Arvind Subramanian has a nice post, which provides additional evidence on the phenomenon of premature industrialization that I have talked about and documented previously. Arvind works with data on industry rather than manufacturing per se, which I prefer. But the result is similar. The inverse U-shaped relationship between income levels and industrialization has shifted down and to the left in recent decades, so that countries are maxing out on industrialization at lower levels of income and, moreover, the peaks themselves are lower than before.
Here I propose a simple explanation for this phenomenon, having to do with global market integration. When poor countries become part of the global market, their industrialization is determined largely by consumption patterns of rich countries. Since consumption in rich countries has already shifted to services, this limits how much poor countries can industrialize. In other words, once developing countries have globalized, their peak industrialization levels are driven largely by the demand patterns in the rich countries rather than their own.
Here is a simple finger exercise. Divide the world into two countries, one poor and the other rich. Let the rich country have a per-capita income level that is 10 times higher. Suppose that consumers in the poor country spend 20 percent of their income on manufactured goods, while the corresponding ratio in the rich country is 10 percent. So in the rich country, the demand shift away from manufactures has already gone quite some way. These numbers are meant to be roughly representative of reality.
Now in autarky the poor country has to produce all the manufactures that the home consumers want. This means manufactures output amounts to 20 percent of poor country income.
Consider what happens when this country integrates with the rich country, and there is a single world market for manufactures. Suppose that the poor country holds 70% of the world’s population. And to rule out trade imbalances, suppose each country supplies a share of the world demand for manufactures that is equal to its share of global income. It can be checked that this requires the share of manufacturing output in the poor country to fall to 11.9 percent – far below the 20 percent it could sustain in autarky.
The rich country can sustain an identical level of industry (11.9 percent), up somewhat from its 10 percent. Because the rich country has the bulk of the market, its consumers exert a larger impact on demand patterns (even though they are fewer in number).
A direct implication of globalization, therefore, is that the industrialization levels of the rich and poor countries must converge, irrespective of their income levels. One can add lots of bells and whistles such as trade costs to this, but the central logic is important and powerful. I am not sure it has been fully appreciated to date. And it has lots of implication for economic and political development in the poor countries.
More to come…