Business Cycle during Structural Change: Arthur Lewis’ Theory from a Neoclassical Perspective

Abstract We document that business cycle dynamics change systematically over the course of development. In countries with large but shrinking agricultural sectors, aggregate employment is uncorrelated with GDP, and agricultural employment falls during booms, even as agricultural labour productivity rises. We develop a unified theory of business cycles and structural change that captures these patterns. The theory emphasises the simultaneous decline and modernisation of agriculture, driven by capital accumulation. As agriculture becomes increasingly capital-intensive, traditional practices are crowded out. We estimate the model and show that it accounts for both structural transformation and business cycle fluctuations in China.