The role of industrialization in economic development: theory and evidence

1. The role of industrialization in economic development: theory and evidence Bineswaree Aruna Bolaky Africa Section Division for Africa, LDCs and special programmes United Nations Conference on Trade and Development UNCTAD

2. Outline of presentation • A – Conceptual definitions • B - The case for industrialization: Economic Arguments (based on Szirmai-UNU) • C - The case for industrialization: some econometric evidence • D - Challenges and opportunities from globalization • E-African initiatives on industrialization

3. A - Concepts 1. Concept of a production function and sources of economic growth Yit = Ait. F( Kit, Hit, Lit) i = country t =time Y= output over time= Gross National Product K= Stock of Capital;H= Human capital; L = Labour A = Total Factor Productivity TFP Growth rate of output over time is a function of • Rate of growth in capital stock =investment • Rate of growth in human capital • Rate of growth in labor • growth in total factor productivity (TFP) or technological change/technological progress • TFP = Solow Residual= portion of output not explained by the amount of inputs used in production • Endogenous (new growth theory) or exogenous (old growth theory)??

4. A - Concepts • Determinants of TFP: TFP is commonly identified with level of technology but actually incorporates a wider variety of factors such as internal organization of firms, level of worker effort, knowledge, ideas, R&D, technical efficiency, economic structure • Capital intensity (K/Y) and labor productivity (L/Y) depend in the long-run on TFP growth or technological change. Both embodied and disembodied. And vice versa • Technological change can be embodied in the quality of new capital goods =capital-embodied technical change • 2. TFP and concepts of efficiency Productive efficiency: Resources are allocated such that firms are producing at lowest possible costs, producing output by minimizing use of inputs, cannot produce more of one good without producing less of another Allocative efficiency: Resources are allocated to their best possible uses , producing right goods at the right prices for the right people

5. A - Concepts 3. Increasing returns to scale: a given proportional change in inputs leads to a more than proportional change in output. 4. Structural change: An economy’s structural transformation changes the composition of output and the contributions of each sector to GDP and employment over time.(UNECA) 5. Globalization: a. free movement of factors of production and goods and services; b. the integration of national economies into the international economy through trade, foreign direct investment, capital flows, migration, the spread of technology, and military presence (Bhagwati)

6. B-The case for industrialization: Theory/Economic Arguments • Industrial development is a driver of structural change which is key in the process of economic development Recent research suggests that economic development requires structural change from low to high productivity activities and that the industrial sector is a key engine of growth in the development process. Virtually all cases of high, rapid, and sustained economic growth in modern economic development have been associated with industrialisation, particularly growth in manufacturing production (Szirmai 2009). .

7. B-The case for industrialization: Theory/Economic Arguments

8. The Five Stages of Development:1. Traditional Society- Refers to a country that has yet to begin developing, where a high percentage of people are involved with agriculture and a high percentage of the country’s wealth is invested in activities such as the military and religion, seen as “nonproductive” by Rostow. 2. Transitional Stage- AKA the preconditions for takeoff. Under the model, the process of development begins when an elite group initiates innovations economic activities. Under the influence of these well-educated leaders, the country starts to invest in new technology and infrastructure, such as water supplies and transportation systems. These projects will ultimately stimulate an increase in productivity likely increasing the GDP. There is a limited production function, and therefore a limited output. There are limited economic techniques available and these restrictions create a limit to what can be produced. Increased specialization generates surpluses for trading. There is an emergence of a transport infrastructure to support trade. External trade also occurs concentrating on primary products.

9. 3. Takeoff- Rapid growth is generated in a limited number of economic activities, such as textiles or food products. These few, takeoff industries achieve technical advances and become productive, whereas other sectors of the economy remain dominated by traditional practices. After take-off, a country will take as long as fifty to one hundred years to reach maturity. Globally, this stage occurred during the Industrial Revolution. Industrialization increases, with workers switching from the agricultural sector to the manufacturing sector. The level of investment reaches over 10% of GNP. The growth is self-sustaining as investment leads to increasing incomes in turn generating more savings to finance further investment.4. Drive to maturity- Modern technology, previously confined to a few takeoff industries, diffuses to a wide variety of industries, which then experience rapid growth comparable to the takeoff industries. Workers become more skilled and specialized. The economy is diversifying into new areas the economy is producing a wide range of goods and services and there is less reliance on imports.5. High Mass Consumption- The economy shifts from production of heavy industry such as steel and energy, to consumer goods, such as motor vehicles and refrigerators. Of particular note is the fact that Rostow's "Age of High Mass Consumption" dovetails with (occurring before) Daniel Bell's hypothesized "Post-Industrial Society." The Bell and Rostovian models collectively suggest that economic maturation inevitably brings on job-growth which can be followed by wage escalation in the secondary economic sector (manufacturing), which is then followed by dramatic growth in the tertiary economic sector (commerce and services).

