Inter-sectoral productivity gaps and structural change

Structural change happens when an economy shifts its sources of growth and employment from agriculture to non-agriculture activities. As factors of production (labor and capital) move away from agriculture into modern economic activities overall productivity rises and incomes expand. The rate at which overall productivity rises in different non-agriculture activities (inter-industry productivity gaps) plays a vital role in bringing about and sustaining this change. [Productivity is defined as the ratio of each sector’s value added to employment in that sector.]

When compared to developed countries, developing countries are characterized more by large productivity gaps among firms and plants within same industry. This is indicative of allocative inefficiencies that reduce overall labor productivity. The inter-sectoral productivity gaps (the differences in average labor productivity) are a feature of underdevelopment.

But, productivity gaps among firms in the same or different industry can be an important source of growth, argues Rodrik and McMillan (2011) in the latest working paper (Globalization, Structural Change, and Productivity Growth). The reason is that when factors of production (mostly labor and capital) move from less productive to more productive activities, the economy grows even if there is no productivity growth within sectors. The movement of labor from low-productivity to high-productivity activities raises economy-wide labor productivity. This is growth-enhancing structural change, which the high-income countries have. The main messages of their paper are:

• In many Latin American and Sub-Saharan African countries broad patterns of structural change have served to reduce rather than increase economic growth since 1990. Factors of production (labor) are moving into less productive sectors (informal and agriculture) from more productive ones in these regions. The opposite happened and is happening in Asia. This is especially true after trade liberalization as competition forced firms to exit the market, forcing them to lay off workers who ended up in the informal sector and low paying services job. [This is happening in Nepal as well. A number of garment workers that were laid off beginning 2000 have gone into the informal sector where wages are low.] The average manufactures-agriculture productivity ratio is 2.3 in Africa, 2.8 in Latin America, and 3.9 in Asia.
  
• Factors that help determine if structural change is going in the right direction (and policy intervention might help): (i) Economies with relative comparative advantage (RCA) in primary products are at a disadvantage as their large share of natural resource exports means that the scope of productivity-enhancing structural change is narrow. These sectors cannot absorb much surplus labor form agriculture. (ii) Countries that maintain competitive or undervalued currencies tend to experience more growth-enhancing structural change as there is positive effect of undervaluation on modern, tradable industries. (iii) Countries with more flexible labor markets have greater growth-enhancing structural change as rapid structural change occurs when labor mobility across firms and sectors is high. [(ii) and (iii) is true in the case of Nepal; (i) may be true if we starting producing hydroelectricity and export it to India like Bhutan is doing.]
  
• Agriculture is the sector with the lowest productivity in poorest economies.
• During economic growth the productivity gap between agricultural and non-agricultural sectors first increases and then falls, exhibiting a U-shaped pattern (ratio of agricultural to non-agricultural productivity with respect to economy-wide labor productivity). The turning point comes at an economy-wide productivity level of around $9000—a development level somewhere between that of India and China. Initially, there is no large productivity gap between agricultural and non-agricultural sectors in poor countries. As economy grows, labor begins to move from traditional to modern sectors, thus leading to convergence of productivity levels across sectors in the economy [First, labor moves from agri to non-agri sector, increasing productivity in non-agri sector and also in agri sector (due to less labor). Then, diminishing marginal returns kicks in in the non-agri sector. Eventually, productivity level converges within sectors and also within countries with same income levels.]

• Differential pattern of structural change account for a bulk of the difference in regional growth rates.
• Domestic convergence, just like convergence with rich countries, is not an unconditional process. Starting out with a high share of labor force in agriculture may increase the potential for structural-change induced growth (not applicable to those having strong comparative advantage in primary products), but the mechanism is clearly not automatic.

This paper contributes Hausmann’s and his work on structural change induced by “jumping monkeys”, where production is moved from one product to another having similar features and using pretty much similar (or upgraded) factors of production. It involves (structural change) moving from the production of peripheral goods to core goods in product space.

Causes of the Great Trade Collapse of 2009

This blog post is adapted from Robert C. Feenstra’s¹ summary of research of the International Trade and Investment (ITI) Program at NBER. It summarizes various papers that explore and explain the causes of the great trade collapse of 2009. Here is a blog post about what economists thought were the reasons for the collapse in trade by about 30 of world GDP in 2009.

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The financial crisis and great recession of 2008-9 brought with it a "great trade collapse": world trade relative to GDP fell by nearly 30 percent between these two years, exceeding the experience of other post-war recessions. Why did trade fall so much, and why did it recover relatively quickly? The leading explanations stress, in varying degrees, the roles of: inventory adjustment for imports; demand for durable versus non-durable goods; the use of intermediate inputs in trade, which might magnify the impact on trade as "supply chains" are temporarily disrupted; and the role of trade credit, which appears to have dried up temporarily during the crisis.

