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Supporting Economic Transformation Supporting economic transformation An approach paper Margaret McMillan, John Page, David Booth and Dirk Willem te Velde March 2017 Overseas Development Institute 203 Blackfriars Road London SE1 8NJ Tel. +44 (0) 20 7922 0300 Fax. +44 (0) 20 7922 0399 E-mail: [email protected] www.odi.org www.odi.org/facebook www.odi.org/twitter Readers are encouraged to reproduce material from ODI Reports for their own publications, as long as they are not being sold commercially. As copyright holder, ODI requests due acknowledgement and a copy of the publication. For online use, we ask readers to link to the original resource on the ODI website. The views presented in this paper are those of the author(s) and do not necessarily represent the views of ODI. © Overseas Development Institute 2017. This work is licensed under a Creative Commons Attribution-NonCommercial Licence (CC BY-NC 4.0). Cover photo: Dignity factory workers producing shirts for overseas clients, in Accra, Ghana. Credit: Dominic Chavez/World Bank. This material has been funded by UK aid from the UK Government, however the views expressed do not necessarily reect the UK Government’s ofcial policies. Acknowledgements This paper has been prepared by Margaret McMillan (IFPRI), John Page (Brookings Institution), David Booth (ODI, Senior Research Fellow) and Dirk Willem te Velde (ODI, Director of the Supporting Economic Transformation [SET] programme). We are grateful for inputs and discussions with Louise Fox (University of California, Berkeley), Neil Balchin, Alberto Lemma and Kasper Vrolijk, and we thank Stuart Tibbs, Miguel Laric, Nick Lea and colleagues from DFID for guidance and comments. We also thank Sheila Page for peer review. All views expressed are those of the authors alone and do not reflect DFID or ODI views. For further information about ODI’s SET programme please contact Sonia Hoque ([email protected]), SET Programme Manager. Contents Acknowledgements iii Acronyms viii Executive summary ix 1 Introduction 1 2 Defining economic transformation 3 2.1 Structural change 3 2.2 Within-sector productivity growth 4 2.3 A working definition of economic transformation 4 3 Measuring economic transformation 6 3.1 Economy-wide changes in labour productivity 6 3.2 Firm-level measures of productivity 9 3.3 Export diversification, value chains and value addition 10 3.4 Conclusion: A framework for measuring transformation in developing countries 12 4 The political economy of transformation 13 4.1 Entry points for political economy 13 4.2 Political-economic fundamentals 14 4.3 Governance reform? 15 4.4 Getting politically smart about economic transformation 17 5 Choosing and combining policies 19 5.1 Policies for economic transformation 19 5.2 Clusters of economic transformation policies 27 5.3 How might international development policies help? 28 6 Country experiences in economic transformation 30 6.1 Transformation outcomes compared 30 6.2 Nigeria 32 6.3 Rwanda 33 6.4 Mauritius 35 6.5 Bangladesh 37 6.6 Indonesia 38 6.7 Summing up 40 7 Conclusions: towards a guided enquiry into economic transformation 41 7.1 What is happening? 42 7.2 Why is it happening? 43 7.3 What needs to be done? 44 7.4 How to make it happen? 44 7.5 Conclusions 45 Endnotes 46 References 47 List of boxes, figures and tables Box 1. Limited economic transformation: country experiences 1 Box 2. Country variations in political economy 16 Box 3. Policy choice: country options 21 Box 4. Pathways of political-economic change 25 Box 5. Supporting economic transformation, a new approach and key propositions 42 Figure 1. Relative labour productivity gap 8 Figure 2. Application of Hausmann product space to Tanzania and Bangladesh, 1995 and 2013 11 Figure 3. The relationship between ubiquity (vertical axis) and diversification (horizontal axis) 31 Figure 4. Decomposition of labour productivity change (annual changes) 31 Figure 5. A guided enquiry into economic transformation at country level 43 Table 1. Productivity decompositions by region 16 Table 2. Pros and cons of selected international databases relevant for transformation 18 Table 3. Four ways to upgrade through global value chains 19 Table 4. Domestic value addition content as a ratio of gross exports by sector 20 Table 5. A typology of public actions to promote economic transformation 35 Table 6. What clusters of factors drive economic transformation? 