chapter 2 the roots of development theory

7/29/2019 Chapter 2 the Roots of Development Theory

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Chapter 2T H E R O O T S O F D E V E L O P M E N T T H E O R YW. ART HU R LEWISPrinceton University

Contents1. Introduction2. Sectoral imbalance3. Overall balance4. Organization5. ConclusionReferences

282831343637

ttan dbo ok of De velopment Economics, Volume L Edited by 11. Chene O, and T.N. Srinivas an Elsevier Science Publishers B. V., 1988


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28 W.A. Lewis

1 . I n t r o d u c t i o n

The theory of economic development established itself in Britain in the centuryand a half running from about 1650 to Adam Smith's T h e W e a l t h o f N a t i o n s(1776). The purpose of this chapter is to investigate how much of the develop-ment theory of today is already to be found in the writings of the eighteenthcentury.There was of course voluminous writing before 1650, but this differs so muchin objective and in methodology that it would prove rewarding only to specialisthistorians. Jumping back a hundred years we are amongst the schoolmen. Theirpurpose was to reconcile modern economic life and institutions (especiallytrading, interest, profit-making, and the right to hold private property) withethics and religion; and their method was to quote from the Bible and thewritings of the early Church. The early mercantilists, who follow, are concernedwith strengthening the military power of the state, in part to unify the country,and in part to fight external enemies (especially the Dutch and the French). Themilitary problem is as acute now for some Third World states as it was at thattime; although their remedy- to keep the king's war chest full of go ld - wouldnot in these days command much support. By the time we have crossed 1650 oureconomists are no longer occupied with military power. The wealth of the kingmoves from center stage, and the income of the nation, as reflected in the balanceof trade, has taken its place. Economics has also begun to be quantitative, underthe leadership of Sir William Petty.The writers of the seventeenth and eighteenth centuries are often disparagedfor being confused and confusing. Much of this is due to misuse of words, as intreating as synonyms for wealth: money, gold, treasure, balance of trade, andbalance of payments. With hindsight it is easy to recognize anomalies oflanguage, and to correct for them. We can also deal with misunderstandings dueto changes in institutional backgrounds. With such adjustments eighteenth-cen-tury economics was surprisingly advanced. We also reduce the burden byconcentrating on the writings of the three superstars of the eighteenth century,Hume, Steuart and Adam Smith, and two whose influence was more restricted,Cantillon and Wallace. We have also set aside the French and German authors.[See Hume (1748), Cantillon (1755), Steuart (1767), Smith (1776), Wallace(1753).]

2 . S e c t o r a i i m b a l a n c e

We approach the subject by assuming that a manufacturer hires more employeesand increases his output, and that the relevant elasticities are such that he must


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Ch. 2: The Roots of Development Theory 29b u y m o r e r a w m a t e r i a l s a n d s e l l m o r e m a n u f a c t u r e s . I f t h i s i s a c l o s e d e c o n o m y ,t h e t e r m s o f t r a d e w il l m o v e a g a i n s t m a n u f a c t u r e s , a n d i f t h is g o e s f a r e n o u g h ,t h e r e v e n u e r e q u i r e d t o s u s t ai n t h e i n c r e a s e i n t h e o u t p u t o f m a n u f a c t u r e s w i lln o t m a t e r i a l i z e . T h e s i z e o f t h e n o n - f a r m p o p u l a t i o n d e p e n d s o n t h e s i z e o f t h ea g r i c u l t u r a l s u r p l u s .

T h i s d o c t r i n e g o e s b a c k v e r y fa r . I ts m a i n p r o p o n e n t s i n t h e e i g h t e e n th c e n t u r ya r e H u m e , S t e u a r t , a n d A d a m S m i t h . H e r e , i n a n u t s h el l, is S m i t h 's f o r m u l a t i o n :

I t i s th e s u r p l u s p r o d u c e o f th e c o u n t r y o n l y , o r w h a t i s o v e r a n d a b o v e t h em a i n t e n a n c e o f t h e c u lt iv a t o r s, t h a t c o n s t i t u t e s th e s u b s i s te n c e o f t h e t o w n ,w h i c h c a n t h e r e f o r e i n c r ea s e o n l y w i t h t h e i n c re a s e o f t h e s u rp l u s p r o d u c e[ Sm i t h ( 1776 , p . 357 ) ] .

B u t t h e r e is a w a y o u t . R e m o v e t h e a s s u m p t i o n o f a c lo s e d e c o n o m y a n d t h et o w n s a r e n o l o n g e r l im i t e d b y t h e s i ze o f t h e d o m e s t i c a g r ic u l tu r a l s u r p lu s . T h e yc a n i m p o r t a n d e x p o r t i n s te a d , l ea v i n g i t t o th e a g r ic u l tu r a l c o m m u n i t y t o d o t h es a m e , o r t o i g n o r e w h a t i s h a p p e n i n g i n t h e m a n u f a c t u r i n g s e c t o r o r b o t h ( t h i sd e p e n d s o n t h e s iz e o f t h e e x p o r t m u l ti p li e r) . T h i s a l t e rn a t i v e is r e c o r d e d b yA d a m S m i t h :

T h e t o w n i n d e e d m a y n o t a l w a y s d e r iv e i ts w h o l e s u b si s te n c e f r o m t h e c o u n t r yi n i t s n e i g h b o r h o o d , o r e v e n f r o m t h e t e r r i t o r y t o w h i c h i t b e l o n g s , b u t f r o mv e r y d i s t a n t c o u n t r i e s ; a n d t hi s, t h o u g h i t f o r m s n o e x c e p t i o n f r o m t h e g e n e ra lr u l e , h a s o c c a s i o n e d c o n s i d e r a b l e v a r i a t i o n s i n t h e p r o g r e s s o f o p u l e n c e i nd i f f e r e n t a g e s a n d n a t i o n s [ S m i t h ( 1 7 7 6 , p . 3 5 7 ) ] .