Beginning with the last of these explanations, Kalina Manova and her co-authors provide the strongest evidence supporting the role of credit constraints on exports. These constraints limit the extensive margin of exports in sectors that are most vulnerable to financial stress.² Furthermore, she argues that such sectors faced greater reductions in their exports to the U.S. market during the financial crisis. ³ That idea is confirmed for Japan by Mary Amiti and David Weinstein.⁴ They find that Japanese exporters faced greater reductions in their sales abroad if they were affiliated with main banks that performed poorly. Focusing on China, my co-authors and I find that firms faced tighter credit constraints on their exports than on their domestic sales, and that exports experienced a significant slowdown because of the 2008 crisis.⁵ Ann E. Harrison and her co-authors find that, for the United States, import prices often rose during the crisis, which is inconsistent with falling demand but can arise from a supply constraint, such as a lack of export credit.⁶

Other work casts some doubt on the importance of export credit. George Alessandria and co-authors instead stress the role of inventory adjustment, which can lead to a rapid fall in imports as stocks are adjusted downwards.⁷ Andrei Levchenko, Logan Lewis, and Linda Tesar also find a limited role for trade credit in their regression analysis of U.S. trade, but they use an accounting definition of "trade credit" that applies equally well to exports or domestic sales.⁸ As an alternative explanation, they find that sectors which are more reliant on imported intermediate inputs suffered more during the crisis, because these supply chains were temporarily disrupted. Fabio Ghironi and his co-authors also stress the importance of imported inputs. They model the different components of aggregate demand (consumption, investment, government spending, and exports) as having different import intensities.⁹ They then construct a weighted average of those factors with the weights reflecting their import intensities. Using the resulting variable as an income term, and including an import price, they are able to construct a model that predicts the fluctuations in import demand during the current crisis and earlier episodes much more accurately than do conventional methods that rely on GDP and aggregate prices.

Of course, in the end it will be a combination of factors that explain the great trade collapse: even if inventories or imported intermediates are more important quantitatively, that finding need not detract from the significance of trade credit. Amiti and Weinstein, for example, argue that trade credit can account for about 20 percent of the fall in exports for Japan, so it was not the most important factor, but it was still economically significant. That point is also made for Peruvian exports by Veronica Rappoport and co-authors, who argue that the reduction in loans from banks performing poorly reduced aggregate exports by 15 percent during the crisis.¹⁰ Perhaps the most comprehensive evaluation of the different factors contributing to the great collapse in trade was written by Jonathan Eaton, Sam Kortum, Brent Neiman, and John Romalis.¹¹ They argue that the relative decline in demand for manufactures was the most important driver of the decline in manufacturing trade, and especially the decline in demand for durable manufactures. These factors account for more than 80 percent of the global decline in trade/GDP. While they find that trade frictions increased and played an important role in reducing trade in some countries, notably China and Japan, these frictions only had a small impact on global trade.

¹ Feenstra directs the NBER's Program on International Trade and Investment and is a Distinguished Professor of Economics at the University of California, Davis.

² K. Manova, "Credit Constraints, Heterogeneous Firms, and International Trade," NBER Working Paper No. 14531, December 2008.

³ D. Chor and K. Manova, "Off the Cliff and Back? Credit Conditions and International Trade during the Global Financial Crisis," NBER Working Paper No. 16174, July 2010.

⁴ M. Amiti and D. E. Weinstein, "Exports and Financial Shocks," NBER Working Paper No. 15556, December 2009.

⁵ R. C. Feenstra, Z. Li, and M. Yu, "Exports and Credit Constraints under Incomplete Information: Theory and Evidence from China," NBER Working Paper No. 16940, April 2010.

⁶ M. Haddad, A. E. Harrison, and C. Hausman, "Decomposing the Great Trade Collapse: Products, Prices, and Quantities in the 2008-2009 Crisis," NBER Working Paper No. 16253, August 2010.

⁷ G. Alessandria, J. P. Kaboski, and V. Midrigan, "The Great Trade Collapse of 2008-09: An Inventory Adjustment?" NBER Working Paper No. 16059, June 2010.

⁸ A. A. Levchenko, L.T. Lewis, and L. L. Tesar, "The Collapse of International Trade During the 2008-2009 Crisis: In Search of the Smoking Gun," NBER Working Paper No. 16006, May 2010.

