Dani Rodrik on Globalization, Development, and Employment 04/11/2011

The inter-sectoral variation (coefficient of variation) in labor productivity is huge in developing countries—especially the poorest—but shrinks dramatically over the course of development, so in rich countries workers displaced from manufacturing go to sectors with only slightly lower productivity.

“there's a chart in the paper which shows that the inter-sectoral variation in labor productivity tends to significantly come down over the course of development... the inter-sectoral variation in labor productivity is huge in the developed countries in part in developing countries and particularly the lowest income among them”

China opened up 'at the margin'—keeping existing state enterprises and their supports in place while creating new incentives (special economic zones, export subsidies) for new export-oriented investment—thereby turning toward world markets without pulling the rug from under medium-productivity industries and avoiding premature deindustrialization, whereas Latin America deindustrialized prematurely.

“how they've opened up is they kept all those industries in place all those supports place but they created at the margin incentives for new investments in export oriented areas so they created a special economic zones they created all kinds of subsidies for exports and non-traditional products at the margin so they turn towards world markets without pulling the rug from underneath these sort of industries with medium level of productivity”

Financial globalization has outrun the regulatory infrastructure needed to sustain it, and since a true global equivalent of domestic regulatory institutions is unattainable, the better path is a global financial system that permits much greater national diversity and discretion in rules (e.g., countries setting capital requirements at 10% or 20% per their own stability-innovation tradeoff), managing regulatory arbitrage by treating non-conforming cross-border financial flows the way we treat non-conforming toy imports—taxing or controlling them to preserve domestic regulatory integrity.

“the alternative is to really have a global financial system that allows much greater diversity and discretion at the national level in terms of how these rules are set so you know some countries may set their Council requirements at 20% other countries might set them at 10%... any financial institution that wants to operate and in the u.s. jurisdiction... ought to operate by the rules set in the United States and... you ought to then allow us and other countries to interfere or tax or otherwise control cross border financial flows”

Financial regulation should be politicized at the national level—where the full course of democratic politics can play out—rather than depoliticized by moving decisions to global fora, because the latter does not depoliticize at all but merely privileges one interest (international finance) over everyone else.

“I actually think that you should politicize the system you know at the national level where you know the whole full course of politics can play out... all that you've done is just privileged one sort of interest over everybody else and that's exactly how the system has worked”

Just as rich countries use patents to let innovators capture monopoly rents and overcome the knowledge-market imperfection, developing-country governments should subsidize the pioneering investor in products new to their own economy because those investments generate learning spillovers (e.g., demonstrating Jamaica can run call centers) that the pioneer cannot internalize.

“the parallel in developing country is that when we're talking about firms in in El Salvador... they're going to be investing in new products that are that are new to their own economy and that provides exactly the same kind of learning spillover... I think it does make sense for Jamaica to want to subsidize the initial investor”

Moving financial regulatory decisions from the national to the global level does not depoliticize them; it privileges one set of interests—internationally powerful financial firms with the biggest stakes and most information—over everyone else, and because there is no accountability (no one loses their job for Basel II's failure) there is no reason to expect successive global regimes to improve.

“it's just if anything going to a globally harmonized system... would be designed by politically powerful people to benefit themselves... who do we blame for basel ii that didn't work so well who do we get mad at who's it who loses their job nobody”

The rise of new productive industries in developing countries is blocked by market failures—coordination failures (needing complementary inputs, skilled workers, cargo service, etc., a chicken-and-egg problem) and learning/cost-discovery externalities, where a pioneer investor who succeeds sends a positive signal others free-ride on but bears all the private cost if it fails.

“there is a problem of what we call cost discovery which is that the first investor who invests in aside a cardboard factory provides a very valuable signal to other potential investors as to whether the cost structure of the economy is conducive to producing cardboards or not”

Development economics requires second-best thinking: in a world riddled with multiple interacting distortions, insisting on first-best policies is often escapism, and the reforms that work best are second-best reforms that isolate or offset distortions elsewhere in the economy.