10. Dual Economy Model-Lewis (source Basu) • 2 sectors: a small industrialized economy and an agricultural sector. • The industrialized sector is typically located in a few urban pockets and operates ,more or less like any modern industrial economy (modern or urban sector), technologically advanced • Larger agricultural sector:primitive modes of production, vast majority of population is very poor-living at or near subsistence consumption (primitive, traditional, rural or subsistence sector); low wages, very low productivity close to zero • Workers in the industrial sector earn higher wages than those in rural sector, wage gap related to productivity gap • Assumption of duality an analytical convenience. While developed countries may have traits of dualism, the claim behind the dual economy literature is that such dualism is much sharper than LDCs

11. Dual Economy Model-Lewis • A closed economy with an industrial sector and a rural sector (or capitalist and subsistence sectors) and a fixed endowment of Labor L • In the rural sector, there is an unlimited labor supply at the subsistence wage: excess supply is sufficiently large so that no employer –incumbent or prospective-has to worry when considering employment expansion about having to bid up wages or about getting rationed in the labor market • If the capitalist sector wishes to draw on this unlimited supply of labor, it has to do so by offering a higher wage w which is a mark-up on the rural subsistence wage m • Only modern sector capitalists, who are profit maximizers, and are wage and price takers save on their profits and use their savings to invest to raise the productivity of labor in the modern sector, demand for labor in the modern sector rises absorbing the surplus labor from the rural sector and over time w rises causing at a certain point m also to rise • Turning point, wages in both the rural and modern sector get equated, rural-urban wage gap disappears and urban employment has grown

12. Replicated from Szirmai(2009): • There are powerful empirical and theoretical arguments in favour of industrialisation as the main engine of growth in economic development. The arguments can be summarised as follows: 1. There is an empirical correlation between the degree of industrialisation and per capita income in developing countries. 2. Productivity is higher in the industrial sector than in the agricultural sector. The transfer of resources from agriculture to manufacturing provides a structural change bonus. 3. The transfer of resources from manufacturing to services provides a structural change burden in the form of Baumol’s disease. As the share of the service sector increases, aggregate per capita growth will tend to slow down. 4. Compared to agriculture, the manufacturing sector offers special opportunities for capital accumulation in developing countries. Capital accumulation can be more easily realised in spatially concentrated manufacturing than in spatially dispersed agriculture. This is one of the reasons why the emergence of manufacturing has been so important in growth and development. Capital intensity is high in mining, manufacturing, utilities and transport. It is much lower in agriculture and services. Capital accumulation is one of the aggregate sources of growth. Thus, an increasing share of manufacturing will contribute to aggregate growth.

13. Replicated from Szirmai(2009): 5. The manufacturing sector offers special opportunities for economies of scale, which are less available in agriculture or services. 6. The manufacturing sector offers special opportunities for both embodied and disembodied technological progress (Cornwall, 1977). Technological advance is concentrated in the manufacturing sector and diffuses from there to other economic sectors such as the service sector. 7. Linkage and spill-over effects are stronger in manufacturing than in agriculture or mining. Linkage effects refer to the direct backward and forward linkages between different sectors. Linkage effects create positive externalities to investments in given sectors. Spill-over effects refer to the disembodied knowledge flows between sectors. Spill-over effects are a special case of externalities which to refer to externalities of investment in knowledge and technology. Linkage and spill-over effects are presumed to be stronger within manufacturing than within other sectors. Linkage and spill-over effects between manufacturing and other sectors such as services or agriculture are also very powerful.

14. Replicated from Szirmai(2009): 8. As per capita incomes rise, the share of agricultural expenditures in total expenditures declines and the share of expenditures on manufactured goods increases (Engel’s law). Countries specialising in agricultural and primary production will not profit from expanding world markets for manufacturing goods.

