The Future of Development Strategy – 1

With Prof Dani Rodrik

At the very basic level, development strategy is about overcoming the challenges of economic development through structural transformation. This means tackling dualism between islands of productivity amid poverty. The traditional understanding of achieving this transformation is moving workers from parts of the economy where productivity is very low and informality is high to more dynamic, modern parts of the economy, such as manufacturing and services. This is a challenge increasingly reappearing in advanced economies, including the United States.

Development Model

What typically happens in the course of this industrialization is that relatively, unskilled less-educated, unproductive subsistence farmers move into urban areas to become higher-productivity, urban workers (the first arrow). After becoming a middle-income country, workers move into a higher productivity sector in services (the second arrow). Typically, the more rapid this transformation, the more rapid the growth.

Rodrik argued that what is happening today is very different from this traditional model of development. The movement of labor out of agriculture is still happening, but the actual employment absorption into manufacturing is much less rapid and much less visible. In fact, in low-income countries, the bulk of the workers that move into urban areas are moving into services. Most of these are informal, petty activities where productivity is not significantly higher than in traditional agriculture, meaning countries are not getting the economic benefits of technological upgrading. This triggers a process Rodrik has coined as ‘premature deindustrialization’, where low- and middle-income countries move away from manufacturing at a much faster pace.

Rodrik went on to compare historical economic development in East Asia with contemporary economic development in industrializing countries. In the Vietnamese and Taiwanese examples, the formal component of employment tracks the very rapid rise in employment, whereas in Ethiopia and Tanzania, new employment instead tracks with the informal economy while formal employment has remained flat. Taking a closer look, Rodrik finds that productivity in these informal firms in manufacturing has been essentially stagnant. This indicates increasing dualism within manufacturing: big firms are highly productive and successful and small informal firms have poor productivity, and the latter is where all new employment is going.

While it is puzzling to understand the full picture of why this is happening, one theory Rodrik is working on with colleagues focuses on the nature of modern technology. The large, high productivity firms in Ethiopia are using capital-intensive technologies that are typical in much richer countries. This indicates these countries are borrowing unsuitable technologies to become more productive and therefore more competitive in global markets, but this creates a dilemma whereby these firms cannot absorb labor at high levels. This is the same reason that very capital-intensive technology sectors in advanced economies are not absorbing a lot of labor but are in fact losing workers, highlighting that this trend is driven by something that has nothing to do with what’s happening in individual countries.

Normally, lower-income, developing countries would choose labor-intensive industries due to their comparative advantage of cheap labor, but as high-productivity, automated technologies become cheaper, they are forced to adapt to remain competitive. Unfortunately, adopting these capital-intensive technologies is less profitable for low-income countries, whether because of tech transfer frictions or higher capital costs.

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