T h e e x i s t e n c e o f th e a l t e rn a t i v e s h if ts t h e c o n s t r a in t o n g r o w t h o f o u t p u t f r o mt h e s i z e o f t h e a g r i c u l tu r a l s u r p l u s t o p o t e n t i a l f o r e i g n e x c h a n g e e a r n in g s . B u tt h e r e i s a l s o m u c h d i s p u t e a s t o t h e s t r e n g t h o f t h e f o r e i g n e x c h a n g e c o n s t r a i n t .S t r u c t u r a l i s t s m a i n t a i n t h a t i t i s v e r y h a r d t o ra i s e th e r a t e o f g r o w t h o f e x p o r t s ,o r t o c u t i m p o r t s ; w h i le " m a r k e t " e c o n o m i s t s c l a im t h a t e l as ti c it ie s a re a d e q u a t e ,a n d t h a t f a i l u r e t o re l y o n t h e m is m i s t a k e n . T h e t w o - g a p m o d e l w a s i n v e n t e d i nt h e 1 9 5 0 s t o i l l u s t r a t e t h e d i f f ic u l t y o f e a r n i n g f o r e i g n e x c h a n g e . P r e s u m a b l y t h ef a c t s o f e a c h c a s e m u s t b e c o n s i d e r e d s e p a r a t e l y . I t s e e m s l i k e l y t h a t t h e r e c e n ty e a r s ( 1 9 7 3 - 1 9 8 8 ) h a v e b e e n m o r e d i ff ic u lt t o m a n i p u l a t e t h a n t h e t w o p r e c e d i n gd e c a d e s .

T h e d e b a t e o n t h e g a i ns f r o m t r a d e h a d b e e n i n p r o g r e s s f o r tw o c e n t u r ie s , a n dw o u l d s t i l l b e i n p r o g r e s s t w o c e n t u r i e s l a t e r . H e r e i s H u m e o n t h e s u b j e c t :

T h e r e s e e m s t o b e a h a p p y c o n c u r r e n c e o f c a u s e s i n h u m a n a f fa ir s, w h i chc h e c k s t h e g r o w t h o f t r a d e a n d r i c h e s , a n d h i n d e r s t h e m f r o m b e i n g c o n f i n e de n t i r e l y t o o n e p e o p l e ; a s m i g h t n a t u r a l l y a t f i r s t b e d r e a d e d f r o m t h ea d v a n t a g e s o f a n e s t a b l i s h e d c o m m e r c e . W h e r e o n e n a t i o n h a s g o t t e n t h e s t a r to f a n o t h e r i n t r a d e , i t i s v e r y d if f ic u l t f o r t h e l a t te r t o r e g a i n t h e g r o u n d i t h a sl o s t ; b e c a u s e o f t h e s u p e r i o r i n d u s t r y a n d s k il l o f th e f o r m e r , a n d t h e g r e a t e rs t o ck s , o f w h i c h i t s m e r c h a n t s a r e p o s se s s e d , a n d w h i c h e n a b l e t h e m t o t r a d e


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30 W.A. Lewison sO much smaller profits. But these advantages are compensated in somemeasure, by the low price of labor in every nation which has not an extensivecommerce, and does not much abound in gold and silver. Manufacturestherefore gradually shift their places, leaving those countries and provinceswhich they have already enriched, and flying to others, whither they are alluredby the cheapness of provisions and labor; till they have enriched those also,and are again banished by the same cause [Hume (1748, "Of Money", pp.34-35)].Whatever may be the individual case, the general principle remains the same.

Foreign exchange and foreign exchange reserves are a potential constraint ongrowth. This was not fully appreciated after the Second World War. SomeDevelopment Plans were made, for instance, in the 1950s without checking thatthe proposed allocation of resources would provide enough foreign exchange. Theconsequences of this neglect are painful. As the country runs short of foreignexchange, it is forced ultimately to reduce the import of raw materials andmachinery, so factories close and unemployment swells.

I speak of foreign exchange and foreign exchange reserves, but this is ananachronism. Reserves were held in gold or silver, not in paper (bills, notes). Thepractice of major countries holding their reserves routinely in the form of entriesin bankers' books in some other country did not begin until the twentieth century[Lindert (1969)]. When the Mercantilists say that one should have an adequatestock of gold, they sound confused, but when a twentieth-century LDC seeks toincrease its foreign exchange reserves, it appears to be highly sensible.

Fundamentally what they were saying was that export industries, or, as wewould say, "tradeable goods", are more valuable than non-tradeable goodsbecause they can be turned into foreign currency. They felt for this distinction,but they never quite reached it. On the way they got bogged down in otherdistinctions. A favorite track led to the question whether agriculture or manufac-turing was the more important. The Physiocrats voted for agriculture, sincemanufacturing does not add to the embodied physical resource; whereas theMercantilists voted for manufacturing partly because its output was easilytradeable at a profit. Twentieth-century development economists are not caughtin such a trap because we do not answer questions involving all-or-nothing. Weoperate at the margin. So our question is by how much to increase bothagriculture and manufacturing, respectively, and our answer depends on time,place, and elasticities. But even today non-professional writing and debating arefascinated by this choice in the language of all-or-nothing. We would also notaccept that services are inferior to commodities, because there is no tangibleproduct. This trapped even Adam Smith:

The labor of some of the most respectable orders in the society is, like that ofmenial servants, unproductive of any value, and does not see or realize itself in


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Ch. 2: The Roots of Development The o~ 31any permanent subject or vendible commodity which endures after that laboris past, and for which an equal quantity of labor could afterwards be procured[Smith (1776, p. 315)].Services add value (in our language) whether they are tradeable, invisible, or

permanent. Governments need to be warned about services because they tend toexpand health, housing, education, and welfare services much faster than na-tional income grows; but the error turns not on the nature of services but onfailure to equilibrate that part of the Development Plan that projects the balanceof payments.In sum, the eighteenth-century economists did not find the precise distinctionbetween tradeable and non-tradeable goods and services, but this was what theywere feeling for. They were also conscious of the difficulties of exporting imposedconstraints on the growth of the economy. If they were obsessed with the balanceof payments, it may also be said that mid-twentieth-century economists under-estimated the importance of this constraint, and paid the penalty in almostcontinual international currency crises from 1913 to the time of writing (1985).

