Bangladesh’s “Lewis Point”

Sir Arthur Lewis (1915-1991) proposed that at the early stage of economic development, developing countries like Bangladesh could grow for a sustained period without nominal wage pressure. However, as the economy develops, the supply of cheap labor could be constrained, leading to a sharper rise in nominal wage.

Another way of putting it: the labor supply curve for a developing country could be flat during the early stages of the development (such that increase in labor do not alter the wage levels). But over time, as the economy grows there comes a point at which the excess labors in rural areas are fully absorbed by nonfarm sector, initiating a rise in nominal wage. This ‘kink’ in the labor supply curve is called the ‘Lewis Point,’ or ‘Lewis Turning Point,’ named after Nobel-Prize winner Sir Arthur Lewis. Graphically the Lewis Point looks as follows:

Lewis Turning Point

According to a new research (paywall), Bangladesh is at the stage of development that fits the view of Lewis Point. A visual evidence that is consistent with the prediction of the Lewis’s model is shown below:


From the above Figure we can clearly see that the gap between the real rural and urban wages has narrowed, particularly since 2008. On top of this, the growth rate of rural real wages has outstripped that of urban real wages. This finding is complemented by similar evidence from the Bangladesh Household, Income, and Expenditure Survey (HIES) data, which is more representative of the population. The HIES results show that since 2005 real wages have improved dramatically. In particular, the real wage of female workers have grown faster than the real wage of male workers.

So what factors explain the rising real wages? Let’s first discuss the factors that do not (or didn’t play pivotal roles) explain this phenomenon. (1) Labor productivity (as would be expected by the predictions of neoclassical theory) alone does not explain the acceleration of wage growth in 2005-10. (2) Alternative theories–namely subsistence and nutrition-based efficiency wage theories–too cannot explain the rising wage trend. (3) Policy-induced factors such as the massive increase in the public spending on social safety net programs (e.g., 100-day employment generation program introduced in 2008-09) cannot explain the rising trend either. (4) The impact of microfinance institutions (MFIs) is at best a weak predictor of the long-term trend in real wage. To be sure, both the government safety nets and MFIs are important, but their contribution in explaining the real wage pattern is only a blip.

So what explains the convergence of rural and urban wages in recent years? In the words of the authors:

This is likely an outcome of the government’s strategies that capitalizes on the country’s comparative advantage in labor intensive technology. A prominent outcome of such a development strategy is the rapid expansion of ready-made garment industries, as well as associated linkages, during the past three of decades. Since the manufacturing sector offers better-paid jobs than the informal and agricultural sectors, expansion of the garment sector has helped more workers, including the ones that migrated from the rural area, improve their incomes and livelihoods (Zhang, Rashid, Ahmad, and Ahmed, 2014, p. 282).

Why this finding is relevant for Bangladesh? The most obvious explanation is ‘poverty alleviation.’ Higher wages help to climb out of poverty cheaply and efficiently. As a result, there will be fewer (certainly not in abundant supply) rural workers available for agriculture, which can be compensated with greater mechanization or higher productivity in the agricultural sector. From a macroeconomic perspective, ceteris paribus, Bangladesh’s passing through its Lewis Point should, in theory, lead to higher inflation.

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