Dual Economy Approach, Structural Change and the role of Industrial Policy

Transcription

1 Dual Economy Approach, Structural Change and the role of Industrial Policy Antonio Angelino Development Economics and Emerging Markets University of Ferrara

2 How do we explain economic growth? Two different approaches Contributions belonging to two main traditions Neoclassical model Solow (1956) structural similarity of productive activities Dual Economy model Lewis (1954) structural heterogeneity of the sectors: 2 sectors (traditional and modern) Where growth comes from? Saving and incentives to human and physical capital accumulation, innovation, technology ( within sector ) Structural change: reallocation of labour force from backward to modern sector. Since modern sector is more productive, this labour force will generate a surplus of output two types of productivity growth ( between sector ) What about convergence? It is a natural process (absolute, conditional convergence) It depends on a country s productive specialization (proactive upgrading policies)

3 Catch up since 1820

4 Manufacturing as engine of growth - Correlation

5 Two main development challenges for a latecomer Structural transformation: how to ensure that resources flow rapidly to the modern economic activities that operate at higher economic productivity (MOVING RESOURCES) Fundamentals: how to accumulate the skills and broad institutional capabilities needed to generate sustained productivity growth not just in a few modern industrial sectors but across the entire range of services and other non tradable activities (DEVELOP CAPABILITIES)

6 How to situate BE in LDCs development strategies? Two fundamental challenges for developing countries: structural change vs fundamentals (McMillan, Rodrik, 2012) STRUCTURAL TRANSFORMATION Slow Rapid INVESTMENT IN FUNDAMENTALS Low (1) NO GROWTH (2) EPISODIC GROWTH High (3) SLOW GROWTH (4) RAPID, SUSTAINED GROWTH 6

7 Different strategies to promote catching up These two challenges require different investment strategies: promote industrialization directly by subsidizing industry in diverse ways or removing specific obstacles to it Promote industrialization indirectly by making broad investments in human capital and institutions and expecting that these will trickle down to investment incentives in industry East Asia: rapid structural transformation (industrialization) without commensurate improvements in fundamentals (e. g. China and Vietnam governance and human capital have lagged significantly behind the country s manufacturing progress) Since the early 1990s, Latin America has considerably improved its governance and macroeconomic fundamentals, but structural change in the region has been growth reducing. Manufacturing and some other modern sectors have lost employment to lower productivity services and informal activities

8 Vietnam vs Ghana: a tale of two countries McCaig and Pavcnik (2013) Vietnam: in the late 1980s agriculture ¾ of country s workforce and 1/3 of the country s GDP large differential in labour productivity across activities. Then FDI-led structural transformation Two other important shifts: transitions from state owned firms to private employment and from family farms and businesses to formal, registered firms. These structural shifts contributed directly to productivity growth within sectors, but also enabled reallocation of factors of production across sectors Achievements: average 7.1% GDP per capita growth from 1990 to 2010; reduction of poverty rate from 58% to 10.8%. Structural change accounts for 38 percent of this increase, with labor productivity growth within sectors accounting for the rest

9 Structural transformation in Ghana Osei and Jedwab (2013) Ghana s real GDP per capita picked up from the mid 1980s on, with labor productivity registering growth of 3.0 percent per year between 1992 and 2010 Negative contribution of structural change to growth at the beginning of 2000s. While agricultural employment did decrease, the labor that was released was absorbed mostly by low productivity services, with limited impact on economy wide productivity Moreover, the bulk of manufacturing took place in the informal sector, where productivity is more than 20 times lower than in formal manufacturing

