The Future of Development Strategy – 2

with Prof Dani Rodrk

Rodrik also pointed out that in protected segments of the economy not faced with import competition, labor intensive technology continues, but these industries are not likely to be globally competitive. Since this is where the bulk of labor is moving in modern industrialization, there is a “triple whammy” on employment: a direct employment loss due to reduction in output, an additional employment loss due to shift in technique and a reduction in employment elasticity to positive profitability shocks. Rodrik made the case that this amounts to a bias against the comparative advantage of developing countries where low skill labor is abundant, making industrialization much less effective as a vehicle for economic growth.

This poses a question: what is an alternative development strategy that can deliver growth and structural transformation? To answer this question, Rodrik argued that it’s essential to understand what made manufacturing special, which boils down to three things: productivity dynamics that straightforwardly led to unconditional convergence, absorption capacity of a reserve army of low-skill workers and basically unlimited demand through global trade.

As the second feature is no longer true, Rodrik asserted that manufacturing no longer works as a development strategy. Rather, he posed potential alternatives in agriculture and services.

Increases in agricultural productivity can support significant growth, but there is a challenge for this sector to absorb high levels of labor since it faces the same technological upgrading challenge as manufacturing. With services, there are broadly two types: the high-productivity, tradable segment and low-productivity, non-tradable. The former also faces labor-absorption challenges, while the latter are unlikely to generate growth as a consequence of being un-tradeable. A clear dilemma emerges, highlighting the difficulty for developing countries today to benefit from the kind of growth rates that successfully industrializing countries managed to achieve in the past.

According to Rodrik, any development strategy of the future will need to focus on creating better jobs in firms that can absorb more workers – the ‘good jobs’ model. These segments are unlikely to be the large-scale exporters or the most tradable parts of the economy, but instead will be services and small- and medium-sized enterprises (SMEs). This will not lead to Chinese or South Korean rates of growth, but has the greatest potential of achieving both economic development and inclusion

The East Asian industrial policy model is the most common understanding of successful economic development, but according to Rodrik, some of the most prosperous recent industrial policy doesn’t really operate in this kind of ex-ante, top-down sort of government, where there’s a strong disciplining of firms. It has become much more collaborative and iterative, starting out with open-ended goals rather than clear targets. For the challenge at hand, Rodrik suggests that more customized approaches with soft conditionality on job creation, and a focus on SMEs is more likely to support labor absorption than traditional subsidies and tax incentives for export champions. This is necessary in a variety of settings and governance levels including localities and municipalities, considering the focus is on supporting hundreds of smaller firms, rather than a few large ones.

Rodrik pointed to a few critical strengths of this ‘good jobs’ agenda. Firstly, that it targets the productive structure directly rather than providing people with cash grants or general-purpose education and hoping that it will produce employment down the line. Secondly, it breaks through institutional fetishism, encouraging an ongoing iteration and collaboration between state agencies and firms or private sector, so the traditional distinction of markets versus state no longer applies. Thirdly, by directly targeting the productive forces in the economy, equity and inclusion strategies are merged with the growth strategy, becoming one and the same.

Following the lecture, Dilip Mookherjee, Director of the Boston University Institute for Economic Development and Professor of Economics, joined Rodrik on stage to discuss questions from the audience. The discussion explored the role of development banks in development strategies, insights regarding middle-income countries, regionalization, migration, job-creation strategies in Africa, the role of climate change technology, direct investment strategies and the relevance of this approach in advanced economies.

Where will the good jobs come from?

I conclude that the key question facing economic development strategy is: “Where will the good jobs come from?”. Good jobs need to be productive – but not necessarily the MOST productive – jobs.  They need to be consistent with skill endowments. And they cannot be created by informal, low productivity firms. It seems inevitable that domestic services will become a crucial part of the answer.

To support the growth of good jobs, growth policy, jobs policy and social policy will need integrating, with complementary interventions for labor supply and demand.  Education and skills will remain crucial. But we also need a new industrial policy. The matrix in figure 2 illustrates possible points of entry. Until now, we’ve focused industrial policies on high productivity sectors, supporting innovation and trade agreements for global market access. Meanwhile, social policies have focused on the low productivity population, including education and training programs, and redistributive transfers.

