Thursday, August 28, 2014
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Development in Reverse

CAMBRIDGE – One does not have to spend much time in developing countries to observe how their economies are a mish-mash, combining the productive with the unproductive, the First World with the Third. In the modern, more productive parts of the economy, productivity (while typically still low) is much closer to what we observe in the advanced countries.

In fact, this “dualism” is one of the oldest and most fundamental concepts in economic development, first articulated in the 1950’s by the Dutch economist J.H. Boeke, who was inspired by his experiences in Indonesia. Boeke believed in a stark separation between the modern, capitalist style of economic organization that prevailed in the West and the pre-capitalist, traditional mode that predominated in what were then called “underdeveloped areas.” Although modern industrial practices had penetrated underdeveloped societies, he thought it unlikely that they could make substantial inroads and transform such societies wholesale.

When contemporary economists think of economic dualism, they think first and foremost of the Nobel laureate Sir W. Arthur Lewis. Lewis turned Boeke’s idea on its head, arguing that labor migration from traditional agriculture to modern industrial activities is the engine of economic development. Indeed, for Lewis, the coexistence of the traditional alongside the modern is what makes development possible.

To take an extreme example, labor productivity in Malawi’s mining sector matches that of the United States economy as a whole. If only all of Malawi’s workers could be employed in mining, Malawi would be as rich as the US! Of course, mining cannot absorb so many workers, so the rest of the Malawian labor force must seek jobs in considerably less productive parts of the economy.

The dualistic nature of developing societies has become more accentuated as a result of globalization. Certain parts of their economies, such as export enclaves, high finance, and hyper-stores, have experienced substantial increases in productivity by linking up with global markets and accessing frontier technologies. Other sectors have not had similar opportunities, and the gaps between them and the “globalized” sectors have widened.

These gaps are problematic, but, as Lewis emphasized, they also constitute a potential engine for economic growth. The trick is to ensure that the economy undergoes the right kind of structural change: a shift from the low-productivity to the high-productivity sectors. In successful economies, such as China and India, the movement of workers from traditional agriculture to manufacturing and modern services accounts for a substantial part of overall productivity growth, just as Lewis predicted.

In many other parts of the world, however, we have observed a rather curious and unwelcome development in recent decades – structural change in the wrong direction. Modern, high-productivity industries have come to employ a smaller share of the economy’s labor force, while informal and other low-productivity activities have expanded. For example, since around 1990, structural change in the typical Latin American and Sub-Saharan African country has undermined rather than boosted growth.

By contrast, most Asian countries continue to behave in typical Lewisian fashion. This difference in patterns of structural change accounts for the bulk of the difference in recent growth rates between Latin America and Sub-Saharan Africa, on the one hand, and Asia, on the other.

This conclusion might seem to fly in the face of the experience of countries like Argentina, Brazil, and Chile, where many firms in the modern parts of the economy (including non-traditional agriculture) have experienced undeniable growth. What has not been sufficiently understood is that much of this growth has come through rationalization of operations and technological upgrading – and thus at the price of job creation. Overall productivity in the economy is not helped much when firms become more productive by shedding workers, who end up in informal activities characterized by substantially lower productivity.

My research with Maggie McMillan of Tufts University and the International Food Policy Research Institute shows that countries with a strong comparative advantage in natural resources are particularly prone to fall into the trap of growth-reducing structural change. For these countries, globalization is a mixed blessing. The natural-resource industries that globalization promotes have limited capacity to absorb employment out of traditional sectors. Globalization therefore entrenches dualism, rather than helping to overcome it.

Appropriate policies can help. One lesson is to avoid premature collapse of import-competing industries that employ substantial numbers of people before sufficient employment opportunities have emerged in more productive industries. Asian countries, for instance, have typically liberalized at the margin (through export subsidies or special economic zones), spurring new export industries without pulling the rug from under the rest.

Second, the exchange rate is vitally important. Competitive currencies promote and protect modern tradable industries that employ a substantial share of the labor force. We found in our research that countries with competitive currencies were much more likely to experience growth-enhancing structural change.

Finally, flexible labor-market policies seem to be important, too. Legal requirements that significantly increase the costs of hiring and firing labor discourage employment creation in new industries.

Structural change does not automatically accelerate economic development. 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.

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  1. CommentedMoctar Aboubacar

    Agreed. What's more, liberalization 'at the margin' has also provided Asian countries with a sort of testing ground for new policies; it's certainly the case of China and its Special Economic Zones.

    I think though that a danger, particularly in Africa, lies with the complacency of oil producing countries. You have a country like Gabon, where oil exports account for 80% of all exports. in Gabon something like 60% of the population works in agriculture, yet the country imports incredibly high proportions of its food. But plans for boosting the all but absent manufacturing sector and diversifying the economy have only come about in the last 3 or so years.

    What's more, growth in these oil exporting African countries is rather good if one looks only at the numbers. Shortly put there is little incentive to strive for the type of structural change prof. Rodrik talks about. It remains of course to be seen how things will change!

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