Fei-Ranis Model of Economic Growth

Submitted by: Neetu Sachdeva Manmeet

 The FeiRanis model of economic growth is a

dualism model in Development economics or Welfare economics. It has been developed by John C.H Fei and Gustav Ranis. It can be understood as an extension of the Lewis model. It recognizes the presence of a dual economy comprising both the modern and the primitive sector and takes the economic situation of unemployment and underemployment of resources into account. According to this theory, the primitive sector consists of the existing agricultural sector in the economy, and the modern sector is the rapidly emerging but small industrial sector.

 Development can be brought about only by a

complete shift in the focal point of progress from the agricultural to the industrial economy, such that there is augmentation of industrial output. This is done by transfer of labor from the agricultural sector to the industrial one, showing that underdeveloped countries do not suffer from constraints of labor supply. At the same time, growth in the agricultural sector must not be negligible and its output should be sufficient to support the whole economy with food and raw materials. Fei-Ranis economic model can be classified as a classical model, as it uses the classical assumption of subsistence wages.

 of the FeiRanis Basics of the modelIn Phase 1 elasticity of the model, the

Depiction of Phase1, Phase2 and Phase3 of the dual economy model using average output.

agricultural labor work-force is infinite and as a result, suffers from disguised unemployment. Also, the marginal product of labor is zero. This phase is similar to the Lewis model. In Phase 2 of the model, the agricultural sector sees a rise in productivity and this leads to increased industrial growth such that a base for the next phase is prepared. In Phase 2, agricultural surplus may exist as the increasing average product (AP), higher than the marginal product (MP) and not equal to the subsistence level of wages.

 According to Fei and Ranis, AD amount

Depiction of Phase1, Phase2 and Phase3 of the dual economy model using average output.

of labor can be shifted from the agricultural sector without any fall in output. Hence, it represents surplus labor. Phase 2: AP> MP After AD, MP begins to rise, and industrial labor rises from zero to a value equal to AD. AP of agricultural labor is shown by BYZ and we see that this curve falls downward after AD. This fall in AP can be attributed to the fact that as agricultural laborers shift to the industrial sector, the real wage of industrial laborers decreases due to shortage of food supply, since less laborers are now working in the food sector. The decrease in the real wage level decreases the level of profits, and the

Depiction of Phase1, Phase2 and Phase3 of the dual economy model using average output.

This re-investment of surplus can be graphically visualized as the shifting of MP curve outwards. In Phase2 the level of disguised unemployment is given by AK. This allows the agricultural sector to give up a part of its labor-force until MP= Real wages=AB= Constant institutional wages (CIW) Phase 3 begins from the point of commercialization which is at K in the Figure. This is the point where the economy becomes completely commercialized in the absence of disguised unemployment. The supply curve of labor in Phase 3 is steeper and both the sectors start bidding equally for labor. Phase 3: MP> CIW

 The amount of labor that is shifted and the time that this

shifting takes depends upon: 1. The growth of surplus generated within the agricultural sector, and the growth of industrial capital stock dependent on the growth of industrial profits; 2. The nature of the industry's technical progress and its associated bias; 3. Growth rate of population. So, the three fundamental ideas used in this model are: 1. Agricultural growth and industrial growth are both equally important; 2. Agricultural growth and industrial growth are balanced; 3. Only if the rate at which labor is shifted from the agricultural to the industrial sector is greater than the rate of growth of population will the economy be able to lift

 This shifting of labor can take place by the landlords'

investment activities and by the government's fiscal measures. However, the cost of shifting labor in terms of both private and social cost may be high, for example transportation cost or the cost of carrying out construction of buildings. In addition to that, per capita agricultural consumption can increase, or there can exist a wide gap between the wages of the urban and the rural people. These three occurrences- high cost, high consumption and high gap in wages, are called as leakages, and leakages prevent the creation of agricultural surplus. In fact, surplus generation might be prevented due to a backward-sloping supply curve of labor as well, which happens when high income-levels are not consumed. This would mean that the productivity of laborers with rise in income will not rise. However, the case of backward-

