ISSUE 02
PARTNER FOR PROSPERITY
MAY 2012
policy brief
CLIMBING THE STAIRWAY OF DEVELOPMENT Structural change as the driver of economic growth • • • •
Key messages Economic growth and development are closely linked to structural change. The nature and pace of structural change drive the rate of economic growth. Shifts in sectors and industries away from labour-intensive towards skill- and capital-intensive activities contribute to raising a country’s income level. Inter- and intra-industrial structural transformations can foster growth through increases in productivity and technological development. Structural change takes place under widely varying conditions, and therefore strategic industrial policymaking cannot be standardized. The relative attractiveness and strategic feasibility of individual industries must be carefully considered in the context of a country’s specific features.
Structural change can foster economic development
Fig. 1 Economic growth and structural change in the industrial sector (average annual change in share of output in the period 1970–2003)
Economic growth and development are intrinsically linked to changes in the structure of economic activity, i.e. to structural change. Structural change generally refers to long-term changes in the relative importance of sectors in an economy in terms of production and share of capital and labour. Structural change can lead to economic diversification, upgrading and deepening, which in turn boost economic growth, reduce economic volatility, create employment opportunities and enhance integration into the global economy. If the direction of structural change is misguided, or if its pace is too slow, the economy will stagnate. ··· the nature and speed of structural change affect the rate of economic growth ··· Structural change as the transition from low-productivity activities with low value—such as agriculture or garment production—to high-productivity activities that can absorb surplus labour, generate higher profits and wages, and are more closely associated with technological development and innovation—such as manufacturing or motor vehicle production, promotes economic growth. Structural change enables the productive sectors to be integrated into the domestic economy, thereby strengthening domestic linkages (Ocampo and Vos, 2008). The speed at which such a transition takes place also has an impact on the rate of economic growth: countries that quickly climb the ladder towards more technologically advanced economic activities grow more rapidly and are more successful in lifting people out of poverty (McMillan and Rodrik, 2011).
Source: United Nations Department of Economic and Social Affairs, 2006
the traditional agricultural sector, and the rapid expansion of the industrial sector and subsequent higher value added production (Fig. 1). When the programme of economic reforms was initiated in China in 1978, 70.5 percent of the total labour force was engaged in primary sector activity (National Bureau of Statistics of China, 2010). This figure declined to 38.1 percent in 2009, while those working in secondary and tertiary industries rose from 17.3 percent to 27.8 percent and from 12.2 percent to 34.1 percent, respectively, in the same period. Today, China is an economic powerhouse on account of its planned and profound structural change, spurred by economic reforms, liberalized foreign trade and investment and a sustained increase in productivity.
As an economy grows, the share of sectors changes (Fig. 2). The remarkable economic growth of China and South-East Asia, for example, is linked to the decline in the significance of Likewise, different industries contribute to the economy more
policy brief
Lin (Lin and Chang, 2009) argues that an economy’s optimal industrial structure at a given point in time should correspond to the country’s endowment structure and its comparative advantage at that particular moment: as capital accumulates and becomes relatively cheaper, a country’s labour-intensive industries should undergo a process of upgrading towards more capital-intensive ones. Chang (Lin and Chang, 2009), on the other hand, asserts that governments can promote investments in physical and human capital which will accelerate the growth of already existing industries or advance the emergence of entirely new industries. That is, governments can implement specific policies that support the development of new industries which ‘defy’ the country’s current comparative advantage and thus generate the technological capabilities necessary to achieve economic growth. ··· structural change entails a shift from the agricultural to the manufacturing and the services sectors ··· Diversification away from the primary sector (for example, agriculture) into high- and rapidly growing productivity sectors triggers a process of sustained growth (inter-sectoral structural change) (Fig. 2). As the share of the total workforce in the primary sector declines in favour of the manufacturing (secondary) and services (tertiary) sectors, the intersectoral process of resource allocation results in systemic changes in the composition of domestic demand, generating a continuous rise in the level of skills, productivity and wages, and, as a consequence, increasing consumer purchasing power. A clear-cut distinction between the secondary and the tertiary 2
UNIDO Policy brief | May 2012
Fig. 2 The global pattern of structural change away from agriculture into industry and services Source: Based on UNIDO dataset
at different stages of a country’s development (Fig. 3). The wearing apparel industry, for example, which is a labour-intensive industry, grows quickly during the early stages of a country’s development, yet decreases rapidly after a level of US$ 8,000 GDP per capita is reached. The motor vehicle industry, by contrast, begins growing once a level of US$ 8,000 GDP per capita is reached (see Fig. 3). Industries with a higher development potential change continuously as the level of income in a country increases.
