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Prof. LIN Yifu: South-South Cooperation from the Perspective of New Structural Economics


Global Development Workshop-2

March 15, Tuesday, 2022

Prof. LIN Justin Yifu


Thank you very much for this opportunity for me to attend the Global Development Workshop. The theme today is South-South Corporation from the perspective of new development economic theories. Certainly this is a good opportunity for me to advocate my own version of development economics, that is the new structural economics. From the perspective of new structure economics, I would like to discuss how to achieve dynamic and sustainable economic development and the South-South Cooperation. Then I'll discuss one very important theme today in the world, which is the premature deindustrialization. Because economic development should be a process of structural transformation by industrialization. But some economists found that developing countries may not have the opportunity to have industrialization as a way for structural transformation. I'd like to discuss, is that a fate or a result of government's policy failure? I will also use new structural economics to analyze this challenging issue.



Late-comer's advantages & theory of new structural economics

From the new structural economic perspective, economic development is a process of structural transformation. It's a process of continuous technological innovation in the existing sectors: agriculture, manufacturing, and services. And not only so, it's a process of continuous industrial upgrading from agriculture to manufacturing and then to service. All the countries are poor to begin with, and at that stage, they are all agrarian. When they want to raise their income, not only they need to improve the technology in agriculture, they also need to shift the labor force from agriculture to manufacturing, because the productivity and value added in manufacturing in general are much higher than agriculture. And then the leading sector gradually move to the service sector. This is so-called the Kuznets curve that has been identified in the early stage of development economics.


In this process of structural transformation, developing countries, compared to the developed countries, have something we call the late-comer's advantages. For economic development in advanced countries, certainly they need to have technological innovation, they also need to have industrial upgrading. But we know advanced countries' technologies are on the global frontiers. If they want to have technological innovation, they will have to invent the technologies. Similarly, for the industrial upgrading. For the advanced countries, since they are on the global frontiers, if they want to have industrial upgrading, they will also have to invent the new industries. Inventions require a lot of capital inputs and are very risky as well. From the historical evidence, high income countries rely on the invention for the technological innovation and industrial upgrading, on the average, they achieve around 3% of economic growth annually. Among these 3 %, 2% come from increase in per capital GDP, and 1% comes from the population growth. That is quite stable for advanced country in the past century.


For the developing country, their income level is low due to their low productivity level, and that means their technologies aren't the best. So there's some technological gap between them and advanced countries. Similarly, for their industries, the value added is not high and there's gap with the value added of industries in the high-income countries. We know that innovation means the technology used in the next period of time is better than the technology used now. It doesn't have to be newly invented. So for the developing countries, they can import, borrow, license better, mature technologies from higher income countries as a way for technology innovation. Similarly, for the industrial upgrading, it only means that the industries in the next period have higher value added than the existing industries. The new industry doesn't have to be newly invented. So there's a possibility for the developing country to enter into mature industries by imitating or borrowing from the high income countries as a way for industrial upgrading. By this way, certainly the cost and risk for the technological innovation and industrial upgrading in a developing country would be much lower than the advanced countries. Hence, a developing country has the potential to grow much faster than a high-income country. If they can grow faster than the high-income countries, they can gradually converge to the income level of high-income countries. This is so-called the latecomer's advantages.


There were a few economies who found a way to tap into the potential and achieved 7% or more growth rate annual and sustained for several decades. With that, their income level can increase rapidly, eg. when China started the transition from a plan economy to a market economy 40 years ago, China was one of the poorest countries in the world. And last year, the per capital GDP in China reached $12551, just about two percentage points away from the threshold of high income country. But unfortunately, most developing countries, even with the latecomer's advantages, their income gap with the high-income countries continues to be widening. Most of them stay in low-income status or mid-income status. So how can a developing country benefit from this late comer's advantages?


From the new structural economics point of view, the most important principle is to follow a country's comparative advantages determined by their factor endowments when they engage in technological innovation and industrial upgrading. That is the most important principle, because if an economy follows its comparative advantages, its cost of production will be among the lowest in the world. And if the economy also has an appropriate infrastructure and institution, the transaction cost will be low, and by that, the economy will be very competitive domestically and internationally. Then their growth will be high and they can accumulate capital very quickly. Once they can accumulate capital quickly, their comparative advantage will change. In this process, they can tap into the potential of the latecomer's advantages by borrowing technologies and industries from advanced country as a way for technology innovation and industrial upgrading. This is the most important principle for dynamic and sustainable economic development in a developing country.


