2b: Growth and structural change Overview 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 Growth and structural change 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)  Growth & structural change: stylized facts  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 Tools: sectoral production functions Aggregate production function Y = F(K, L) Sector (industry) level production function Yj = Fj(Kj, Lj), for all industries j GDP (value-added):G = N PjYj= j=1 Factor employment: ∑ N j j jj P ∑j=1 F (K L)  Total factor supply:L, K  So full employment of factors constrains total output:  Ex.: L€ =L1 + L2 + L3 Maximum output that can be produced subject to € constraints: production possibilities factor supply frontier € Growth implies outward shift of PPF Assume: M sector is K-intensive, A sector is L-intensive Growth: factor accumulation: ΔK, ΔL, orK, ΔK, ΔL, orL, or technical progress Faster rel rate of K accumulation Equal rates of K and L accumulation OR faster technical progress in manufacturing sector OR Equal rates of technical progress in both sectors A A M M 10 Agriculture ‘Balanced growth’ line - no str change D C Manufacturing Balanced growth: equal rates of K and L accumulation > equal growth rates of ag & mfg sectors 11 Agriculture ‘Balanced growth’ line - no str change D C Rise in GDP, measured in terms of manufactures at constant prices Manufacturing 12 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? 13 Price changes and structural change • Exogenous change in world market price ratio  Ex Food price rise: pA’ > pA, so pA’/pM > pA/pM  Alters optimal mix of goods produced • 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, pA/pM will decline • Policies that alter prices Ex tariff at rate tM: pM(1+tM) > pM, so pA/pM(1+tM) < pA/pM 14 Agriculture E C Manufacturing 15 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 16 The dual economy model 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? 17 Industry wage Industry labor demands D1 Labor in industry L1M Wage in ag Subsistence ag wage = AP(L) Labor in ag Total ag.output (read from right to left) YA f L1A g h Labor in ag Industry wage Industry labor demands D1 L1 Wage in ag M D2 Labor in industry L2M Subsistence ag wage Labor in ag Total ag.output (read from right to left) YA f YA L1A L2A g h Labor in ag 19 Industry wage Industry labor demands D1 L1 Wage in ag M D3 D2 L2M L3 Labor in industry M Subsistence ag wage Labor in ag Total ag.output (read from right to left) YA f YA L1A L2A g YA L3A h Labor in ag 20 ... structure and structural change Simple 2-sector models of economic structure & change Classical development theory: the dual economy Neoclassical two sector model Growth and structural change... Vietnam, many rural and unskilled workers report working less hours than they would like “Classical” development models did not assume full employment 16 The dual economy model Examines growth and