UNIDENTIFIED PERSON: NPR.
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STACEY VANEK SMITH, HOST:
Hey, everyone - Cardiff and Stacey here. This is THE INDICATOR FROM PLANET MONEY. The late economist Arthur Lewis had a reputation as a very kind, principled and contemplative thinker. And in August of 1952, he was strolling down a road in Bangkok, Thailand, as you do, when suddenly he had this flash of insight about a problem that had been baffling him.
CARDIFF GARCIA, HOST:
Yeah. Lewis observed that when the economy of a poor country starts growing really fast, the new businesses in that country do make a lot of money, and they do hire a lot of workers. But it takes a long time before the wages that those businesses pay to the workers also start going up. That was the puzzle that Arthur Lewis would go on to solve.
VANEK SMITH: Peter Blair Henry is an economist whose own research has followed in the footsteps of Lewis' work. And Peter says Lewis' insight changed our understanding of the ways that poor countries can raise living standards for their citizens.
PETER BLAIR HENRY: This is what dawned on Lewis as he's walking down the streets of Bangkok. He said, hey (laughter). I'm sort of - he didn't actually say that.
VANEK SMITH: Right.
HENRY: But (laughter)...
GARCIA: He might have. He might have. We don't know that. He subconsciously said, hey (laughter).
HENRY: He's much more erudite, you know? He probably would've said eureka or something, right?
GARCIA: Arthur Lewis ended up turning that eureka insight into an economic model, a model for which he would become the first Black economist to ever win the Nobel Prize in economics, one of many achievements in a truly pathbreaking career that ranged from academic research to advising governments all around the world.
VANEK SMITH: Today on the show, in the third installment of our series about the contributions of unsung economists from the past, we explain Arthur Lewis' dual-sector model of development and how this model sheds light on the enormous challenges that poor countries are facing in the decades ahead.
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VANEK SMITH: Peter Blair Henry is an economist and the dean emeritus at the Leonard N. Stern School of Business at New York University.
HENRY: So Sir W. Arthur Lewis won the Nobel Prize for his dual-sector model. The dual-sector model's called the dual-sector model because there are two sectors.
GARCIA: Imagine a poor country with just two economic sectors. One sector is the subsistence sector, which is just farming, basically - producing food. This sector does not have sophisticated technology or good equipment, and so the work can be routine and menial. The subsistence sector is also not very efficient, and it pays really badly. But most workers in this hypothetical developing country are in this subsistence sector.
HENRY: In most developing countries, there are far more people doing that kind of activity that are needed to do that activity to generate a given level of output in that sector. And that's why there's surplus labor. There's people who are basically underemployed.
VANEK SMITH: And the other economic sector in our hypothetical country is the modern sector - for example, manufacturing, working in a factory, making toys or clothes or cars or things like that. This sector is smaller, but it has better technology for its workers to use. And that makes it possible for the businesses in this sector to pay a higher wage to workers than the workers who work in the farming sector.
GARCIA: Yup, which means that all those surplus workers in the farming sector would have an incentive to take new jobs in the manufacturing sector.
HENRY: If the wage that manufacturers are paying is just, you know, even a little bit above what those workers can get in the subsistence sector, well, those workers are going to have an incentive because they want to have a higher income, chance to buy shoes for their kids and so forth. They'll move from the subsistence sector into the modern sector and work in the factory.
VANEK SMITH: And here is Arthur Lewis' key insight. Because there are so many available workers from the farming sector that can be hired into the manufacturing sector, the manufacturing sector would not have to raise wages for a very long time. Those wages only have to be slightly higher than the wages in the farming sector.
GARCIA: Yeah. And the outcome then would be good for the workers, who get paid more money than they would get paid as farmers. And the outcome would also be profitable for the factories in the manufacturing sector because they can keep making money without paying higher wages over time. And so those profits would also incentivize manufacturing businesses to keep expanding to building new factories.
HENRY: And so you get this symbiotic relationship where output increases, factory owners make profits. And because they're making profits, they build more factories, and they hire more workers.
GARCIA: Eventually, though, all those extra workers from the farming sector will be hired by the modern manufacturing sector. And at that point, factories will actually have to compete with each other to start hiring more of the workers. So they'll finally, finally start raising wages. And the point at which that happens, by the way, when wages finally start rising in the modern sector of the economy, is called the Lewis tipping point. And that is how a low-income country modernizes its economy and improves living standards for its workers.
VANEK SMITH: Lewis formerly wrote down his model in the mid-1950s, and Peter says it turned out to be a really accurate way to understand the poor countries that successfully developed in the decades that came after Lewis invented this model.
HENRY: But the point is that Lewis' model that he came up with in the 1950s walking down the streets of Bangkok foreshadowed - absolutely foreshadowed the turnaround from what we once called third-world countries into what are now emerging markets - China, India, South Korea, Taiwan, Singapore. These were all, you know, sort of examples of the Lewis dual-sector model at work in one form or another.
GARCIA: And crucially, Peter explains, there do have to be some conditions in place for the model to work. The condition that a lot of people struggle with is that modern businesses in these poor countries do have to be able to make a profit in the early stages of a country's development because those profits are what incentivizes those businesses to keep hiring workers out of the less-developed sectors of the economy.
HENRY: I think this is the thing. It's sometimes hard for, you know, young idealists, right? Two things can simultaneously be possible. Firms can be profitable and be good for society. Those two things are not - don't have to be at odds with one another.
VANEK SMITH: Peter has confirmed these ideas in his own research. He and his colleagues studied what happens when developing countries put in place policies that generally made it easier for businesses to thrive, things like reducing inflation or opening their economies up to free trade and foreign investment, starting around the mid-1990s.
HENRY: Post-1994, a number of emerging economies have increased their average growth rates from 3.5% per year to 5.5% per year.
VANEK SMITH: And Peter says the lessons of Lewis' model are especially important for developing countries in the decades ahead exactly because their populations are expected to grow much faster than the populations of rich countries.
HENRY: Between 1978 and 2014, when China was going through the most miraculous period of economic growth in history, it was adding 1.1 million workers a month to the labor force. And those workers are being absorbed precisely through the channels that the Lewis model articulated.
GARCIA: And fast-forward to today. Peter has looked at the demographic trends for a group of the world's poorest developing countries, like the countries in sub-Saharan Africa and Pakistan and also Egypt and the Philippines - countries like that. And according to his estimates, in the coming decades, those countries will be adding about 1.7 million workers per month to the labor force.
HENRY: So those countries have to find essentially 1 1/2 times as many jobs per month as China generated through the most miraculous period of economic growth in world history.
VANEK SMITH: Peter says these countries should invest in the right infrastructure for businesses to thrive in and more generally to put in place sound macroeconomic policies because the stakes of getting these policies right are incredibly high.
HENRY: When things get out of balance in a developing country where the average income is something like $5,000 per year, when people can't work because governments are pursuing policies that make it inimical for factories to expand and hire workers, people starve. People don't have money to send their kids to school, don't have shoes. It's a matter of life and death.
GARCIA: There is so much more to the life and career of Arthur Lewis than just the dual-sector model that we presented today. So if you want to read more, we're going to link to a whole bunch of stuff at npr.org/money. And also, we want to give an extra-special thanks to Bob Tignor, a retired Princeton historian who wrote a great biography about Arthur Lewis and discussed it with us. It's called "W. Arthur Lewis And The Birth Of Development Economics."
This episode of THE INDICATOR was produced by Brittany Cronin with help from Gilly Moon. It was fact-checked by Sam Cai. The INDICATOR is edited by Paddy Hirsch, and it is a production of NPR.
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