Growth reducing structural change

I have been doing some work on the relationship between structural change and economic growth in different parts of the world, and some of the early results are too striking to wait for the paper to come out.

Here is a chart that provides a key insight on why Latin America has done worse than Asia since 1990. The chart decomposes labor productivity growth in the two regions into three components: (i) a “within” component that is the weighted average of labor productivity growth in each sector of the economy; (ii) a “between” component that captures economy-wide gains (or losses) from the reallocation of labor between sectors with differing levels of labor productivity; and (iii) a “cross” component that measures the gains (or losses) from the reallocation of labor to sectors with above-average (below-average) productivity growth.

(The countries identified by “HI” are the high-income countries.)

Note first that Latin America does better than Asia in terms of the “within” component (the blue bars). The representative Latin America country has experienced faster productivity growth in its individual economic sectors than the representative Asian economy. (China is not included in this data set.)

Why then did Latin America do so much worse overall? Because the reallocation terms have contributed negatively to overall economic growth. Note in particular the hugely negative “cross” term for Latin America (the green bar). In Latin America, labor has moved from sectors with high productivity growth to sectors with low (or negative) productivity growth, offsetting to a large extent the large “within” effect and the much smaller (but still positive) “between” effect.

Here is what’s behind the large and negative cross effect. The scatter plot below shows the correlation for Latin America between the change in a sector’s employment share and the sector’s labor productivity growth.

The main message of the scatter plot can be summarized easily. Labor has moved from tradable sectors (agriculture and manufacturing) where labor productivity growth has been rapid to non-tradables, especially wholesale and retail trade, where productivity growth has been negative.

Put differently, the mechanism through which tradables have achieved significant productivity growth in Latin America (remember the large “within” terms noted above) has been to lay off workers. Such “rationalization” is OK from a partial-equilibrium perspective, but doesn’t look great when the displaced labor moves to sectors with worse performance.

As the first chart shows, Asia (where manufacturing has expanded rather than shrunk) has largely avoided this problem, and has ended up with superior overall performance.

Want to help me write my paper? Provide some hypotheses as to why the structural change patterns in the two continents have been so different.

UPDATE:  First, I should have pointed out that the underlying data for the charts here come from the Groningen Growth and Development Centre.  Second, in response to Tim Worstall’s puzzlement, the modern supermarkets he has in mind make up a tiny proportion of employment in “wholesale & retail trade.”  The bulk of employment in this sector is informal, which is why productivity is low and has plummeted further as the ranks of informality have swelled.  

Comments

[Curmudgeon]

I don't see this as hard to explain.

South America was subjected to the Washington Consensus, which has the ultimate effect of driving labor into nontradable sectors (e.g. services) high employment in tradable sectors (e.g. manufacturing) is inherently incompatible with neoliberal economic policies.

Asia rejected the Washington Consensus and adopted an export-oriented development model instead. Export oriented development requires by definition labor to shift into manufacturing and other tradable sectors.

[Michael Landesmann]

The stylized facts across the two regions might be correct, but the simple decomposition method has also its problems:
Take the case of a first economy in which certain sectors have dramatic labour productivity growth leading to the shares of these sectors in GDP to grow very strongly inspite of constant or even slightly falling employment shares of these sectors.

Compare this economy with another one in which these sectors (still the sectors with the faster productivity growth) show much lower productivity growth and these sectors increase their labour shares to some extent, but the shares of these sectors in GDP grow by much less than in the first economy.

By the method you employ the second economy will show a 'positive structural change' contribution (as it is defined by shifts in employment shares) while the first economy would show either zero or a negative 'structural change' contribution.

The snag of this traditional method of decomposing aggregate labour productivity growth is that it (has to) define positive/negative structural change contributions by shifts in employment shares rather than in output shares.