⁹ M. Bussiere, G. Callegari, F. Ghironi, G. Sestieri, and N. Yamano, "Estimating Trade Elasticities: Demand Composition and the Trade Collapse of 2008-09," presented at the International Trade and Investment Program Meeting, March 25-26, 2011.

¹⁰ D. Paravisini, V. Rappoport, P. Schnabl, and D. Wolfenzon, "Dissecting the Effect of Credit Supply on Trade: Evidence from Matched Credit-Export Data," NBER Working Paper No. 16975, April 2011.

¹¹J. Eaton, S. Kortum, B. Neiman, and J. Romalis, "Trade and the Global Recession," NBER Working Paper No. 16666, January 2011.

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Finance-Trade-Growth nexus

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We study linkages between financial development, international trade, and long-run growth using data since 1880 for seventeen now-developed “Atlantic” economies and a set of cross-country and dynamic panel data models. We find that finance and trade reinforced each other before 1930, but that these effects did not persist after the Second World War. Financial development has positive effects on growth throughout the sample period, while trade affects growth strongly and independently after 1945. We attribute the rising importance of trade in explaining growth to major post-World War II changes in tariffs and quantity restrictions associated with the GATT, the establishment of the European Common Market, and the gradual elimination of capital controls after 1973. The findings are robust to the use of ‘deep’ fundamentals such as legal origin and indicators of the political environment as instruments for financial development and trade. Financial development, however, is more closely linked to these fundamentals than trade.

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Abstract from a paper by Bordo and Rousseau (2011). Read the full paper here.

Changes are coming to Nepal–The Youth Dividend!

[This was published in The Week, Republica National daily, May 20, 2011, p.10]

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Changes are coming to Nepal

Chandan Sapkota & Rita Shrestha

The prevailing perception right now is that whatever progress we’ve achieved so far is going down the drain. Try having an engaging conversation with people gathered at teashops or in restaurants. Most harbor pessimistic views of the country. Resigned remark such as “Kehi hunewala chhaina, dubayo desh neta harule” (Nothing is going to happen, the leaders have ruined the country) is deeply entrenched in the minds of the public.

As youth experiencing the undercurrents of hope and changes sweeping the society and economy, we’ll part away from the pessimistic views and argue that positive changes are happening, albeit gradually. The agents of change are the enterprising youth (for our case, consider the age group 15-34) who have pretty much lost faith in their political leaders.

This band of enterprising and energetic population is realizing that it’s in their hands to constructively bring about a positive change of hope in the society and dispel the fear that nothing is happening. Change and progress are happening by not talking only, but by putting ideas into action and showing best practices in a range of activities and vocations.

They are seeing hope amidst chaos and opportunities amidst challenges. The only constraint that’s slowing down this progressive change is the regressive ideas and actions of the selfish political leaders.

Changing landscapes

In August 2010, a group of energetic youth organized BarCamp Kathmandu, an ad hoc and informal gathering where youth discussed a range of issues pertinent to Nepal’s growth, innovation and development. Connecting with interested youth via Facebook and Twitter, the organizers were able to bring together over 600 participants of various age and nationalities. The networking, discussions, and outcome of the ad hoc gathering were more revealing, enchanting and inspiring than the finest and most productive day at the Constituent Assembly (CA).

“The CA Members should come and see firsthand how to make discussions productive, civilized and engaging,” remarked Shankar Pokharel, one of the organizers of the event, during tea break. The reaction from other youth was that the leaders will be humiliated to see how smoothly this kind of large yet ad hoc event runs without any drama. This is an example of how youth are constructively shaping socio-political-economy debates.

Take another example of a youth who is working on to provide drinking water in remote places cursed by altitude and dryness. Nirmal Adhikari and his associates at Kanchan Nepal—an organization based in Pokhara that focuses on water management in rural areas—visit remote places such as Doti, Dailekh and Jajarkot, study water availability, document lifestyle and help households install rainwater-harvesting tanks. Sharing a picture of such a tank on Flickr, he commented, “Apart from saving time and resources devoted to fetch water everyday, people are also using the conserved water to grow vegetables in places where you might just think it was impossible before the installation of the tank. Furthermore, it’s having an impact on household education and health standards.” Adhikari is making an impact by doing what he wanted to, not just pessimistically talk about the gloomy economic scenario of the country. This is an example of how youth are constructively engaged in development activities and making real impacts.

