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 Stylized facts of economic structure and structural change
 Simple 2-sector models of economic structure & change
 Classical development theory: the dual economy
 Neoclassical two sector model
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 Growth inevitably involves change in product mix of production, demand and trade
 Growth causes structural change:
 in the sectoral composition of GDP
 in the allocation of labor and other resources
 in the distribution of income

 by factors (L, K, etc) by households (rural, urban, etc)
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40
30
20
10
0
Structural change: ag share of GDP
Agriculture share in value-added (%)
60
50
Source: WDI
Indonesia
Malaysia
Philippines
Thailand
Vietnam
3

Structural change: industry share of GDP
Industry share in value-added (%)
30
20
10
0
60
50
40
Indonesia
Malaysia
Philippines
Thailand
Vietnam
Source: WDI
4

70
60
50
40
30
20
10
0
Changing composition of labor demand (1)
Agriculture share of total employment (%)
90
80
Indonesia
Lao PDR
Malaysia
Philippines
Thailand
Vietnam
5

35
30
25
20
15
10
5
0
Changing composition of labor demand (2)
Industry share in total employment (%)
40
Indonesia
Lao PDR
Malaysia
Philippines
Thailand
Vietnam
Source: WDI
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


In the poorest countries, agriculture generates largest share of income, employment and trade revenues
The relative decline of agriculture is driven (in part) by economic expansion & growth of per capita income



Demand changes: Engel effects
Relative factor endowment growth rates (“Rybczinski effects”)
Relative factor productivity differentials
Policies & global markets may also play a role
 In general, poor countries tax agriculture to finance industrialization, reducing agr. profitability and investment
 Global market prices may signal incentives for some sectors to expand, others to contract
 Policies that increase international integration may matter
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 Aggregate production function Y = F ( K, L )




Sector (industry) level production function Y j = F j ( K j , L j ) , for all industries j
GDP (value-added):
 N j

1
P j Y j 
 N j

1
P j F j (K j L j )
Factor employment:
G



Total factor supply:
L , K
So full employment of factors constrains total output:
 Ex.: L

L 1 
L 2 
L 3 ...
supply constraints: production possibilities frontier

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Growth implies outward shift of PPF
Assume: M sector is K-intensive, A sector is L-intensive
Growth: factor accumulation: ΔK, ΔL, or technical progress
Equal rates of K and L accumulation
A
OR Equal rates of technical progress in both sectors
A
Faster rel. rate of K accumulation
OR faster technical progress in manufacturing sector
M
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M

Balanced growth at constant prices
Agriculture
C
D
‘Balanced growth’ line - no str. change
Manufacturing
Balanced growth: equal rates of K and L accumulation
--> equal growth rates of ag. & mfg. sectors
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Balanced growth at constant prices
Agriculture
C
D
‘Balanced growth’ line - no str. change
Rise in GDP, measured in terms of manufactures at constant prices
Manufacturing
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Structural change at constant prices
Agriculture
C
E
Manufacturing
Unbalanced growth: faster rate of K accumulation
 faster relative growth rate of M sector.
• What happens to the composition of GNP?
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Price changes and structural change
• Exogenous change in world market price ratio


Ex. Food price rise: p
A
’ > p
A
, so p
A
’/p
M
Alters optimal mix of goods produced
> p
A
/p
M
• Endogenous changes
–
–
Engel effects: As incomes rise, budget share of food diminishes.
Domestic valuation of ag. relative to mfg. will decline; if prices are set in domestic markets, p
A
/p
M will decline
• Policies that alter prices. Ex. tariff at rate t
M
: p
M
(1+t
M
) > p
M
, so p
A
/p
M
(1+t
M
) < p
A
/p
M
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Structural effects of price changes
Agriculture
E
C
Manufacturing
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Is full employment constraint realistic in a poor economy?
 Structural change stories are driven in part by the need to
‘give up’ factors from one sector in order to permit another to expand
 Assume full employment of factors
 Much ‘hidden’ unemployment in low-income economies
 Ex.: in Vietnam, many rural and unskilled workers report working less hours than they would like
 “Classical” development models did not assume full employment
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 Examines growth and str. change of an economy with surplus labor in agriculture.
 Surplus labor: marginal product of labor in ag. is initially zero
 Output sharing: each ag. worker receives average product, not
marginal product, so wage in ag > marginal product of L
 Can withdraw some labor without reducing total ag. production
 Thus growth = expansion of industry, with unchanged ag. output (compare Rybczinksi)
 What happens to sectoral GDP shares?
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Development of the dual economy
Industry labor demands
Industry wage
D
1
L
1
M Wage in ag.
Subsistence ag wage = AP(L)
Total ag.output
(read from right to left)
Y
A
Labor in industry
Labor in ag.
f L
1
A g h 0
Labor in ag.

Industry wage
Industry labor demands
D
1
L
1
M
D
2
L
2
M
Wage in ag
Subsistence ag wage
Total ag.output
(read from right to left)
Y
A
Y
A f L
1
A L
2
A g
Labor in industry
Labor in ag.
h 0
Labor in ag.
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Industry wage
Industry labor demands
D
1
L
1
M
D
2
L
2
M
D
3
L
3
M Wage in ag
Subsistence ag wage
Total ag.output
(read from right to left)
Y
A
Y
A
Y
A
Labor in industry
Labor in ag.
f L
1
A L
2
A g L
3
A h 0
Labor in ag.
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 “Traditional” vs. “modern” dichotomy; assumed
“irrationality” of behavior in former sector
 Origins in studies of SE Asia (Boeke; Higgins, 1950s)
 Alt. characterization: “traditional” sectors are constrained by mkt failures (esp. capital mkt) & by risk, social norms
 Dual development patterns consistent with this
 What kinds of data might verify DE assumption?
 What about income distribution as dual economy develops?
 Functional distbn = shares of income paid to labor, land, capital
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





Similar to “final” phase of Lewis model
No labor can be transferred without a reduction in ag. output
A stagnant agricultural sector, i.e., one with little new investment or technological progress, will cause wages of workers in industry to rise rapidly and thereby reduce profits and investment
Industry will develop successfully only if agriculture grows fast enough to catch up with higher levels of consumption and prevent the terms of trade from turning against industry
In the labor-surplus model, planners can ignore agricultural development until the surplus of labor is exhausted
But in the neoclassical model there must be a balance of growth rates between industry and agriculture
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Industry wage
Industry labor demands
D
1
L
1
M
D
2
L
2
M
D
3
L
3
M Wage in ag
Subsistence ag wage
Total ag.output
(read from right to left)
Y
A
Y
A
Y
A
Labor in industry
Labor in ag.
f L
1
A L
2
A g L
3
A h 0
Labor in ag.
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Prying open the Lewis and Solow models
 Why are product prices assumed fixed if producers sell only to the domestic market?
 Does industry growth really come only from domestic savings and investment?


Imports of capital goods and intermediates are important
How are these paid for? Natural resource exports
 Does structural change explain part of divergence?
 Product cycle: increasing capital-intensity in production delays diminishing returns to capital
 Depends on international markets with elastic demand
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