3 . O v e r a l l b a l a n c e

Now let us close the economy, and concentrate on internal balance. Suppose thatthere is a balanced expansion (balanced sectorally as between industry andagriculture), and financed by a proportionately equal increase in the quantity ofmoney. Will the money so spent turn up as income more or less equal to thatwhich was originally expanded? In the language of Keynes: Will aggregatedemand equal aggregate supply? This is one of the oldest questions in economicdevelopment.

The first point to note is that the money would circulate. Harvey discoveredthe circulation of the blood in 1616, and this image was in the mind of mosteconomists from then onwards. Nearer home, the idea of circulation is inherentin Quesnay's T a b l e a u E c o n o m i q u e , but this was not published until 1758. What isknown as Say's Law was not formulated until 1821, but the question is mucholder.

That all costs become equivalent incomes is tautological. The question is: Whathappens to the incomes? Adam Smith's proposition that: "What is annuallysaved is as regularly consumed as what is annually spent" [Smith (1776, p. 321)]assumes that all income will be re-spent, if not for consumption, then oninvestment. But this need not be so. Income receivers may hoard; savers may failto invest; the chain of expenditure, to use a different metaphor, may break.

Smith would not accept that the level of employment would depend on thedivision of expenditure between savings and consumption, but he did put


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32 W.A. Lewis

f o r w a r d h i s o w n d i s t i n c ti o n , w h i c h i s e f f ec t iv e i n t h e l o n g r u n b u t n o t i n t h es h o r t . T h i s w a s th e d i s ti n c t io n b e t w e e n " p r o d u c t i v e " a n d " u n p r o d u c t i v e " l a b o r .L a b o r , w h o s e p r o d u c t w a s s o l d f o r a p r o f i t , w a s p r o d u c t i v e b e c a u s e i t y i e l d e d a ni n v e s t i b l e s u r p l u s . T h u s , i f a m a n h i r e s a m a i d t o w o r k i n h i s h o t e l , h e r l a b o r i sp r o d u c t i v e , b u t i f h e h i re s h e r t o w o r k i n h i s h o u s e , h e r s e rv i ce s a re u n p r o d u c t i v e .S o i f l a b o r w a s t r a n s fe r r e d f r o m p r o d u c t i v e t o u n p r o d u c t i v e o u t p u t , t h e s h o r t - t e r ml e v e l o f e m p l o y m e n t w o u l d n o t c h a n g e , b u t t h e l o n g - r u n r a t e o f g r o w t h w o u l dd i m i n i s h b e c a u s e o f s l o w e r g r o w t h o f t h e s t o c k o f a c c u m u l a t e d c a p i t a l . A t t h en e x t s t a g e o f th i s a r g u m e n t t h e s u m p a i d i n w a g e s is tr a n s m u t e d i n t o a " f u n d f o rt h e e m p l o y m e n t o f l a b o r " . A n y c h a n g e i n t h e s t r u c t u r e o f n a t i o n a l i n c o m e w i l la l t e r t h e p r o p o r t i o n o f p r o d u c ti v e t o u n p r o d u c t i v e i n t h e w a g e s fu n d , a n d s o r ai seo r r e d u c e t h e g r o w t h r a t e o f o u t p u t i n t h e l o n g r u n . F o r e x a m p l e , i n o u r d a y i tw a s p r o p o s e d t h a t " s u r p l u s l a b o r " b e u s e d i n t h e s l a c k a g r i c u l t u r a l s e a s o n t ob u i l d , i n p a r t s o f I n d i a , u s e f u l l o c a l i n f r a s t r u c t u r e , s u c h a s i r r i g a t i o n c h a n n e l s ,f a r m t o m a r k e t r o a d s , s c h o o ls , e t c. S u r p l u s l a b o r c a n b e c o n v e r t e d t o s a v i n g w h e nt h e l a b o r i s w i l li n g t o w o r k w i t h o u t p a y ; b u t i f i t is n o t , t h e n e x t r a f o o d a n d o t h e rc o n s u m e r g o o d s m u s t b e m o b i l i z e d f o r t h e v i l l a g e r s a l o n g w i t h e x t r a p a y . S o t h ep r o g r a m a b s o r b s s a v i n g s i n s t e a d o f g e n e r a t i n g s a v i n g s . O n e c a n s t a t e t h i s i nt e r m s o f S m i t h ' s f o r m u l a : u n p r o d u c t i v e w o r k e r s a re b e i n g c o n v e r t ed i n t o p r o d u c -t i v e o n e s , b u t n o t h i n g i s g a i n e d b y d o i n g t h i s , b e y o n d r e c o g n i z i n g t h a t t h e n e e df o r s a v i n g s i s a f u r t h e r c o n s t r a i n t u p o n g r o w t h e v e n w h e n u s i n g s u r p l u s l a b o r .T h e w a g e s f u n d m o d e l s p u r r e d a l o t o f a r g u m e n t a m o n g t h e cl as si ca l e c o n o m i s t sb u t i t w a s c o n f u s i n g a n d d i d n o t c o n t a i n a n y u s e f u l i n s i g h t . T h e f a c t t h a t i ts u r v i v e d i n t o t h e s e c o n d h a l f o f th e n i n e t e e n t h c e n t u r y i s r a t h e r s u r p r i s in g . O t h e rw r i t e r s d i d n o t a c c e p t S m i t h ' s a s s u m p t i o n s o r h i s c o n c l u s i o n t h a t o u t p u t w a su n a f f e c t e d b y t h e r a t i o o f c o n s u m p t i o n t o n a t i o n a l o u t p u t . T h e y i n s i s t e d t h a tw h a t w e n o w c a l l " a g g r e g a t e d e m a n d " m i g h t f a l l s h o r t o f o r e x c e e d a g g r e g a t es u p p l y , a n d t h a t i t w a s t h e r e f o r e n e c e s s a r y t o b o l s t e r c o n s u m p t i o n i f f u l le m p l o y m e n t w a s t o b e m a i n t a i n e d . T h i s w a s t h e p o s it i o n t a k e n b y M a n d e v i ll e inhis The Fable o f the Bees, b u t i t w a s a l s o t h e o p i n i o n o f h i g h l y r e g a r d e de c o n o m i s t s l ik e H u m e , i n w h o s e w o r d s : " L u x u r y , w h e n e x ce s si v e, i s t h e s o u r c e o fm a n y i l l s ; b u t i s i n g e n e r a l p r e f e r a b l e t o s l o t h a n d i d l e n e s s , w h i c h w o u l dc o m m o n l y s u c c e e d in i ts pl ac e , a n d a r e h u r t f u l b o t h t o p r i v a t e p e rs o n s a n d t o t h ep u b l i c " [ H u m e ( 17 48 , " O n R e f i n e m e n t i n t h e A r t s " , p . 3 2 ) ]. T h i s , f r ee l y t r a n s -l a t e d , m e a n s : u n e m p l o y m e n t ( id l en e ss ) i s b a d , a n d n e e d s t o b e m i n i m i z e d b ys p e n d i n g o n c o n s u m e r g o o d s; b u t s p e n d o n m a t t e r s t h a t g iv e g e n e r a l p l e a su r e( a r t m u s e u m s , e t c . ) r a t h e r t h a n o n l o o s e l i v i n g .

