Industrialisation is instrumental in an economy’s long run economic growth as large scale domestic production leads to the creation of higher paid jobs, which in turn creates greater demand for manufactured goods. One reason why many developing countries are unable to achieve sustained economic growth and higher living standards, like those in the Western Europe, may be attributable to the incapacity of these countries to industrialise. As Kaldor maintains, ‘there can be little doubt that the kind of economic growth which involves the use of modern technology and which eventuates in high real income per capita, is inconceivable without industrialisation’ (Kaldor 1967:54).
The final structural division is the service sector. This includes commerce, finance, real estate, tourism and insurance. Services ‘have one basic feature in common: none of the activities represents in any significant way the production of commodities; each renders a product that is intangible and not easily embodied in a lasting and measurable form’ (Kuznets 1966: 143).
Services are more common in more developed areas like Western Europe and USA, where incomes are high and there are considerable levels of demand for such services. However some developing countries such as India and much of the Caribbean also have a growing service sector (software in India and tourism in Caribbean states) that contributes to the total gross domestic product. Charles Smith also has the view that ‘it should not be necessarily assumed that a large tertiary sector can be used to define an MDC’ (Smith 1994:80). Smith also gives the example of Germany, who despite being a developed country, has a large manufacturing sector and places less emphasis on service industries.
Structural Changes in an Economy
‘The transition from a traditional to a developed economy can be defined in general terms as the set of changes in the economic structure required to sustain a continued increase in income and social welfare’ (Chenery 1979:6)
The idea that there is one defining factor that initiates structural change from agriculture, where produce is consumed to industry, where large scale production takes place is somewhat contentious; however Kuznets explains that the transition from agriculture to industry could be characterised into four components; a greater demand for non-agricultural goods as a result of higher incomes per capita, a widening domestic market supply for non-agricultural products, ‘which reduces an economy’s comparative disadvantage and thus widens the economic base for import substitution industries outside the agricultural sector’, the increasingly improved means of transportation and communications through globalisation, that lower the comparative advantage that developed countries once had due to the increasing exposure of competition from less developed countries in the forms of lower costs, and finally the advance of modern technology that reduces the reliance on the agricultural sector. For example the substitution of ‘mechanical for animal power’, ‘synthetic for natural products’ and ‘tractors and automobiles for horses’ (Kuznets 1966: 114-115).
As a result of this transition (commonly seen as the industrialisation process), much of the labour force that becomes engaged in industry benefits from higher incomes and therefore causes demand for low income elasticity of demand (agricultural) goods to decline, so that over time, as the real income of the population rises, the demand for such goods may also rise but at a lower proportional rate to incomes and supply. Consequently, much of demand and supply will shift from agricultural products to relatively higher income elasticity of demand (industrial) goods such as automobiles, furniture, utilities and facilities for education and healthcare.
As a country successfully industrialises and a greater percentage of the economy’s GDP is accounted for by manufactured goods, the level of savings in the economy will rise as people acquire higher levels of disposable income. As a result, investment will rise and domestic firms will invest in improving the quality of existing physical and human resources, increasing the volume of capital machinery and raising the potential output of all or specific resources through innovation or research and development, which will in turn increase output and productivity levels. However the extent to which an economy can progress will depend on how quickly and efficiently an industry can work to supply for the new changes in demand.
One outcome of industrialisation is the improvement of an economy’s balance of payments position. As the total output of domestic industries increase (shown diagrammatically in outwardly shifting of the Production Possibility Curve), firms are able to export goods to other countries. However, the degree of improvement of a country’s BoP position will depend on the willingness of foreign countries to accept export prices as they may impose protectionist barriers, as well as the volume of goods that will be imported as a result of higher per capita incomes.
Another outcome of industrialisation is the increase in the standard of living in society due to higher incomes and the provision of basic needs such as food, healthcare, education and transport.
A combination of capital accumulation, technological progress and increasing growth in the population and workforce (Todaro and Smith 2006:97), result in sustained economic growth and continuing increases in GDP per capita. As this occurs the share of total output and demand shift once more from industry to higher YED goods in the service sector. This de-industrialisation process instigates a shift of labour into services, where there is greater demand from domestic firms for workers, in order to increase supply and maintain a state of equilibrium as consumption rises.
The opportunities for commerce and increased government spending are created by further advances in technology and communications and higher tax revenues (Wolf 2004:119). This leads to a ‘post industrial’ phase of development where there is increased provision of public welfare services, with comparatively high income elasticises.
In the social aspect of this structural change, the general standard of living rises as people are able to save, invest and spend much larger amounts of their increased disposable income.