After completing undergraduate degree in the US, Vidhan Rana returned home with a market research outsourcing project that involves creating and maintaining client database for various state and local government agencies in the US. He has not only opened an office in Bag Bazaar and expanded his team, but is also hosting space for a local NGO, also run by youth, that is constructing schools and providing training to teachers and educational materials to schools it works with in remote areas. Rather than incessantly ranting about underdevelopment and directionless economy, youth like Rana are doing their part to ensure a direction for the services industry and making an impact by providing access to education for the disadvantaged and marginalized ones. Unlike “youth traders,”, i.e., those who make easy money by importing goods and selling them with a hefty margin without adding any value to the productive capacity of the nation, youth like Rana are the real entrepreneurs who are not only creating a foundation for future economic growth but are also giving others an opportunity to realize their potentials.

Similarly, enterprising citizens who have knowledge, experience and expertise about entrepreneurship have founded Entrepreneurs for Nepal (E4N) to encourage youth to become agents of change and real entrepreneurs. A group of conscious youth is leading a campaign against bandas. Another group of youth is engaged in cleaning public parks and airports during weekends. Even more are trying to mobilize citizens, via personal and social networking sites, to hold their elected representatives accountable.

These are some of the examples of how youth are voluntarily becoming agents of change because they have lost faith in political leadership and believe that change should come from within. These smart youth are slowly rising up in political sphere, banking sector, I/NGOs, intellectual circles, policymaking, and so forth. They are gradually changing the socio-political and economic landscapes.

Changing demographics

By the end of this decade, the number of people in the age range 15 to 34 is expected to be about 14 million, which is approximately 40 % of the estimated total population in 2020.

The number of people in the age group 15-24 will peak in 2017 and the 15-34 segments will peak in 2023. They will be the agents of change and a catalyst to the engine of growth.

Source: Computed from US Census Bureau’s population projection

With a sizable young population and low dependency ratio, the consumer market will see a huge rise in expenditure. Nepal will be one of the countries dubbed as “Young Asia” with low dependency ratio by 2050. Properly managing and encouraging the sheer number of people in this age group to constructively engage in socio-economic, development, and political activities will be of immense importance for the future of Nepal. They not only need predictable and bankable policy and political environment, but also jobs in virtually all sectors.

Hence, achieving high economic growth rate is necessary to accommodate the already enterprising youth as well as those who have zeal but lost faith in the economy. Returns to investment in this age group are enormous. Instituting an appropriate structure and policy to give direction, opportunities and jobs to the growing number of youth will be one of the most pressing economic challenges in the next few years. Else, we’ll see more migration of thousands of youth to the Gulf and other employment destinations in Asia and North Africa.

Changing challenges

The economic and political challenges faced by our nation are changing rapidly. On the economic front, our per capita income is increasing at a very slow pace and economic growth has been below 5% for years now. Compare this with the strides in growth rate and per capita income of not just India and China, but also Bhutan: they are galloping but we’re treading at snail’s pace and that too with great resistance. Meanwhile, the biggest macroeconomic challenges in the coming decade will be to rectify our trade deficit (i.e. bringing down exports to imports ratio of 1:6 to about even-even), accelerate economic growth, bring about structural transformation by reducing the number of people engaged in agriculture and finding them gainful employment in non-agriculture sector, relax the most binding constraints to economic activity (infrastructures and governance), tame surging prices of food, fuel and commodities, and provide safety nets to the most vulnerable population. With the existing pace of reform, it’s impossible to tackle these myriad of challenges. Its course has to change and it can’t be initiated by the existing political leadership who are in their 50s or more. It requires new energy, new people, new vision and enterprising youth that are less selfish than the existing leaders.

On the political front, the dynamics is changing so rapidly that it’s even hard for political analysts to correctly fathom the trend and where it’s heading to. Perhaps one reason for this is that the political rhetoric and superficial commitments of our politicians have no consistent logic as they change statements and commitments like anything. This is leading to disequilibrium in politics, policy, commitment and action. For instance, consider the commitments made by our leaders to bring out a Constitution within two years, integrate the PLA fighter within months, stimulate double-digit economic growth rate in a few years, produce 20,000MW of electricity in two decades, and not to impose bandas in 2011. All of these commitments are unfulfilled and repeatedly rebuffed by the same leaders who committed themselves to these pledges on paper.

Unchanging constraints

While youth are exploring opportunities amidst challenges in their own pace, it’s the responsibility of the state to further accelerate the novel exploration so that innovation and structural transformation occur at a speedy rate and sustainable fashion. Unfortunately, the biggest constraint to this change for the better is our political leadership, which has already shown its party-centered selfish, myopic, opportunistic and at times oppressive facades. They are not only ignoring but also undermining the changes happening in the country. Worse, they are averse to youth’ new ideas and demand for accountability and results. To counter this, even more conscious youth are needed in the political sphere.

Changing from within

Having that said, let us be mindful of the fact, however, that not all youth –such as the indoctrinated party cadres and illiterate and misguided ones – are acknowledging this change and the need to change from within. But it’s the duty of those who’ve realized this to ensure that those who haven’t realized are made aware by instituting best practices.