15. 1. Correlation between industrialisation and economic growth • Focus on the share of manufacturing in the total commodity production (i.e. agriculture and industry, including mining, manufacturing, construction and utilities) rather than in total GDP. The share of manufacturing in commodities is set out against a country’s per capita gross national income in 2000. • Szirmai finds a significant positive correlation of 0.79 between the logarithm of income per capita and the share of manufacturing. • Major exceptions among the advanced economies are primary exporters such as Norway, Canada and Australia. • Among the developing countries, Taiwan, Thailand and Brazil rank higher in terms of industrialisation than in terms of income. Nevertheless, the table illustrates the general point about industrialisation. The poorest countries in the table are invariably those with the lowest shares of manufacturing (and the highest shares of agriculture). The more prosperous countries are the more industrialised ones.

18. 2. The Structural Change Bonus-static shift and dynamic shift • A transfer of labour from low productivity agriculture to high productivity industry results in an immediate increase in overall productivity and income per capita. This transfer has been a major source of growth in developing countries. It is referred to as the structural change bonus (Positive static effect). • Szirmai analyses data on value added per worker for a selected number of developing countries for which data are available for longer periods. Immediately clear that value added per worker is much higher in manufacturing than in agriculture. Table 5 Dynamic shift effect • If productivity growth in manufacturing is more rapid than in other sectors, a transfer of resources to this sector will result in more rapid aggregate growth (This is referred to as the dynamic shift effect). Here the evidence is more mixed. In the richest countries of the world growth of labour productivity in agriculture in the post-war period has been higher than in industry - particularly due to biotechnological innovation. However, in developing countries since 1950, productivity growth in manufacturing has been more rapid than in the primary sector.

19. 2. The Structural Change Bonus-static shift and dynamic shift Table 6 • Between 1950 and 1973, the growth rate of labour productivity in manufacturing is substantially higher than in agriculture and also higher than that in the total economy. This is even more pronounced if we look at growth of output (8.6% versus 3.9%). Manufacturing is clearly a very dynamic sector contributing to overall growth performance. In ten of the fourteen developing countries, productivity growth in manufacturing is higher than in agriculture. In the case of value added, all countries show higher growth in manufacturing • After 1973, the picture becomes more complicated.

20. 2. The Structural Change Bonus-static shift and dynamic shift • Summarising the information in both tables, we can say that in developing countries manufacturing is indeed one of the more dynamic sectors in terms of productivity and output growth, especially in the period 1950-73. In the period 1973-2003, productivity growth in agriculture surpasses that of manufacturing, but manufacturing still dominates in terms of output growth.

21. 3. Structural change burden-Baumol’s disease • In many service sectors, the possibilities for productivity growth are limited due to the inherently labour intensive nature of service production. This implies that an increasing share of services results in a productivity slowdown (Baumol’s law). Such service sectors include personal services, restaurants and hotels, health care and medical services and government. • Baumol’s law has recently come under fire, because there are some very important market service sectors such as the financial sector and sales and distribution where there are major productivity improvements, based on ICT technologies • The working hypothesis is that a country with a large service sector will tend to grow slower than a country with a smaller service sector. As advanced economies are predominantly service economies, this creates new possibilities for catch up in developing countries where the industrial and the manufacturing sector have a proportionately larger share in output.

22. 4. Capital Accumulation • Reasons for high and rapid labour productivity growth in manufacturing: capital accumulation, economies of scale and technological progress. • Spatially concentrated activities such as manufacturing offer better possibilities for capital accumulation and capital intensification than spatially dispersed agriculture. The most capital intensive sectors in the economy are manufacturing, mining, construction and utilities. SEE TABLE 8 • In developing countries capital intensity in manufacturing is much higher than in agriculture (as expected). The same is true for mining and utilities. The shift from agriculture to manufacturing is important in the process of aggregate capital accumulation • In the advanced economies capital intensity the roles of agriculture and manufacturing have been reversed. Capital intensity in the small sector of agriculture is much higher than in manufacturing. This has to do with the ‘industrialisation of agriculture’. In the advanced economies the share of agricultural labour and value added has declined enormously, but agriculture has become much more productive due to the application of very capital intensive technologies

23. 4. Capital Accumulation • In economic growth accounting studies, the contribution of growth of physical capital to growth of output in post-war advanced economies turns out to be less important than previously thought. Other factors such as growth of employment, growth of human capital and disembodied technological change are very important as well. • However, for developing countries, physical capital accumulation still seems to be of great importance, because they start with so much less capital per worker

