Development, Growth, and Structural Change

1. Development, Growth, and Structural Change Lecture 2: Rediscovering Structural Change National Graduate Institute For Policy Studies IDTP Fall 2013 John Page

2. What is structural change? • An idea as old as the study of economic development • Kuznets, Chenery • “Observational Economics”: the search for empirical regularities or “stylized facts” • Grounded in theory, but not a “theory of growth” (Lewis) • Structural Change • A set of changes in economic structure that accompany (and may be required to sustain) continued increases in income per capita

3. What is structural change? • What do we mean by economic structure? • The structure of production (sectors) • The structure of employment (sectors, skills) • The structure of demand (consumption, investment) • The structure of international trade • A key insight: all of these change as incomes rise • (Is that the same as saying as development takes place?)

4. Rediscovering Structural Change • Academic interest in structural change waned in the 1980s • Cross country regressions consigned it to the “residual” • The result for public policy was a focus on “whole economy” drivers of growth such as openness, institutions, governance, etc. • These prescriptions proved to be of little practical relevance to public policy

5. How Do We Measure Structural Change? • Cross-country data • International Income and Price comparisons • Econometric specification (and issues) lnX = γ1 + γ2lnY + γ3 (lnY)2 + γ4 lnN + γ5 (lnN)2 + γ6F where X is the dependent variable, usually taken as a ratio to GDP Y is the income level measured as GNP per capita N is the country’s population F is the net resource inflow, measured as imports minus exports of goods and nonfactor services as a share of total GDP.

6. Stylized Facts:The structure of output and employmentOutput shares Employment shares

7. Stylized Facts:Patterns of AccumulationThe birthplace of the “two-gap” Aid model.Internal balance External balance

8. Stylized Facts:Savings and Income

9. Stylized Facts:The Structure of TradeCountry size and resource endowments matter.

10. Stylized Facts:The Structure of Trade(A picture to warm UNIDOs heart)

11. The Top Ten “Stylized Facts” • Stylized Fact 1: Sectoral Shares of GDP • As GDP per capita rises, the share of agriculture in GDP falls and the shares of industry, manufacturing, and services to GDP rise. • Stylized Fact 2: Total and Private Investment • The share of gross domestic investment in GDP, domestic fixed investment in GDP and fixed private investment in GDP increases as GDP per capita rises. • Stylized Fact 3: Savings, Total and Private Consumption • The savings ratio is higher, the higher the level of GDP per capita. The shares of total and private consumption in GDP fall as GDP per capita rises. • Stylized Fact 4: Government Expenditures and Government Revenues • The share of government expenditures and the share of government revenues are generally higher for countries with high levels of GDP per capita than for countries with low levels of GDP per capita. • Stylized Fact 5: Current Account, Capital Account, and Trade Intensity • As GDP per capita rises, current account deficits and capital account surpluses decrease while trade intensity (openness) increases.

12. The Top Ten “Stylized Facts” • Stylized Fact 6: Total and Merchandise Exports • The shares of total exports and merchandise exports in GDP increase as GDP per capita rises. • Stylized Fact 7: Composition of Exports • As GDP per capita rises, the share of machinery exports in GDP as well as in total exports increases and the share of primary exports in total exports decreases. • Stylized Fact 8: Export Product Concentration • A country’s export product concentration is higher, the poorer the country is. • Stylized Fact 9: Export Market Power • A country’s market power in world exports is higher, the higher its GDP per capita. • Stylized Fact 10: Financial Market Development • A strong positive relationship exists between GDP per capita and appropriately defined financial market development.

13. What Underpins the “Stylized Facts”? • Is this just measurement without theory? • No, it’s “informed data mining” • So what informs it? • Common elements from basic theory • Changes in consumer demand with changes in income (Engle’s law) • The need for accumulation to increase output (production function) • Access to similar technology • Access to international trade

14. What Underpins the “Stylized Facts”? • Why do observations vary? • Variations in economic policies (or social objectives) • Variations in resource endowments • Variations in country size • Variations in access to external capital • Changes in common factors over time • Are outliers useful? • You bet; they are part of the practicing development economist’s tool kit.

15. Patterns as a Diagnostic Tool

16. The Most Important “Stylized Fact” • A defining characteristic of low-income countries is large and persistent differences in labor productivity across sectors. • As resources shift from low productivity to high productivity sectors, the economy gets a “productivity boost”, raising per capita income. • But which way does causality run?

17. The Most Important “Stylized Fact”Relative Productivity of Labor by Sector

18. Why Does It Matter? • “Structuralists” (old and new) regard the differences in economic structure between advanced and poor economies as an important issue in thinking about development policy. • Structuralism has influenced: • Growth models (Lewis, two-sector) • Macro-management (inflation modeling) • Financial development (financial deepening) • And, last but not least: industrial policy

19. “Old” Structuralism:The Lewis Model • A closed economy with two sectors: • Traditional (often confused with agriculture) • Modern (often confused with industry) • What matters is the organization of production (and wage setting behavior) • What is it trying to explain? • How output per capita increases as a result of shifts of labor from the traditional to the modern sector • How a self-sustaining growth process is attained • What brings the early, rapid process to a halt

20. “Old” Structuralism:The Lewis Model • Two key assumptions: • Labor is available to the modern sector (over a considerable time) at a constant opportunity cost – “surplus labor” • “Capitalists” (owners of the modern sector) save and invest (it’ a closed economy so savings equal investment) ; “peasants” do not. • Why is it “structuralist”? • Structure determines the organization of production • Structure determines wage setting behavior in the traditional sector • Structure determines the opportunity cost of labor to the modern sector • Structure determines how savings (and investment) are allocated

21. The simple geometry of the Lewis Model

22. “Old” Structuralism:The Lewis Model • The Lewis Model is really old (1954)! • Surely it can’t still be relevant. • Think again. It (or variations on the theme) is still central to many development policy debates: • What is the role of agriculture in development? • How does “dualism” affect income distribution? • What are the causes and consequences of “urban bias” • What determines savings and investment behavior?

23. New Structuralism:Structural Change and Income Growth • The point of departure is the most important stylized fact: In countries at low levels of income productivity differences between sectors are large • Moving resources from low productivity to high productivity employment drives growth (and the reverse) • Public policy can influence structural change • But which public policies are effective? (Stay tuned!)

24. New Structuralism:Africa has the largest differences in productivity Differences in Labor Productivity Between Sectors Source: McMillan and Rodrik (2011); author’s calculations

25. New Structuralism:Going up the down escalator “Perverse” structural change slows productivity growth

26. New Structuralism:Structural Change and TFP • In developing countries different sectors have different levels and rates of change of TFP (reflected in differences in output per worker) • Economy-wide TFP is the weighted average of the individual sector’s TFP levels (and rates of change). • What if it were possible to use public policy to encourage the growth of sectors with high TFP or more rapid TFP growth rates? • But which public policies are effective? (Stay tuned!)

27. New Structuralism:Persistent differences across sectors in TFP