T h e s e e c o n o m i s t s n e e d e d t o h a v e a t h e o r y o f w a g e s , s i n c e t h e l e v e l o f w a g e sw o u l d d e t e r m i n e t h e s i z e o f t h e s u r p l u s a v a i l a b l e f o r i n v e s t m e n t a f t e r p a y i n g o f ft h e l a b o r e r s . T h e m o d e l w a s a l r e a d y e s t a b l i s h e d i n w h i c h n e t s a v i n g w a s d o n eo n l y o u t o f p r o f i ts in c o m e , a n d n o t o u t o f r e n t o r w a g es : t h e f o r m u l a t h a t w o u l d


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Ch. 2: The Roots of Development Theory 33c o n t i n u e t o b e u s e d o v e r th e n e x t c e n t u ry . H e r e i s H u m e ' s v e r s i o n o f i t:

T h e r e i s n o o t h e r p r o f e s s i o n , t h e r e f o r e , e x c e p t m e r c h a n d i s e , w h i c h c a n m a k et h e m o n i e d i n t e r e s t c o n s i d e r a b le , o r , i n o t h e r w o r d s c a n i n c r e a se i n d u s t r y a n d ,b y a l so i n c r e a s i n g f r u g a li ty , g iv e a g r e a t c o m m a n d o f t h a t i n d u s t r y t o p a r t ic u -l a r m e m b e r s o f t h e s o c ie ty . W i t h o u t c o m m e r c e t h e s t a te m u s t c o n s i s t c h ie f ly o fl a n d e d g e n t ry , w h o s e p r o d ig a l it y a n d e x p e n s e m a k e a c o n t in u a l d e m a n d f o rb o r r o w i n g ; a n d o f p e a s a nt s w h o h a v e n o s u m s t o su p p l y t h at d e m a n d . T h em o n e y n e v e r g a t h e rs i n t o l a rg e s t o c k s o r s u m s w h i c h c a n b e l e n t a t i n te r e st . I ti s d i s p e r s e d i n t o n u m b e r l e s s h a n d s , w h o e i t h e r s q u a n d e r i t o n i d l e s h o w a n dm a g n i f i c e n c e , o r a p p l y i t i n t h e p u r c h a s e o f t h e c o m m o n n e c e s s a r i e s o f l i f e .C o m m e r c e a l o n e a s s e m b l e s i t i n t o c o n s i d e r a b l e s u m s [ H u m e ( 1 7 4 8 , " O fI n t e r e s t " , p . 54 ) ] .T h e w a g e l e v e l a ls o d e t e r m i n e d t h e s u p p l y o f la b o r i n t h e s h o r t r u n , s i n c e t h e

w o r k e r s w e r e " s l o t h f u l " a n d o f f e r e d t h e m s e l v e s f o r f u l l e m p l o y m e n t o n l y a sw a g e s f el l. A d a m S m i t h t h o u g h t t h e o p p o s i t e , n a m e l y th a t w o r k e r s w o r k e d m o r ea s w a g e s r o s e . H e a l s o t h o u g h t t h a t w a g e s w o u l d r i s e a b o v e s u b s i s t e n c e l e v e l i ft h e e c o n o m y w e r e g r o w i n g f as t. A s h e s a id : " I t i s n o t t h e a c t u a l g r e a tn e s s o fn a t i o n a l w e a l t h , b u t i t s c o n t i n u a l i n c r e a s e , w h i c h o c c a s i o n s [ h i g h w a g e s [ " [ S m i t h( 1 7 7 6 , p . 6 9) ]. A d a m S m i t h f a v o r e d a w a g e l e v el b e y o n d s u b s is te n c e , b u t o t h e re c o n o m i s t s , p r e o c c u p i e d w i t h t h e b a l a n c e o f t ra d e , w a n t e d w a g e s t o b e a s c lo s e tos u b s i s t e n c e a s p o s s i b l e s o t h a t e x p o r t s b e s t i m u l a t e d a n d i m p o r t s c h o k e d b y l o wB r i t i sh p r i c e s . T h e i r p o s i ti o n w a s n o t u n l ik e t h a t o f t w e n t i e t h - c e n t u r y s e ek e r sa f t e r a p r i c e s a n d i n c o m e s p o l i c y t h a t w i l l e n a b l e a c o u n t r y t o k e e p i t s m o n e yc o s t s p e r u n i t o f o u t p u t r is in g n o f a s te r t h a n c o s ts i n c l o s e ly c o m p e t i n g c o u n t r ie s .