“you are always in a second best world... I think often we just say you know take the first best and that just becomes you know it's often escapism because you are inherent in a second best world given that that's not the only distortion you're talking about everything is is entangled with something else and often the reforms that work best are those that are second best reforms”

Government failures—red tape, corruption, weak property rights, and poor contract/rule-of-law enforcement—impose disproportionate costs on the modern parts of an economy compared to traditional activities (e.g., a barber needs no inputs or customs, while a cardboard factory does), which is one reason the modern sector remains underdeveloped.

“all these you know problems with with the government and the and legal and contractual environment clearly impose disproportionate costs on the modern parts of the economy compared to the traditional part so that's one reason why the modern part is underdeveloped”

Labor productivity in Malawi's mining sector is so high (because it is extremely capital-intensive) that it matches US output per worker, but the sector cannot absorb much labor, so workers who cannot enter mining end up in agriculture, informal activities, or petty trade where their productivity is a tiny fraction of the mining level.

“labour productivity is very high in fact so high in Malawi that it matches output per worker in the US economy as a whole”

In Malawi the mining sector is so capital-intensive that output per worker matches the US economy as a whole, but mining has limited employment-absorption capacity—you cannot put the whole labor force into it—so workers who cannot enter mining fall back into agriculture and petty trade where productivity is a tiny fraction of mining's.

“labour productivity is very high in fact so high in Malawi that it matches output per worker in the US economy as a whole... the workers that you cannot get into mining end up in in you know either in agriculture informal activities petty trade where their productivity is really just a tiny fraction”

Government failures—red tape, corruption, weak property rights and poor rule of law—impose disproportionate costs on the modern parts of the economy (which need inputs, customs, tax compliance and contracts) compared to traditional petty trade, which is why the modern sector remains underdeveloped.

“all these you know problems with with the government and the and legal and contractual environment clearly impose disproportionate costs on the modern parts of the economy compared to the traditional part so that's one reason why the modern part is underdeveloped”

If markets worked well and governments imposed no artificial impediments on labor mobility, wages and the marginal value product of labor would be equalized across sectors; the persistence of large gaps indicates either government failures or market failures preventing this.

“if these you know markets in these economies worked well and governments didn't impose artificial impediments on labor moving across sectors then what we would expect is that that wages and value marginal product of labor would be would be equalized across different sectors”

Economic development, following Arthur Lewis's dual-economy model, is fundamentally a process in which labor moves from traditional low-productivity sectors (typically traditional agriculture) to modern, more productive sectors (typically urban industry).

“he defined that the process of economic development as one where basically labor moves from the more traditional parts of the economy typically traditional agriculture to more modern more productive parts typically urban sectors but industry as a leading modern independent sector”

If markets in poor economies worked well and governments imposed no artificial impediments to labor mobility, wages and the marginal value product of labor would equalize across sectors; the persistence of large gaps is the puzzle to be explained.

“if these you know markets in these economies worked well and governments didn't impose artificial impediments on labor moving across sectors then what we would expect is that that wages and value marginal product of labor would be would be equalized across different sectors”

The consequences of globalization depend on how countries integrate into the global economy: in China, India and some Asian countries productivity, employment and growth-promoting structural change all expanded, whereas in Latin America and sub-Saharan Africa labor moved in the wrong direction—from more productive to less productive activities including informality.

“the very diverse outcomes we observe among developing countries suggest that the consequences of globalization depend on the manner in which countries integrate into the global economy”

In many Latin American manufacturing sectors, productivity gains came through technological upgrading and capital accumulation rather than employment increases (often employment shrank)—a 'rationalization' phenomenon—and because displaced labor did not move to other productive parts of the economy but to less-productive informal services, the result was growth-reducing structural change.

“increases in productivity takes place through technological upgrading through increased capital accumulation and not employment increases often in fact employment strength so we get this phenomenon of rationalization”

Just as a patent system in rich countries overcomes the market imperfection in the market for knowledge, developing countries should subsidize pioneer investors who introduce products new to their economy because those investors generate learning spillovers (cost-discovery surplus) they cannot fully capture in competitive industries with normal profits.

“the patent system is meant to overcome this market imperfection and market for knowledge I think that the parallel in developing country is that when we're talking about firms in El Salvador... they're going to be investing in new products that are new to their own economy and that provides exactly the same kind of learning spillover”

Latin American countries experienced premature deindustrialization—manufacturing's employment share began to shrink earlier than cross-country development benchmarks predict—whereas in China manufacturing employment share steadily increased.

