Monday, February 28, 2011

U-curve in economic development

Relative productivity of agriculture exhibits a U-shaped pattern over the course of development, argues Rodrik. Labor productivity first falls and then rises, as countries get richer.

Within countries as well, the trend is consistent.

Why does this happen? Because new, high-productivity activities (typically outside agriculture) are needed for development to happen. Relative productivity in agriculture falls. Labor tends to move from low to high productivity activities as economies grow. The gap between productivity in agriculture and non-agriculture reduces. Diminishing marginal returns (in terms of productivity) gradually kicks in on non-agriculture sector. Relative productivity in agriculture sector again rises and the curve starts to slope outward.

economic development requires both new activities (diversification) and ongoing transfer of resources from traditional to modern activities. Some countries are stuck with no new industries, so they never grow. Others get a few new industries (e.g. mining and other natural resource-based industries), but these do not expand sufficiently and absorb much labor, so development gets stuck at an intermediate level of income. The real successful countries are those that pull off both tricks.