24. 5. Opportunities for scale economies • Economies of scale: Average costs of production fall as output increases. • Historically the industrial sector (including mining, manufacturing, construction and utilities) profited in particular from economies of scale, compared to service sectors and agriculture. This is partly due to the nature of technologies which are most productively applied in large scale production • It also has to do with learning by doing. Expansion of production expands the scope for learning. Thus, the rate of growth of productivity in manufacturing depends positively on the rate of growth of output (Verdoorn, 1949; Kaldor,1966) • Learning by doing: Each new input is used more effectively than the old ones, holding capital stock and technology constant

25. 5. Opportunities for scale economies • With the rise of ICT technologies this has may have changed from the 1990s onwards. In certain service sectors, scale effects have become overwhelmingly important, as the marginal costs of providing an additional unit of service have come close to zero. The question is justified whether the role of manufacturing in future growth may become less important than in the past sixty years. The service sector might become the new engine of growth. It is too early to say whether this is indeed the case

26. 6. Technological Change • The manufacturing sector offers special opportunities for both embodied and disembodied technological progress. • Rapid capital accumulation is associated with embodied technological progress, as new generations of capital goods embody the latest state of the art of technology. • Disembodied technological progress refers to changes in the knowledge of product and process technologies in firms and in the economy as a whole. • Since, the industrial revolution, technological advance has been concentrated in the manufacturing sector and diffuses from there to other economic sectors such as the service sector. Cornwall (1977) in particular has argued that manufacturing is the locus of technological progress

27. 6. Technological Change • Embodied Technological change: the shift over time from technologically less sophisticated to technologically more advanced capital goods • In the course of economic development, output per unit of input (total factor productivity) can increase due to various factors, among which shifts from one economic sector to another, economies of scale and more efficient allocation of resources within sectors. One of the most important factors, which can cause increases in output per unit of input, is so-called disembodied technological change • Disembodied technological change refers to general advances in science, technology and the state of knowledge, changes in the stocks of knowledge available to firms, sectors or countries; improvements in the level of knowledge absorbed by employees and managers in educational institutions and on the job (Maddison, 1987, p. 662), learning by doing by workers and managers on the job, improvements in the collective technological capabilities of firms or the social capabilities of countries and finally positive external effects of investment in knowledge and new technologies, through spill-overs from firm to firm or from country to country.

28. 7. Linkages and Spillovers • Linkage effects refer to the direct backward and forward linkages between different sectors. Linkages are direct physical relations of inter-sectoral supply and demand. The positive external effect of linkages is that they can create economies of scale in the domestic economy. • Spillover effects refer to the disembodied knowledge and technology flows between economic actors and economic sectors. Actors learn from each other, so that investment in technological knowledge or increased efficiency in one firm has positive external effects in the economy as a whole. • Intersectoral backward and forward linkages in manufacturing are perceived to be much stronger than in mining or agriculture which are typically characterised by weak linkages (Hirschman, 1958, Cornwall, 1977; Myint, 1980). Investment in one branch of manufacturing can have strong positive external effects on other sectors. • Spillover effects between manufacturing and other sectors are also very powerful. The manufacturing sector is one of the primary sources of technological advance in the economy as a whole. It is here that most product and process technologies are developed. One of the important spillover effects in modern economies is that from the industrial sector to other sectors, such as the service sector. Thus, advances in ICT hardware technologies produced in the manufacturing sector (silicon chips, glass fibre cables) fuel technological change in the software producing and software using service sectors

29. 8. The Engel Law • The lower the per capita income of a country, the larger the proportion of that income will be spent on basic agricultural foodstuffs. This is the famous Engel law (Engel, 1857). As per capita incomes increase, the demand for agricultural products will decline and the demand for industrial products will tend to increase. • Economic development creates a mass market for industrial products. This creates dynamic opportunities for manufacturing. If a country remains in agriculture and fails to develop its domestic manufacturing industry, it will have to import increasing amounts of manufactured goods

