Lewis's Theory of Unlimited Supply of Labor

William Arthur Lewis first propounded the theory of unlimited supply of labor in 1954. This theory is based on the concept that if the large surplus of labor available in underdeveloped countries is employed in productive economic activities, workers will receive wages for their livelihood, and producers will earn profits from their investments.

It believes that if economically backward countries can utilize their vast labor force in economic activities, the country can achieve rapid economic development.

The main concepts of this theory are as follows:

1. Unlimited Supply of Labor

In underdeveloped nations, a significant portion of the workforce is engaged in agriculture. Lewis suggests that if a large number of workers unnecessarily involved in agriculture could be employed in productive industries, trade, and businesses, both workers and entrepreneurs would benefit comparatively.

If this could be achieved, industries could be supplied with an unlimited number of workers even at lower wage rates. As a result, workers could earn higher wages than in the agricultural sector, while entrepreneurs could benefit by utilizing workers at relatively lower costs.

Lewis primarily presented the concept of unlimited labor supply because it benefits both parties.

2. Two-Sector Model

The economies of underdeveloped countries are often divided into a subsistence-based agricultural sector and a capitalist sector based on industries.

Productivity in the subsistence-based agricultural sector is low. In the capitalist sector based on industries, along with laborers, machines, equipment, and tools are also used, resulting in much higher productivity compared to agriculture.

In this context, workers from the subsistence sector are employed in the industrial sector with wages 30 to 50 percent higher. In Lewis's view, the minimum wage rate in the industrial sector often remains stable. 

With the supply of unlimited labor at a stable low wage, the profit per labor increases, leading to significant profits for producers, which is not possible in subsistence agriculture.

3. Wages of Labor

The productivity of workers in the subsistence agricultural sector is low, so their average wage is also lower than in the industrial or capitalist sector. To attract such workers to the capitalist sector, wages higher than in the agricultural sector must be provided.

The cost of living in the industrial or capitalist sector is higher than in rural areas. No worker may be willing to move from the agricultural sector to work in the industrial sector for the same wage. 

Therefore, Lewis believed that workers in the industrial sector should be paid 30 to 50 percent higher wages than in the subsistence sector.

4. Process of Capital Formation

We should save a portion of our earned income instead of spending it all. The saved amount can be invested in productive sectors to increase further income and savings.

Lewis believed that if every individual or institution in the economy gradually increases savings and investment, economic activities will accelerate, leading to economic development.

When unlimited workers from the subsistence agricultural sector are attracted to the industrial sector where wages are comparatively higher, the productivity of workers increases, leading to an increase in per capita income and savings.

Additionally, industrialists, by employing an unlimited number of workers in production, increase their income and savings and can reinvest, creating opportunities for increased employment, income, and savings. This process of capital formation and economic development continues at a high level until the supply of unlimited labor from the subsistence sector ceases.

When the supply of labor from the subsistence sector stops, disguised labor in agriculture is eliminated. As a result, the productivity of the remaining workers in agriculture also increases. Thus, the productivity, income, savings, and investment of workers in both the agricultural and industrial sectors increase, accelerating economic development.

He also believed that entrepreneurs investing in industries can contribute to the country's economic development by using cheap labor to increase production, income, savings, and investment.

Process of Economic Development in the Lewis Model

In the initial stage, the traditional agricultural sector has an excess labor force, where workers are engaged beyond the necessary level of productivity. Due to this surplus, labor remains cheap, allowing the modern industrial sector to absorb workers at relatively low wages, facilitating industrial expansion.

As workers shift from agriculture to industry, productivity and income levels rise, leading to increased economic activity. The profits generated in the industrial sector are reinvested into expanding production, creating more employment opportunities, and accelerating economic growth.

With continuous labor migration, the surplus labor in agriculture gradually declines. As a result, wages in both sectors begin to rise, reducing income disparities and marking the transition toward a more advanced and developed economy.

According to Lewis, technological progress plays important role in economic development. It can occur in two different ways which are as follows:

1. Capital-Saving Innovations, which improve efficiency without significantly increasing labor requirements.

2. Labor-Saving Innovations, which enhance productivity while reducing dependence on excess labor.

The Lewis model explains the transformation of an economy from a traditional agricultural base to a modern industrial structure by utilizing the surplus labor available in underdeveloped economies.

Graph 6.0: Lewis's Theory of Unlimited Supply of Labor

In the diagram 6.0, the horizontal axis (OX) represents the quantity of labor employed, while the vertical axis (OY) denotes marginal productivity. The wage rate in the subsistence agricultural sector is represented by OS, while OW is the wage rate in the capitalist industrial sector.

Initially, the economy has an unlimited supply of labor, depicted by the horizontal labor supply curve WW. At the start, when OE₁ labor is employed in the capitalist sector, the marginal productivity curve is A₁D₁, and the total output in this sector is OA₁B₁E₁. Out of this total production, laborers are paid wages equal to OWB₁E₁, while the remaining WA₁B₁ represents the capitalist surplus or profits.

As this capitalist surplus is reinvested, the marginal productivity curve shifts upward to A₂D₂, increasing employment to OE₂ and surplus to WA₂B₂. With continuous reinvestment, the productivity curve further shifts to A₃D₃, and employment rises to OE₃. This process continues until the entire surplus labor is absorbed into the industrial sector.

Once surplus labor is fully utilized, the supply curve of labor begins to slope upward, indicating rising wages and employment. This transition signifies the end of unlimited labor supply, leading to wage increases in both sectors.

Criticisms of Lewis’s Theory of Unlimited Supply of Labor

The theory of unlimited supply of labor has been criticized in various ways by different economists. Some of the main criticisms are presented below:

1. Assumption of Unlimited Labor Supply
   The theory assumes that underdeveloped countries have an unlimited supply of surplus labor in agriculture. However, in many cases, the actual availability of surplus labor is lower than expected, which may slow industrial expansion.

2. Overemphasis on Industrial Growth
   This theory mainly focuses on industrial expansion while ignoring the agricultural sector. If labor shifts from agriculture to industries without improving agricultural productivity, food production may decline, leading to economic instability.

3. Unrealistic Wage Stability Assumption
   Lewis assumes that wages in the capitalist sector remain constant until surplus labor is fully absorbed. However, in reality, wages may increase due to trade unions, labor strikes, and government policies, which can reduce industrial profits.

4. Failure to Address Capitalist Behavior
   The theory assumes that the profits earned by capitalists will always be reinvested in industries. However, in practice, capitalists may spend profits on luxury consumption or invest in non-productive sectors, reducing the rate of industrial growth.

5. Neglect of Rural Development
   Lewis focuses on shifting surplus labor to industries but does not emphasize rural development. If rural areas remain underdeveloped, income inequality may increase, and overall economic development may not be sustainable.