Structural change theory

The Lewis Model

The Lewis model, presented in 1955, dominated development theory between the 1960s and 1970s. It is also known as the two sector model, and the surplus labour model. It focused on the need for countries to transform their structures, away from agriculture, with low productivity of labour, towards industrial activity, with a high productivity of labour.

In the Lewis model the line of argument runs:

An economy starts with two sectors; a rural agricultural sector and an urban industrial sector. Agriculture generally under-employs workers and the marginal productivity of agricultural labour is virtually zero.
Therefore, transferring workers out of agriculture does not reduce productivity in the whole economy.
Labour is then released for work in the more productive, urban, industrial sector.
Industrialisation is now possible, given the increase in the supply of workers who have moved from the land.
Industrial firms start to make profits, which can be re-invested into even more industrialisation, and capital starts to accumulate.
As soon a capital accumulates, further economic development can sustain itself.

Evaluation of the Lewis model

Though highly influential at the time, and despite the considerable logic of the Lewis approach, the benefits of industrialisation may be limited because:

Profits may leak out of the developing economy and find their way to developed economies through a process called capital flight.
Capital accumulation may reduce the need for labour in the urban industrial sector.
The model assumes competitive labour and product markets, which may not exist in reality.
Urbanisation may create problems, such as poverty, squalor and shanty-towns, with unemployment replacing underemployment.
The financial benefits from industrialisation might not trickle down to the majority of the population.

Development of a tertiary sector

Clark-Fisher

As early as 1935, Allen Fisher had suggested that economic progress would lead to the emergence of a large service sector, which followed the development of a primary and secondary sector. Later, in 1940, Colin Clark developed this theme to create the Clark-Fisher development theory, also called the Fisher-Clark model.

The Clark-Fisher model shares some characteristics of early linear stage models and later structural change models. In this model, structural change must occur for economic progress to occur in capitalist economies.

Their work is still very relevant to modern explanations of development and the importance of a large service sector as an indicator of development. The Clark-Fisher hypothesis states that development will eventually lead to the majority of the labour force working in the service sector.

Why does a service sector emerge after industrialisation?

According to this model, there are two essential reasons why a service sector will emerge.

High income elasticity of demand

There is generally a high income elasticity of demand for services, especially leisure, tourism and financial services. As incomes rise, demand for services increases and more employment and national output are allocated to service production. For example, in the UK and many developed economies over two-thirds of all workers are employed in the service sector (for the UK it is around 72%).

Low productivity of labour

Secondly, productivity in the service sector is lower than in the manufacturing sector because it is harder to apply new technology to many services. This means that, over time prices of services rise relative to primary and secondary goods.

The effect of high income elasticity of demand and low productivity is that an increasing proportion of national income and consumption is allocated to the service sector.

Victor Fuchs

The importance of the service sector

In the 1960s and 1970s, American economist Victor Fuchs also focussed on the service sector, and attempted to develop a general theory of economic development by looking, in particular, at changes that were happening within the American economy during that period. In particular he looked at changing patterns of employment associated with the rise of a service sector, and took this to be a key indicator of economic progress. Increasingly, growth in service sector employment could be seen across western economies.

This, he argued, also contributed to the slow-down in economic growth rates in more developed economies. As the Clark-Fisher model had proposed, productivity growth in the service sector would tend to be much slower than for the manufacturing sector. He argued that the service sector itself would need to go through an industrialisation process if growth rates were to be maintained. Fuchs also pointed to the increased participation of females in the labour force as being an important contributory factor to service sector development – families with working wives tend to spend more of their income on services.

Balanced and unbalanced growth

One of the earliest debates in development economics was about whether development would proceed more effectively with balanced or unbalanced growth. The advocates of balanced growth stressed that, as an economy grew, it needed all sectors to grow to support each other. The interconnectedness of different sectors implied that growth was required across the economy at a constant rate.

This view suggested a clear role for government in supporting those sectors that might not ‘naturally’ grow, or might lack investment from the private sector. If all parts of the economy need to grow, then government should support those sectors that might not naturally develop.

Big push theories are an extension of the balanced growth approach. A big push might be needed by a government to help the economy grow in a balanced way. For example, ensuring that farming remains well developed even when the economy is experiencing a manufacturing boom.

In contrast, unbalanced growth theory, which is associated with the German political economist Albert Hirschman, suggests that overall growth is faster when it is unbalanced. If growth is unbalanced, resource prices will rise in those areas where output growth is relatively slow, and this will act as a signal for investors to allocate funds to opening up these bottlenecks. An imbalance is likely to result in greater investment and growth because it leads to a more efficient allocation of resources. The role of government should be to help support those industries with the strongest linkages to the growth industries. For example, if off-shore banking is seen as a growth industry, then the government should encourage resources to support this industry – such as giving grants to students to train in banking and finance. Similarly, if the tourist industry is the driver of growth, it might be necessary for the state to provide incentives to farmers and growers to diversify into tourist-friendly foodstuffs.