Chapter 24: Structural Change
and Adjustment
An Introduction to International
Economics: New Perspectives on the
World Economy
© Kenneth A. Reinert, Cambridge University
Press 2012
Analytical Elements
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Countries
Sectors
Factors
Currencies
© Kenneth A. Reinert, Cambridge University
Press 2012
Structural Change
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The basic notion of structural change is that, as
development proceeds, productive factors move out of
lower-productivity activities into higher-productivity
activities
One limited application of this lens is to simply view
development as the process of resources moving out of
agriculture and into manufacturing
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This limited application ignores the important role of the service
sector
As development proceeds, the service sector expands, partly due
to the role of producer services
Evidence on this process is presented in Table 24.1
© Kenneth A. Reinert, Cambridge University
Press 2012
Table 24.1: Sector Composition of GDP,
Selected Years (percent of GDP)
Income
Sector
1970
1980
1990
Low income
Agriculture
38
38
35
25
Low income
Manufacturing
12
12
11
13
Low income
Services
50
50
54
62
Middle income
Agriculture
25
20
18
11
10
Middle income
Manufacturing
24
26
23
22
20
Middle income
Services
51
54
59
67
70
High income
Agriculture
6
4
3
2
1
High income
Manufacturing
24
21
18
16
High income
Services
72
76
80
83
Source: World Bank, World Development Indicators
© Kenneth A. Reinert, Cambridge University
Press 2012
2000
2010
Structural Change
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The data presented in Table 24.1 presents gross
domestic product (GDP) of low, middle and high income
countries, spit up between agriculture, manufacturing
and services for available years
If we were to generalize from the data in this table, we
can see that, as development proceeds
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Agriculture declines from approximately 40 percent of GDP to
approximately 2 percent of GDP
Manufacturing initially increases from approximately 10 percent
of GDP to approximately 25 percent of GDP and subsequently
falls below 20 percent of GDP
Services increase from approximately 50 percent of GDP to
approximately 80 percent of GDP
© Kenneth A. Reinert, Cambridge University
Press 2012
Structural Change: The Decline of
Agriculture
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One reason why agriculture declines as a percent of
GDP is that of what is known as Engel’s Law
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Engel’s law states that the income elasticity of demand for food is
less than one
A second reason why agriculture declines with economic
growth is that it tends to be less capital intensive than
manufacturing and, as economies become more capital
abundant in growth processes, labor intensive sectors of
the economy tend to shrink relative to capital intensive
sectors (the Rybczynski theorem discussed below
Finally, there is a tendency for the income elasticity of
demand for services to be greater than one
© Kenneth A. Reinert, Cambridge University
Press 2012
Traded and Non-Traded Goods
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There is a particular treatment of the structure of
economies that involves a distinction between traded
and non-traded goods
The distinction between these two categories of goods is
made in Table 24.2
Non-traded goods include more service sub-sectors than
traded goods, and traded goods include more agriculture
and manufacturing sub-sectors than non-traded goods
Some researchers go so far as to equate non-traded
goods with the service sector, but this is not entirely
accurate
© Kenneth A. Reinert, Cambridge University
Press 2012
Table 24.2: Trade Goods vs. Non-Traded
Goods
Good
Price Determination
Traded
Prices of traded goods
are determined in world
markets.
Non-traded
Prices on non-traded
goods are determined in
domestic markets.
Consumption and
Production
Domestic consumption and
domestic production of
traded goods can differ,
causing a trade surplus or
deficit.
Domestic consumption and
domestic production must be
equal.
© Kenneth A. Reinert, Cambridge University
Press 2012
Traded vs. Non-Trade Goods in a PPF
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We can represent the supply side of the traded/nontraded economy with a production possibilities frontier
(PPF) as in Figure 24.1
The production of traded goods as an aggregate entity is
measured along the vertical axis, and the production of
non-traded goods as an aggregate entity is measured
along the horizontal axis
The PPF depicts the combinations of output of traded
goods and non-traded goods that the economy can
produce given its available resources and technology
The PPF is depicted as the concave line in the figure
© Kenneth A. Reinert, Cambridge University
Press 2012
Figure 24.1: Ghana’s PPF with Traded and
Nontraded Goods
© Kenneth A. Reinert, Cambridge University
Press 2012
Internal and External Balance
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The concepts of internal balance and external balance
can be considered in Figure 24.2
Ghana’s production point is given by point B
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Since the production point B is on the PPF rather than inside it,
all of Ghana’s resources are efficiently employed
This is what we mean by internal balance
Ghana’s consumption point is given by point C and is
exactly the same point as point B.