30. Prebisch-Singer Hypothesis (1950) • The Prebisch-Singer hypothesis normally refers to the claim that the relative price of primary commodities in terms of manufactures shows a downward trend. Prebisch and Singer based this conclusion on a visual inspection of the net barter terms of trade—the relative price of exports to imports—of the United Kingdom from 1876 to 1947. The inverse of this was taken to be a proxy for the relative price of primary commodities to manufactures • Why? Singer for example argued that the demand for primary commodities showed relatively low income elasticity, so income growth tended to lower the relative demand for, and hence relative price of, primary commodities. • Moreover, he argued that technical progress in manufacturing tended to be raw-material saving (e.g., synthetics), thereby causing the demand for primary products to grow slower than for manufactures • Does PS still holds? Harvey et al (2010). Their data set comprises 25 commodities and provides a new historical perspective, spanning the seventeenth to the twenty-first centuries. Their estimation results show that eleven price series present a significant and downward trend over all or some fraction of the sample period. In the very long run, a secular, deteriorating trend is a relevant phenomenon for a significant proportion of primary commodities. • But Kaplinsky (2006): In the short-run, that is from the 1990s for the case of manufactures and from around 1999 for the case of commodities, there has been an observed change in historic price trends for both commodities and manufactures.IMPACT OF CHINA AND INDIA???

31. C- Some Econometric Evidence • Szirmai (2009): In the more recent literature one finds, that manufacturing tends to be more important as an engine of growth in developing countries than in advanced economies and also more important in the period 1950-1973 than in the period after 1973.

32. C- Some Econometric Evidence • Fagerberg and Verspagen (1999):regress real growth rates on growth rates of manufacturing. If the coefficient of manufacturing growth is higher than the share of manufacturing in GDP, this is interpreted as supporting the engine of growth hypothesis. Fagerberg and Verspagen find that manufacturing was typically an engine of growth in developing countries in East Asia and Latin America, but that there was no significant effect of manufacturing in the advanced economies. • Fagersberg and Verspagen (2002):they examine the impact of shares of manufacturing and services in three periods: 1966-72, 1973-83 and 1984-95 for a sample of 76 countries. They find that manufacturing has much more positive contributions before 1973 than after. • The interpretation in both papers is that the period 1950- 1973 offered special opportunities for catch up through the absorption of mass production techniques in manufacturing from the USA. After 1973, ICT technologies started to become more important as a source of productivity growth, especially in the nineties. These technologies are no longer within the exclusive domain of manufacturing, but operate in the service sector

33. C-Some Econometric Evidence • Timmer and de Vries (2007): also confirms the increasing importance of the service sector. Using growth accounting techniques, they examine the contributions of different sectors in periods of growth accelerations, in periods of normal growth and in periods of deceleration. In periods of normal growth they find that manufacturing contributes most. In periods of acceleration, this leading role is taken over by the service sector, though manufacturing continues to have an important positive contribution • Tregenna (2008):Her study examines the linkages between the manufacturing and services sectors in South Africa, and between each of them and the rest of the domestic economy, based on analysis of input-output tables and employment trends. The study reveals that manufacturing is particularly important as a source of demand for the services sector as well as the rest of the economy through its strong backward linkages, which suggests that in this respect a decline in manufacturing could negatively affect future growth. Services are especially important in terms of employment creation, both direct and indirect.

34. C-Some Econometric Evidence Szirmai and Verspagen (2010): • Analyse a dataset of 90 countries, including 21 advanced economies and 69 developing countries, covering the period 1950- 2005. The focus of the analysis is on the ‘Engine of Growth Hypothesis’ which posits that manufacturing is the key sector in economic development. • 6 Hypotheses/research questions: • Is there a positive relationship between the value added share of manufacturing and growth of GDP per capita? Their hypothesis is that there is a positive relationship for the 90 countries in the period 1950-2005. • Is the relationship between the value added share of manufacturing and per capita GDP growth stronger than that between the value added share of services and growth of per capita GDP? Their hypothesis is that the relationship between manufacturing and growth is stronger than between services and growth. • Does the relationship between the share of manufacturing and growth of GDP per capita become weaker over time? Their working hypothesis is that the relationship between manufacturing and growth will be stronger in the period 1950-75 than in the period 1975-2005.

