Has Globalisation Caused Premature Deindustrialisation ?

1. Keynote Lecture, Westminster Development Symposium, 17 May 2019 Kunal Sen, Director of UNU-WIDER Has Globalisation Caused Premature Deindustrialisation?

2. Understanding Economic Development • Economists have long searched for patterns that relate successful economic development to structure and policy (Chenery 1989). • This comparative approach in development economics was initiated by Simon Kuznets and predicated on “the existence of common, transnational factors and a mechanism of interactions among nations that will produce some systematic order in the way modern economic growth can be expected to spread around the world (Kuznets, 1959, p. 170). • One of the most striking findings of this comparative approach to economic development was the “universal inverse association of income and the share of agriculture in income and employment” (Chenery 1989, p. 172). • One of the key features of modern economic growth was the movement of workers from agriculture to manufacturing and services (Kuznets 1966).

3. Structural Transformation and Economic Growth • The comparative approach identified the manufacturing sector as the engine of economic growth for most countries and the rate at which industrialisation occurred differentiated successful countries from unsuccessful ones (McMillan et al. 2014, Haraguchi et al. 2017). • The movement of workers from agriculture to manufacturing, and then to services is the path of structural transformation that has been witnessed in all the countries which comprise the high income club as well the successful growth experiences of East Asia. • This path of structural transformation has received a great deal of attention among economists, and underpins most of the theoretical understanding of structural transformation all the way from scholars in classical economics such as Kuznets, Lewis, Chenery and Syrquin to more modern approaches that are rooted in the neoclassical tradition (see Duarte and Restuccia 2010, Dabla-Norris et al. 2013, Herrendorf et al. 2014, McMillan et al. 2014, Diao et al. 2017).

4. An Alternate Path of Structural Transformation? • However, the “conventional” path of structural transformation may no longer be the route to economic development that we observe in low income countries. • We observe a different path of structural transformation where workers are moving directly from agriculture to nonbusiness services which as a sector does not have the same productivity gains that we observe in manufacturing. • This has been happening before these countries have had a proper experience of industrialisation.

5. What Do We Mean By Premature Deindustrialisation? • First, descriptively, in that many developing countries are undergoing deindustrialization much earlier than historical norms. • Second, premature in that deindustrialization may have detrimental effects on economic growth. • Why is industrialization important for economic growth? • Manufacturing is a technologically dynamic sector. • Formal manufacturing exhibits unconditional labour productivity convergence (Rodrik 2013) • Manufacturing is a tradable sector, most of services is not.

6. Premature Deindustrialisation, graphically (Rodrik 2016)

7. What Explains Premature Deindustrialisation? • Rodrik (2016) argues that it is primarily due to globalization. • Open economies which are price takers are “importing” deindustrialization, as their manufacturing sectors shrink with a negative trade balance. • This is particularly true for countries which do not have a comparative advantage in manufacturing – Latin America and Sub-Saharan Africa. • But Rodrik does not offer a systematic analysis of the effect of globalization on industrialization.

8. My Contribution • I undertake a systematic analysis of the effect of globalization on deindustrialization. • But first, I show that countries follow different paths of structural transformation (ST), which needs to be taken into account in the empirical analysis. • I argue that business services are different from nonbusiness services, and have some of the properties of manufacturing. So we need to differentiate between bus and non bus services in understanding ST. • I also look at the role of Foreign Direct Investment (FDI) separate from International Trade.

9. Outline of my presentation • What do we mean by structural transformation? • Classifying countries by stages/paths of structural transformation • Are we seeing premature deindustrialization? • Why should globalization matter for structural transformation? • Descriptive evidence • Econometric Evidence • Conclusions

10. What do we mean by structural transformation? • Traditionally, manufacturing has been the sector of relevance for structural transformation. • However, within services, business services has very different properties than nonbusiness services. • Firstly, the productivity of the business services sector far exceed that of the nonbusiness services sector, and is comparable to the productivity of the manufacturing sector. • Secondly, the business services sector includes the more tradable part of the services sector (such as information technology) while the nonbusiness sector broadly corresponds to the non-tradable services sector. • Thirdly, most of the activity that occurs in the business services sector are in enterprises that are in the formal sector (for example IT firms and banks), while a large part of the activity in the nonbusiness services sector are in the informal sector – for example, self employed or household enterprises in trade, hotels and restaurants or personal services (e.g fruit and vegetable street vendors) (the only exception here is the government sector where workers are usually in permanent jobs that are reasonably well paid).

