Economic Development Case Study

1. In effort to revive the classical model of economic development, Lewis reintroduces the assumption of an unlimited supply of labor in some developing countries. In large sectors of an economy such as agriculture, there exists a point when additional workers fail to produce additional output. The marginal productivity of labor is equal to zero when the additional output from adding a worker is zero or negligible. With overpopulation, technology, and methods to improve efficiency, the agricultural and domestic sectors may reach a zero or negligible marginal productivity of labor and thereby increase the supply of subsistence wage labor. For the domestic sector specifically, household tasks can be completed more efficiently at a lower cost

According to Lewis, the central problem in the theory of economic development is how countries achieve higher savings from lower savings, or more specifically, “the process by which a community which was previously saving and investing 4 or 5 percent of its national income or less, converts itself into an economy where voluntary saving is running at about 12 to 15 percent of national income or more” (72). Since savings equate to investment and, accordingly, economic growth, the question is how a country is able to experience economic development if savings and investment are initially low. Thus, to explain economic development, savings increases must be explained (72). Lewis attributes economic development to those who save and invest, and the capitalist class is the class that saves and invests the most. Whether it is industrial capitalists or state capitalists, greater savings and investment are prerequisites to higher profit and higher savings. The greatest obstacle to higher savings is possessing the capital to invest. If capital is low to begin with, then profit and savings are low. Greater capital equates to greater profit and as a result savings and investment would be greater (75). State capitalists have the advantage of taxes and other resources, which may provide additional capital to invest and the ability to

A third source of capital beyond profit and taxes is simply creating capital through credit or printing money. The danger to creating capital by creating extra money, however, is the risk of inflation. An increase in the money supply immediately lowers the value of money and raises the price of market goods as the value of money is questioned by the people. Confidence in the newly fabricated money might be lost and prices may rise, especially if equilibrium or balance in the market takes a longer amount of time to be reached (80). Lewis views these danger as justified, however, if the purpose of creating new money is to create new capital to invest; the consequential inflation will be “self-destructive” and may even lead to lower prices (79). By investing the newly created money, production and output increase. Creating capital, therefore, leads to higher input and investment that subsequently increases output and lowers prices. While inflation through creating money temporarily lowers other’s incomes, it increases profit and output until equilibrium is reached (78). Thus, a smaller capital-output ratio, or the production time relative to the initial investment, is preferred to avoid panic and price rises. If it takes too long to increase the production and output required to overcome price rises and attain equilibrium in the supply and demand of produced goods, then inflation will not be reduced. In this case, the quantity or supply of consumer goods will fail to