Industrialization and the role of policy

1. Industrialization and the role of policy African Economic Development Renata Serra – Feb 19th 2007

2. Structural transformation • How would you define an economic structural transformation? • The dual-sector economic model (Lewis, Todaro etc.): • The starting point is labor surplus in agriculture … • But it could also be productivity and investment increase in the agricultural/traditional sector • … and investment in the industrial/modern sector • Labor moves from the agricultural/traditional to the industrial/modern sector • Capital accumulation continues to require more labor • Economic growth is a function of the investment rate

3. The imperative of economic diversification • Economic diversification is essential for low-income countries • The relationship between income levels and specialization is negative first and then positive • The fastest growing economies have always a large and increasing share of manufacturing in GDP • Manufacturing shares in SSA, South Asia, MENA and LA&C are now around 15% on average • The major goal is to learn how to do new things and do them well!

4. Advantages from industrialization • Increasing returns • Positive spillovers from technology transfers • Learning-by-doing • Greater chance of further diversification • Jumping into other, high-quality products is more likely • Increase in the share of tradable goods • Better producing tradable than non-tradable goods • In the modernization version, industrial development comes along with urbanization, socio-economic modernization, emergence of a female labor force, decreases in fertility rates…

5. Determinants of industrialization • Geography • Factor endowments • Quality of factors (land and soil; human capital) • Distance to markets • Other geographical characteristics (mountainous country) • History – path dependence • Inherited comparative advantages: static concept • Policies • Comparative advantages can be transformed: dynamic concept

6. Determinants (cont’d) • Other factors are also important, and are determined by policies: • Political security • Macro-economic stability • Institutional and market efficiency • Infrastructures • Savings (domestic or foreign) and investment • Human capital

7. Positive externalities • What are examples of spillovers and externalities from industrial activity? • Ex. of industrial districts: • A firm’s cost function is a decreasing function of the district’s total level of production (or of the number of firms producing the same goods) • Why may individual entrepreneurs invest sub-optimally in these activities? • If externalities, then state policy is necessary. • But which type of policy? • Read Rodrik (2006)

8. Import liberalization • Import liberalization (IL) is intended to stimulate export production • Lerner symmetry theory • But IL may squeeze import-competing sector without stimulating non-traditional exports, if: • The traditional exportable sector exhibits high supply elasticity: X increases, but GDP may decline (remember what is the source of growth!) • There is an increase in the trade deficit • This is Rodrik’s interpretation why IL failed to spur economic growth in Latin American countries

9. Export oriented policies • The non-traditional tradable sector must be nurtured so that it is not penalized by liberalization • Access to cheap inputs, export subsidies, export processing zones • IL follows only in a second phase • Subsidies to the non-traditional tradable sector possibly squeezes the traditional tradable sector, without affecting the import-competing sector • Hence economic growth accelerates • This explains the success of East Asian countries in the past as now (China)

10. Competitive exchange rates • Large budget deficits will discourage non-traditional exports • Because of higher prices, wages, and overvalued exchange rates; and also due to the volatility in exchange rates associated with capital inflows • Governments can try to keep a ‘competitive’ (undervalued) exchange rate through: • Encouragement of capital outflows, restrictions on capital inflows, tighter fiscal policies, nominal devaluations • This is more beneficial to economic growth than inflation targeting, which leads to volatile exchange rates

11. The role of industrial policy • Set of policies conducive to expansion in non-traditional sectors (rather than selection of particular sectors and goods to favor) • Challenges for African governments: • Go beyond IS and support exporting sectors • Align industrial policies with the interests of the economy as a whole (while they mostly failed to promote national interests) • Capture the benefits from greater regional integration