But to make the development according to a country's comparative advantages possible, two fundamental institutions are needed. The first one is a competitive market. Because only with a competitive market, the relative factor prices can reflect each factor's relative abundance in the factor endowments. This kind of price signals can guide the entrepreneurs to choose the right technologies and enter into the right industries, to develop the economy according to the comparative advantages and to explore the latecomer's advantages. Meanwhile, a facilitation state is needed, because economic development is a process of continuous technology innovation, industrial upgrading and improvement of infrastructure and institution. The economy needs to have appropriate infrastructure and institution to make the technological potential of an industry to be realized. And we know that the improvement of infrastructure and institutions inevitably have all kinds of market failures. Their improvements require coordination of different actors, and very often the state needs to provide those kinds of services. Therefore, to develop according to a country's comparative advantages, an active facilitation state is required. If a country has these two fundamental institutions, then the country can develop according to its comparative advantages and grow very fast to narrow the gap with the high-income countries. This is the main message of new structural economics, which I have been advocating.



Broad Prospects of South-South Cooperation

If we look from the prospective of new structural economics, there's a lot of opportunities for the Southern countries to cooperate and to enjoy rapid economic growth together simultaneously. Because when a country develops according to their comparative advantages, it can accumulate capital and change its comparative advantage quickly. So today, a country may have comparative advantages in certain industries, but because it accumulates capital so fast, the country is going to lose comparative advantages in those industries quickly. When a higher-income country loses its comparative advantages in certain industries, the country will open the opportunity for the lower-income country to enter into those industries. And also, the higher-income country will have the incentive to relocate those industries to lower-income countries. The country will open up the market for the lower-income countries. This is something referred to as the flying geese pattern. From the historic evidence, a few successful developing countries all captured the window of opportunity from the global relocation of the labor-intensive industries from higher-income countries as described by the flying geese pattern.


In the 1950s, Japan grew very fast. Japan achieved rapid growth because the US lost the comparative advantage in labor-intensive industries and Japan captured that opportunity to develop labor-intensive industries. In the 1960s. Japan already became a high-income country, and lost the comparative advantages in the labor-intensive industries, and it opened the window of opportunity for the East Asian Tigers, South Korea, Taiwan China, Hong Kong and Singapore, to enter into the labor intensive industries. They became newly industrialized economies. In 1980s, they all became high income economies and opened up the window of opportunity for Vietnam and China to develop the labor-intensive industries and to transform from the agrarian to the manufacturing economies.


As you know, China enjoys fast growth. Today China is almost a high-income country, as a result, China will release the development opportunity of the labor intensive industries for countries with lower income than China. And this opportunity will be large because in the 1960s, Japan all together employed 9.7 million workers in manufacturing. In the 1980s, South Korea employed 2.3 million workers in manufacturing. Taiwan China employed 1.5 million workers in manufacturing. Hong Kong employed 1 million workers in manufacture and Singapore employed half a million in manufacturing. All together less than 6 million. But now, in 2018, China employed 121 million workers in manufacturing, and among them about 80 million in labor-intensive industries. Those labor-intensive industries will have to go away sooner or later. There will be the opportunity for almost all the developing countries in South Asia, Central Asia, Africa, and also in Latin America to enter in this flying-geese pattern of industrialization. It's a good opportunity for the South-South cooperation, especially with the improvement in the infrastructure and connectivity to enable the Belt and Road Initiative partner countries to catch this window of opportunity.



Premature De-industrialization: Fate or Failure?

But now there's a very influential idea circling around in the world. That is the so called the premature de-industrialization, which was the title of an article published by Dani Rodrik in 2016. He is the professor at Harvard, and now the president of International Economic Association. In the article, he found that Latin America and Africa have already experienced de-industrialization. Latin America countries are mid-income countries, they should be on the rising process of industrialization and rely on manufacturing for development. But Dani Rodrik found that their manufacturing is declining. In African countries, most of them are still low-income countries. They also experience the de-industrialization. Both Latin American and African countries certainly have workers to migrate from rural agriculture to urban works. Historically for the successful countries, when the workers moved from agriculture to the urban area, they moved to the manufacturing sectors with higher level of productivity. So their income could increase. But in the case of Latin America and Africa, in the 1980s, 1990s and early 2000s, workers moving from agriculture, instead of going to the manufacturing sector with higher level of productivity, they moved to the service sector where the labor productivity was much lower than the manufacturing sector. Also the workers in manufacturing sectors lost their jobs and they were forced to move into the low value, low productivity service sectors as well. Last year, Dani Rodrik published another paper based on a very careful household data in Tanzania and in Ethiopia. For Tanzania, the year is from 2008 to 2016, and for Ethiopia, from 1996 to 2017. The data confirms his premature de-industrialization hypothesis. In African countries, large firms, small in number, would not increase workers. Medium size firms lost out. And there were only small manufacturing firms with low productivity. Agrarian workers moved to the urban areas and in general went to the low value-added service sectors. So he is very pessimistic about the possibility for the developing countries to have the successful structural transformation from agriculture to manufacturing, and then move up the industrial ladder in manufacturing to become high income countries.


