As countries develop, they follow a process of gradual absorption of both labor and capital into the “modern” economy. This model of development was described in Walter Rostow’s book The Stages of Development (1960), and the concept has influenced policy decisions since that time. Rostow’s five stages are outlined in the chart below.
The process is driven by the migration of labor from rural to urban locations, followed by the decline in fertility and family size. In Europe, it started in the late Medieval period (13th century) with the rise of city-states in Italy and the Netherlands, though serfdom persisted in Eastern Europe into the 19th century. The rise in urbanization allows for increased labor specialization and industrialization. Migration provides abundant labor which promotes investment and capital accumulation, until, eventually, as fertility declines wages rise, and consumption expands. The five stages are detailed below. It is important to stress that the stages are not clear cut either chronologically or geographically. For example, India’s current standing covers the first three stages; though the country is arguably on the verge of take-off, it has a large traditional rural population. Though China can be categorized as mature, one third of its population remains in a traditional rural condition. Brazil is also is a mature economy with a significant population of subsistence farmers.
Stage 1- Traditional Rural – Populations are rural and consist of subsistence farmers with minimal engagement in commerce. Much of sub-Saharan Africa, rural India and rural Indonesia are still at this stage today. At this stage, capital deployment and economic output are minimal.
Stage 2- Pre-take Off – Migration from farm to city provides cheap labor and initiates specialization and capital accumulation. The poor consume little, the rich consume luxury goods.
Stage 3- Take Off – The culmination of stage 2: super-abundant labor and rapid industrialization lead to high growth and capital accumulation and great fortunes (“robber barons”). This is the period of “economic miracles,” also called Golden Ages: England (1850-1870); United States (1870-1910); Argentina (1880-1900); Brazil (1950-1970); China (1980-2008), etc… Arguably, India is in this stage today, ruled by an alliance of robber barons and politicians.
Stage 4 – Maturity – Labor becomes scarcer, leading to pressure for higher wages and political conflict. Organized labor gains bargaining power, with the support of politicians. Wages rise, boosting consumption, but returns on capital decline: Western Europe (starting in the 1870s), the United States starting in 1900, Brazil in the 1970s, China starting in 2015 (despite Xi’s efforts to stifle dissent). Mercantilist countries (Germany, the Asian Tigers, including China) seek to repress labor by capturing foreign demand.
Sometime between Stage 4 and Stage 5, the Lewis Turning Point occurs. This concept describes the moment when excess rural labor is fully absorbed into the manufacturing sector, causing unskilled industrial wages to rise. Economists guesstimates for the turning point are: England (1890), France (1900), the U.S. (1910), Japan (1965), Brazil (1975), Korea (1975), Mexico (2000) and China (2015). India, Indonesia and Vietnam are expected to reach the Lewis turning point in the next 15 to 20 years.
Stage 5 – Mass Consumption – Most developed countries now have economies dominated by the consumer. These countries are at or near the technological frontier and have highly developed physical infrastructure and costly labor, conditions that result in the share of GDP coming from consumption dominating that revived from investment. Mercantilist countries like Germany and Japan reduce consumption to some degree by repressing wages, allowing them to capture through exports some of the consumption demand from countries like the U.S., France and Spain. East Asian “Tigers” have delayed the mass consumption stage by implementing mercantilist policies which enable them to capture foreign demand through exports. Latin American countries have badly managed the transition from maturity to mass consumption, and they find themselves in the “Middle-income Trap,” with low returns on investment and insufficient consumer demand from most of their citizens.
Below, a few graphic examples of the different stages are shown. The data measures the components of GDP (World Development Indicators, World Bank)
Senegal (Traditional Rural, entering Pre-Take Off): Senegal is a low-income country with a large part of the population engaged in low-tech farming. Household consumption has dominated the economy but is now declining quickly as investment is ramping up. The current account is negative, as the country imports capital to finance investment.
Indonesia (Take-off): Indonesia entered the Pre-Take Off stage in the late 1960s, as migrants left subsistence farming to settle in urban areas. Take-off occurred in the 1980s (briefly interrupted by the Asian financial crisis). Rising capital accumulation and investment have brought high GDP growth and caused a reduction in the consumption share of GDP. As Indonesia approaches the Lewis Turning Point in the 2030s, investment can be expected to start declining and consumption should rise.
India (Take-off): India entered the Pre-Take Off stage with economic reforms in the 1980s, leading to a long period of high GDP growth, rising investment contribution to GDP and declining consumption share of GDP. India is now in a typical Take-Off, with high capital accumulation and obscenely rich “robber barons” dominating the economy (like China in 2000). India should reach the Lewis Turning Point over the next 20 years, at which time returns on investment will decline and the economy will become driven more by consumption.
China (Maturity): China had its Pre-Take Off (with plenty of ups and downs) in the 1950s and 1960s. Take Off came with the economic reforms in 1980, resulting in very high GDP growth driven by investments and marked by enormous capital accumulation concentrated in few hands. The 1980-2005 “economic miracle” saw investments reach extremely high levels and plummeting of consumption’s share of GDP. The economy started losing steam in the 2000s because of high debt and declining returns on investments. China reached the Lewis Turning Point around 2015. It now has approached the technology frontier and faces rising labor costs and low returns on investment. In this Maturity stage, investment share of GDP should decline, and consumption contribution should rise, but China is finding it difficult to abandon its debt-fueled investment model because of entrenched political interests. This raises the possibility of a long period of low growth and a “Middle-Income Trap.”
Korea (Maturity): Korea had its Pre- Take Off and Take Off stages in rapid succession in the 1960s. A twenty-year “Economic Miracle” was marked by high levels of investment and capital accumulation and a plummeting of the consumption share of GDP. The country reached the Maturity Stage in the 2000s, and now operates largely at the technology frontier. Korea, like China, is finding it difficult to move to a more consumer-driven economy. The country has been able to pursue mercantilist policies to secure demand from abroad for its exporters, so that it can delay increasing domestic consumption.
