Pakistan Institute of Development Economics



On Capital Allocation And The Real Cost Of Labour (Notes & Comments)

Author: F. E. Banks

This note is an extension of several contributions to the problem of resource allocation in a developing economy. In separate papers, I.M.D. Little and F. Seton* have introduced a model in which labour in a developing economy cannot be shifted from the subsistence to the industrial sector at zero opportunity cost, even though this labour displays zero marginal product in its ‘traditional’ occupations; and in what follows this problem will be attacked via a diagrammatic analysis. A short appendix will treat a side issue of the topic. As Little presented the model, there was an initial amount of capital K to be divided between two sectors, the I (industrial) sector, and the C (subsistence, traditional, or agricultural) sector. In the C-sector, there is excess labour or disguised unemployment, in the sense of Professor W. A. Lewis2, in that the marginal product of labour in this sector is taken as equal to zero. As it happens, however, this labour cannot be moved to the I-Sector without an increase in production in the C-sector. The reason for this is because as labour is transferred to the industrial sector, consumption per head increases in the C-sector, thus decreasing the surplus available for workers being transferred to the I-sector. The transfer can only be carried out if a surplus equal to the difference between the industrial wage in C-goods and the amount of C-goods ‘released’ by the C-sector is forthcoming, and for this an increased production of C-goods (via the input of capital into the C-sector) must take place. A similar situation would exist if transferring workers required a wage differential; or if C-goods had to be exported to obtain certain types of capital goods for the labour being reallocated, and/or housing, training, etc.

F. E. Banks

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