10 A possible explanation: natural resources specialization In Ghana manufacturing expanded very little while investment and growth were concentrated in the resource sector. Aside from oil, Ghana s main exports are gold, cocoa beans, timber products and other natural resources. Vietnam, meanwhile, is a major exporter of textiles and garments. In 2012, manufactures share of merchandise exports stood at 65 percent in Vietnam, but only 9 percent in Ghana A manufacture based growth strategy has two distinct advantages 1- Most of manufacturing is labor intensive, so a) it can absorb large amounts of relatively unskilled workers from the rest of the economy; b) it does not require significant investments in human capital and no high barriers for investment in physical capital. By contrast, resource sectors tend to be very capital intensive and absorb few workers. Growth benefits the state or a rentier class, spawns inequality and distributive politics, and proves generally detrimental to institutional development 2- Manufacturing exhibits a remarkable property: unconditional convergence. Labor productivity in lagging manufacturing sectors tends to converge to the frontier as if on an automatic escalator, at a rate of 2 3 percent per year. The greater the distance from the productivity frontier, the faster the rate of productivity growth. Convergence takes place regardless of the quality of domestic policies or institutions and other aspects of economic context such as geography and infrastructure

11 Not only endowments, the role of political strategies Firpo and Pieri (2013), show that trade and industrial policies, as well as the level of the real exchange rate, play an important role in promoting productive diversification. ISI PERIOD: Structural change was quite rapid in Brazil from the 1940s through the 1970s, accounting for up to half of total growth. As agricultural employment shrank, manufacturing expanded, and modern service activities even more so. By the late 1970s, manufacturing accounted for 45 percent of Brazil s GDP EOI PERIOD: From the 1980s on, growth had to rely on within sector enhancements in productivity, which in turn required sustained investments in human capital and new technologies (in agriculture especially) as well as institutional improvements

12 Lewis Model The interactions between agriculture and nonagricultural sectors and resources flows from agriculture to industry are basic to the development process Resources flows from agriculture: supply of labour to industry and the surplus of food that allow a nonagricultural labour force to survive Industry supplies inputs to agriculture: tractors, pump sets, chemicals; agriculture is a major source of demand for the industrial products (durables + final consumption goods) Agricultural exports (commodities) can serve as a source of foreign exchange to import inputs for industrial production

13 Assumptions 1. The model assumes that a developing economy has a surplus of unproductive labor in the agricultural sector. 2. These workers are attracted to the growing manufacturing sector where higher wages are offered. 3. It also assumes that the wages in the manufacturing sector are more or less fixed. 4. Entrepreneurs in the manufacturing sector make profit because they charge a price above the fixed wage rate. 5. The model assumes that these profits will be reinvested in the business in the form of fixed capital.

14 The dual economy In the economy coexist a traditional (subsistence) and a modern (capitalist) sector. Distinction in terms of products, technologies and economic organization (older vs new techniques; labour vs capitalintensive; family vs wage labour) Movement from traditional to modern sector traditional sector supplies labour to the modern sector. Part of the labour is not immediately absorbed because the scale of the modern sector is limited by the supply of capital capital accumulation in the modern sector becomes the engine of development Labour is virtually unlimited in supply whereas the rate of savings and investment limits the pace of development

15 Differences in organization between a profitmaximizing firm and a family firm We know that a firm hires labour only to the point where MPL = W/P Because land is fixed there are diminishing returns to the labour input (farmers do not use capital) in situations of population pressures there is an unsustainable number of people per acre of land ORGANIZATIONAL ASYMMETRY BETWEEN TRADITIONAL AND MODERN SECTOR Profit-maximizing firm: wage cost of production to subtract from revenues in order to arrive at final profits. When MPL tends to zero: cutting employed labour Family firm: output shared among family members (firm may employ beyond the point where MPL = W/P). Wage paid is not given by MPL but it is equal the average output of a farm all the output divided by the inputs With income sharing family members address the difficulties of finding employment elsewhere (common in urban informal sector as well)

16 Dynamics in the agricultural sector Population surplus presence of redundant labour in agriculture Surplus labour in agriculture becomes supply of labour in the modern sector Some generalizations 1) Disguised unemployment: related to the question of efficient allocation of the resources (switch to more efficient sectors is not automatic) a) as long as the avergage product in traditional activities is equal to the marginal products elsewhere no individual has an incentive to move; b) as long as the average product is lower than MP elsewhere, there will be gains from a relocation of the resources.