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A dotted line proceeds to the left from points B and C to the
vertical axis
This tells us that the consumption of tradable goods (point C) is
exactly the same as the production of tradable goods (point B)
This means that there is external balance
© Kenneth A. Reinert, Cambridge University
Press 2012
Figure 24.2: Internal and External Balance
© Kenneth A. Reinert, Cambridge University
Press 2012
External Imbalances
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Next consider Figure 24.3
This figure shows two consumption points, CTS and CTD
If consumption is at CTD, the consumption of traded
goods exceeds the production of traded goods along the
vertical axis and Ghana has a trade deficit
If consumption is at CTS, the production of trade goods
exceed the consumption of traded goods and Ghana has
a trade surplus
In contrast to Figure 24.2, in both the trade deficit and
trade surplus cases depicted in Figure 24.3, there is
external imbalance
© Kenneth A. Reinert, Cambridge University
Press 2012
Figure 24.3: External Balance
© Kenneth A. Reinert, Cambridge University
Press 2012
Balance of Payments Adjustment
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To understand some issues behind balance of payments
adjustment, we are going to consider an initial position of
a trade (current account) deficit as in Figure 24.4
Included in this figure are price ratio lines
We use PT to denote the price of traded goods and PN to
denote the price of non-traded goods
A price ratio lines in the figure indicate that consumers
and firms face the price ratio PN / PT, the relative price of
non-traded goods
We are going to see how Ghana can adjust if this current
account deficit becomes unsustainable
© Kenneth A. Reinert, Cambridge University
Press 2012
Figure 24.4: A Current Account Deficit
© Kenneth A. Reinert, Cambridge University
Press 2012
Adjustment Via Demand Reduction
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One possible adjustment path recognizes that the
external imbalance problem comes from the demand for
tradable goods being too high
Therefore demand reduction is required to reduce the
demand for tradable goods as in Figure 24.5
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We begin with consumption at CTD1 and production at B1
If we reduce incomes to the value of production at point B1 ,
consumption would fall to CTD2
At CTD2, there is still a current account deficit of TD2
We can maintain employment in the traded goods sector and
moving production and consumption to points B3, C3
External balance has been achieved at the cost of internal
balance
© Kenneth A. Reinert, Cambridge University
Press 2012
Figure 24.5: Adjustment Bia Demand
Reduction
© Kenneth A. Reinert, Cambridge University
Press 2012
Adjustment Via Demand Switching
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An alternative adjustment path involves demand
switching through a change in the nominal exchange
rate (devaluation or depreciation)
If the currency were to lose value, the price of traded
goods would increase, and the PN / PT line would flatten
As can be seen in Figure 24.6, this has two effects
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First, it increases the incentive to produce traded goods
Second, it decreases the incentive to consume traded goods
Both of these effects tend to reduce the trade deficit
Adjustment can proceed without necessarily increasing
unemployment
© Kenneth A. Reinert, Cambridge University
Press 2012
Figure 24.6: Adjustment via Demand
Reduction and Switching
© Kenneth A. Reinert, Cambridge University
Press 2012
Traded Goods and Growth
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Some researchers have attempt to establish a
relationship between the production of tradable good in
developing countries and growth
We can visualize this argument in Figure 24.7
The increased production of traded goods involved in the
movement from point B1 to point B2 causes positive
growth externalities
This has the effect of shifting out the PPF along the
traded goods axis
The economy ends of at point B3, C3 on an expanded
PPF
© Kenneth A. Reinert, Cambridge University
Press 2012
Figure 24.7: Adjustment via Demand
Reduction and Switching Reconsidered
© Kenneth A. Reinert, Cambridge University
Press 2012
The Order of Economic Liberalization
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Traditionally, structural adjustment programs have
included the following components
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Exchange rate depreciation or devaluation
Reductions in government expenditures, including reduction in
public sector workforces, elimination of agricultural and industrial
subsidies, and elimination of food and medical subsidies
Wage controls to reduce demand and to prevent inflation
Elimination of import quotas and export taxes
Reduction of ad valorem tariffs to “moderate” levels of 10-15
percent
The privatization of state-owned enterprises
The liberalization of domestic financial markets
© Kenneth A. Reinert, Cambridge University
Press 2012
The Order of Economic Liberalization
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There is evidence that failure to consider the order of
economic liberalization can significantly compromise the
sustainability of adjustment policies
Here is one possible order of economic liberalization
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Seek a means of securing central government revenue through a
broad-based tax
Depreciate or devalue the exchange rate to initiate switching
Tariffy quotas on imports of consumer goods and remove quotas
on imports of intermediate and capital goods
Selectively begin to privatize state owned enterprises
Liberalize the foreign direct investment component of the
capital/financial account
Develop an effective system of bank regulation
© Kenneth A. Reinert, Cambridge University
Press 2012
The Rybczynski Theorem
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The application of the Rybczysnki theorem for our
purposes here is due to an increase in physical capital
relative to labor in a process of capital deepening
discussed in Chapter 21
This is presented in Figure 24.8
An increase in physical capital favors the capitalintensive sector (motorcycles) over the labor intensive
sector (rice)
The PPF consequently moves out more along the M axis
than along the R axis
© Kenneth A. Reinert, Cambridge University
Press 2012
Figure 24.8: The Rybczynski Theorem
© Kenneth A. Reinert, Cambridge University
Press 2012
The Rybczynski Theorem
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For a given world price ratio, the production point moves
from B1 on the original PPF to B2 on the new PPF
As we can see in the figure, this involves an increase in
the production of motorcycles but a decrease in
production of rice
The increase in physical capital via capital deepening
results in a shift of the structure of the economy away
from rice (the labor-intensive sector) and towards
motorcycles (the capital-intensive sector)
This is an insight that comes from the Rybczynski
theorem and reflects what happens as countries
accumulate physical capital
© Kenneth A. Reinert, Cambridge University
Press 2012