Table 1 Levels of Growth in GDP and economic structures (%)
Source: growth World Bank, ‘2007 World Development Indicators’ (Section 4.1- ‘Growth of Output’ p. 192).
As Table 1 shows, there is a general shift in output from agriculture to services. With the exception of some countries, namely Latin America, and Europe, there have been significant increases in the percentage growth in services within these time periods. Differences from these general trends may be due to the state of particular economies and their capacity for further growth. For example the average percentage growth in services is higher in both periods in Europe; however comparably the rate of growth in this sector has declined.
Structural Change Models
I will now examine two models that consider that economic growth can be attained through the movement of labour from agriculture to industry, where marginal productivity is greater and there are higher levels of GDP per capita leading to increases savings and investment.
Rostow’s Stages of Growth Model
Rostow suggested that a study of history demonstrates that developed countries have passed through five identifiable ‘stages of growth’ on the process of their economic development to their current positions. He also proposed that it is necessary for developing countries to pass through these stages if they are to reach the point of self sustaining growth. ‘It is possible to identify all societies, in their economic dimensions, as lying within one of five categories: the traditional society, the pre-conditions for take-off into self-sustaining growth, the take-off, the drive to maturity and the age of mass consumption’ (Rostow 1960:4). Rostow also acknowledges the need for labour to move from agriculture to industry where productivity is greater (Rostow 1960:21-23).
The most critical assumption of this model is that Rostow attempts to fit the process of economic progress into a single linear system of only a few stages. This model therefore does not take into account the reality that many countries may reach a degree of transition and then move backwards. Rostow is also vague about exactly what factors are responsible for take-off and it is difficult to assess exactly what stage an economy is currently at, as in reality economies may be in between stages.
The Lewis Two-Sector Model
The Lewis two-sector model is more explicitly about structural change and Lewis goes a step further than Rostow, in that his model explains how structural change may come about.
Lewis, as shown above, views the economy as dualistic in nature, consisting of a rural subsistence sector and a modern urban industrial sector. In this model, the traditional agricultural sector is typically characterized by low wages, an abundance of labour, and a marginal productivity of labour that moves towards zero because of the labour intensive production process. In contrast, the modern manufacturing sector is defined by higher wage rates than the agricultural sector, a higher marginal productivity and high initial demand for more workers. In addition, the manufacturing sector is assumed to use a production process that is more capital intensive, so investment and capital accumulation are possible in the manufacturing sector over time as profits are reinvested locally. Therefore economic development would occur from the process of migration of surplus labour from agriculture into the urban industrial sector, where productivity, real GDP per capita and overall production is higher (Lewis 1954).
However, a number of debatable assumptions are made in this model. Firstly, it is unlikely that all profits that are gained in the industrial sector will be reinvested locally, as profits may be consumed, saved or invested elsewhere. Lewis also assumes that there is a surplus of labour in the rural sector and full employment in the urban sector; whereas the actual migration that has taken place in many developing countries in recent years suggests that the area of surplus labour is in fact the urban sector. Furthermore, Lewis ignores the fact that a continual transfer of labour to urban areas will result in overpopulation and unemployment as well as rural neglect, thus furthering dualism and inequality.
From this assessment, it is clear that both Lewis and Rostow emphasize a need for an increase in savings and (more importantly) investment in order to reach a stage where economic growth is sustainable. It is through investment that an economy increases its productive capacity, which lends itself to economic development and the progression of an economy’s structure.
Conclusion
In this essay, I have attempted to identify and discuss the structural changes that take place both in an economy and in society during development as production moves through the three economic sectors and incomes rise. I have therefore attempted to examine theoretical and empirical evidence to explain how and why rising incomes, among other factors, have lead to such changes in production structures.
As I have mentioned earlier, industrialisation may be one of the single most influential factors to which a developing country advances towards ‘maturity’ and sustained economic growth. However in reality, the record of industrialisation in the ‘Third World’ is to some extent diverse. In some newly industrialised economies such as Malaysia, Thailand, South Korea and China (to a degree China may be considered as a developed country), there has been continuous economic growth of up to 10%-15% of GDP per annum. This may be due to the ability of these countries to successfully promote a good financial system, political and social stability and an economy that welcomes foreign direct investment through state provisions of merit goods and infrastructure.
‘Modern economic growth’ as defined by De Long ‘is the large-scale shift of employment from agriculture to manufacturing and now services. And it is the creation of large business organisations’ (De Long 2002:131). Although it is important to progress through the economic divisions of an economy, it is also fundamental that all three sectors are maintained, as all sectors support each other in such a way that agriculture provides many of the industrial sector’s inputs – cotton, tobacco and rubber and industry releases labour for the service sector.
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