S o f a r w e h a v e n o t c o n s i d e r e d t h e e ff e c ts o f m o n e y o n o u t p u t . S e v e n t e e n t h -a n d e i g h t e e n t h - c e n t u r y e c o n o m i s ts w r o t e c o p i o u s l y o n t h is s u b j ec t , e s ta b l is h i n gh o w i t w o u l d b e a p p r o a c h e d u n t i l t h e t w e n t i e th c e n t u r y . W e c a n t h e r e f o r e b eb r i e f .

T h e Q u a n t i t y T h e o r y o f m o n e y w a s w e ll k n o w n t o e c o n o m i st s t h r o u g h o u t t h ee i g h t e e n t h c e n t u r y , o n a c c o u n t o f it s fo r m u l a t i o n b y J o h n L o c k e [ L o c k e ( 16 9 1) ].I t w a s f a m i l i a r i n i t s s i m p l e s t f o r m , w h e r e a n i n c r e a s e i n t h e q u a n t i t y o f m o n e yl e a d s t o a n e q u a l p r o p o r t i o n a t e i n c r e a s e i n p r i c e s . B u t i t w a s a l s o d e b a t e d i n i t sm o r e s o p h i s t i c a t e d f o r m , w h e r e so m e i n c r e a se in e m p l o y m e n t w o u l d o c c u r , a sw e l l a s m o r e w o r k b e c o m e a v a i l a b l e f o r t h o s e a l r e a d y a t w o r k b u t n o t f u l l yo c c u p i e d ( t h e d i s g u i s e d u n e m p l o y e d ) . T h i s w a s S t e u a r t ' s p o s i t i o n . T h e s y n t h e s i sw a s p r o v i d e d b y D a v i d H u m e in h is e ss a y " O f M o n e y " . T h e i n c r ea s e i n m o n e yw o u l d f ir st r a is e p r ic e s b y m o r e t h a n c o s ts , b u t i n t h e lo n g r u n c o s t s w o u l d c a t c hu p :

W e f i n d t h a t i n e v e r y K i n g d o m , i n t o w h i c h m o n e y b e g in s t o f lo w i n g r e a t e ra b u n d a n c e t h a n f o r m e r l y , e v e r y t h i n g t a k es a n e w f ac e ; l a b o r a n d i n d u s t r y g a i n


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34 W.A. Lewis

l i f e , t h e m e r c h a n t b e c o m e s m o r e e n t e r p r i s i n g , t h e m a n u f a c t u r e r [ i . e . i n d u s t r i a lw o r k e r ] m o r e d i l i g e n t a n d s k i l l f u l , a n d e v e n t h e f a r m e r f o l l o w s h i s p l o w w i t hg r e a t e r a l a c r i t y a n d a t t e n t i o n . . . A t f i r s t n o a l t e r a t i o n i s p e r c e i v e d ; b y d e g r e e st h e p r i c e r i s e s , f i r s t o f o n e c o m m o d i t y , t h e n o f a n o t h e r ; t i l l t h e w h o l e a t l a s tr e a c h e s a j u s t p r o p o r t i o n w i t h t h e n e w q u a n t i t y o f s p e c i e w h i c h i s i n t h eK i n g d o m . I n m y o p i n i o n i t i s o n l y i n t h i s i n t e r v a l o r i n t e r m e d i a t e s i t u a t i o n ,b e t w e e n t h e a c q u i s i t i o n o f m o n e y a n d r i s e o f p r i c e s t h a t t h e i n c r e a s i n gq u a n t i t y o f g o l d a n d s il ve r i s f a v o r ab l e to i n d u s t r y [ H u m e (1 74 8, " O f M o n e y " ,p. 37)].H u m e t o o k t h e s a m e " i n t e r m e d i a t e " p o s i t i o n o n t h e e ff e ct s o f a n i n c re a s e in

t h e q u a n t i t y o f m o n e y o n t h e ra t e o f i n te r e st ; h e t h o u g h t t h a t t h e ra t e w o u l d f a l la t f i r s t , b u t t h e r e a f t e r r e t u r n t o i t s p r e v i o u s l e v e l . H e w a s f l a n k e d b y C a n t i l l o na n d S m i t h o n t h e o n e s i de , i n si s ti n g o n t h e n e u t r a l i t y o f m o n e y , a n d b y L o c k ea n d S t e u a r t o n t h e o t h e r s i d e , e s t a b l i s h i n g t h e m o n e t a r y c a s e . T h i s d e b a t ec o n t i n u e s .

