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­Regime Change in the Global Economy

Summary:
After helping to drive decades of development and modernization in emerging economies, the twentieth-century economist W. Arthur Lewis's Nobel Prize-winning growth model can now be applied to the entire world. Unfortunately, what it shows is that we are heading into a period of deep uncertainty and supply-constrained growth. MILAN – In 1979, W. Arthur Lewis received the Nobel Prize in economics for his analysis of growth dynamics in developing countries. Deservedly so: His conceptual framework has proved invaluable in understanding and guiding structural change across a range of emerging economies. ­Regime Change in the Global Economy Ji Haixin/VCG via Getty Images

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After helping to drive decades of development and modernization in emerging economies, the twentieth-century economist W. Arthur Lewis's Nobel Prize-winning growth model can now be applied to the entire world. Unfortunately, what it shows is that we are heading into a period of deep uncertainty and supply-constrained growth.

MILAN – In 1979, W. Arthur Lewis received the Nobel Prize in economics for his analysis of growth dynamics in developing countries. Deservedly so: His conceptual framework has proved invaluable in understanding and guiding structural change across a range of emerging economies.

The basic idea that Lewis emphasized is that developing countries initially grow by expanding their export sectors, which absorb the surplus labor in traditional sectors like agriculture. As incomes and purchasing power rise, domestic sectors expand along with the tradable sectors. Productivity and incomes in the largely urban, labor-intensive manufacturing sectors tend to be 3-4 times higher than in the traditional sectors, so average incomes rise as more people go to work in the expanding export sector. But, as Lewis noted, this also means that wage growth in the export sector will remain depressed as long as there is surplus labor elsewhere.

Because labor availability is not a constraint, the key factor with respect to growth is the level of capital investment, which is needed even in labor-intensive sectors. The returns on such investment depend on competitive conditions in the global economy.

These dynamics can produce startlingly high growth rates that sometimes continue for years, even decades. But there is a limit: when the supply of surplus labor is exhausted, the economy reaches the so-called Lewis turning point. Typically, this will happen before a country has climbed out of the lower-middle-income range. China, for example, reached its Lewis turning point 10-15 years ago, which brought about a major shift in the country’s growth dynamics.

At the Lewis turning point, the opportunity cost of shifting more labor from traditional to modernizing...

Michael Spence
Nobel Prize in economics, Economics professor at Stern School of Business NYU, author of The Next Convergence

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