How important is sectoral reallocation for catch-up in productivity?

There has been a re-emergence of catch-up in productivity by emerging market and developing economies (EMDEs) to advanced economies (Dieppe 2020). Understanding how the sector-specific source or the changing sectoral composition (i.e., structural change) has contributed to the aggregate beta convergence in productivity is an area that has so far been under-explored.

In low-income countries (hereafter “LICs”), a high share of employment and low labor productivity in agriculture is mainly responsible for low aggregate productivity. The average share of employment in the agricultural sector in LICs was over 65 percent in 2018, compared to just 3 percent in advanced economies. Furthermore, the level of agriculture productivity in LICs is only 4 percent of advanced-economy productivity. One way for countries to boost productivity and drive long-run growth and catch-up to advanced economies is to undertake reallocation of employment from low productivity sectors to higher productivity sectors. Such structural change has been taking place in many LICs over the last decade, particularly in Africa (Diao et al. 2017; Dieppe 2020; Rodrik 2018).

To understand the role of structural change in convergence we constructed a new sectoral dataset for 8 sectors and 91 countries over 1995-2018 (and for 60 countries over 1975-2018) (Dieppe and Matsuoka 2021). This is the first comprehensive database covering a broad range of both advanced economies and emerging and developing economies over a long time. This more detailed dataset and a more recent sectoral decomposition improve the scope to assess the contribution of structural change in driving the productivity convergence, particularly as the estimates are sensitive to the level of aggregation (Üngör 2017).

Between sector effects supporting productivity growth in LICs

We start by employing a shift-share analysis which decomposes aggregate labor productivity into the within sector and between sector effects. Between sector effects are driven by the reallocation of employment to sectors with higher productivity levels. Within-sector productivity growth may reflect the effects of improvements in human capital, investments in physical capital, technological advantages, or the reallocation of resources from the least to the most productive firms within each sector.

This decomposition shows that productivity growth in advanced economies had been almost entirely driven by within-sector productivity growth mainly in the manufacturing, transport and finance sectors. However, since the 2000s both within-sector and between-sector productivity growth have slowed. In contrast, in Emerging and Developing Economies, productivity growth has been supported by both within-sector and between-sector changes over the last forty years. The within-sector growth has been broad-based-including in agriculture as well as manufacturing, trade, transport, and finance services, while the between-sector productivity gains mainly reflected a move out of agriculture into services. In LICs, between-sector productivity gains in LICs reflected a broad-based shift out of agriculture into services such as trade, transport, and finance.

Figure 1. Within sector and between sector effects

_{Note: Median contribution to productivity growth.}

Both within and between sector effects are driving catch-up in labor productivity

The unconditional (beta) convergence hypothesis suggests that productivity catch-up growth may occur fastest where productivity differentials are the largest across countries. Even though if sectors are not converging to the frontier, the reallocation of labor to other sectors with higher productivity levels could also be an important engine of beta convergence. Following Wong (2006), this aggregate beta unconditional convergence can be decomposed into the contribution of the within-sector growth and that of sectoral reallocation. Dieppe and Matsuoka (2021) using the new database are the first to undertake this decomposition for aggregate beta convergence for a large number of countries ranging from advanced economies to low-income countries over a long sample.

The decomposition of aggregate convergence suggests that since 1995 both within and between sector effects have become important drivers of aggregate convergence in labor productivity (Figure 2). This reflects larger productivity improvements in many sectors in EMDEs (especially the LICs) compared to advanced economies as well the fact that many EMDEs experienced rapid sectoral shifts from agricultural sectors over the last few decades. Looking across the sectors, agricultural productivity growth has been a significant contributor to aggregate convergence, whereas catch-up in other sectors has only contributed a small amount to convergence. Our result is in line with Ivanic and Martin (2018) and Ligon and Sadoulet (2018) which illustrate that the increase in agricultural productivity has a larger poverty-reduction effect than increases in other sectors.

Figure 2. Decomposition of beta convergence

A. Decomposition of beta convergence

B. Contributions of sector-specific within effects on beta convergence

_{Note:"Other industry" includes utilities and construction; “Trans. and Fin.” illustrate transport and finance services; "Others" include government and personal services.}

Sectoral reallocation can be facilitated with the right policies

Although the potential productivity gains from sectoral reallocation have become more challenging to achieve, there would still be important payoffs from some policies that supported diversification, including: developing human capital, including at the tertiary level; promoting good governance, and easing the cost of doing business; strengthening institutional capabilities; reducing distortions such as uncompetitive regulations and subsidies; supporting R&D; and promoting exports and developing stronger managerial capabilities. Removing barriers to migration can also help to facilitate structural transformation. Given the low level of productivity in EMDE agricultural sectors and its role as the primary employer in LICs, policies to raise agriculture productivity would pay significant dividends.

References

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