Schultz & Lewis (1979): Development Economics, Human Capital, and the Dual Economy

Why Are Some Countries Poor?

This is perhaps the most important question in economics. In 1979, the Nobel Prize went to two men who attacked it from complementary angles. Arthur Lewis, born in the small Caribbean island of Saint Lucia, built a model showing how poor agricultural economies transform into industrial ones — the mechanics of development. Theodore Schultz, an American agricultural economist, showed that the key to development isn’t machines or factories — it’s people. Invest in education, health, and skills, and even the poorest farmers become engines of growth.

Together, they founded modern development economics and changed how the world thinks about poverty.

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Lewis: The Dual-Sector Model

W. Arthur Lewis (1915–1991) published his landmark paper Economic Development with Unlimited Supplies of Labour in 1954. It became one of the most influential papers in economics.

Lewis observed that developing countries have a dual economy — two sectors that operate by completely different rules:

• The traditional sector (subsistence agriculture): Characterized by surplus labor — more workers than needed. The marginal product of labor is near zero. Removing a worker from the farm barely reduces output. Wages are at subsistence level
• The modern sector (industry, manufacturing): Operates on capitalist principles. Pays wages slightly above subsistence to attract workers from the countryside. Generates profits that can be reinvested

The engine of development:

1. Capitalists in the modern sector hire surplus workers from agriculture at low wages
2. Because labor is abundant, wages stay low and profits stay high
3. Capitalists reinvest profits, expanding the modern sector
4. More workers are absorbed from agriculture
5. This continues until the surplus labor is exhausted — the Lewis turning point
6. After the turning point, wages begin to rise across the entire economy

This model captured the experience of countries like Japan, South Korea, and later China — where massive migration from farms to factories powered decades of rapid industrialization. Lewis also analyzed the terms of trade between developing and developed countries, arguing that poor countries exporting primary commodities faced systematically declining terms of trade — a structural disadvantage in the global economy.

Lewis was the first Black person to receive a Nobel Prize in a category other than Peace — a fitting recognition for a scholar who devoted his life to understanding why the world’s poorest people remain poor.

Schultz: Poor People Are Rational — They Just Lack Investment

Theodore Schultz (1902–1998) challenged a deeply held prejudice: that farmers in developing countries are backward, tradition-bound, and resistant to change. Through careful empirical research, he proved the opposite.

His key insight in Transforming Traditional Agriculture (1964):

• Poor farmers are rational: They allocate their scarce resources efficiently given the technology and information available to them. They’re not inefficient — they’re operating at the frontier of what’s possible with traditional methods
• The problem isn’t motivation — it’s opportunity: What poor farmers lack isn’t rationality but access to better seeds, better techniques, education, and health care. Give them modern inputs and knowledge, and they respond quickly and effectively
• The Green Revolution proved him right: When high-yield crop varieties became available in India and other developing countries, farmers adopted them rapidly — exactly as Schultz predicted rational actors would

From this foundation, Schultz developed human capital theory — the idea that people are not just labor inputs but investments:

• Education is investment, not consumption: Spending on schooling yields returns just like spending on machinery — higher productivity, higher earnings, better decision-making
• Health is capital: A healthy worker is a more productive worker. Investments in nutrition, sanitation, and healthcare have enormous economic returns in developing countries
• Research and extension: Agricultural research and the systems that bring new knowledge to farmers are among the highest-return investments a developing country can make
• Entrepreneurial ability: The capacity to deal with disequilibria — to adapt, innovate, and reallocate resources when conditions change — is itself a form of human capital that education develops

Two Views, One Revolution

Lewis and Schultz approached development from different angles but reached complementary conclusions:

	Lewis	Schultz
Focus	Structural transformation	Human capital investment
Key mechanism	Labor transfer from agriculture to industry	Education, health, and technology for farmers
View of agriculture	Source of surplus labor for industry	A productive sector that responds to investment
View of the poor	Trapped in low-productivity subsistence	Rational agents lacking opportunities
Policy implication	Industrialize by absorbing surplus labor	Invest in people — education, health, research

Their 1979 Nobel Prize was awarded “for their pioneering research into economic development research with particular consideration of the problems of developing countries.”

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Explain It to a Child

Lewis said: imagine a farm with 10 workers but only enough work for 5. The extra 5 could move to a factory in the city, make things, earn money, and the farm would produce just as much as before. That’s how poor countries get richer — by moving people from where they’re not needed to where they are. Schultz said: wait — don’t forget the farmers who stay. If you teach them better farming, give them better seeds, and keep them healthy, they can grow twice as much food. The real secret to development isn’t just building factories — it’s investing in people.