35. C-Some Econometric Evidence • Is there a positive relationship between the share of manufacturing and the rate of growth during growth accelerations? Their working hypothesis is that the impact of manufacturing on growth is stronger during growth accelerations. • Is the relationship between the share of manufacturing and growth during growth accelerations stronger or weaker than that between the share of services and growth? Their working hypothesis is that the coefficient of manufacturing share is higher than that of services in general and that the difference between the coefficients is greater in acceleration periods than in non-acceleration periods. • Are there systematic differences between the role of manufacturing in countries with different characteristics (e.g. level of GDP per capita, human capital and region)? Their working hypotheses/expectations are the following: a. the relationship between share of manufacturing and growth is weaker at higher levels of GDP per capita than at lower levels. (i.e. more advanced economies are less dependent on manufacturing for their growth) b. the relationship between the share manufacturing and growth will be stronger in countries with high levels of human capital.

36. Results • The results of the empirical analysis in their paper are in line with the engine of growth hypothesis. For the whole sample, the share of manufacturing is positively related to economic growth and this effect is more pronounced for the poorer countries. No such effects were found for services. These results are consistent with their first two hypotheses concerning the importance of manufacturing. • They distinguish across three periods 1950-1970, 1970-1990 and 1990-2005. Their expectation that the role of manufacturing becomes less important over time is not confirmed. The impact of manufacturing is more important in the middle period than in the early period and then becomes less important in the final period. With regard to services, they find significant effects in the first two periods and hardly any effects in the final period. This runs counter to predictions concerning the increasing importance of service-led growth. • They broke down their sample into four groups of countries: Asia, Latin America, Africa and advanced economies. There are interesting differences between country groups Effects of average shares of manufacturing on average rates of growth are important in Latin America, but not in the other groupings. Manufacturing continues to be important in the advanced economies, but its effect decreases as advanced countries come closer to US income levels, while the effects of services increase. For Africa, no significant relationships are found. • They find that the effects of manufacturing are particularly pronounced in periods of growth acceleration. The tentative conclusion is that manufacturing is especially important in periods of accelerated growth. Services also play a role in growth accelerations, but are less important than manufacturing.

37. C-Some Econometric Evidence McMillan and Rodrik (2011) Developing economies are characterized by large productivity gaps between different parts of the economy. Dual economy models à la W. Arthur Lewis have typically emphasized productivity differentials between broad sectors of the economy, such as the traditional (rural) and modern (urban) sectors. More recent research has identified significant differentials within modern, manufacturing activities as well. Large productivity gaps can exist even among firms and plants within the same industry. Whether between plants or across sectors, these gaps tend to be much larger in developing countries than in advanced economies. They are indicative of the allocative inefficiencies that reduce overall labor productivity. • The upside of these allocative inefficiencies is that they can potentially be an important engine of growth. When labor and other resources move from less productive to more productive activities, the economy grows even if there is no productivity growth within sectors. • This kind of growth-enhancing structural change can be an important contributor to overall economic growth. High-growth countries are typically those that have experienced substantial growth-enhancing structural change.

38. C-Some Econometric Evidence McMillan and Rodrik (2011) • Data base consists of sectoral and aggregate labor productivity statistics for 38 countries, covering the period 1990 up to 2005 -29 are developing countries (9 African countries) and 9 are high-income countries. • All developing countries in the sample have become more “globalized” during the time period under consideration. They have phased out remaining quantitative restrictions on imports, slashed tariffs, encouraged direct foreign investment and exports, and, in many cases, opened up to cross-border financial flows. • Labor productivity gaps between different sectors are typically very large in developing countries. This is particularly true for poor countries with mining enclaves, where few people tend to be employed at very high labor productivity. In Malawi, for example, labor productivity in mining is 136 times larger than that in agriculture! • The average manufactures-agriculture productivity ratio is 2.3 in Africa, 2.8 in Latin America, and 3.9 in Asia. • Inter-sectoral productivity gaps are clearly a feature of underdevelopment - The movement of labor from low-productivity to high-productivity activities raises economy-wide labor productivity.

39. C- Some Econometric Evidence McMillan and Rodrik (2011) 2 sources of labor productivity growth • First, productivity can grow within economic sectors through capital accumulation, technological change, or reduction of misallocation across plants (within component of productivity growth). • Second, labor can move across sectors, from low-productivity sectors to high-productivity sectors, increasing overall labor productivity in the economy (structural change). • Structural change has made very little contribution (positive or negative) to the overall growth in labor productivity in the high-income countries in their sample. • Structural change has played an important role in all three regions. But most striking of all is the differences among the regions. In both Latin America and Africa, structural change has made a sizable negative contribution to overall growth, while Asia is the only region where the contribution of structural change is positive.