But the question is that, is the premature deindustrialization in Latin America and Africa a fate or is it because of government's policy failure? We can look the experiences of East Asian countries like Vietnam and Cambodia, and South Asian countries, like Bangladesh and India, in the same period of Rodrik's studies. They are in the same global environment, but actually like other successful countries, they continue to expand manufacturing. For example, in Cambodia, according to the World Bank, in 1993, the manufacturing contributed 3.5% of the GDP, and by the time of 2020, it contributed 16.2% about a five-time increase. Manufacturing growth rate in those 27 years was 11.4% per year, and its GDP growth rate was 5.2%. So it was in a very rapid industrialization process. Vietnam similarly, in 1995, the manufacturing share in GDP was 9.6 %. But in 2020 it was 11.4 %. And manufacturing growth rate was 8.3% per year compared to the GDP growth rate of 6.4 %. In Bangladesh in 1980, the manufacturing share in GDP was 8.7 %. But 2020, 19.7 %. And manufacturing growth rate was 7.3% per year compared to the GDP growth rate of 5.2%. In India in 1980, manufacturing was 12.4% in GDP, and in 2020, 14.5 %. The manufacturing growth rate was 6.1% per year and the GDP growth rate 5.7%. So from all these data during the same global environment, East Asian countries and South Asian countries, they, like other successful catching-up countries, continued to have fast speed in manufacturing growth which contributed to their dynamic economic growth. So from this comparison, the premature de-industrialization in certain part of the world is not a fate. If it's not a fate, how come the Latin America countries and African countries face the issue of premature deindustrialization?


I think it was because their development policy was guided by wrong development idea. From the 1980s, the most prevailing idea, influenced by the neo-liberalism, is that the government should not intervene in the economic development and should not adopt industrial policy or any kind of targeted policies, except for providing law and order, education and health for the whole nation. But we know economic development is a process of structural transformation. A country needs to have the technological innovation and industrial upgrading according to its changing comparative advantages. But if a country develops its economy according to the comparative advantage, it only means the factor cost of production will be low. If the country wants to be competitive in the market, the country also needs to have appropriate infrastructure for the industries. Certainly the country also needs to improve institution supporting the industrial development. The improvement of infrastructure and institution will not happen spontaneously. The government need to play a proactive role in the improvement of infrastructure and institutions. In a developing country, the infrastructure is often poor everywhere. Institution is also poor. But the government's resource is limited. So if the government wants to facilitate the industrialization, the government needs to have a priority of industries and understand what kind of infrastructure the prioritized industry requires and what kind of improvement in institution is needed. The government may create something like a special economic zone and within the economic zone infrastructure and business environment will be facilitated to support the targeted industries. If the government can do so, then any developing country can develop industries according to its comparative advantages, and turn them into their competitive advantages quickly.


But unfortunately, in the 1980s and 1990s, the dominant thinking was neoliberalism, which advised the government not to play those kind of facilitation role. Industrial policy became a taboo in some countries. Luckily these Asian economies were much more pragmatic. In China, Vietnam and Cambodia, the government actively used industrial policies, set up special economic zones and engaged in investment promotion and so on. Similarly, back in 1980, Bangladesh started to develop apparel industry with only one joint-venture firm with Korea’s Dawoo. By the time 2000, the apparel industry employed 0.5 million workers. Now it employs more than 5 million workers. In India, it was not that effective as in East Asia. But Modi, when he was the Chief Minister of Gujarat in 2001-2014, adopted policies of investment promotion, export orientation and infrastructure improvement like those in East Asia, the Gujrat state achieved an annual growth rate of 10% for 14 years under his leadership. So premature deindustrialization is not a fate but a result of government's policy failure guided by inappropriate developing thinking, which advised the government not to provide needed improvement in infrastructure and institution to facilitate the development of targeted industries in a developing country with poor infrastructure and institution.  



Concluding Remarks

So let me conclude, economic development is a process of continuous structural transformation. In this process, the country needs to follow the principle of comparative advantages. The country also needs to have a competitive market as well as a facilitation state. If a country follows these ideas, there is a huge scope for the developing countries to cooperate with each other, because dynamic growth in a country will leave the space for other countries to grow dynamically and also create a market for each other. For this to happen, we need to have new ideas, guided by new theories. New structural economics is a theory that generates from the experiences of success and failure of developing countries. It provides a policy framework for a developing country to grow dynamically and for the developing countries to support each other. And following the ideas embodied in new structural economics, all the developing countries can grow dynamically together.


The ideas from new structural economics is especially important for the developing countries because the development of AI and automation in the Fourth Industrial Revolution. Currently, the use of AI and automation to replace workers in labor-intensive industries are not cost effective yet. There still be opportunities for the labor intensive manufacturing to flourish. Certainly AI may improve further, and by that time, the workers in labor intensive industries may be replaced by robots. It may take ten years or twenty years for that stage to come. So for the developing countries, it is very important to utilize the remaining window of opportunity for the development of manufacturing, and to allow them to transform from low value-added agriculture, or low value-added service, to higher value-added manufacturing. By that, they can grow faster and accumulate capital. When robot becomes cheap enough to replace worker in the labor-intensive industry, they will have sufficient capital to employ robots. So let's take the last window of opportunity to industrialize in the developing countries.


Thank you very much.


Editor: Olivia LOU