17 Less workers constant output 2) Surplus labour vs surplus labourers Issue of mantaining an adequate surplus of food in the economy after the flows from agriculture to industry increasing demand of food with reduced supply Necessity of mantaining agricultural output constant remaining labourers in traditional activities typically adjust their labour input (> productivity output doesn t fall) This is not sure: labour can be used in alternative ways (leisure, part time work elsewhere). The marginal utility of these alternatives corresponds to the marginal cost of working on the farm If the marginal cost increases as a result of the remotion of units of labour there will not be a full compensation (less output). If it is constant (identical across family members), then the total family input (number of labourers) is determined independently of family size removal of labourers has no effect on total output

18 Summary Unlimited labour supply in the traditional sector push labourers towards the modern sector (this generally stimulates compensations in terms of agricultural productivity) In the capitalist sector labor is employed up to the point where its marginal product equals wage (profit-maximizing firm) The amount of resources transferred to the modern sectors are employed in a more productive way favouring capitalist surplus (profit), capital accumulation and spuring growth The process of productivity growth does come to an end at some point when capital accumulation catches up with population so that there is no longer any surplus labour left

19 How the process breaks If the capital accumulation is proceeding faster than population growth decline in the number of people in the agricultural or subsistence sector The increase in the size of the capitalist or industrial sector in comparison to the subsistence sector may generate an alteration of the terms of trade between the two sectors more demand for food increase price increase real wage The subsistence sector may adopt new and improved methods and techniques of production, this will raise the level of subsistence wages in turn forcing an increase in the capitalist wages. Thus, both the surplus of the capitalists and the rate of capital accumulation will then decline The workers in the capitalist sector may begin to imitate the capitalist way of life and therefore may need more to live on. This will raise the subsistence wage and also the capitalist wage and in turn the capitalist surplus and the rate of capital accumulation will decline

20 Structural Change Basic Factors Developing economies are characterized by large productivity gaps between different parts of the economy These allocative inefficiencies can be an important engine of growth When labour moves from less productive to more productive activities, the economy grows even if there is no productivity growth within sectors growth-enhancing structural change A similar framework allows us to account for the whole change in productivity experienced by an economy. It captures the changes in intersectoral allocative efficiency (between) as well as improvements in within-industry productivity

21 Decomposing Productivity Y = Q/L; y i = q i /l i ; Q= Σ q i etc Y = Σ (l i /L) y i = Σ θ i y i within Structural change Y (overall), y (sectorial) productivity levels; θ i is share of employment in sector i at time t

22 General trends of structural change 1- Economies with a revealed comparative advantage in primary products are at a disadvantage (minerals and natural resources do not generate much employment; very high productivity but they cannot absorb the surplus labour from agriculture) 2- Countries that maintain competitive or undervalued currencies tend to experience more growth-enhancing structural change (UNDERVALUATION ACTS AS A SUBSIDY) 3- Countries with more flexible labour markets experience greater growth-enhancing structural change (labour can flow easily across firms and sectors)

23 Evidence Intersectoral productivity gaps are a feature of underdevelopment The relationship between the dispersion of sectorial labour productivity and the average labour productivity in the country is negative and highly statistically significant The productivity gap between the agricultural and non-agricultural sectors behaves non-monotonically during economic growth. The gap first increases and then falls (U-shaped pattern as the economy develops) At a certain point, labour begins to move from traditional agriculture to the modern parts of the economy. Past a certain point, this second force becomes the dominant one, and productivity levels begin to converge within the economy

24 Evidence 1: Dispersion - Africa Source: McMillan and Rodrik, 2011

25 Evidence 2: Dispersion and Development

26 Evidence 3: Agr/Nonagr vs Productivity

27 Productivity Decomposition in Latin America Industry rationalization: least productive firms exit the industry and remaining firms shed excess labor. Displaced workers may have ended up in less-productive activities. In other words, rationalization of manufacturing industries may have come at the expense of inducing growth-reducing structural change.