36 Table 7. International support for economic transformation (illustrative examples) 37 Table 8. Economic transformation in Nigeria 41 Table 9. Economic transformation in Rwanda 43 Table 10. Economic transformation in Mauritius 44 Table 11. Economic transformation in Bangladesh 46 Table 12. Economic transformation in Indonesia 47 Table 13. Public actions that supported economic transformation (illustrative country examples) 49 Acronyms AfDB African Development Bank AfT Aid for Trade AU African Union CAADP Comprehensive Africa Agriculture Development Programme CGE Computable general equilibrium DFI Development Finance Institution DFID Department for International Development DHS Demographic and Health Surveys ECOWAS Economic Community of West African States EPZ Export Processing Zone EPZDA Export Processing Zones Development Authority ERD European Report on Development FDI Foreign direct investment FLFP Female labour force participation FLFPR Female labour force participation rate GDP Gross domestic product GNI Gross national income GVC Global value chain HS Harmonised System ICT Information and communications technology IFPRI International Food Policy Research Institute IMF International Monetary Fund IPA Investment promotion agencies JICA Japan International Cooperation Agency LGAF Land Governance Assessment Framework LIC Low-income country MFA Multi-Fibre Arrangement OECD Organisation for Economic Co-operation and Development PSF Private Sector Federation RER Real exchange rate RHS Right hand side SEZ Special Economic Zone SME Small and medium enterprise TFP Total factor productivity UNCTAD United Nations Conference on Trade and Development UNECA United Nations Economic Commission for Africa UNIDO United Nations Industrial Development Organization WDI World Development Indicators WDR World Development Report WTO World Trade Organization SUPPORTING ECONOMIC TRANSFORMATION | AN APPROACH PAPER Executive summary The quality of economic growth matters. For the majority Prescribed policy options should be realistic about the of today’s developing countries, a change of gear from disincentive effects on investment generated by typical steady but low-quality growth to a process of economic patterns of politics and interest-representation. They should transformation is the only secure route to sustained poverty also be aware of the scope for stepwise, cumulative change reduction. Supporting economic transformation involves and politically-smart interventions to address particular better understanding the determinants of productivity blockages. at the micro (firm) and macro levels and showing how, Section 5 offers a typology of policy approaches to under the right conditions, resources can shift from supporting economic transformation. The types of public low-productivity to high-productivity uses, diversifying a actions proposed in the literature divide into those intended country’s productive capabilities, generating new sources to accelerate the relative growth of higher value-added of export competitiveness and expanding formal-sector sectors in the economy – in other words, policies to support employment. This paper explains the main concepts and structural change – and those intended to accelerate the methods underpinning policy discussion on economic pace of within-sector productivity growth. Within each transformation and sets out an approach to analyse and of these policy sets, the literature further distinguishes tackle the challenges it poses. between ‘horizontal’ or enabling interventions and targeted After a brief introduction, Section 2 of the paper interventions. This produces a two-by-two classification presents a simple definition of economic transformation matrix. We argue that, while a combination of policy types rooted in the recent academic literature. Economic is likely to be needed in most cases, the choice should be transformation is understood as a continuous process influenced by a judgement about the feasibility of making of (a) moving labour and other resources from lower- headway in spite of the identified political-economy to higher-productivity sectors (structural change) and constraints. Whilst domestic action is in the driving seat, (b) raising within-sector productivity growth. Within- the international community can contribute to economic sector productivity growth entails the adoption of new transformation in several ways, including by influencing technologies and management practices that increase international policy (for example, trade agreements that the efficiency of production. It can be brought about by lower costs, or more stable and efficient banking rules) and increasing the efficiency of existing firms or by reallocating with well-designed aid programmes (for example, building resources away from less productive firms towards more skills). productive firms. Enhanced productivity typically also Section 6 draws together the diagnosis of involves trade and production diversification and increased transformation deficits, the policy typology and our value addition in export activities, especially those serving approach to political economy by examining the experience large and
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