12. Stages of Structural Transformation • We categorise our countries by the different stage of structural transformation that they are in. • Agriculture is still the largest sector in terms of the share of employment in the most recent time period available: structurally under-developed. • More people are employed in the services sector than agriculture, with agriculture being the second largest sector: structurally developing countries. • More people employed in manufacturing sector than agriculture: structurally developed.

13. Data • Groningen Growth and Development Centre’s 10-Sector Database. 40 countries in sample between 1960 and 2012, and 12 more African countries from Mensah et al. (2018), covering 80 per cent of SS Africa’s GDP. • The GGDC database consists of annual series for the gross value-added output and the number of people employed in 10 sectors. • A key strength of the employment data is that the source of the data is the population census, which ensures full coverage of the working population as well as a precise sectoral breakdown. • A feature of the data is the careful attention paid to intertemporal, international and internal consistency.

14. GGDC SECTORAL CLASSIFICATION

15. Stages of Structural Transformation

16. Paths of Structural Transformation All ST developed

17. ST Developing ST Underdeveloped

18. Trade and Manufacturing Driven Structural Transformation • Trade can affect manufacturing employment in three ways (Sen JDS 2019). • Firstly, through the scale effect – trade has an effect on the size of the manufacturing sector. E.g export oriented industrialization allows the manufacturing sector to expand. • Secondly, through the composition effect – trade may alter the composition of industrial employment to more labour intensive sectors. • Thirdly, through the labour intensity effect – trade may lead to changes in labour intensity of production – e.g if trade leads to higher labour productivity, it decreases the intensity of labour use. • In my JDS paper, I find that the scale effect is positive, but the composition and labour intensity effects are negative.

19. What about Trade and Business Services? • With increasing proportion of trade that is flowing through global value chains (GVCs), trade in goods and services is accompanied to a large degree in a corresponding trade in tasks. • As the WDR (2020, forthcoming) notes, “The fragmentation of goods production has been associated with the outsourcing of not just manufacturing tasks but also services tasks, the back office of many US manufacturers is now in India” (p. 8). • Out-sourcing may lead to an increase in the share of tradable business services in employment/VA.

20. FDI and Manufacturing Driven Structural Transformation • The earlier literature highlighted the difference between market seeking FDI and efficiency seeking FDI. • As well as which sectors drew most of the FDI. • Market seeking FDI may have a different effect on manufacturing than efficiency seeking FDI – if import substituting, there would be a limit to the increase in the size of the manufacturing sector, versus export oriented FDI. • Also, productivity effects may be different. • If FDI is mostly in mining, then it may have zero or negative effect on manufacturing ST (the latter through the increase in non-tradable prices).

21. FDI and Business Services driven ST • Very similar to the effect of trade in tasks, as most out-sourcing occurs through investment by Northern MNCs in Southern country affiliates in IT/finance. • FDI in Bus Serv is also complementary to FDI in Manuf, so should have similar positive effects.

37. Econometric Analysis • We estimate equations for Employment Shares in Manufacturing, Business Services and Nonbusiness Services separately. • As a robustness check, we also estimate Value Added Shares in Manufacturing, Business Services and Nonbusiness Services. • We look at the role of Trade (Exports and Imports)/GDP and FDI/GDP in explaining structural transformation. • We use standard controls for government size, human capital and level of economic development. • We take into account country heterogeneity and macro shocks to employment and VA shares by using two way fixed effects.

38. Methodology • Two way Fixed Effects • Y is manufempl share, bus serv empl share, nonbus serv empl share, manufva share, bus serv va share, nonbus serv va share • Five year averaged data, 1960-2012 • 48 countries. • Country and period effects • Controls: Govt Consumption/GDP, Secondary school enrollment rate, Per Capita GDP (sources: WDI)

39. All Countries

40. Developed ST

41. Developing ST

42. Underdeveloped ST

43. Conclusions • Whether globalization has been responsible for premature deindustrialization has been a matter of debate. • We find that the effect of trade on manuf driven ST has been positive. • However, as Rodrik conjectured, its effect has been negative for ST underdeveloped countries, though positive for ST developed and developing countries. • Surprisingly, FDI has an overall negative effect on manuf ST overall. This effect is most clearly observed in ST developed and developing countries. • However, FDI has a positive effect on Bus Serv ST, and the effect is most observed in ST underdeveloped countries (negative for ST developing). • Future work needs to look at the mechanisms of why FDI has this differential effect. • Overall, one has to be sanguine about the possibility of globalization facilitating ST in low income countries. • Some of it has to do with factor endowments, but a large part of it is due to poor institutions.