# 05 Chapter 5: Industrialization and Structural Change

FLEX Course Material

Students will have a concept of capital accumulation as necessary to

industrialization.
Students will also know the disadvantages and the advantages, when

Population
industrialization in the urban area overwhelms and the rural areas remain
agricultural.

Module Goals
 # 05

At the end of this module, the students are expected to have:

Explained through essay format one of the two questions given below:
Discuss the interrelationship between education and the shift that have taken place in

industrial production in Asia over the past two or three decades. How does comparative
advantage fir into the paradigm?

Is the motivation to migrate from the rural areas to the city generally the same as the
motivation to work overseas? Discuss some of the possible differences in the variables
that explain migration in these two cases.

Learning Goals
 Economic Development in Asia
Chapter 5- Industrialization and Structural Change
 Industrialization
• Rapid industrial development is the key element of
structural transformation from an agrarian based rural
economy to a modern state.

• In the Lewis-Fei-Ranis (LFR) model, capital

accumulation fuels the development of the industrial
sector.

• There is a dramatic shift from agriculture to industry.

 Industrialization
• Labor removed from agriculture does not affect output much since
there is a surplus of labor in the rural sector.

• As labor moves from the traditional sector to industry, overall labor

productivity increases.

• Wages in industry are higher than they are in agriculture resulting in

labor migration.
 Industrialization
• The flow of labor to the city and to the industrial sector
provides a new gain to society.

• Once the stock of surplus labor is exhausted, wages are

driven up in both sectors.

• Terms of trade between the two sectors will depend, to

some extent, upon government policy.
 Industrialization
• A delicate balance is necessary to
keep agriculture viable yet allow
for investment in industry.

• Linkages between the two sectors

are important as backward
linkages with suppliers in the
rural sector help both sectors to
grow as industry flourishes.

• Forward linkages help countries

to upgrade their industrial bases.
 Linkages
• Backward linkages are strong in industries such as
leather, clothing, textiles, food and beverages and paper
products.

• Forward linkages are strong in industries such as

petroleum and chemical and some heavy industries and
also in some labor intensive electronics.
 Industrialization
• Choice of technology will be
determined, under competitive
conditions, by the relative costs of
capital and labor.

• Economies of scale can be important

in enabling industries to move to the
lowest point on the cost curve.

• Exporting to foreign markets is one

way to achieve economies of scale,
particularly if the domestic economy
is limited.
 Economic Efficiency
• Despite economies of scale,
overall economic efficiency
depends on a number of
other factors including
management, marketing and
distribution. Technology is
also important.

• To become efficient, it is
often argued that new
industries need to be
protected from competition
until they grow to be efficient
enough to compete
internationally.
Infant Industry Protection
• Such infant industry
protection has been used to
erect tariff barriers and import
restrictions in a number of
countries. [Refer
Supplementary Article 5a]

• Generally, the evidence from a

number of developing countries
suggests that such protection
increases inefficiency rather
than reduce it.

• There are some exceptions in

Asia, including Korea and
Taiwan.
Small Scale Industrial Development
• Small and medium scale industries (SMEs) are generally
more labor intensive.

• Given a good policy environment, SMEs can thrive,

particularly where large scale economies are not
necessary. Taiwan is a good example, where
outsourcing and international networking were used to
build up the industrial base.
 Openness and Foreign Trade
• Foreign direct investment (FDI) can be an important
source of capital and expertise, particularly for export
oriented industries in the early stages of development.
• The issues of FDI and international trade will be taken up
more systematically in the next chapter.
 The Asian Experience with
Industrialization
Unprecedented in economic history.
Per capita income increased by about 7% per year
in the NIEs for 30 years.
At the end of this period, incomes were four times
higher than in the base period.
Industry’s share of income increased
dramatically.
 The Asian Experience
Some countries had high savings rates and medium to
rapid labor force growth (Russia and Spain) but they
didn’t grow as fast.
There was more to the Asian miracle than the brute
force of high investment and rapid growth in the
labor force.
Innovation, better industrial organization, growing
globalization all contributed. [Refer Supplementary
Article 5b]
 The Asian Experience
This process of innovation and structural
change resulted in a dramatic shift in the
composition of industrial output.
The share of manufactured goods increased as
did the share of exports (Table 5.2).
Exports shifted quickly to light and heavy
industry from primary industry (Table 5.3).
 The Asian Experience

There was also a shift, from the 1980s, to more

“science” based industries such as electronics,
pharmeceuticals and biotechnology.
The electronics sector began to feature prominently in
the exports and production of the NIEs and in
Southeast Asia.
Growth followed an ‘S’ shape, accelerating rapidly in
the 1970s and 1980s.
 Technological Transfer
There were different patterns of technological
transfer.
Korea and Taiwan followed a pattern of producing
locally for foreign firms to the foreign firms’
specifications or a combination of local and foreign
designs and specification. They did not form joint
venture or encourage foreign firms to set up
independent operations.
 Technological Transfer
Singapore and Hong Kong welcomed foreign
direct investment. Singapore had a more hands
on industrial policy by training and provision
of infrastructure.
See Table 5.4 for comparisons of openness,
role of government and size of firms.
 Technological Transfer
Despite differences, four factors were common.
1. Low inflation and interest rates and high saving
rates.
2. Outward looking trade policies.
3. Forward looking human resources strategy.
4. Appropriate (for local conditions) government
industrial strategy.
 Comparative Advantage and
Industrialization
The Asian industrial experience can be further
analyzed by looking at revealed comparative
advantage or by comparisons with best practice firms
in industrial countries.
Such comparisons allow us to draw several
inferences. Some of them reinforce previous
observations.
 Comparative Advantage