“what you experienced in countries like that in America is a premature deindustrialization and in China if anything the other way around”

China globalized successfully by opening 'at the margin'—keeping existing state enterprises and their supports in place while creating new incentives (special economic zones, export subsidies for non-traditional products) for new export-oriented investment—thereby turning toward world markets without pulling the rug from under medium-productivity industries, which avoided the premature deindustrialization Latin America suffered.

“they kept all those industries in place all those supports place but they created at the margin incentives for new investments in export oriented areas so they created a special economic zones they created all kinds of subsidies for exports and non-traditional products at the margin”

The argument that the US external deficit is a pure gift to US consumers holds only at full employment; if there is a Keynesian (demand-side) element to US unemployment, as is plausible when unemployment is near 9-10%, then the welfare conclusion is undermined—which is why Keynes himself, once a strong free-trader, advocated protectionism in the 1930s.

“up until the point where you know you get in the United States and hundred nine percent unemployment rate and then you have to start asking the question to what extent that is still true... if you believe that there is some element of Keynesian unemployment in the United States today then the argument about the external deficit the United States being a gift to US consumers”

There is no better industrial policy than an undervalued (competitive) currency, because exchange-rate undervaluation subsidizes all tradable industries across the board (e.g., a 10% undervaluation subsidizes all tradables by 10%) without requiring governments to pick winners, whereas an overvalued currency from capital inflows cannot be undone by any micro-level industrial policy.

“there is no better Industrial Policy than our valued currency”

Inter-sectoral variation in labor productivity (the coefficient of variation across sectors) is huge in poor developing countries but shrinks dramatically over the course of development, so in rich countries displaced manufacturing workers move to sectors with only slightly lower productivity, avoiding large aggregate productivity losses.

“the inter-sectoral variation in labor productivity is huge in the developed countries in part in developing countries and particularly the lowest income among them... by the time you look at the rich countries that the gaps have really shrunk”

Because new industries in developing countries (call centers, canned pineapple, cut flowers) are competitive with thin margins, pioneer investors earn only normal profits and cannot recoup the social surplus they generate; the subsidy should target only the incumbents (pioneers), not the subsequent copycats—a distinction governments often get wrong by subsidizing everyone.

“if subsequent investors can just come in and just bid his workers away and this being a competitive industry can only look forward to normal profit subsequently then he has no incentive of coming in”

There is no realistic path to a global equivalent of the comprehensive domestic regulatory infrastructure needed to sustain finance; global financial regulation will be either weak and ineffective or the lowest common denominator, so the better approach is a system allowing greater national diversity and discretion in setting rules.

“there's no way we're going to get anything like the global equivalent of the kind of domestic regulations that we have to sustain domestic finance... either we're going to get regulations at the global level that will be very weak... or will get sort of like the lowest common denominator”

Most gains from further liberalization in trade in goods have already been realized and pursuing more wastes political capital at high legitimacy cost; the largest remaining gains lie in liberalizing the movement of people, so trade negotiators should shift from the Doha round toward negotiating an expansion of temporary work-visa schemes worldwide.

“in goods I think we've eked out most of the benefits from further liberalisation we're wasting a lot of political capital at huge costs in terms of legitimacy”

China's manufacturing employment share steadily increased and only recently began to shrink, whereas Latin America experienced premature deindustrialization—manufacturing employment began shrinking too early relative to cross-country development benchmarks.

“the share of employment in manufacturing has steadily increased in China way beyond his only reason he has begun to shrunk whereas in Latin America for example it began to shrink prematurely... what you experienced in countries like that in America is a premature deindustrialization”

There is no better industrial policy than an undervalued (competitive) currency; Latin American countries (notably Mexico) systematically got this wrong by letting currencies float and opening capital accounts, causing appreciation that kills new investment at the margin in tradable industries, while Asian countries carefully prevented appreciation.

“I say that there is no better Industrial Policy than our valued currency and... this is one thing that Latin American countries have systemically gotten wrong including most notably Mexico... you opened up your capital account money comes in the currency appreciate and it basically kills sort of no new investments at the margin in in in tradable industries”

Currency undervaluation is superior to selective industrial policy because it subsidizes all tradable industries across the board (a 10% undervaluation subsidizes them all by 10%) without requiring the government to pick winners, and because micro-level industrial policies cannot undo a 20% currency overvaluation caused by capital inflows.

