Jorgenson (1970, p. 323) proposes that the process o f economic development may be studied as an increase in income per capita when a high proportion of employment is in agriculture. Alternatively, the process may be studied as an increase in the role of industrial activity compared to agriculture. These two developments are intimately related in the theory of the dual economy.
Lewis (1954) analyses the process of economic development in a dual economy that consists o f a capitalist sector and a subsistence sector. The capitalist sector is defined as "that part of the economy which uses reproducible capital, and pays capitalists for the use thereof' and the subsistence sector as "all that part of the economy which is not using reproducible capital" (Lewis, 1954, p. 146)^. The two sectors are related in the process of economic development : when the capitalist sector expands, it draws people out o f the subsistence sector into capitalist employment. The supply o f labour in the subsistence sector is assumed to be unlimited in the sense that the supply of labour at the prevailing wage in the capitalist sector is unlimited : the marginal product of labour
1) Lewis in his later essay (1972, p. 76) stresses that the division he made was between capitalist and non-capitalist, and not between agriculture and industry which is now a popular division made by other writers. His version of division of sectors was later changed and called ’modem' and 'traditional' (1979, pp. 211-215). The modem sector depends on the traditional sector for its inputs (such as, food, raw materials) and expansion of the traditional commodities. On the other hand, expansion of the modem sector may benefit the traditional sector through four ways: (1) provision of employment, (2) sharing physical facilities, (3) modernisation of ideas and institutions, and (4) trade.
in the subsistence sector is negligible, or zero~). The unlimited supply of labour from the subsistence sector consists of those in domestic service and the self-employed workers in family enterprises, which includes handicrafts and petty retailing as well as farms. Another source of increased labour is through the increased participation of women, as well as through natural increase and through immigration.
The wages paid in the capitalist sector are determined by what people earn in the subsistence sector. In other words, they are determined by what is required for subsistence consumption, so the minimum wage in the capitalist sector is set higher than the average product of the farmer. This gap prevails in order to offset the higher cost of living in the capitalist sector, and the psychological cost of transferring labourers from the traditional life of the subsistence sector. The gap in wages between two sectors is usually around 30.0 per c en t
The key to the process of economic expansion in Lewis' model is the use of the capitalist surplus and its rising share in national income. The surplus is increased by its reinvestment to create new capital. As the capitalist sector grows, and the wage-price rado remains constant, the share of profits in national income increases and therefore capital formation is also increased. Labour is continually withdrawn from the subsistence sector into the capitalist sector. The surplus is then even larger, the accumulation of capital grows, and the process continues until the labour surplus in the subsistence sector disappears.
The capitalist sector can grow until the transfer of surplus labour is finished and the supply of labour is less than perfectly elastic. So, as investment contributed a rising proportion of national income, a backward economy develops into an advanced economy characterised by disappearance o f disguised unemployment. However, the capitalist sector will be adversely affected when capital accumulation catches up with 2) Zero marginal product as used by Lewis is the marginal product of a person, not marginal
labour supply and wages begin to rise above the subsistence level, and investment will no longer necessarily grow relative to the national income.
Lewis' approach was first applied to the development of a backward Asian economy by Fei and Ranis (1964). They retain the fundamental postulate of Lewis' theory; but divide the sectors of the economy into industrial and agricultural sectors. This classification is different from Lewis's. The process of development is divided into three phases. Phase one is marked by the existence of labour redundancy, which reflects the disguised unemployment. Labour is considered redundant when marginal productivity is equal to zero. Wages are institutionally determined at the average product of labour. Therefore, the "disguised unemployed" in agriculture include all those with zero marginal productivity and those with a low (if positive) marginal productivity which is below the constant institutional wage (average product of labour).
Phase two is the range for which the positive marginal product is less than the institutional wage. Hence, disguised unemployment exists. Once phase two is entered, the marginal productivity of the released agricultural workers is positive. Their transfer will thus result in a loss of agricultural output, and cause a decline in the surplus of agricultural goods. The impact of the surplus depends on the economy's ability to harness it by preventing its use in conspicuous consumption. The surplus can be siphoned off by means of government investment activities. A relative shortage of surplus agricultural goods to be exchanged for industrial goods raises the prices of the former and worsens the terms of trade for the industrial sector. In phase two, as the labour reallocation process continues, a shortage of agricultural output emerges. This leads to a deterioration in the terms of trade of the industrial sector and a rise in the industrial real wage in terms of industrial goods.
Phase three of the development process occurs when the marginal productivity of labour in the agricultural sector equals the prevailing industrial wage. As the disguised
unemployed disappeared, the agricultural sector becomes competitive, and in phase three agriculture becomes commercialized. This stage is regarded as a "turning point" of major significance in the development process. At this stage all factors of production are scarce, and wages are no longer constant as accumulation proceeds to the commercialization point. So, development towards an advanced economy begins after the third phase of development has been reached. The disappearance of disguised unemployment in the agricultural labour force and the commercialization of the agricultural sector imply that the agricultural real wage itself begins to rise along with the marginal productivity of labour. So the consequence is that the industrial real wage also increases. Such an increase is required if the industrial employer is to be able to compete successfully with the landlord for the supply of labour. Fei and Ranis described the third phase as a major landmark in the development process.