Great development economists remind us that we can oversimplify.
Listener: 22 April, 2006.

Keywords: Growth & Innovation; History of Ideas, Methodology & Philosophy;

West Indian Arthur Lewis (1915-91) shared the 1979 Nobel Memorial Prize in Economic Sciences for his work in development economics. His “Lewis” model divided the economy into two sectors – (subsistence) farming and (capitalist) manufacturing. Labour shifting from the first to the second presents a very powerful growth process. I am using his model in my Marsden study on the globalisation of nations (particularly to explain Chinese economic growth). He was also an early advocate of the importance of infrastructure and education in development – views that are today’s conventional wisdom.

Famously, Lewis described economic development as turning a “five percent [of income] saver into a 15 percent saver”. If a country is a low net saver, it has only enough to replace worn-out capital and meet the needs of a growing population. More savings can be invested in more capital per worker, generating higher productivity.

Although he was never awarded the Nobel Prize, German-Jewish refugee Hans Singer (1911-2006), who died last month, made parallel contributions. With Raoul Prebisch (1901-86), he is best known for the thesis that there has been a long-running tendency for food export prices to fall relative to manufacturing prices. My study found this true in the 20th century, but suggests that it may not be true in the 21st.

I most recall Singer, a kindly, courteous man, for his insight that development was turning an 80 percent farmer into a 15 percent farmer. As economic development progresses, the economy’s proportion of farmers diminishes as the manufacturing and service sectors expand. However, and in this respect Singer differed from some of his contemporaries, it is not just a matter of promoting the manufacturing sector. Raising farm productivity is crucial, for the fewer farmers still have to feed everyone.

Both economists were primarily concerned with poor economies, but they also offer critical lessons for rich countries. Economic development is not just about there being more of everything. It is also about the changing balance among sectors.

It is a lesson easily overlooked. There are good political reasons to do so. No sector nor business wants to be told that it is going to grow slower than average. But the lesson’s logic is that, despite the hardship to those involved, some businesses are going to be closed down because their products can be better sourced offshore, with the released resources shifted to where they will be more productive.

Treating the economy as merely GDP can be dangerous. An economy’s output can be thought of as a basket of produced goods and services. It is not just a matter of the basket getting bigger; the composition of the basket also changes. A basket with a fixed composition of product is equivalent to a single-commodity economy.

English economist Joan Robinson (1903-83), who missed out on the Nobel Prize because of politics, although thrice worthy of it, invented the notion of “leets” (the reverse of steel), a general sort of product that can do everything. You eat them, wear them, live in them, travel in them and even use them for health and entertainment. We treat GDP as if it is a basket of leets. Although a single-commodity economy is not very plausible, you would be surprised how often the economy is treated as if it produced only leets. Important economic issues get lost.

For instance, insofar as the Singer-Prebisch thesis is true, it explains many of the difficulties that we, and other rich food producers, have faced. But the argument is unintelligible if we treat both food and manufactures as leets. Another example is that too much of our monetary policy thinking has been based on leets, so that one price index (the consumer-price index) is used to summarise all the complexities of the inflationary process. That leads to ignoring the exchange rate, which, in a single-commodity theory, is unintelligible. What is the point of exporting and importing the same leets? Hence the reluctance of leets-driven economists to think about the external sector.

In order to attain some rigour, we have to simplify. But as British-Hungarian economist Tommy Balogh (1905-85) said, “Rigour can go to the point of rigor mortis.” The great economists of the past were rigorous, but they never forgot the complexity of economies.