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The Informal Sector

Parallels between the Lewis Model
and the Informal Sector

Hari Srinivas
Concept Note Series E-069. March 2015.

The "dual-sector" model is a model in development economics, which explains the growth of a developing economy in terms of a labour transition between two sectors, the capitalist sector and the subsistence sector [Wikipedia].

Aurther Lewis propounded his 'unlimited labour supply' theory by initially identifying the existence of two sectors in a national economy - the rural-based agricultural sector, and the urban-based industrial sector. Lewis postulated that there is a large 'reserve army' of labour in unlimited supply in the rural areas and this could be used to bring about economic development by using the labour in the industrial sector.

The various stages of the Lewis Model, as his postulate came to be known, and its relevance to the urban informal sector concept is compared below.

Lewis visualized the rural sector as a source of 'unlimited supply' of labour which could be tapped for the development of the industrial sector. He recommended increasing the urban wages slightly more than the rural wages so that this becomes attractive for the people living in the rural areas to migrate to the urban area and be absorbed into the industrial sector. Lewis made the following assumptions to justify his model:

1.  ... that the level of industrial growth and urbanization is more than that of the population.
This has not been so. In fact, population growth (Lewis assumed one percent urban growth) has far exceeded the industrial growth in less developed countries. The very fact of the existence of an 'informal sector' is justification in this direction.

2.  ... that the rate of migration from the rural to the urban area will equal that of the number of jobs generated by the formal sector.
But the rate of migration (due to both 'push' as well as 'pull' factors) has far exceeded the expectation of the Lewis Model. The Todaro Model throws some light on this: (1) rural populations migrate to the city on the expectation or probability of a job and the urban informal sector has helped to 'absorb' these expectations; (2) creation of one job int he formal sector actually attracts more than one migrant and so the urban informal sector has been able to generate employment for them by using labour-intensive technologies (though not for this reason alone)

3.  ... that the level of technology will increase over this period
This has not taken place and the formal sector, consequently, has not generated the required growth. Thus, the urban informal sector, using adoptive and appropriate technologies, has been able to utilize its capital more efficiently than the formal sector.

4.  ... that there would be capital for investments into the formal sector
in fact, the capital scarce condition of most less developed countries has not increased investments, and the urban informal sector, as an alternative, has been able to function in such conditions by using low-cost labour intensive and appropriate technologies.

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