The Lewis Two-Sector Model. Lewis began with the assumption that the economies in Latin America consisted of two sectors: (1) a traditional rural subsistence sector, characterized by zero or very low productivity surplus labor and (2) a high productivity modern urban industrial sector into which labor from the subsistence sector is gradually transferred.
The primary focus of the model is both on the process of labor transfer and on the growth of employment in the modern sector. Both labor transfer and urban employment growth are brought about by output expansion in the mode n sector. The speed with which they occur is given by the rate of industrial capital accumulation in the modern sector. Such investment is made possible by the excess of modern-sector profits, on the assumption that capitalists reinvest all of their profits in capital expansion. Finally, the level of wages in the urban industrial sector is assumed to be constant and determined as a fixed premium over a constant subsistence level of wages in the traditional agricultural sector.
Lewis assumed the urban wage would have to be at least 30 percent higher than the average rural income in order to induce people to migrate from their home areas into the city. The model thus assumed that rural-to-urban migration was an essential part of the development process, and was, therefore, a good thing.
People expected that ISI would lead to the overall development of a country through a series of linked processes: the growth of urban industry; the migration of people out of unproductive jobs in rural areas; the expansion of employment in the productive modern sector; and an increase in the total wages earned by workers. Once this process is set in motion, then, presumably, it would continue to grow indefinitely. All labor would be transferred from the traditional sector into the modern sector.
This depiction of what was supposed to happen in Latin America is more or less consistent with what happened in the United States. The assumption, of course, is that what happened in the United States could be replicated in Latin America. The result would be the transformation of Latin America from a rural-based semi-feudal economy, characterized by a mass of poor peasants and a wealthy elite, to an industrialized capitalist economy characterized by well-paid factory workers and a growing middle class. In effect, Latin America would come to look just like the United States.
The critical flaw in the logic was the assumption that the rate of labor transfer and employment creation in the modern sector would be proportional to the rate of urban capital accumulation: the faster the rate of capital accumulation, the higher the rate of new job creation.
But what if the profits that capitalists earned were reinvested in more sophisticated labor-saving technology? Such a strategy would make sense, from the capitalist’s standpoint, if only because more efficient technologies could be easily...