The share of manufactured goods in total exports

increased dramatically.
This shift in production corresponded closely with a
similar shift in production taking place in the world
economy.
The export push began in labor intensive goods and
moved to electronics and other science based exports.
 Comparative Advantage
The pattern was more pronounced in East Asia
and Southeast Asia but was also observed in
South Asia.
Because of this shift, Asian countries were able to
gain market share of world exports over a twenty
year period (Table 5.5).
 Role of Innovation
If we break down the composition of output growth
in the NIEs and SE Asia:
- About 20% is due to labor force growth.
- As much as 25% or more is attributed to
educational improvements of the labor force.
Innovation requires the active involvement of labor
since it requires a destruction of old ways of doing
things and creation of new methods and processes.
 Innovation
Entry and exit of firms have to be facilitated in
order for innovation to take place efficiently and
smoothly
Costs of entry and exit are high for larger firms
and are particularly high when large firms have a
special relationship with the government.
 Innovation
In PRC, India, Vietnam and Indonesia, large firms are
kept in business because of the feared adverse effects
on employment.
One method of facilitating entry into new business
and of attracting overseas FDI is through the set up of
Special Economic Zones (SEZs).
Many countries in Asia have set them up.
 Innovation
SEZs can be extended to the notion of an industrial
cluster.
3 main kinds of industrial clusters are large
metropolitan agglomerations, small groups of firms
with similar interests and clusters with a few main
producers and their suppliers.
 Innovation
Much innovation in Southeast Asia has been
the result of spending by MNCs.
Innovation and technology transfer takes place
most often when capital equipment and
components are imported by export oriented
manufacturing firms
In East Asia, it has been generated internally
and with the help of strategic alliances with
foreign firms.
 Innovation
Research is often conducted jointly with these
foreign firms.
Innovation in marketing and distribution as
ICT and transportation efficiency gains have
cut costs.
State owner enterprises are notoriously slow to
innovate
 Innovation
Labor intensive innovation can take place when
technical change is based on skill intensive industries.
It is important that labor markets remain flexible in
order to facilitate labor absorption.
Until the Asian crisis, most economies in the NIEs
and Southeast Asia were close to or fully employed.
 Innovation
The importance of private research and development
can not be overemphasized.
The role of FDI has also been critical.
State owned enterprises (SOEs) are not good at R and
D or innovation.
60 % of FDI in East Asia is in manufacturing.
This is a much larger proportion than in industrial
countries.
Innovation, Education and Growth
Convergence
There was growth convergence between Asian NIEs
and industrial countries.
This resulted from synergies created by technology,
education, openness and competitiveness.
It is important that appropriate technology be employed
at each stage of the industrialization process.
Innovation, Education and Growth
Convergence
Research and development not only increases
with per capital income but it accelerates at an
increasing pace.
Appropriate technology is more important than
state of the art technology.
 Employment Growth and
Industrialization
Flexible wages and appropriate technology are
needed to absorb labor into industry quickly and
effectively.
This enables employment to grow with output
without inflation.
 Employment Growth and
Industrialization
Most East and Southeast Asian economies were fully
or nearly fully employed for most of their growth
spurt.
South Asia was not as fortunate as income growth
was not sufficient to reduce unemployment
dramatically.
 Rural to Urban migration

As industrialization proceeded, so did the

movement of labor from rural to urban areas.
Harris-Todaro model predicts that
unemployment can coexist with rapid labor
movement to the city.
 Rural to Urban migration
This is because workers were willing to wait in low
paid and not fully employed positions in the city
waiting to get a job in the higher paid occupations.
This seeming irrationality could have been the
systematic overestimation of prospects in the city.
It could also have been the result of other benefits
perceived from living in the city.
 Rural to Urban Migration
It is also possible that the lure of the city and the
stories told by their relatives that had just migrated
were enough to induce the young workers to migrate.
The move would have appealed to the risk takers in
the countryside – likely to be the young and
adventurous rather than the secure and middle aged.
Workers also migrate in order to provide remittance
income for their families at home.
 Migration in Asian Countries

Migration within/between Asian economies has been

primarily a function of wage differentials. [Refer
Supplementary Article 5c]
International migration from the poorest to the richest
– Indochina, Philippines, South Asia to industrial
countries and the NIEs.
Lots of restrictions in migration because of fears of
social disruption and tension.
 Migration in Asian Countries

Rich countries are willing to take temporary migrants

for short term employment in low-skilled
occupations.
Permanent migration is more likely for the skilled and
professional.
 Government Policy
Nurturing industrial growth depends on the wisdom
of industrial policy – infrastructure spending, prudent
infant industry protection, free labor markets,
attractive incentives for foreign businesses and
technology, use of special zones.
Efficiency and welfare were traded off in the early
stages in favor of the former.
Only recently are social safety nets being constructed
in the Asian region.
 Summary
Lewis-Fei-Ranis (LFR model)
Discussion of the Asian experience with
industrialization
Role of technological transfer and Innovation
Rural to urban migration
Government policies and strategies