“the beauty of the exchange rate under valuation is that it's across the board you don't have to pick you basically know if your currency is undervalued by ten percent all trainable industries being subsidized across the board by 10%... when your currency is overvalued because of capital inflows... no amount of of industrial policy can really undo the effect of that”

The consequences of globalization for developing countries depend on the manner in which they integrate into the global economy: China, India and some Asian countries saw productivity, employment and growth-enhancing structural change, while in Latin America and sub-Saharan Africa labor moved in the wrong direction toward less productive activities, notably informality.

“the consequences of globalization depend on the manner in which countries integrate into the global economy... in many other cases in Latin America and sub-saharan Africa globalization appears not to have foster the desirable kind of structural change labor has moved in the wrong direction for more productive - less productive activities including most notably informality”

In many Latin American manufacturing sectors, productivity rose through technological upgrading and capital accumulation rather than employment growth (a 'rationalization' of production), and the labor displaced moved to less productive informal services rather than to more productive parts of the economy.

“in in in many of these manufacturing sectors increases in productivity takes place through technological upgrading through increased capital accumulation and not employment increases often in fact employment strength so we get this phenomenon of rationalization... there has been a massive movement in the wrong direction from these more productive more open parts of the economy to the less productive services”

Latin America liberalized in line with standard trade theory (lower tariffs, let uncompetitive import-competing firms shrink, expect labor to move to higher-productivity export sectors), but because new competitive industries failed to rise rapidly, displaced labor did not go to more productive sectors—producing growth-reducing structural change.

“Latin America did it in a way that was fully consistent with our standard tree theory standard trade theory says you lower your bet your tariff barriers your import competing firms that are not sufficiently productive shrink and the labor that's released from those industries go to a whole bunch of other places... but the labor that's released doesn't necessarily end up in industries that are significantly more productive”

Because new export industries in developing countries (call centers, canned pineapple, cut flowers) compete globally with thin margins and cannot earn supernormal profits, the pioneer who reveals the country's viability for that industry cannot recoup the social surplus, so without subsidy these high-spillover industries fail to emerge.

“the guy who's going to be providing you know you know canned pineapples to the US market or you know to be the investors in call centers or they're not the guys who are producing cut flowers... all new industries in these kinds of settings necessarily to earn extra supernormal profits whether they come in and yet from the perspective of the economy they generate huge social surplus”

Most gains from further liberalization of trade in goods have been exhausted (wasting political capital at high cost to legitimacy), whereas the gains from liberalizing the temporary movement of people (e.g., expanding temporary work visa schemes) are huge—comparable to where trade in goods stood in the 1950s.

“in goods I think we've eked out most of the benefits from further liberalisation we're wasting a lot of political capital at huge costs in terms of legitimacy... in people... we're sort of like where we were with the trade route in the 1950s which is a huge amount of gain to be had... start talking about negotiating an expansion of temporary work visa schemes around the world where the gains are huge”

Global harmonization of financial regulation (Basel I, II, III) is a dead end because it is inherently dominated by the international financial firms with the biggest stakes and most information, who give inputs that benefit themselves rather than the world, and because there is no accountability—no one loses their job when a Basel framework fails.

“it's not designed to be gotten right it's a process it's inherently going to be run by the people with the... biggest stakes and the most information those would be international financial firms why would you expect them to give inputs to the political process that would be good for the world rather good for them... who do we blame for basel ii that didn't work so well... nobody”

High output per worker in capital-intensive facilities (e.g., US egg or pencil production) reflects productivity embedded in the machinery rather than the skill of the workers, who are mainly there to keep the machinery running; the same logic applies to Malawi's mining workers.

“it's really not the workers that are productive it's the machinery that is smart and allows a relatively unskilled worker to work in that factory and look like the source of the productivity in fact what's really going on is that the labor embedded in the machinery is where the productivity lies”

Market failures—coordination failures (complementary inputs, infrastructure, cargo service all needing to exist simultaneously, a chicken-and-egg problem) and learning/cost-discovery externalities (the pioneer investor reveals whether the cost structure supports an industry but bears private costs while later entrants free-ride on the positive signal)—prevent the rise of new productive industries in poor economies.