[Ivanbrugal]

Creating synergies within industries create positive externalities. Having developed apt suppliers for car manufacturing for example, creates sinergies within the car manufacturing industry, and then steel and other metals, electronics, computers, software and so on. When a country or an economic region has an "anchor" key industry derived from certain competitive advantage it is positioned to develop productivity growth in related industries as well, if it succeds a certain point, other industries that supplement it are likely to follow. If this productiviy growth reaches an even higher plateau, it can succeed into other more complex industries like aviation for example.
Asia is becoming the manufucturing center of the world and that means that someone who worked 10 years making motors can then go to cars, and then maybe to airplanes with incremental trainings,(given that the other relevant industries are also experiencing enought productivity growth), while Latin America really cant create aviation without first developing real know how in these others industries.
Which is why before America surpassed Europe there was Ford, and before Japan was taken seriously there was Toyota and Sony, and relevant industries are placed rather closer, like Detroit, in order to obtain the mass benefit from the sinergies of interindustry productivity.
I would say Latin Americas "anchor industry" has not been able to create synergies with the relevant industries. Why? Maybe relative costs were way better in Asia for the starter industries, or local potential host countries markets were bigger in economics term, or, these countries were more export minded. In a geopolitical sense, maybe there was a higher war threat, if so it becomes more urgent to provide crucial knowledge or conditions like industry knowhow and access of local markets as long as the costs in the balance of trade and productivity drains are trought of being smaller than the gains in efficiency and strenghtening vital allies.

[Andres Echeverry]

Dani,

I start by putting the question you raise into different words: why has Latin America's structural transformation favored sectors with
a) lower rates of technological change, and/or
b) lower growth in physical capital intensity
As both these factors will contribute to lower labor productivity growth rates.

On the first point I would explore if the disregard for industrial policy over the time period you are analyzing left the sectors with high rates of technological change - generally knowledge intensive, tradeable and also capital intensive - without proper policy support during a period of lowering trade protections and drove them towards extinction.

And perhaps building on that on the second point I would also suggest that over the time period you are exploring, Latin America did not have policies in place to promote capital accumulation and sustain high levels of investment. Moreover, it suffered from relatively high inflation rates, significant macroeconomic and political instability across the region, and the related low levels of savings and high interest rates.

Both these circumstances could promote a labor force shift towards industries with low levels of knowledge and capital intensity such as the non-tradeables that you highlight, which can close productivity gaps far easier and hence have a positive between and within components.

[JC]

Is there a mystery here? Or is this just a pop quiz?

The answer stressed in the literature (and by this I mean things of the sort Dani Rodrik's might write) is: Real exchange rate appreciation (which, by definition, entails a rise in the relative price of non-tradables) and urban biased policies in Latin America.

Of course that answer begs the question of why those policies. I'm inclined to think that the highly unequal initial distribution of land and natural resources in Latin America, and entrenched opposition to redistribution, led to political pressures to redistribute resources via government and macro-policy, and repeatedly postponed adjustment which meant long periods of real over-valuation and macroeconomic crisis. End result: badly applied ISI and later, excessive use of nominal anchor fixed-exchange rate regimes and badly sequenced financial liberalizations in an attempt to break built-in inflationary expectations and liberalize the economy.

In contrast many of those Asian countries started with more equal distributions of assets and, in part because of that, rural constituencies that would help resist urban-bias. They also had (part endogenous, part exogenous) policymakers strongly directed toward maintaining a real exchange rate more likely to be under-valued (and hence stimulating labor-intensive exports) than overvalued-valued.

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[Luis Enrique]

Perhaps the interpretation "Asia is doing much better than Lat Am" is wrong?

Wholesale and retail sound like useful sectors in which to accumulate workers for an economy to service domestic demand, even if productivity growth in them is low.

Concentrating resources in export, only to have the surplus accumulated in sovereign wealth funds, doesn't sound so great for the average Joe (although you say China is not in the dataset).

As countries get richer, they tend to shift towards services, where productivity growth is slower.

If the objective is (something like) to maximize the consumption of the median citizen, is LatAm doing better relative to Asia then the gulf in economic growth rates suggests? Is there any sense in which LatAm might be better balanced, and Asian economies somehow `unbalanced' and storing up some difficulties for tomorrow despite higher growth today?

I don't know - these are just ideas, and I can see plenty of counter arguments already.

[Tim Worstall]

The bity that's confusing me is the claim that there is falling labour productivity in retail and wholesale.

Links and long outlay of argument here.

http://timworstall.com/2010/09/29/a-howlingly-weird-finding/

But supermarkets have grown from 10% to perhaps 60% of the retail market in Latin America over this time and 2-20% in India and Vietnam (I assume they are in the data set even if China isn't).