With all the undercurrents of change sweeping, albeit slowly, among the young generation, the country’s economic and development scenario isn’t as gloomy as is perceived by those who have lost faith in the political system. Change is coming to Nepal and is led by the young generation. The only unchanging constraint is the political leadership.

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[Published in The Week, Republica National Daily, May 20, 2011, p.10]

Food crisis: Simulation versus self-reporting

Derek Headey doubts the existing literature and analysis on food crisis and argues that the negative impacts of higher food prices in 2007-08 was more-than-compensated by economic growth (and insufficient coverage of China and India), something the existing models don’t take into account. Here is a paper (Was the global food crisis really a crisis?) by Headey.

Heady shows that global self-reported food insecurity fell during 2005 and 2008, with 60 million to 250 million fewer food-insecure people. The main reasons for this are rapid economic growth and very limited food price inflation in the world’s most populous countries, particularly China and India. Hence, he argues that food insecurity outcome shown by simulations do not match up with self-reported food insecurity level by countries. So, if the existing estimates are incorrect, then are the policy interventions designed to counter food insecurity misplaced?

Estimates of global trends in self-reported food insecurity, 2005/06 to 2007/08 (million)
Estimation scenarios	Estimated change
Raw results, 70 countries	-408
Raw results, 70 countries, plus assumptions for 16 omissions	-326
Raw results, 68 countries, after excluding China and India	9
Raw results, 69 countries, after excluding China	-132
Raw results, China and India trends adjusted by error margins	-250
Raw results, China and India reductions=3 percentage points	-63
Predicted change with econometric model, 88 countries	-87

Source: Headey (2011) estimates from Gallup World Poll data.

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In a new IFPRI discussion paper I show that these simulations suffer from serious flaws, and that their results are largely contradicted by self-reported food insecurity trends from the Gallup World Poll. The poverty simulations are often quite nice studies, but they are partial equilibrium studies with no wage adjustments, no changes in other commodity prices (like fuel, cotton, coffee, minerals), and no changes in incomes (which were growing all around the developing world from 2000-2008). Hunger simulations have more fundamental problems. Basically they count calorie availability, but the problem with a food or a financial crisis is that it is an access shock, not a production shock. Hence the FAO had to rely on a USDA model (which included reduced "calorie imports") to provide estimates of changes in hunger during the crisis. Yet in my paper I show that USDA's estimates of calorie availability (from early 2008) seem to be contradicted by USDA's own historical data on cereal availability.

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[Note that self-reported food insecurity varies from country to country: in Colombia it is 67 percent, but in Nepal it is just 9 percent. The figures discussed here are global level data, not country-specific.]

Impact of climate change on food prices

Duncan Green cites a new paper that shows that changes to the climate (higher temperatures, changed rainfall, increased CO2 concentration) has meant:

• global food prices have risen by 6.4%
• the world has spent an additional $50bn per year on food
• crops equivalent to one year’s production of maize in Mexico and wheat in France have been lost

Here is the abstract from David Lobell and Wolfram Schlenker’s (2011) paper:

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Efforts to anticipate how climate change will affect future food availability can benefit from understanding the impacts of changes to date. Here we show that in the cropping regions and growing seasons of most countries, with the important exception of the United States, temperature trends for 1980-2008 exceeded one standard deviation of historic year-to-year variability. Models that link yields of the four largest commodity crops to weather indicate that global maize and wheat production declined by 3.8% and 5.5%, respectively, compared to a counter-factual without climate trends. For soybeans and rice, winners and losers largely balanced out. Climate trends were large enough in some countries to offset a significant portion of the increases in average yields 16 that arose from technology, CO2 fertilization, and other factors.

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Green adds:

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These may seem like relatively small numbers so far, but the key driver identified in the study – temperature rises – is projected to increase at significantly faster rates in the coming decades than occurred in the period of this study (global average temperatures have risen by 0.13C per decade since 1950, and are projected to rise by 0.2C per decade over next 2-3 decades, according to IPCC, with higher rises likely in areas of cultivated land – so local impacts in food growing areas will be more extreme, even assuming that there are no tipping points along the way).

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NREGA wages first converging and then diverging

Full story here. The tussle between center government and state government might affect the performance of one of the most extensive and successful (so far) safety net interventions.  More about NREGA here. In short, the program offers 100 days of guaranteed employment per annum to at least one member of rural household; unemployment benefits are given if the state fails to provide jobs within 15 days of work demanded by workers; and wage is equal to minimum unskilled agricultural wage.