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

1
 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

2
 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

a) Rate of growth in capital stock =investment
b) Rate of growth in human capital
c) Rate of growth in labor
d) 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)??

3
 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

4
 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 economys 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)
5
 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).

6
B-The case for industrialization:
Theory/Economic Arguments

7
 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 countrys 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.

8
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).

9
 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

10
 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

11
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 Baumols 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.

12
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.

13
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 (Engels
law). Countries specialising in agricultural and primary
production will not profit from expanding world markets for
manufacturing goods.

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 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
countrys 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.

15
16
17
 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.

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 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.

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 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.
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3. Structural change burden-Baumols 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 (Baumols law). Such service
sectors include personal services, restaurants and hotels, health
care and medical services and government.

Baumols 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.

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 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

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 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

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 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

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 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

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 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

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 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.

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 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

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 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

29
 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 tradethe relative price of exports to importsof 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???

30
 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.

31
 C- Some Econometric Evidence
Fagerberg and Verspagen (1999):regress
(1999): 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

32
 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.

33
 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.

34
 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.

35
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.

36
 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 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.
37
 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.

38
 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.

39
 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.

40
 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 globalizations 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.

41
 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.

42
 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.

43
 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 economys 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 economys overall productivity depends not only on whats
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.

44
 D- Challenges and Opportunities
from 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.

45
 D- Challenges and Opportunities
from 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

46
 D- Challenges and Opportunities
from 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.

47
 D- Challenges and Opportunities
from 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

48
 D- Challenges and Opportunities
from 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.

49
 D- Challenges and Opportunities
from 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.

50
 E-African Initiatives for Industrialization
Lagos Plan of Action for the economic development of Africa

From the concepts and objectives of the Lagos Plan of Action emerged the idea of a decade
specifically devoted to translate the goals of the Lagos Plan of Action into industrial
programmes and projects. Proposals for an Industrial Development Decade for Africa (IDDA),
1980-1990 were adopted at the Sixth Conference of African Ministers of Industry, held at
Addis Ababa, Ethiopia in November 1981. UNIDO IDDA Support Programme

The Alliance for Africa's Industrialisation (1996):initiated by UNIDO in cooperation with the
Economic Commission for Africa and the Organisation of African Unity, and launched in Cote
d'Ivoire, yet another initiative aiming at revitalizing African economies. Intended to provide a
mechanism for African leaders to define appropriate industrial development strategies and
commit political will and resources to their achievement. It is also an effort to draw the
attention of African decision makers and the international community to Africa's industrial
development potential and the need to fully realise this potential.

New Partnership for Africa's Development (NEPAD) adopted by African Leaders in 2001
identified economic transformation through industrialisation as a critical vehicle for growth
and poverty reduction in the region. Trade, Industry, Market Access and Private sector
development as one of the 9 priority sectors in AU/NEPAD African Action Plan 2010-2015

In February 2008, African Heads of State adopted a Plan of Action for the Accelerated
Industrial Development of Africa (PIDA). Implementation strategies for the Plan were
subsequently endorsed by African Ministers at the 2008 Conference of African Ministers of
Industry (CAMI).

51
 AU/NEPAD STRATEGIC OBJECTIVES IN TRADE,
INDUSTRY, MARKET ACCESS AND PRIVATESECTOR
DEVELOPMENT

52