Inequalities in Economic Development
By: Shereein Saraf
Tags: Inequality, Capitalism, Economics, Development, Policy

Inequalities in Economic Development

Why are some nations rich and others poor? These inequalities — whether economic, social, or political — are the by-products of many inequities persisting in the under-developed and developing economies.

In an essay titled Economic Development with Unlimited Labor Supply (1954), Arthur Lewis, a development economist, employed the Classical assumptions of unlimited labor supply at subsistence wages to conceive rural-urban dynamics. This assumption explains the condition of surplus labor to achieve economic development in Marxist literature. It makes for a fundamental presupposition to formulate this model of distribution, accumulation, and growth.

An under-developed economy is, primarily, agrarian society with an inept industrial and manufacturing sector. All the labor force engaged in the agricultural sector work as farmers, casual laborers, or retailers. Resources and capital are scarce as opposed to an unlimited labor force, bringing down the marginal productivity. Disguised unemployment is another feature of such agrarian economies.

Income determination theory asserts that wages equalize the marginal product. Due to an unlimited supply of labor, the wages must fall to a negligible value or even zero. But a rural household, working on agricultural land, divides the income generated among themselves for consumption and investment purposes. The wages, thus, are equal to the average product rather than the marginal product. This outcome is equitable but not efficient. Workers who do not produce any marginal output gain the same wages as the ones who are productive. There is surplus labor, being unproductive in the agricultural sector.

With industrialization and development, a manufacturing sector competes for this surplus labor. The primary sources of this surplus labor are women, who were then engaged in household chores and allied agricultural activities. Another reservoir of workers comes from the disguised unemployment of the fields. Further, there is technical progress due to industrialization, which creates a need for a skilled workforce.

Apart from these, another mechanism is at play in these developing economies. Malthus, known for his law of population, postulated that with economic development, the population increases. Modern economic laws, notably the theory of demographic transition, brings this idea into the context of developing countries. It states that as an economy progresses, the death rates decline, increasing the population growth rate, keeping birth rates constant. This shift is due to an increase in the effectiveness of healthcare.

Further development reduces the birth rates along with death rates, declining the overall population growth. The initial stickiness in birth rates is due to the lack of awareness around contraceptive measures among women and low female employment. As women start to work, they find relatively less time for caregiving activities, leading to lower birth rates.

In a typical rural household in any developing country, some members migrate to urban areas to better their life and employment prospects. The rest of them stay at home to sow the seeds and till the land. Migrating members send remittances back to their families; rural members send food supplies.

This transition is inevitable to achieve economic development, as it creates linkages between the primary and secondary sectors or the agricultural and manufacturing sectors. The rise in industries creates more urban spaces to house the migrants, the surplus labor, who ensure increased productivity in the economy.

Income in the industrial sector is in tandem with their productivity. It follows the economic principle of wages equalizing to marginal productivity, thus, creating an efficient outcome.

It emphasizes that there lies an income differential between the rural and the urban sector. In an extreme case, in a utopian world, all rural population would migrate to the urban industrial sector to take advantage of this wage differential. The state, through its policies of appropriate taxation and subsidies, maintains a rural-urban migration balance. It sets the price indices such that costs of living increase with migration.

Urbanization, in turn, leads to a rise in demand and higher standards of living, further leading to diversification of this demand. Consumption increases, giving feedback to the industries to increase the supply of produce.

On the producer’s side, thus, there is a rise in capital-output and profits. Note that the assumption used was that of fixed resources, owing to scarcity. However, with technical progress and increased labor productivity, output increases, which raises profits and re-investment to production. This process leads to the accumulation of capital.

Capitalism is a means of development, as it increases productivity and, thereby, the efficiency of labor and capital. It raises standards of living, leads to a price rise or inflation but at the same time, is exploitative of labor. This mechanism, described above, accounts only for the surplus of capitalists and not the injection of bank credit into the cycle of production. Add credit to supply lines, the investment increases, leading to a further increased rise in prices. The concept of the multiplier effect of the money supply comes into play.

Although the dual nature of the economy (at the heart of the interplay of agriculture and industry) ensures a step towards development, it also gives rise to inequalities of income and accumulation.

One way to maintain checks and balances on the capitalists is the influx of government control or state planning. The state is responsible for overseeing credit lenders and financing deficits in the economy. Such is the role of modern-day central banks. On the other hand, it stands equally accountable in protecting the interests of labor classes from exploitative capitalists.

This article was originally published on What-if Economics. View and subscribe to my newsletter to get insights right in your mail.