“there is a problem of what we call cost discovery which is that you know the the first investor who invests in aside a cardboard factory provides a very valuable signal to other potential investors as to whether the cost structure of the economy is conducive to producing cardboards or not and but you know if you end up being a failure you you know all the costs are private if you're successful then you're sending a positive signal then you cannot fully internalize all the benefits”

Cross-border financial flows should be regulated like toy imports: any financial institution operating in a jurisdiction must abide by that country's rules, and to maintain the integrity of those rules countries should be allowed to interfere with, tax, or control cross-border financial flows—analogous to barring toys that fail lead-content requirements.

“when we importance toys from China we say they better abide by our all by US health and safety requirements... our rule should be the same that any financial institution that wants to operate in the u.s. jurisdiction ought to operate by the rules set in the United States”

Even if pioneer investors generate uncaptured spillovers, this does not imply a subsidy is warranted; the spillovers may only mean the investor makes a smaller-than-optimal investment, and government subsidies are unlikely to be set well because they are driven by political motivations.

“the fact that you don't capture all of it fact that there spill overs doesn't really mean that there should be there's no implication is you need a subsidy to do it just means you don't capture all of it”

In developing-country policy one is always in a second-best world where multiple distortions are entangled, so insisting on first-best reforms is often escapism; the reforms that work best are pragmatic second-best reforms that isolate and target the specific interacting distortions.

“you are always in a second best world... I think often we just say take the first best and that just becomes it's often escapism because you are inherent in a second best world”

In El Salvador, despite extensive liberalization, privatization and stabilization with a sound contractual environment, nothing except garments took off (and only due to a special US trade privilege); investors asked what they would do with $25 million said they would rather put it in Miami, illustrating that the binding constraint was market failures associated with low income, not government failure.

“El Salvador an economy which had really done tremendous amount in terms of just liberalizing his economy privatizing stabilizing... nothing except for garments had taken off... You ask people if I give you 25 million dollars what would you invest in in the Salvadoran economy and they would... say well can I put it in Miami”

High measured labor productivity in capital-intensive facilities is largely attributable to the machinery and embedded labor in technology, not the skill of the workers themselves, who mainly oversee that the machinery functions.

“it's really not the workers that are productive it's the machinery that is smart and allows a relatively unskilled worker to work in that factory and look like the source of the productivity”

Latin America gets locked into a pattern of specialization intensive in natural resources and primary products, which generate little employment and also encourage political rent-seeking, making such specialization bad for governance and politics.

“they get locked into a pattern of specialization that's much more intensive in natural resources and primary products those sectors don't generate a whole lot of employment and also generate a lot of political rent-seeking”

Latin America gets locked into a pattern of specialization intensive in natural resources and primary products, which generate little employment and a lot of political rent-seeking, which in turn is bad for governance and politics—a self-reinforcing 'lousy dynamic'.

“they get locked into a pattern of specialization that's much more intensive in natural resources and primary products those sectors don't generate a whole lot of employment and also generate a lot of political rent-seeking they say generate is bad for governance and bad for politics for that reason that so it's a it's a lousy dynamic”

China's manufacturing success is less a matter of Chinese workers 'getting good at making things' and more that China allowed capital and modern technology to come in, making its citizens the vehicle for productivity change (e.g., sweaters now made with the same machinery used in South Carolina rather than by hand).

“it's not it's not that that China got good at making things they allowed people to bring in the capital that made their citizens the vehicle for that change... a sweater factory in China was a bunch of women with knitting needles... that's not how they make sweaters in China anymore they make them with the same machinery they would use I think... in South Carolina”

Following Arthur Lewis's dual-economy model, economic development is the process by which labor moves from traditional low-productivity sectors (typically traditional agriculture) to more modern productive sectors (typically urban industry as the leading modern sector).

“going back to a very you know early tradition in development economics that goes back to really Sir Arthur Lewis's work in the 1950s when he developed these models of of the dual economy and he defined that the process of economic development as one where basically labor moves from the more traditional parts of the economy typically traditional agriculture to more modern more productive parts typically urban sectors but industry as a leading modern independent sector”