28 Productivity Decomposition by Region ( )

29 Within and Structural Change components

30 What explains Structural Change? (policy styles, endowments, regulations) Common external environment: globalization (quantitative restrictions on imports, reduced tariffs, encouraged direct foreign investment and exports, financial flows) differentiated patterns of structural change Import competition as a result of liberalization - has caused many industries to contract and release labor to less-productive activities, such as agriculture and informality Asian-style globalization (Taiwan, South Korea, China high tariffs on strategic sectors, subsidized credit, industrial policy) has protected labour in firms that might otherwise get decimated by import competition. Globalization promotes specialization according to comparative advantage. In natural resource rich countries opening up to the world economy reduces incentives to diversify towards modern manufactures and reinforces traditional specialization patterns Another factor influencing the rate of structural change is the ease of entry and exit into industry and by the flexibility of labor markets. E. g. Rigidity in firing costs: makes firms more likely to respond to new opportunities by upgrading plant and equipment rather than by hiring new workers

31 Determinants of the magnitude of Structural Change

32 Policies for Structural Change A government may use simple industrial/trade policy tools (tariffs, subsidies) to stimulate structural change A tariff benefits production but harms demand (consumption); a production subsidy has the same effect on production but doesn t harm demand (it may harm competitiveness monitoring issues) Scope of trade Policy: address externalities related to non rival goods and increasing incentive to innovative investment Learning- Knowledge, technology, market research, export market development Training Workers, once trained, move to rivals Establishing national reputation Tariffs don t solve externality problems: increase incentive to innovate but also to imitate (net effect uncertain) Infant Industry Protection Protection from competitiveness, direct support of sectors and firms Tariffs relax pressure for scale and efficiency ( + ) need for domestic scale ( - ) less efficiency because lack of foreign competition Need super-normal profit in future to offset for initial investment Address high private cost and risks related to investments in capital intensive manufacturing activities externalities, no human capital, technological gap (but at the same time with public support risk not to be competitive)

33 The theoretical case for Industrial Policy Development is fundamentally about structural change: it involves producing new goods with new technologies and transferring resources from traditional activities to these new ones Market imperfections make the economic development a non automatic process 1. Credit market risk in formal credit, absence of complementary services and inputs 2. HC movement of qualified workforce after training 3. Learn by doing and imitation Under these conditions, the deck is stacked against entrepreneurs who contemplate diversifying into non-traditional areas. Poor countries remain poor because markets do not work as well as they could to foster the structural transformation that is needed To accomplish all these functions and leave market free to expand you need the state, IP, long term consistent strategy

34 Critiques to Industrial Policy 1. Existing distortions economies are full of distortions, such as labor market regulations, energy subsidies getting the price right better allocation of the resources 2. Political capture industrial policies are too easily captured by politically powerful groups who then manipulate it for their own purposes rather than for structural transformation. Decision making is captured by rent-seekers 3. Government does not have the ability and the technical information necessary to achieve the targets 4. Firms not sectors Industrial policy has typically targeted sectors. Picking winners logic based on preferential treatment attributed to strategic sectors. But firms are the main actors of economic process there is a great heterogeneity of firms within a sector. Target successful firms and not sectors This lead to government failures

35 Industrial Policy «A la Rodrik» Knowledge about constraints and spillovers is widely diffused Business will game any system Beneficiary is society, not government or business Preconditions Embedded autonomy for bureaucracy i.e. close relations with business, but independent Good quality and committment of civil service Sticks and carrots Introduction of temporary criteria to monitor performances Failures are natural: avoiding bail-out of non competitive firms (selection) Accountability of business to bureaucracy, bureaucracy to business Transparency, rule of law, contrast to corruption