How should jobs policies in developing countries respond to the emerging pattern of structural change? “Kuznets’ paradigm” for jobs and structural change no longer holds. Kuznets expected labor to move gradually from informal agriculture into better jobs with higher productivity and wages in well-organized, formal manufacturing and (eventually) services.

But in Sub-Saharan Africa, we see labor moving out of agriculture into informal jobs in both services and manufacturing. There are few formal jobs. Even in manufacturing, informality predominates. We can observe this clearly in Ethiopia and Tanzania. It contrasts with what happened a generation ago, in places such as Taiwan and Vietnam, where formal manufacturing jobs were the key to structural transformation. In Ethiopia, for example, manufacturing jobs are growing – they rose from 3% to 10% of jobs in the last ten years. But formal manufacturing jobs are stagnant. Manufacturing is experiencing exacerbated dualism. There’s a cluster of large, formal firms with high productivity and few jobs – and thousands of small, informal, low productivity firms, with lots of jobs.

Conventional hypotheses would explain this by market failures that affect small firms – such as high labor costs and capital market failures. But there’s little evidence of a “missing middle”. And at the top end of the distribution of firms, the capital intensity of formal manufacturing in Tanzania and Ethiopia is higher than in the Czech Republic. This is inconsistent with their factor endowments, where low-skilled labor is abundant and capital is scarce and expensive.

The explanation may be that frontier technologies tend to be shared across economies. So, Ethiopia and Tanzania’s formal manufacturing firms are importing technologies that predominate in global markets and reflect global factor endowments. As a result, the global collapse in demand for low skilled jobs in manufacturing is being replicated in Sub Saharan Africa. Figure 1 shows you what might be happening.

The starting point is that there are two sets of technologies – the capital-intensive technology on the left, and a more labor-intensive technology towards the right. At first, low-income countries use the latter. With the market price at Po, the labor-intensive technology is more profitable. But then, the system is shocked by a downshift in the cost function for capital intensive technologies (e.g. due to automation). The result is a new (lower) global market price (Pi), which lies below the entire (unshifted) cost function for the labor-intensive factories.

So, Low-Income Countries (LICs) no longer have a comparative advantage in labor intensive manufacturing. Their output falls (due to the loss of market share) and jobs are cut even more (because the lost output was relatively labor intensive). Note, also, that the new cost curve for the capital-intensive segment is steeper than the old one, reflecting the increased marginal importance of skills and other expensive complements, such as public infrastructure, to output growth. So, it’s harder for skill-constrained, infrastructure-poor LICs to transition to this model.

What are the alternatives to manufacturing-led jobs growth? Can other sectors absorb large amounts of low skilled labor? Can they exploit global markets, so their growth isn’t hampered by domestic demand constraints ? Unfortunately, it’s hard to see how agriculture and tradeable services tick those boxes. Jobs in agriculture will have to shrink, as productivity rises faster than demand.  High productivity, tradable services have few jobs and don’t match the skill endowments of LIC economies. Even success stories like India and the Philippines have hit skill constraints.

I conclude that the key question facing economic development strategy is: “Where will the good jobs come from?”. Good jobs need to be productive – but not necessarily the MOST productive – jobs.  They need to be consistent with skill endowments. And they cannot be created by informal, low productivity firms. It seems inevitable that domestic services will become a crucial part of the answer.

To support the growth of good jobs, growth policy, jobs policy and social policy will need integrating, with complementary interventions for labor supply and demand.  Education and skills will remain crucial. But we also need a new industrial policy. The matrix in figure 2 illustrates possible points of entry. Until now, we’ve focused industrial policies on high productivity sectors, supporting innovation and trade agreements for global market access. Meanwhile, social policies have focused on the low productivity population, including education and training programs, and redistributive transfers.

Instead, we should focus on the middle productivity activities that can produce lots of better jobs.  As we do so, the potential for creating good jobs in domestic services will loom large. Supporting this process means addressing complex problems. Uncertainties preclude the likely effectiveness of simple Pigouvian employment subsidies. We should consider, instead, customized business incentives, explicitly designed to create jobs, e.g. by using soft conditionalities, and not necessarily focused on export champions.

Across the board, governments should integrate the large externalities that are linked to better jobs into their funding decisions for training and the incentives for investment and the choice of technology.  This is a “structuralist” or “productivist” approach, which merges the equality/inclusion agenda with the jobs and economic growth agenda.

posted by gandatmadi46@yahoo.com

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