So we seem to be saying that supermarkets have lower labour productivity than Mom and Pop systems of distribution. Which is, umm, odd, to say the least.

Are we absolutely certain that labour productivity is being correctly measured?

[Camilo Pizarro]

Agriculture and basic manufacture are stigmatized in "Latin America" as activities for the poor.

From a pure individual perspective, moving to the services sector i.e. restaurant, a store, or something similar would be perceived as progress.

[Mitch]

I think JC above is one to something important when he brings up rural and urban populations. Brazil, for instance, was more urbanized that China at the beginning of the 1980s. A great deal of Chinese growth has been driven by internal migration.

[Greg Van Paassen]

1. Different factor abundance: LA has more land, suggesting trade specialization in agriculture.

2. Anti-free-trade agricultural policies of developed countries constraining growth of agriculture, and food manufacturing, below the productivity growth rate.

Conditions mentioned by other commenters would also have an impact, in particular political instability, disastrous policies, and cultural biases to consumption.

[sam rothstein]

One idea: w/r changed in the period, therefore the optimal K/L also changed.

You have that growing industries are growing by investing more in the relatively cheap K (due to real overvalued exchange rates in the region and tariff reforms). As K increases, PMgL increases too. You have that growing industries grow, K increases in those industries, L is stagnant in those industries, labor productivity in that industry therefore grows and (given the growth of the job market), the share of labor in that industry compared to the employed population is decreasing.

On the other hand, the industries that cannot use more capital (ie, services: you cannot have a robot as a cleaning lady) didnt experience labor productivity gains and increased its share of employment (since L in that industry continues to grow at the same rate as always, like the economy).

What happened to the Labor that is not being absorbed by increasingly productive industries? They are unemployed (and unemployment grew in the '90s, at least in Argentina). Or they are underemployed in the informal sector, which means services. Or they start their own small enterprise

Does this make any sense?

[Jan]

I also think the answer is obvious, but the neoliberals will reject my answer come what may. Very briefly:

Private owners (and their agents)try to maximize enterprise profits, not collective or national welfare. But if they are not corrupted by private owners or other group interests, including caste and clan, the political elite will try to maximize collective welfare.

Surely, democracy has some impact on the political elite's utility function. But affluent residents of stable democracies greatly over-estimate that impact. Far more important is the elite's identity and legitimacy.

And that's why the east Asian economies are rising and certain other national economies are in accelerating decline.

But of course most of the neolibs never will understand. "Science progresses one funeral at a time," Max Planck said.

[T Man]

The IADB's book "The Age of Productivity" convincingly argues that high corporate taxes coupled with high informality work as a subsidy for small low-productivity companies in the service sector. The result is that many of the laid-off workers from the few tax-paying productivity-enhancing companies move to the service sector, where they join or start a small informal business. Given the service sector’s significant weight in the Latinamerican economies, the end result is low national/regional aggregate productivity.

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Technological advance has two sides to it: Product innovation (which increases labor participation) and automation (which reduces it). Depending on a county's international competitive position one or the other will dominate. This study may permit a look at the key issues of the present worldwide crisis if the Groeningen data allow a grouping of current account surplus and deficit countries.

[Daniel]

Is there maybe a relationship with the amount/form of aid received, so that the developments could have been induced by aid related Dutch disease (as argued in Van Wijnbergen ("Macroeconomic Aspects of the Effectiveness of Foreign Aid", JIE, 1986)?

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[Owen]

Could it be that LAC is getting undercut in the tradeable sector by Asia, so labour has to shift to non-tradables?

[escalante blogger]

But it's not a constant change. Perhaps due to loss of supplies.

[wholesaledunk]

ntly, the mechanism through which tradables have achieved significant productivity growth in Latin America (remember the large “within” terms noted above) has been to lay off workers. Such “rationalizati

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[CVR]

Suppose (just for the sake of argument) the only thing happening in an economy was the reallocation of workers with zero MPL in a high productivity sector to a low productivity sector, would you not get the result of high "within" and low "cross" effects? Yet, overall productivity would have increased.

I missed what the difference between the "cross" and "between" effect was.

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