Charting a new path to income convergence

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Developing countries made substantial gains during the 2000s, resulting in a big reduction in extreme poverty and a significant expansion of the middle class. More recently that progress has slowed—and the prognosis is for more of the same, given an environment of lackluster global industry, a lack of jobs coupled with skills mismatches, greater income inequality, unprecedented inhabitants aging in richer countries, and youth bulges in the poorer ones. As a result, developing countries are improbable to close the development space anytime soon.

HOW COUNTRIES CAN GROW

Against this backdrop, we examine exactly how seven countries fared from 1990-2010 in their development quest. The test includes Brazil, India, Vietnam plus four African countries—Botswana, Ghana, Nigeria, and Zambia—all of which experienced fast growth in recent years, but for different factors.

For all the countries, there is a unifying framework that draws the distinction between the “structural transformation” plus “fundamentals” challenges in growth:

  • “Structural transformation” challenge : Ensuring that resources circulation rapidly to modern economic actions (manufacturing and services) that work at a higher level of labor productivity than traditional activities (agriculture).
  • “Fundamentals” challenge : Accumulating the skills and broad institutional capabilities needed to create sustained productivity growth, not just in some modern industrial sectors but over the entire range of services and other nontradable activities—what we term “within” sectoral change. Lumped into this group are the quality of institutions (governance, rules of law, and the company environment) and the level of human funds (education, skills, and training).

Although the two challenges appear quite similar, with some overlap, you are able to have rapid structural transformation (in other words, industrialization) without significant improvements in fundamentals. It is also probable to invest in fundamentals without reaping much reward in terms of structural transformation.

We can visualize these opportunities in Figure 1 depicting a typology of growth patterns and outcomes. Ultimately, sustained growth plus convergence require both processes—as South Korea, Taiwan, and Hong Kong have demostrated.

Figure 1: The typology of growth patterns and outcomes

HOW COUNTRIES ARE DEVELOPING

So how do the seven countries fit into this typology? We discover that none of them have managed to definitively reach the nirvana of item (4)—rather they hover typically among episodic growth and slow development.

  • Botswana provides high fundamentals, but has skilled limited growth from structural modify in recent years. While growth in Vietnam has benefitted from relatively rapid structural change although fundamentals remain relatively low.
  • Ghana, Nigeria, and Zambia have had growth-promoting structural change, but vacillate between episodic growth and slow growth.
  • Brazil has moved through episodic growth to slow development, reflecting greatly improved fundamentals yet slow structural change.
  • India has not experienced the kind of structural change that successful import-substituting nations or the East Asian exporters have got gone through, so its growth potential customers remain limited.

FOCUSING ON THE FUNDAMENTALS

What do these findings indicate in terms of how developing countries need to focus their energies to achieve convergence? While there is still enormous potential for structural transformation in India, Nigeria, and Zambia, all of these countries have to improve within sector productivity – especially by focusing more on four key areas: political economy, work regulations, institutions and education, plus infrastructure.

Political Economy

In Zambia , where structural change has not translated into economic transformation, a major problem has been a lack of macroeconomic stability plus persistent policy volatility. In the 1990s and 2000s, mining remained a good enclave sector, manufacturing continued in order to decline, agriculture remained stagnant, informal trade became the dominant nonfarm employer, and high-value services benefited mainly the middle class. As a result, Zambia is now composed of the rural bad, the urban poor, and a increasing middle class that has reaped the advantages from growth. Reconciling positive structural change with large-scale transformation will stay a major economic, social, and political concern.

In Botswana , some of the restrictions are as much political economy as technical. Building up the industrial sector involves issues of political capture, and making more land readily available for business, involves issues of property markets and even immigration. Although Botswana’s rapid economic growth has brought this into upper-middle-income status, many are left behind. Unemployment, income inequality, plus poverty are high. For the time being, growth is most likely to come from improvements within fundamentals that facilitate productivity development within sectors like services.

Labor Regulations

In India , labour regulations appear to be a major impediment in order to employment growth in manufacturing. Yet even in a democratic country like India, changing these laws is not really easy. This may lower growth, considering that the future potential of agriculture plus services in generating overall development is limited at India’s stage in the development process. Rapid growth has come primarily from its expanding services industry rather than from manufacturing leaving more than half of the country’s labor force relatively unproductive agriculture.

Institutions and Education

In Vietnam , large productivity spaces within and across sectors remain even after a period marked by fast growth resulting primarily from structural change brought on by an expansion in modern manufacturing. Roughly 50 percent of Vietnam’s labor force still works within agriculture; facilitating access to land and capital will be needed to help more workers transition out of agriculture or to enhance agricultural productivity.

In Brazil , policies that raise overall labour productivity—like improving educational quality—are more likely to have a deeper impact on growth than those concerned with accelerating an unfinished structural change. Between 1950 and 1980, structural change played an important role in the diversification and growth associated with Brazil’s economy but after that, many productivity gains came from within specific economic sectors. Without trade liberalization, Brazil’s economic performance almost certainly would have been worse.

Infrastructure

In Nigeria , the employment share in low-productivity agriculture is still quite higher, indicating a potential for rapid structural change. But the levels of human capital and infrastructure are still abysmal, making a rapid exodus out of agriculture not likely in the near future. Better infrastructure—especially power—would proceed a long way toward stimulating manufacturing plus business services.

In Ghana , which seems to have managed economic development without a green, industrial, or service revolution, diversification away from a heavy reliance on cocoa and gold exports is necessary. Agricultural productivity remains far beneath that of industry and services. Going forward the manufacturing sector needs to be made more competitive. High non-labor expenses could be reduced by investing in roads, power, and the regulatory framework.

TEMPERING EXPECTATIONS

Our findings suggest that we ought to not be surprised if changes across sectors play a more muted role in the future than changes within areas. A key reason is a less beneficial environment for the classic path of rapid catch-up through industrialization, mostly owing to: (i) many African nations being much better endowed with organic resources and not as well positioned just for specialization in manufacturing; (ii) stepped up competition from East Asian countries, especially given globalization and decrease trade barriers worldwide; (iii) new trade rules that limit the space for industrial policies; and (iv) technological changes in manufacturing that make it more capital and skill intense.

The problem—and hence a reason for tempering our expectations—is that structural transformation can lead to rapid and relatively quick growth simply by moving labor into more productive sectors, while the growth payoffs in order to investments in fundamentals like human being capital and institutions are likely to much more. The bottom line is that future East Asia-style “economic miracles” are unlikely. Instead, development will have to happen the hard method.

For more, read the book “Structural Change, Fundamentals, and Growth” here, the overview here, as well as the brief here.

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