The Banking Executive Magazine - December Issue 2022

Regime Change in the Global Economy ISSUE 168 DECEMBER 2022 the BANKING EXECUTIVE 9 The basic idea that Lewis empha- sized is that developing countries ini- tially grow by expanding their export sectors, which absorb the surplus labor in traditional sectors like agri- culture. As incomes and purchasing power rise, domestic sectors expand along with the tradable sectors. Pro- ductivity and incomes in the largely urban, labor-intensive manufacturing sectors tend to be 3-4 times higher than in the traditional sectors, so av- erage 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 ex- port sector will remain depressed as long as there is surplus labor else- where. Because labor availability is not a constraint, the key factor with respect to growth is the level of capital in- vestment, which is needed even in labor-intensive sectors. The returns on such investment depend on com- petitive conditions in the global economy. These dynamics can produce star- tlingly high growth rates that some- times continue for years, even decades. But there is a limit: when the supply of surplus labor is ex- hausted, the economy reaches the so-called Lewis turning point. Typi- cally, this will happen before a coun- try has climbed out of the lower-middle-income range. China, for example, reached its Lewis turn- ing point 10-15 years ago, which brought about a major shift in the country’s growth dynamics. At the Lewis turning point, the op- portunity cost of shifting more labor from traditional to modernizing sec- tors is no longer negligible. Wages start to increase across the whole economy, which means that if growth is to continue, it must be driven not by shifting labor from low- to higher-productivity sectors, but by productivity increases within sectors. Because this transition often fails, the Lewis turning point is when many developing economies fall into the middle-income trap. Lewis’s growth model is worth revis- iting because something similar is happening today. When the global economy started to open and be- come more integrated several decades ago, massive amounts of previously disconnected and inac- cessible labor and productive capac- ity in emerging economies shifted to the manufacturing and export sec- tors, producing dramatic results. Manufacturing activity relocated from developed countries, and emerging economies’ exports grew faster than the global economy. Owing to the sheer scale of relatively low-cost labor in emerging economies (especially China), wage