New Products, More Value Can Advance Economic Take-Off
IMF Institute for Capacity Development
March 4, 2013
- Introducing new products—and raising quality of existing ones—are critical
- Low agricultural productivity often reflects policy distortions
- Policies should stimulate economy’s core capabilities, not target specific products
To reach the next level of development, low-income countries should strive to transform the structure of their economies by diversifying into new sectors and producing new, higher value-added products, speakers told a gathering at the IMF on February 21.
In much of the developing world, sustained economic take-off remains elusive, and growth often relies on traditional, commodity-producing sectors, noted participants at the conference “Diversification and Structural Transformation for Growth and Stability in Low-Income Countries,” which was jointly organized by the IMF and the UK’s Department for International Development.
“What are the obstacles to diversification, the development of modern activities, and improvements in product quality?” asked IMF Deputy Managing Director Min Zhu in his opening remarks. “How can policy overcome such obstacles? Those are the key questions.”
Zhu pointed to the huge, unexplained differences across countries in the pace of economic development. Sustainable development critically involves the transformation of a country’s economic structure: diversifying into new sectors, upgrading the quality of existing products, and reallocating resources towards more productive firms.
But much remains unclear about the process. What precisely are the barriers to transformation? Do low- and middle-income countries face different challenges? What new opportunities and risks does globalization present for attempts to diversify? And what is the appropriate role for government policy? These questions served as the basis for discussion at the one-day conference.
Ricardo Hausmann (Harvard University) argued that development and diversification are best thought of in terms of “capabilities”—that is, the key inputs needed to produce goods (for instance, specific skills or public goods). Advanced economies have more capabilities, and can therefore produce a wider range of more complex products. Low-income countries are less diversified because they have few productive capabilities and, as a result, make a few, simple products that generate less income.
But such capabilities are developed only incrementally, by moving into new products that are similar to the existing product base. Developing radically different capabilities, and entering completely new markets, requires the complicated coordination of many different economic actors, and is therefore likely to fail, Hausmann explained.
In many low-income countries, the diversification of capabilities and products is made difficult by the dearth of existing capabilities that can be combined with new ones, and by the few links between existing and new products. Quantitatively, indicators of both the range of existing capabilities and the ease of acquiring new ones are strong predictors of growth at the country level. Other variables, such as institutions, human capital, or financial development, do matter. But they matter because they facilitate the accumulation of different capabilities, not because they are substitutes for it, Hausmann said.
William Maloney (World Bank), drawing on work with Daniel Lederman, pointed out that the potential implications for growth of producing any given good are hard to measure, not least because of the variety of country experiences. Natural resources, for instance, have sometimes been associated with fast growth, he noted, and sometimes with stagnation. He also observed that any given product, whether wine or shirts, will typically be produced by a wide range of countries at different income levels and sell for a wide range of different prices.
This raises the possibility that what a country produces may be less important than how it produces it, and at what quality level. Likewise, unlikely success stories, such as Finnish mobile phone producer Nokia—which started out as a pulp and paper manufacturer—cast doubt on the relevance of the “connectedness” of different products in favor of factors such as a country’s innovative capacity.
Ultimately, Maloney said, the best policy recommendation may be to focus on resolving market failures related to innovation, to risk-taking, and to other barriers to the emergence of new goods and the improvement of old ones.
Christian Henn (IMF) and Fidel Perez-Sebastian (University of Alicante), drawing on research with Chris Papageorgiou (IMF) and Nikola Spatafora (IMF), both stressed that development relies critically on improving the quality of existing products. Their new, extensive dataset confirms significant cross-country differences in product quality: overall, quality in sub-Saharan Africa and South Asia is lower, and has been growing more slowly, than in East Asia.
The dataset also indicates that the scope for quality upgrading is greatest in manufactures, but is also present in agriculture. Better institutions and greater skills help increase the pace at which countries upgrade the quality of products, leading to faster growth in GDP per capita, Henn said.
Impact of globalization
Globalization changes the nature of—and prospects for—diversification and structural transformation, argued Kei-Mu Yi (Federal Reserve Bank of Minneapolis). In particular, rising trade openness leads to a reallocation of labor by sector and speeds up structural change, Yi said, citing his research with Tim Uy (University of Minnesota) and Jing Zhang (University of Michigan).
Following the presentation, participants debated whether China’s emergence on the global economy is complicating other economies’ attempts to expand their manufacturing sector.
In a discussion of the relationship between structural change and economic integration, Romain Wacziarg (UCLA) noted a pattern that has emerged from new data on the European Union, the United States, China, and India. In the early stages of development, countries engage in an expanded range of activities, diversifying into different sectors. At the same time, new sectors localize in specific geographic regions, and these different regions’ production structures increasingly differ.
By contrast, in the later stages of development, the conference heard, countries tend to specialize in a few sectors. But these specialized activities are increasingly carried out in all regions, and different regions become increasingly similar, Wacziarg said. His presentation drew on work with Jean Imbs (Paris School of Economics) and Claudio Montenegro (World Bank).
Low agricultural productivity
Richard Rogerson (Princeton University) noted that world’s poorest countries are particularly unproductive in agriculture—and yet this sector employs most of their labor force. Is this inefficient, and if so what are the underlying distortions?
Douglas Gollin (Oxford University), drawing on work with David Lagakos (Arizona State University) and Michael Waugh (New York University), analyzed whether low measured productivity in agriculture in low-income countries truly reflects resource misallocation, as opposed to measurement problems. They adjusted existing measures to capture sectoral differences in hours worked and in human capital per worker, and allowed for shortcomings in national accounts data by using household income and expenditure surveys. In the end, these adjustments reduce but do not eliminate the phenomenon of low relative agricultural productivity.
Low agricultural productivity in low-income countries often reflects policy-induced distortions, argued Diego Restuccia (University of Toronto), citing his research with Tasso Adamopoulos (York University). For instance, farms are on average 34 times smaller in poor countries. Much of this reflects farm-level policies that misallocate resources from large to small farms, such as land reforms that impose a ceiling on farm size, and progressive land taxes. Since labor productivity is much lower in small farms, this has a significant impact on agricultural and aggregate productivity, Restuccia contended.
Participants in the concluding policy panel (watch video) noted that in many low-income countries—particularly in sub-Saharan Africa—growth over the past 15 years has been relatively rapid, but the manufacturing sector has expanded slowly, agricultural productivity remains low, and service sectors are still largely informal. This has to change if growth is to be sustained.
Participants agreed that policies focusing on specific sectors can deliver rapid growth for a period. However, broader “horizontal” policies, cutting across sectors, are required to sustain growth over time.
While participants acknowledged that the appropriate role for government policy in fostering diversification and structural transformation is still open to debate, they had the following broad recommendations for low-income countries:
• Public inputs—including infrastructure—are critical, as is continuous consultation between governments and businesses;
• Healthy economies constantly reinvent themselves, so instead of emphasizing any particular product, policies should aim at increasing productivity more broadly; and
• Countries should strive to create an environment where firms can improve their capabilities and technology; in this context, structural reforms and improvements in the business climate are crucial.