N o t e t h e a p p a r e n t e x p e c t a t i o n t h a t i n n o r m a l t i m e s t h e l a b o r m a r k e t i s s l a c k ,a n d t h a t i t c o m e s t o f u l l e m p l o y m e n t o n l y i n r es p o n s e t o a m o n e t a r y s t i m u l u s . A sP e t t y p u t i t , " T h e r e a r e s p a r e h a n d s e n o u g h a m o n g t h e K i n g o f E n g l a n d ' ss u b j e c ts t o e a r n t w o m i ll io n m o r e p e r a n n u m t h a n t h e y d o n o w " [ q u o t e d f r o mJ o h n s o n ( 1 9 3 7 , p . 1 1 3 ) ] . T h e r e w a s , h o w e v e r , n o s u g g e s t i o n o f a r e g u l a r t r a d ec y c le , e v e n t h o u g h w i t h h in d s i g h t w e' c a n s ee t h a t m o n e y a n d c o m m e r c e w e r ea l r e a d y s h o w i n g s u c h a p a t t e r n ( i n d u s t r y w a s s t i l l t o o s m a l l t o m a t t e r i n t h i sc o n t e x t ) .

P o p u l a t i o n t h e o r y w a s s ti ll in c o n f u s i o n . W h i le t h e r e w a s n o t m u c h d i s p u t ea b o u t t h e s h o r t - t e r m e f f e c ts o n w a g e s o f a n in c r e a s e in t h e d e m a n d f o r l a b o r , t h el o n g - r u n e f f e c t s w e r e d i s p u t e d b y a t l ea s t t h r e e g r o u p s : t h o s e w h o b e l i e v e d i ni n c r e a s i n g r e t u r n s , t h o s e w h o s a w a n i n f i n i te l y e l a s ti c s u p p l y o f la b o r , a n d a t h i r dg r o u p t h a t e x p e c t e d d i m i n i s h i n g r e tu r n s . T h e i s s u es w o u l d n o t b e c l e a r ly s o r t e do u t u n t i l t h e n i n e t e e n t h c e n t u r y .

4 . O r g a n i z a t i o nE c o n o m i c i n s t i t u t i o n s w e r e d i f f e r e n t t h e n f r o m n o w , a n d t h i s i s r e f l e c t e d i n t h es h a p e o f d e v e l o p m e n t t h e o r y .

F i r s t , i n t h e p u r e m o d e l t h e e c o n o m y c o n s i s t s o f l a n d l o r d s , c a p i t a l i s t s , a n dw a g e e a r n e rs , a n d t h e t h e o r y o f d i s t r ib u t i o n e x p l a in s h o w t h e p r o d u c t i s d i v i d e da m o n g s t t h e s e c l a s s e s . E n g l i s h a g r i c u l t u r e d i d i n d e e d h a v e t h a t p a t t e r n , b u t i no t h e r c o u n t r i e s t h e l a b o r f o r c e c o n s i s t e d o f s m a l l f a r m e r s , w o r k i n g i n v a r i o u sl e g a l f o r m s , f r o m n e a r s l a v e r y u p w a r d s . T h e i r w a y s o f l i v in g w e r e n o t r e p r e s e n t e di n c u r r e n t t h e o r y .


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Ch. 2: The Roots o f Development Theory 35S i m i l a r l y , t h e f a r m e r i n t h i s m o d e l r e p r e s e n t s t h e e n t r e p r e n e u r , a n d a l s o t h e

b e a r e r o f i n n o v a t i o n s . T h e e n t r e p r e n e u r a s s u c h s e e m s t o h a v e h a d h i s f u n c t i o na n d p r o c e d u r e s a n a l y z e d b y o n l y o n e e co n o m i s t o f o u r p e ri o d , n a m e l y R i c h a r dC a n t i l l o n . H e s t r e s s e d t h e r i s k - b e a t i n g f u n c t i o n , i n s t e a d o f c a p i t a l p r o v i s i o n ,w h i c h w a s i n t h o s e d a y s m o r e c o m m o n . O n e c a n u n d e r s t a n d t h e g e n e r a l l a c k o fi n t e r e s t . T h e t y p i c a l e n t r e p r e n e u r a t t h is t im e w a s n e i t h e r a f a r m e r n o r a ni n d u s t r i a l t y c o o n , b u t a m e r c h a n t a d v e n t u r e r i n f o r e i g n tr a d e . H i s c a p i ta l w a sw o r k i n g c a p i t a l r a t h e r t h a n f i x e d c a p i t a l ; a n d h i s a b i l i t y t o s u p p l e m e n t i t b yb o r r o w i n g w a s r e s t r i c t e d b y t h e f a c t t h a t f i n a n c i a l i n s t i t u t i o n s w e r e r a t h e rr u d i m e n t a r y . W e d o n o t h a v e t o a s k , l i k e M a x W e b e r , w h e r e a l l t h e s e c a p i t a l i s t sc a m e f r o m . O n c e t h e s c h o o l m e n h a d g i v e n t h e i r b l e s s i n g t o c o m m e r c e , t h e r ew o u l d b e n o s h o r t a g e o f m e r c h a n t a d v e n t u r e rs . M a n y c o u n t r i e s t o d a y a re i n t h es i t u a t i o n t h a t t h e y h a v e a n " u n l i m i t e d s u p p l y " o f b u s i n e s s m e n w h i l e s o r e l yl a c k i n g i n d u s t r i a l e n tr e p r e n e u rs h i p . A d a m S m i t h d e t e s te d b u s i n e s s m e n ; C a n t i l lo na n d H u m e t h o u g h t t h e y w e r e w o n d e r f u l [ S m i t h ( 17 76 , p . 2 50 ), C a n t i l l o n (1 7 5 5,p p . 6 3 - 7 3 ) , H u m e ( 1 7 4 8 , " O f I n t e r e s t " , p . 5 2 ) ] .

T h e e c o n o m i c s o f l a n d t e n u r e i n v i t e d i n t e r e s t f r o m t h e t i m e o f C r o m w e l l ' sc o n q u e s t o f I r e l a n d , b u t d i d n o t b l o s s o m u n t i l t h e n i n e t e e n t h c e n tu r y . P a r t o f t h isp r o b l e m i s t h a t t h e L a w o f D i m i n i s h i n g R e t u r n s , w h i c h w o u l d d o m i n a t e d i st r ib u -t i o n t h e o r y u n t i l t h e 1 9 6 0 s , w a s n o t f o r m u l a t e d u n t i l a f t e r t h e e n d o f o u r p e r i o d[West (1815)] .