Connectivity between sectors

Fei and Ranis emphasized strongly on the industry-agriculture

interdependency and said that a robust connectivity between the two would encourage and speedup development. If agricultural laborers look for industrial employment, and industrialists employ more workers by use of larger capital good stock and labor-intensive technology, this connectivity can work between the industrial and agricultural sector. Also, if the surplus owner invests in that section of industrial sector that is close to soil and is in known surroundings, he will most probably choose that productivity out of which future savings can be channelized. They took the example of Japan's dualistic economy in the 19th century and said that connectivity between the two sectors of Japan was heightened due the presence of a decentralized rural industry which was often linked to urban production. According to them, economic progress is achieved in dualistic economies of underdeveloped countries through the work of a small number of entrepreneurs who have access to land and decision-making powers and use industrial capital and

Agriculture Sector
In (A), land is measured on the

Land Labor production function

vertical axis, and labor on the horizontal axis. Ou and Ov represent two ridge lines, and the production contour lines are depicted by M, M1 and M2. The area enclosed by the ridge lines defines the region of factor substitutability, or the region where factors can easily be substituted. Let us understand the impact of this. If te amount of labor is the total labor in the agricultural sector, the intersection of the ridge line Ov with the production curve M1 at point s renders M1 perfectly horizontal below Ov. The horizontal behavior of the

 If Ot is the total land in the

Land Labor production function

agricultural sector, ts amount of labor can be employed without it becoming redundant, and es represents the redundant agricultural labor force. This led Fei and Ranis to develop the concept of Labor Utilization Ratio, which they define as the units of labor that can be productively employed (without redundancy) per unit of land. In the left-side figure, labor utilization ratio R= ts/Ot which is graphically equal to the inverted slope of the ridge line Ov.

 Fei and Ranis also built the

Land Labor production function

concept of endowment ratio, which is a measure of the relative availability of the two factors of production. In the figure, if Ot represents agricultural land and tE represents agricultural labor, then the endowment ratio is given by S=tE/Ot which is equal to the inverted slope of OE. The actual point of endowment is given by E. Finally, Fei and Ranis developed the concept of non-redundancy coefficient T which is measured by T=ts/te

 These three concepts helped them in formulating a

relationship between T, R and S. If T=ts/te, then T=(ts/Ot)/(te/Ot)=R/S, or T=R/S This mathematical relation proves that the nonredundancy coefficient is directly proportional to labor utilization ratio and is inversely proportional to the endowment ratio. Figure (B) displays the total physical productivity of labor (TPPL) curve. The curve increases at a decreasing rate, as more units of labor are added to a fixed amount of land. At point N, the curve shapes horizontally and this point N conforms to the point G in (C, which shows

Industrial Sector

Like in the agricultural sector, Fei

Capital-Labor Production Function

and Ranis assume constant returns to scale in the industrial sector. However, the main factors of production are capital and labor. In the graph (A) right hand side, the production functions have been plotted taking labor on the horizontal axis and capital on the vertical axis. The expansion path of the industrial sector is given by the line OAoA1A2. As capital increases from Ko to K1 to K2 and labor increases from Lo to L1 and L2, the industrial output represented by the production contour Ao, A1 and A3 increases accordingly. According to this model, the prime labor supply source of the

 PP2 represents the straight line

Capital-Labor Production Function

part of the curve and is a measure of the redundant agricultural labor force on a graph with industrial labor force on the horizontal axis and output/real wage on the vertical axis. Due to the redundant agricultural labor force, the real wages remain constant but once the curve starts sloping upwards from point P2, the upward sloping indicates that additional labor would be supplied only with a corresponding rise in the real wages level. MPPL curves corresponding to their respective capital and labor levels have been drawn as Mo, M1, M2 and M3. When capital stock rises from Ko to K1, the marginal physical productivity of labor rises from

 At this point, the total real wage

Capital-Labor Production Function

income is Wo and is represented by the shaded area POLoPo. is the equilibrium profit and is represented by the shaded area qPPo. Since the laborers have extremely low income-levels, they barely save from that income and hence industrial profits (o) become the prime source of investment funds in the industrial sector. Kt = Ko + So + o Here, Kt gives the total supply of investment funds (given that rural savings are represented by So) Total industrial activity rises due