HUANG Zongye^a and YOU Yu^b

(a: Capital University of Economics and Business; b: Liaoning University)

Summary:

Economic development is always accompanied by structural change in the economy: the agriculture employment share decreases, the service sector employment share increases, and the manufacturing employment share exhibits a hump-shaped pattern. To analyze structural change, it is important to consider two aspects: the demand side factors and the supply side factors. From the demand side, the role of consumption and international trade on structural change are well explored in the literature. However, the role of investment is mostly ignored. We show that investment rate exhibits another hump-shaped pattern, which can directly affect the manufacturing sector, because the production of capital goods is skewed towards manufactured goods. From the supply side, previous studies attributes structural change to different production functions among different sectors. However, structural change can also occur if there is technological change within a sector. In particular, the agriculture sectors in developed and developing countries are using very different technologies. Thus, the technology change in the agriculture sector (agriculture modernization), can be a key driver of modern economic growth.

       The goal of this paper is to incorporate these two factors into a general model of structural change. Our theoretical model highlights the importance of agricultural modernization as a central mechanism that triggers the transition from traditional economy to modern growth. When agriculture relies on traditional technology, which is labor-intensive and does not improve overtime, the agriculture sector has to occupy a large portion of the labor force to meet the subsistence level of food consumption. Nevertheless, there exists a modern agriculture technology that uses reproducible capital as a key input and its efficiency persistently improves along with other modern sectors at an exogenous rate. After passing a certain threshold, the modern technology becomes superior to the traditional technology and is gradually adopted for agriculture production. This modernization is an endogenous choice by farmers and affects the demand of capital goods (investment) in two ways. First, the adoption of modern technology requires capital inputs, which directly cause investment demand to rise. Second, it releases excess workers to other sectors who have to accumulate capital goods to move and settle down. Both channels increase the demand for physical capital that are mostly produced by the manufacturing sector. As a result, agriculture modernization causes both investment rate and manufacturing employment to increase (industrialization). When the majority of workers in the traditional agriculture sector have moved into other sectors, the agriculture modernization completes, investment demand for manufactured goods peaks and begins to shrink, which causes the manufacturing employment share to drop (deindustrialization).

Based on the above theoretical model, this paper empirically examines the relationship between structural change and economic growth, using a panel data of 34 countries from 1950 to 2005. The data source is the 10-sector database from Groningen Growth and Development Centre. Using fixed effect, random effect, and instrument variable models respectively, we confirm two propositions from the theoretical model: 1) the stronger the agriculture technology adoption, the higher the investment rate is. This relation will disappear once manufacturing employment passes its peak. 2) The strength of agriculture technological change has no direct effect on manufacturing employment share. It has indirect effect on manufacturing employment share through investment.

This paper contributes to the literature in three ways. First, we provide a unified framework to explain the hump-shaped pattern of manufacturing employment shares by incorporating agriculture modernization, which is a novel explanation to understand structural change. Second, we emphasize the role of capital accumulation in understanding structural change. We argue that agriculture modernization first affects investment rate, and then affect manufacturing employment. Finally, using numerical simulation and regression analysis, we empirically confirm two implications of our theoretical model.

Keywords: Agricultural Modernization; Structural change; Hump-Shaped Pattern

JEL Classification: O13, O14, O41