income. A society in his words saved little not because they were poor but because their capital sector was too small. This cycle would continue as long as the capitalist sector continually invest in profitable and productive opportunities. Therefore the rule of law, minimal social disruptions and an supporting enabling environment positively affects this cycle. A distinction could be made between a truly capitalist class where surpluses are invested in productive activities and a society existing of a dominant class consisting of landlords and traders who do not reinvest as do capitalist.

Lewis then spoke to a country which may internally have labour scarcity but may be surrounded by other nations with surplus labour at subsistence wages. Immigration he posited can limit the rise of internal real wages which will have otherwise lowered profitability and hence adversely affect reinvestment and capital formation. Efforts therefore to stymie immigration results in high wages and lower profits, capital and output.

In conclusion the piece showed that a risk taking entrepreneurial class which continually reinvested in improving its operations could spur economic development. The key insight and takeaway from his piece was that he motivated the need for a capitalist sector at a time when social and political issues of the day ran counter to this.

(Contribution from NCPC Advisor: MrJanaiLeonce, Deputy Chief Economist, Ministry of Finance. For more information on the subject matter, please contact the National Competitiveness and Productivity Council on the Second Floor of the Financial Centre, Bridge St at 468 5576. You can also visit the Council’s Facebook page at https://www.facebook.com/stluciancpc or email them at stluciancpc@gmail.com).

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