sectors is not always possible – high-valueadded, manufacturing-related services, such as design, R&D and logistics, are not pure services. They are triggered by manufacturing growth and in the past were considered part of the manufacturing sector. Hence, they linger somewhere on the periphery between the two sectors. This implies that the growth of certain service industries is contingent on productivity growth in specific manufacturing industries. ··· shifts also take place across and within manufacturing industries ··· Domestic and international competition as well as innovation continuously force a country's manufacturing sector to change. Shifts take place in the form of diversification Fig. 3
from labour-intensive industries such as textiles and apparel, which are characterized by low skill-, capital- and technology intensity, to industries which have high skill-, capital- and technology intensity, such as the production of advanced machinery, automobiles or chemicals (inter-industry structural change) (Fig. 3). These interindustry shifts involve the reallocation of investments and resources from one industry to another and the emergence of new industries. Manufacturing structural change also entails shifts in the form of expansion and upgrading within existing industries (intra-industry structural change), thereby improving the country's domestic and international position. Examples include moving away
The global pattern of structural change within the manufacturing sector
Source: Based on INDSTAT, 2012
policy brief Structure of MVA in the Republic of Korea (1963) and Indonesia (1977) at US$ 2,000 GDP per capita
Source: Based on INDSTAT, 2012
Fig. 4
from mass-market garments to more exclusive collections or from the production of low-value fibres to high-tech fibres for specialized applications. Intra-industry shifts also involve industrial deepening which result in the creation of more forward and backward linkages within industries, as well as of complementarities between different sectors and industries within a country. Such shifts usually generate the introduction of new and superior technologies and machinery, higher quality inputs and raw materials and new production processes. Structural change in action: The development experience of the Republic of Korea and Indonesia Structural change analysis is a powerful tool with which to compare and contrast the development experience of different countries. Looking at how much and how fast countries have diversified the structure of their manufacturing sector as they climbed the stairway of development can reveal useful insights into the sustainability of their growth strategies. A comparison of the development experience of the Republic of Korea and Indonesia, two countries with similar comparative characteristics relative to the world’s average level, illustrates this point. Figure 4 compares the structure of the manufacturing sector in the Republic of Korea and in Indonesia when both countries had roughly reached the same level of development (US$ 2,000 GDP per capita), namely in 1963 and 1977, respectively. The figures indicate that
both countries had similar production structures, with resource-based and labour-intensive products (such as chemicals, food and beverages, tobacco and textiles) accounting for nearly 50 percent of MVA (manufacturing value added). In fact, the overall structure of manufacturing in Indonesia was slightly more diversified than in the Republic of Korea, as denoted by the flatter red curve.
industries such as electrical machinery and apparatus and motor vehicles grew by six and five percent, respectively.
