In the growth models of the preceding chapter, we assumed that factor markets function perfectly. Although such an assumption may be reasonable in developed economies, it is rather questionable in developing countries. Dualistic models have been a prominent feature of the development literature for some time (Lewis 1954; Fei and Ranis 1964). Although the concept of unlimited supplies of labor is no longer as popular as it was fifteen to twenty-five years ago (e.g., Kelley et al. 1972), the notion of an industrial wage set by institutional forces at a level above the agricultural wage is still widely accepted (e.g., Little et al. 1970, pp. 80–99, 335–6; Healey 1972; International Labour Office 1973; Morawetz 1974). The present chapter will use this assumption to construct a model of economic growth and capital utilization.

The model to be presented in this chapter is a model of the industrial sector. Formally, it differs from that of Chapter 10 only in that the wage rate is fixed, but the present model should be viewed as a component of a larger model containing at least two sectors, rather than as a model of the entire economy. The implications of the fact that there are other sectors in the economy will be mentioned at various points in the discussion.

Just as in Chapter 10, we shall distinguish between the static effects and the growth effects of an increase in utilization.