T h e e i g h t e e n t h c e n t u r y c o u l d n o t c o n t r i b u t e s p e c ta c u l a rl y to t h e m o n e t a r yt h e o r y o f t h e t w e n t i e t h c e n t u r y s i n c e t h e i n s t i t u t i o n a l b a c k g r o u n d d i f f e r e d s og r e a t l y a s b e t w e e n t h e tw o p e ri o d s. O u r s i s a n a g e o f p a p e r m o n e y - b a n k n o t e sc h e c k s a n d s o o n - w h e r e a s t h e i r s w a s s t i l l a n a g e o f p r e c i o u s m e t a l s c i r c u l a t i n ga s m o n e y . B u t t h e t r a n s i t i o n t o p a p e r h a d b e g u n . B a n k s w e r e i s s u i n g n o t e s a n dc r e a t i n g c r e d i t ( t h o u g h d e n y i n g t h e l a t te r ). A n d t h e a m b i g u i t y o f d e c id i n g w h a tw a s a n d w h a t w a s n o t t o b e i n c l u d e d i n t h e c o u n t a s m o n e y h a d a l r e a d y b e g u n .H o w f a r a p a r t w e a re is i l lu s t ra t e d b y A d a m S m i t h ' s p r o n o u n c e m e n t t h a t :

T h e w h o l e p a p e r m o n e y o f e v e ry k i n d w h i c h c a n e a s i ly c i rc u l at e i n a n y c o u n t r yc a n n e v e r e x c e e d t h e v a l u e o f t h e g o l d a n d s il v er o f w h i c h i t su p p l i e s t h e p la c e ,o r w h i c h ( t h e c o m m e r c e b e i n g s u p p o s e d t h e s a m e ) w o u l d c i r c u l a t e t h e r e i fthe re w as no p ape r m on ey [Smi th (1776, p . 284) ].

T h i s s t a t e m e n t i s e i t h e r a t a u t o l o g y o r f a l s e .T h e r o l e o f g o v e r n m e n t o c c u p i e d e i g h t e e n t h - ce n t u r y ec o n o m i s t s a s m u c h a s it

o c c u p i e s o u r o w n g e n e r a t i o n . G o v e r n m e n t w a s i n d e e d m u c h s m a l l e r , a l m o s tc e r t a i n l y n o t e x c e e d i n g 5 p e r c e n t o f n a t i o n a l i n c o m e , i n c l u d i n g d e f e n s e . T h e ya r g u e d a s t o w h e r e t o d r a w t h e l i n e b e t w e e n p r i v a t e e n t e r p r i s e a n d o w n e r s h i pa n d g o v e r n m e n t e n t e r p r i s e a n d o w n e r s h i p , a n d p o s s i b l e m i x t u r e s ; t h e a r g u m e n tt u r n i n g p r i n c i p a l l y o n i n ef f ic i en c y a n d c o r r u p t io n , m u c h a s i t d o e s i n t h e T h i r dW o r l d t o d a y . A d a m S m i t h u s e s t h e c o n c e p t o f e x t e r n a l e c o n o m i e s i n d e s c r i b i n g


10/11

36 W.A. Lewish u m a n c a p i t a l, b u t d o e s n o t d e v e l o p i t:

[ T h e c a p i t a l o f t h e c o u n t r y c o n s is t s] f o u r t h l y o f a c q u i r e d a n d u s e f u l a b i li t ie s o fa ll t h e i n h a b i t a n t s o r m e m b e r s o f t h e s o c i e ty . T h e a c q u i s i t io n o f s u c h t a le n t s,b y t h e m a i n t e n a n c e o f t h e a c q u i r e r d u r i n g h i s e d u c a t i o n , s t u d y o r a p p r e n t i c e -s h i p a l w a y s c o s t s a r e a l e x p e n s e , w h i c h i s a c a p i t a l f i x e d a n d r e a l i z e d , a s i tw e r e , i n h i s p e r s o n . T h o s e t a l e n t s , a s t h e y m a k e a p a r t o f t h i s f o r t u n e , s o d ot h e y l i k e w i s e o f t h a t o f t h e s o c i e t y t o w h i c h h e b e l o n g s [ S m i t h ( 1 7 7 6 , p p .2 6 5 - 2 6 6 ) ] .

T h e d u t y o f t h e g o v e r n m e n t to d o w h a t e v e r w a s n e e d e d t o im p r o v e t h e e c o n o m yw a s n o t c h a l l e n g e d ; t h i s , a f t e r a l l , w a s i m p l i e d i n t w o c e n t u r i e s o f a r g u m e n ta b o u t f o r e i g n t r a d e . W e l o o k f o r a t h e o r y o f s h a d o w p r i c e s , b u t t h i s w a s s t i l l ac e n t u r y a h e a d . M o n o p o l y w a s d e n o u n c e d n o t s o m u c h f o r re a s o n s o f a ll o ca t io n ,a s b e c a u s e i t w a s s e e n a s a n o b s t a c l e t o t h e d i v is i o n o f l a b o r a n d a l so a n u n j u s tt a x u p o n t h e p u b l i c .

F i n a l l y , a n o t e o n p u b l i c f i n a n c e . O u r e c o n o m i s t s c r e a t e d t h e m o l d w i t h i nw h i c h t h is s u b j e c t w o u l d l iv e fo r t h e n e x t h u n d r e d a n d f if ty y e a r s. T h e r e w a s n ot h e o r y o f p u b l i c e x p e n d i t u r e ; t h e e m p h a s i s w a s r a t h e r o n t h e t h e o r y o f t h ei n c i d e n c e o f d i f f e r e n t k i n d s o f t a x e s .