In contrast, the pace of structural change was slower in Indonesia and did not follow the average trend: the share of resource-based and low-tech industries actually increased at the expense of medium- and high-tech ··· the extent of diversification was industries (except motor vehicles). much higher in the Republic of ··· the Republic of Korea's Korea than in Indonesia ··· economy grew rapidly ··· Figure 5 compares MVA in both This variance in the nature and pace the Republic of Korea and Indonesia of structural transformation is associated when their income levels reached with differing GDP per capita growth approximately US$ 5,200 GDP per rates: in the Republic of Korea, GDP per capita, in 1977 for the Republic of capita grew seven percent in the period Korea (i.e. within 14 years) and in 1963-1977, but in Indonesia only by a 2007 for Indonesia (i.e. within 30 more modest three percent between years, nearly twice as long). The extent 1977 and 2007. In other words, although of diversification was higher in the case of the Republic of Korea than in both countries started off with similar Indonesia, where the economy production structures at the same GDP remained relatively more concentrated per capita level, the Republic of Korea (this is denoted by the red curves in was able to successfully transform its Figure 4 and 5—the Republic of structures of production to become one Korea's curve became much flatter of the fastest-growing manufacturing over the years while that of Indonesia economies in the world. did not change significantly). The In Indonesia, on the other hand, no changing pattern of production in the profound structural changes took Republic of Korea is comparable to the place, i.e. the composition of industry average trend of structural change did not change significantly and the illustrated in Figure 3, with a pace of transformation was sluggish, significant decline in resource-based resulting in a much slower growth of low-tech industries and an expansion the country’s economy. of medium- and high-tech industries. Accordingly, the food and beverages, Climbing the stairway of tobacco and textiles industries in the development: The need for effective industrial policies Republic of Korea declined by five, Structural change takes place under eight and four percent, respectively, while more high-skill intensive widely varying conditions, and strategic unido policy brief | may 2012
3
policy brief Structure of MVA in the Republic of Korea (1977) and Indonesia (2007) at US$ 5,200 GDP per capita
Source: Based on INDSTAT, 2012
Fig. 5
industrial policymaking can therefore not be standardized, despite the fact that development experiences show that countries usually follow a stylized pattern of manufacturing development. Industrial policymaking must therefore be tailored to the country’s specific circumstances (already existing manufacturing activities, stage of development, endowment structures, country size, etc.) to promote structural change and economic growth. Identifying the development patterns of the manufacturing sector can help policymakers elaborate a long-term development strategy with regard to when a given manufacturing industry is likely to contribute most to the country’s economic development and at what point in time to shift to services. If policymakers are aware of which industries will promote or inhibit development at different levels of income and given certain country characteristics, they can pursue a path of industrialization consistent with their country-specific features by investing in those industries that are most likely to succeed.
This is particularly relevant for sustained economic growth, as the decline of certain industries needs to be substituted by the emergence of others in the continuous process of structural change.
activities will only be feasible in the medium- and long-term through building new capabilities).
··· market forces and the government play a role in diversification and upgrading of production structures ···
There is widespread agreement among development economists that structural change is necessary for economic growth, and that the state— and not market forces alone—has a role to play in promoting economic development and technological advancement. It is also agreed that the government should not attempt to modify the structures of the current economy too quickly or too drastically. Yet, how closely a government’s industrial policies should conform to the country’s current comparative advantage or to what extent a country’s industrial structure should deviate from it, continue to be debated.
The diversification and upgrading of production structures is predominantly driven by private entrepreneurs and market forces. However, the government plays an important role in assisting the private sector in the exploration of new upgrading and diversification opportunities, and in the improvement of information and knowledge flows. A successful industrial strategy thus involves careful consideration of the relative attractiveness of given industries (i.e. the economic growth potential of specific sectors at the country’s current level of development) and the strategic feasibility of individual manufacturing sectors (i.e. which manufacturing activities are immediately viable, given available capabilities, and which
··· to conform or to deviate from the country’s current comparative advantage ···
For further information, contact: A.Alcorta@unido.org or visit: www.unido.org
Further reading Lin, J. and Chang, H.-J. (2009), Should Industrial Policy in Developing Countries Conform to Comparative Advantage or Defy it? A Debate Between Justin Lin and Ha-Joon Chang. Development Policy Review, 2009, 27 (5): 483–502. McMillan, M. and Rodrik, D. (2011), Globalization, Structural Change and Productivity Growth, in Making Globalization Socially Sustainable, Bacchetta, M. and Jansen, M. (eds.), Geneva: International Labour Office and World Trade Organization. National Bureau of Statistics of China (2010), China Statistical Database, http://www.stats.gov.cn/english/statisticaldata/yearlydata/ Ocampo, J.-A. And Vos, R. (2008), Structural Change and Economic Growth, in Ocampo, J.-A. and Vos, R. (eds.): Uneven Economic Development, London: Zed Books. United Nations Department of Economic and Social Affairs (2006), World Economic and Social Survey 2006 – Diverging Growth and Development, New York: United Nations Department of Economic and Social Affairs. UNIDO (2010a), In Search of General Patterns of Manufacturing Development, Working Paper 02/2010, Vienna: United Nations Industrial Development Organization. UNIDO (2010b), Emerging Patterns of Manufacturing Structural Change, Working Paper 04/2010, Vienna: United Nations Industrial Development Organization. UNIDO (2011), Industrial Policy for Prosperity: Reasoning and Approach, Working Paper 02/2011, Vienna: United Nations Industrial Development Organization. 4
UNIDO Policy brief | May 2012