40. C- Some Econometric Evidence • Examples Zambia and Nigeria • In both countries, the employment share of agriculture has increased significantly (alongside with community and government services in Nigeria). By contrast, manufacturing and relatively productive tradable services have experienced a contraction • The expansion of agricultural employment in Zambia is particularly large – more than 20 percentage points of total employment between 1990 and 2005, if the numbers are to be believed. These figures indicate a veritable exodus from the rest of the economy back to agriculture, where labor productivity is roughly half of what it is elsewhere. Thurlow and Wobst describe how the decline of formal employment in Zambian manufacturing during the 1990s as a result of import liberalization led to many low-skilled workers ending up in agriculture. • Ghana, Ethiopia and Malawi are three countries that have experienced growth-enhancing structural change. In all three cases, the share of employment in the agricultural sector has declined while the share of employment in the manufacturing sector has increased. However, labor productivity in manufacturing remains notably low in both Ghana and Ethiopia.

41. C- Some Econometric Evidence McMillan and Rodrik (2011) • Globalization has facilitated technology transfer and contributed to efficiencies in production. Yet the very diverse outcomes we observe among developing countries suggest that the consequences of globalization depend on the manner in which countries integrate into the global economy. • In several cases – most notably China, India, and some other Asian countries – globalization’s promise has been fulfilled. High-productivity employment opportunities have expanded and structural change has contributed to overall growth. But in many other cases – in Latin America and Sub-Saharan Africa – globalization appears not to have fostered the desirable kind of structural change. Labor has moved in the wrong direction, from more productive to less productive activities, including, most notably, informality. • Import competition has caused many industries to contract and release labor to less productive activities, such as agriculture and informality. One important difference among countries may be the degree to which they are able to manage such downsides.

42. C- Some Econometric Evidence McMillan and Rodrik (2011) • In their empirical work, they identify three factors that help determine whether (and the extent to which) structural change goes in the right direction and contributes to overall productivity growth. • First, economies with a revealed comparative advantage in primary products are at a disadvantage. The larger the share of natural resources in exports, the smaller the scope of productivity-enhancing structural change. The key here is that minerals and natural resources do not generate much employment, unlike manufacturing industries and related services. Even though these “enclave” sectors typically operate at very high productivity, they cannot absorb the surplus labor from agriculture. • Globalization promotes specialization according to comparative advantage. Here there is another potentially important difference among countries. Some countries – many in Latin America and Africa – are well-endowed with natural resources and primary products. In these economies, opening up to the world economy reduces incentives to diversify towards modern manufactures and reinforces traditional specialization patterns. Some primary sectors such as minerals do operate at very high levels of labor productivity. The problem with such activities, however, is that they have a very limited capacity to generate substantial employment. So in economies with a comparative advantage in natural resources, we expect the positive contribution of structural change associated with participation in international markets to be limited. Asian countries, most of which are well endowed with labor but not natural resources, have a natural advantage here.

43. C-Some Econometric Evidence • Second, they find that countries that maintain competitive or undervalued currencies tend to experience more growth-enhancing structural change. Undervaluation acts as a subsidy on those industries and facilitates their expansion. • Finally, they also find evidence that countries with more flexible labor markets experience greater growth-enhancing structural change. This also stands to reason, as rapid structural change is facilitated when labor can flow easily across firms and sectors. By contrast, they do not find that other institutional indicators, such as measures of corruption or the rule of law, play a significant role. • Countries that do well are those that start out with a lot of workers in agriculture but do not have a strong comparative advantage in primary products. That most Asian countries fit this characterization explains the Asian difference.

44. C-Some Econometric Evidence-Rodrik on structural change and globalization • “A key promise of globalization was that access to global markets and increased competition would drive an economy’s resources toward more productive uses and enhance allocative efficiency. It is certainly true that firms that are exposed to foreign competition have had no choice but to either become more productive or shut down. As trade barriers have come down, industries have rationalized, upgraded and become more efficient. But an economy’s overall productivity depends not only on what’s happening within industries, but also on the reallocation of resources across sectors. This is where globalization has produced a highly uneven result. Our empirical work shows that countries with a comparative advantage in natural resources run the risk of stunting their process of structural transformation. The risks are aggravated by policies that allow the currency to become overvalued and place large costs on firms when they hire or fire workers.” • “Structural change, like economic growth itself, is not an automatic process. It needs a nudge in the appropriate direction, especially when a country has a strong comparative advantage in natural resources. Globalization does not alter this underlying reality. But it does increase the costs of getting the policies wrong, just as it increases the benefits of getting them right.”

