2b: Growth and structural change

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OverviewStylized facts of economic structure and

structural changeSimple 2-sector models of economic structure &

changeClassical development theory: the dual economyNeoclassical two sector model

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Growth and structural changeGrowth inevitably involves change in product mix

of production, demand and tradeGrowth causes structural change:

in the sectoral composition of GDP

in the allocation of labor and other resources

in the distribution of income by factors (L, K, etc) by households (rural, urban, etc)

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Growth & structural change: stylized factsIn the poorest countries, agriculture generates largest

share of income, employment and trade revenuesThe relative decline of agriculture is driven (in part) by

economic expansion & growth of per capita incomeDemand changes: Engel effectsRelative factor endowment growth rates (“Rybczinski

effects”)Relative factor productivity differentials

Policies & global markets may also play a role In general, poor countries tax agriculture to finance

industrialization, reducing agr. profitability and investmentGlobal market prices may signal incentives for some

sectors to expand, others to contract Policies that increase international integration may matter

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Tools: sectoral production functionsAggregate production function Y = F(K, L)Sector (industry) level production function Yj =

Fj(Kj, Lj), for all industries jGDP (value-added):Factor employment:

Total factor supply:So full employment of factors constrains total output:

Ex.:Maximum output that can be produced subject to

factor supply constraints: production possibilities frontier

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€

G= P jY jj=1

N∑ = P jF j(K jLj)j=1

N∑

€

L, K

€

L=L1 +L2 +L3...

Growth implies outward shift of PPF

Assume: M sector is K-intensive, A sector is L-intensive

Growth: factor accumulation: ΔK, ΔL, or technical progress

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A A

M M

Equal rates of K and L accumulation

OR Equal rates of technical progress in both sectors

Faster rel. rate of K accumulation

OR faster technical progress in manufacturing sector

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Agriculture

Manufacturing

‘Balanced growth’ line - no str. change

CD

Balanced growth: equal rates of K and L accumulation --> equal growth rates of ag. & mfg. sectors

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Agriculture

Manufacturing

‘Balanced growth’ line - no str. change

CD

Rise in GDP, measured in terms of manufactures at constantprices

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Agriculture

Manufacturing

C E

Unbalanced growth: faster rate of K accumulation faster relative growth rate of M sector.• What happens to the composition of GNP?

Price changes and structural change• Exogenous change in world market price ratio

Ex. Food price rise: pA’ > pA, so pA’/pM > pA/pM

Alters optimal mix of goods produced

• Endogenous changes– Engel effects: As incomes rise, budget share of food

diminishes. – Domestic valuation of ag. relative to mfg. will decline;

if prices are set in domestic markets, pA/pM will decline

• Policies that alter prices. Ex. tariff at rate tM: pM(1+tM) > pM, so pA/pM(1+tM) < pA/pM

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Agriculture

Manufacturing

C

E

Is full employment constraint realistic in a poor economy?Structural change stories are driven in part by

the need to ‘give up’ factors from one sector in order to permit another to expand

Assume full employment of factorsMuch ‘hidden’ unemployment in low-income

economiesEx.: in Vietnam, many rural and unskilled workers

report working less hours than they would like“Classical” development models did not assume

full employment

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The dual economy modelExamines growth and str. change of an economy

with surplus labor in agriculture. Surplus labor: marginal product of labor in ag. is

initially zeroOutput sharing: each ag. worker receives average

product, not marginal product, so wage in ag > marginal product of L

Can withdraw some labor without reducing total ag. production

Thus growth = expansion of industry, with unchanged ag. output (compare Rybczinksi)What happens to sectoral GDP shares?

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Industry wage

Wage in ag.

Subsistence ag wage = AP(L)

Total ag.output(read from right

to left)

Labor in industry

Labor in ag.

Labor in ag. f L1A g h 0

Industry labor demands

D1

L1M

YA

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Industry wage

Wage in ag

Subsistence ag wage

Total ag.output(read from right

to left)

Labor in industry

Labor in ag.

Labor in ag. f L1A L2

A g h 0

Industry labor demands

D1

L1M

D2

L2M

YA YA

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Industry wage

Wage in ag

Subsistence ag wage

Total ag.output(read from right

to left)

Labor in industry

Labor in ag.

Labor in ag. f L1A L2

A g L3A h 0

Industry labor demands

D1

L1M

D2

L2M

D3

L3M

YA YA YA

Thoughts on dual economy“Traditional” vs. “modern” dichotomy; assumed

“irrationality” of behavior in former sectorOrigins in studies of SE Asia (Boeke; Higgins, 1950s)

Alt. characterization: “traditional” sectors are constrained by mkt failures (esp. capital mkt) & by risk, social normsDual development patterns consistent with this

What kinds of data might verify DE assumption?What about income distribution as dual economy

develops?Functional distbn = shares of income paid to labor, land,

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The neoclassical two sector modelSimilar to “final” phase of Lewis modelNo labor can be transferred without a reduction in ag. outputA stagnant agricultural sector, i.e., one with little new

investment or technological progress, will cause wages of workers in industry to rise rapidly and thereby reduce profits and investment

Industry will develop successfully only if agriculture grows fast enough to catch up with higher levels of consumption and prevent the terms of trade from turning against industry

In the labor-surplus model, planners can ignore agricultural development until the surplus of labor is exhausted

But in the neoclassical model there must be a balance of growth rates between industry and agriculture

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Industry wage

Wage in ag

Subsistence ag wage

Total ag.output(read from right

to left)

Labor in industry

Labor in ag.

Labor in ag. f L1A L2

A g L3A h 0

Industry labor demands

D1

L1M

D2

L2M

D3

L3M

YA YA YA

Prying open the Lewis and Solow models

Why are product prices assumed fixed if producers sell only to the domestic market?

Does industry growth really come only from domestic savings and investment?

Imports of capital goods and intermediates are important

How are these paid for? Natural resource exportsDoes structural change explain part of divergence?

Product cycle: increasing capital-intensity in production delays diminishing returns to capital Depends on international markets with elastic

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