5 . C o n c l u s i o nW e s e t o u t t o s ee h o w m u c h o f m o d e r n d e v e l o p m e n t th e o r y w a s a l re a d y a v a i la b l ei n t h e y e a r 1 7 76 . B y d e v e l o p m e n t t h e o r y I m e a n t h o s e p a r ts o f e c o n o m i c s t h a tp l a y c r u c i a l r o l e s w h e n o n e t r i e s t o a n a l y z e t h e g r o w t h o f t h e e c o n o m y a s aw h o l e . T h e r e w a s q u i t e a g o o d b e g in n i n g , t h a t g a v e u s t h e c o n s t r a in t s i m p o s e d o ng r o w t h b y t h e a g r i c u l t u r a l s u r p l u s , o r f o r e i g n e x c h a n g e , o r s a v i n g . A l s o w e h a dS a y ' s L a w , t h e " Q u a n t i t y T h e o r y o f M o n e y " , in f la ti on , c o n ti n u a l u n e m p l o y m e n t ,e n t r e p r e n e u r s h i p a s a s e p a r a t e f a c to r o f p r o d u c t i o n , t h e t h e o r y o f b a n k c r e d i t,h u m a n c a p i t a l , a n d t h e i n c i d e n c e o f t a x e s . J u s t a h e a d o f u s i n t h e f i r s t h a l f o f t h en i n e t e e n t h c e n t u r y w o u l d c o m e t he la w o f d i m i n i s h in g r e t u r n s , t h e l a w o fc o m p a r a t i v e c o s t , p o p u l a t i o n t h e o r y , a n d t h e t h e o r y o f l a n d t e n u r e . A f t e r t h a t ,i n t e r e s t i n d e v e l o p m e n t t h e o r y w o u l d a l m o s t d i e o u t u n t i l t h e th e o r e t i c al e x p l o -s i o n o f t h e 1 9 5 0 s a n d a f t e r .

F i n a l l y , e c o n o m i c s m a y c h a n g e , b u t n o t e c o n o m i s ts . L e t u s g iv e th e l a st w o r dt o A d a m S m i t h :

T h e a n n u a l p r o d u c e o f t h e l a n d a n d l a b o r o f E n g l a n d , f o r e x a m p l e , is c e r t a i n lym u c h g r e a t e r t h a n i t w a s , a l i t t l e m o r e t h a n a c e n t u r y a g o a t t h e r e s t o r a t i o n o fC h a r l e s I I . T h o u g h a t p r e s e n t , f e w p e o p l e , I b e l ie v e , d o u b t o f t h is , y e t d u r i n gt h is p e r i o d f iv e y e a r s h a v e s e l d o m p a s s e d a w a y i n w h i c h s o m e b o o k o r


11/11

Ch. 2 : Th e Roots o f Development Theory 37p a m p h l e t h a s n o t b e e n p u b l i s h e d , w r i t t e n t o o w i t h s u c h a b i l i t i e s a s t o g a i ns o m e a u t h o r i t y w i t h t h e p u b l i c , a n d p r e t e n d i n g t o d e m o n s t r a t e t h a t t h e w e a l t ho f t h e n a t i o n w a s f a s t d e c li n in g , t h a t th e c o u n t r y w a s d e p o p u l a t e d , a g r i cu l tu r en e g l e c t e d , m a n u f a c t u r e r s d e c a y i n g , a n d t r a d e u n d o n e . N o r h a v e t h e s e p u b l i c a -t i o n s b e e n a l l p a r t y p a m p h l e t s , t h e w r e t c h e d o f f s p r i n g o f f a l s e h o o d a n dv e n a l i t y . M a n y o f t h e m h a v e b e e n w r i t t e n b y v e r y c a n d i d a n d v e r y i n t e l l i g e n tp e o p l e ; w h o w r o t e n o t h i n g b u t w h a t t h e y b e li e v ed , a n d f o r n o o t h e r r e a s o n b u tbecause they be l i eved i t [Smi th (1776 , p . 327 ) ] .

R e f e r e n c e sC a n t i l l on , R i c ha rd (1755) Essa i su r la n a tu re d u co mmerce en g en era l . London: F le tcher Gyles .Hume , Da v i d (1748) E s s a y s m o r a l a n d p o l i t ic a l (edi ted by Eugene Rotwein; London: Ne lson, 1955) .Johnson, E.A.J . (1937) Predecessors o f Ad a m S m i th . New York: Prent ice Ha l l , Inc .Linder t , P .H. (1969) K e y cu rrenc ies a n d g o ld , 1 9 0 0 -1 9 1 3 , Prince ton S tudies in In te rna t iona l F inance ,no. 24, Princeton Universi ty.Locke, J . (1691) So m e consideration o f the consequences o f lowering the ra te o f in terest. Reprin ted in :M. Crans ton, ed . , Lo ck e on poli t ics , rel ig ion , an d education . New York: Col l ie r Books , 1965.Smi th , Adam (1776) Th e w ea l th o f n a t io n s ( e d i t e d by Edwi n C a nna n ; Ne w York : The Mode rnLibrary, 1937).S teuar t , James (1767) En q u iry in to th e p r in c ip les o f p o l i t i ca l eco n o my (edited by Andrew S. Skinner;Lo ndo n: Ol ive r & Boyd, 1966).Wal lace , Rober t (1753) , A d issertat io n o n th e n u mb ers o f ma n k in d in a n c ien t a n d m o d ern t ime s .Edi nburgh : Ha m i l t on & B al fou r.West , S i r Edward (1815) Essay on the applica tion o f capita l to land. Reprin ted as : S i r E d w a r d W e s t onth e a p p l ica t io n o f ca p i ta l to la n d 1 8 1 5 . Balt imore: The Lord Balt imore Press, 1903.

chapter 2 the roots of development theory

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