45. D- Challenges and Opportunitiesfrom globalization • Need for economic diversification Increased vulnerability to economic shocks Haddad et al (2009): trade openness reduces volatility when countries are well diversified -panel of 77 developing and developed economies over the period 1976-2005. • The effect of trade openness on growth volatility is positive on average, there is strong evidence pointing to the important role that export diversification plays in reducing the vulnerability of countries to global shocks. In addition, they find that product diversification clearly moderates the effect of trade openness on growth volatility, while the market diversification measures yield much more mixed results. • They were able to identify positive thresholds in terms of their product diversification indicators at which the effect of openness on volatility changes sign. • The relationship completely breaks down when they exclude low-income economies from the analysis, and this is irrespective of the diversification indicator employed This suggests that much of the action indeed lies with low- and middle-income economies, for which export diversification matters more in shielding their economies from external shocks. • One possible explanation for this outcome is that developed economies possess other means of insuring their economies against shocks, whereas developing countries depend more strongly on implicit insurance as represented by a more diversified export basket.

46. D- Challenges and Opportunitiesfrom globalization • Imbs and Wacziarg(2003)- characterizes the pattern of sectoral diversification along the development path. Using data on sector-level employment and value added, covering a wide cross section of countries at various levels of disaggregation, they provide new and robust evidence that economies grow through two stages of diversification. At first, sectoral diversification increases, but there exists a level of per capita income beyond which the sectoral distribution of economic activity starts concentrating again. In other words, sectoral concentration follows a U-shaped pattern in relation to per capita income. • The estimated turnaround point occurs quite late in the development process and at a surprisingly robust level of income per capita. Thus, increased sectoral specialization, although a significant development, applies only to high-income economies. Countries diversify over most of their development path • Portfolio motive v/s comparative advantage

47. D- Challenges and Opportunitiesfrom globalization • Important roles for agriculture and services Rattso and Torvik (2003) show that discrimination against the agriculture sector could lead to the contraction of industry, through trade linkages. De Janvry and Sadoulet (2010) stress the need for complementarity between agriculture and industry. They also argue that agricultural development can contribute to the creation of competitive advantage in industry. Furthermore, in the short-to-medium term the agriculture sector will continue to be an important source of foreign exchange required to import intermediate inputs needed by domestic industries. It is also important to recognize that the provision of producer services also matters for the competitiveness of the manufacturing sector. In this context, the challenge for policymakers is how to create mutually supportive linkages between the industrial and non-industrial sectors of the economy.

48. D- Challenges and Opportunitiesfrom globalization • Challenges and opportunities on how to indsutrtialize? Just 3 examples • (i) New multilateral trade rules are slowly shrinking the policy space available to African countries for promoting industrial development. For example, the rules of the World Trade Organization (WTO) prohibit the use of industrial policy instruments such as quotas and local content requirements. The use of export subsidies have also been banned, except for the Least Developed Countries. Furthermore, as a result of the Economic Partnership Agreements (EPAs) African countries are under increasing pressure to abandon the use of tariffs as a measure of protection. Consequently, African industrialisation will have to take place in an environment in which the use of some industrial policy instruments applied by the developed and emerging economies are either banned or regulated

49. D- Challenges and Opportunitiesfrom globalization • Just 3 examples (ii) The global environment in which manufacturing production takes place is changing in the sense that firms are increasingly facing stiff competition in global export markets due to the reduction in tariff and non-tariff barriers to trade in industrial products coupled with the significant decrease in transport costs and improvements in information and communication technology. For African countries, the new environment is challenging because of the rise and growing role of large developing countries such as China, India and Brazil in labour-intensive manufactures (Kaplinsky 2007). These new competitive pressures imply that an effective response to competition is no longer just about selling products at lower cost. It is also about producing better products and getting them to consumers in a timely manner.

50. D- Challenges and Opportunitiesfrom globalization • Just 3 examples (iii)Third, increasing concerns over climate change is forcing firms to adopt or switch to new technologies and methods of production. In particular, manufacturers are under increasing pressure to adopt climate-friendly technologies and methods of production. Consequently, if African industrialisation is to be sustainable it cannot rely on the old technologies and methods of production used by the developed countries when they were at a similar stage of development.