the process of catching up or even put the economy into a trajectory of falling the real output of the manufacturing industry and its positive effects on the.
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STRUCTURAL CHANGE AND ECONOMIC DEVELOPMENT: IS BRAZIL CATCHING UP OR FALLING BEHIND? André Nassif, Carmem Feijó and Eliane Araújo No. 211 October 2013Acknowledgements: The authors thank Luis Carlos Bresser Pereira, José Luis Oreiro, David Kupfer, Fernando Puga, Erika Amorim, Claudio Leal, Jorge Arbache, Samuel Pessôa and the two anonymous UNCTAD referees for their comments and suggestions. Any remaining failures are the authors™ responsibility. UNCTAD/OSG/DP/2013/1

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ii of the UNCTAD secretariat or its Member States. The designations and terminology employed are also those of the authors.UNCTAD Discussion Papers are read anonymously by at least one referee, whose comments are taken into account before publication.Comments on this paper are invited and may be addressed to the author, c/o the Publications Assistant, Macroeconomic and Development Policies Branch (MDPB), Division on Globalization and Development Strategies (DGDS), United Nations Conference on Trade and Development (UNCTAD), Palais des Nations, CH-1211 Geneva 10, Switzerland; e-mail:; fax no: +41 22 917 0274. Copies of Discussion Papers may also be obtained from this address. UNCTAD Discussion Papers are available at O11; O40; O47

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iiiContentsPageAbstract .1 I. INTRODUCTION ..1 II. STRUCTURAL CHANGE AND ECONOMIC DEVELOPMENT: THE THEORETICAL FRAMEWORK ..3 A. Towards a structuralist theory of economic development: a Kaldorian-Thirlwallian approach .3 B. Stylized facts and a basic hypothesis on structural change and economic development 6 III. STRUCTURAL CHANGE IN THE BRAZILIAN ECONOMY: INDUSTRIALIZATION (OR DE-INDUSTRIALIZATION), CATCHING UP (OR FALLING BEHIND) SINCE THE 1970 s? 8 A. An overview of the Brazilian industrialization process ..8 B. The connections between the stylized facts on structural change and economic development and the empirical evidence for the Brazilian economy .10 IV. ECONOMETRIC EVIDENCE: THE KALDOR-VERDOORN™S AND THIRLWALL™S LAWS .18 .18 .19 V. CONCLUDING REMARKS .22ANNEX A: Manufacturing industry according to technological intensity 24ANNEX B: Data sources .25REFERENCES .26List of tables 1 The main sectors of activity as a share of total real value added in Brazil, selected years ..9 2 Participation of employment in Brazil by sector of economic activity, selected years ..13 econometric estimate of equation (2) 19 4 Explanatory factors and income elasticity of demand for imports in Brazil 20 5 Explanatory factors and income elasticity of demand for exports in Brazil 21 6 Thirlwall™s Law 21 1 Value added in the Brazilian manufacturing sector according to technological intensity, selected years .11 2 Percentage of total employment in the Brazilian manufacturing sector according to technological intensity, selected years ..12 .15 4 The Brazilian technological gap: relative labour productivity in the Brazilian .15 16 17

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2and human capital accumulation as well as technological progress. 2 In practical terms, these latter factors are responsible for sustaining high rates of growth in productivity in a particular country, and therefore, considering the average growth in the world economy as a given, for accelerating the process of catching up. Yet, the central point of divergence among economists is concerned with the most important sources for boosting growth rates in productivity both in absolute and relative terms in a developing country in order to reduce the technological gap with respect to developed countries and, therefore, to ease the process of catching up in the long run. 3 Kaldorian in the sense that the behaviour of productivity in the long run is mainly determined by factors from traditional sectors like the primary one to the manufacturing one, and then, after the country has achieved high levels of real income per capita, to the service sector. Several authors have argued that, together with other facts, when the rapid and large loss of participation of the manufacturing sector in total value added and mainly in total employment occurs before the country has reached high levels of per capita income, this phenomenon characterizes an early de-industrialization 4 and can strongly retard the process of catching up or even put the economy into a trajectory of falling behind. 5, 6 It is important natural phenomenon in developed countries, because at this stage of development, the domestic income elasticity of demand for services is a little higher than that for manufactured goods (see Clark, 1940). The theoretical framework of this paper is based on Kaldor and Thirlwall theories on the basic driving forces of the behaviour of productivity and economic growth in the long run. From the Kaldorian view, we will base our work on the hypothesis that the main sources of the behaviour of the aggregate productivity that it has the highest capacity to disseminate its gains from productivity to the economy as a whole. 7 By anchoring on this Kaldorian hypothesis, we also show that the more a country is able to construct a to sustain high rates of economic growth in the long run. In the literature on economic development, 2 Within the neoclassical literature, see Lucas (1988), Romer (1986, 1990), and Grossman and Helpman (1991), among others. For a structuralist-evolutionary view, see Nelson and Winter (1982), Fagerberg (1988), and Dosi, Pavitt and Soete (1990), among others.3 In economics, the long run refers to economic time, rather than calendar time. However, even in terms of calendar time, the period during which a country becomes successful in catching up depends on several factors, such as the size of these latter policies with macroeconomic policies. For instance, the Republic of Korea could catch up in a period of around 25 years, while China, if it will actually succeed in doing that, will take much more than 30 years. See Amsden (1989) for the Republic of Korea, and Amsden (2001), for comparing the hard efforts of several developing countries to search for adequate strategies to promote structural change and catching up.4 For other details on the recent literature about early de-industrialization, see Rowthorn and Wells (1987), Rowthorn and Ramaswany (1999) and Palma (2005).5 of the manufacturing sector in total employment, rather than in total value added. 6 developed countries, because at this stage of development, the domestic income elasticity of demand for services is a little higher than that for manufactured goods. For other details on de-industrialization, see Rowthorn and Wells (1987), and Rowthorn and Ramaswany (1999).7 than doubles. Therefore, considering that the factor prices used in that investment are kept constant, the long-term unit cost innovations over time and, therefore, tends to accumulate learning-by-doing, knowledge and major technological capacity.

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3this relationship between the real output of the manufacturing industry and its positive effects on the productivity of the economy as a whole is known as the Kaldor-Verdoorn Law. This Kaldorian theoretical framework will additionally be complemented by the Thirlwall hypothesis on the importance of a country to have an income elasticity of demand for exports above the income elasticity of demand for imports if the country intends to sustain economic growth without facing balance of payments constraints (Thirlwall™s Law). This hypothesis makes it clear why it is important for a its net exports (exports minus imports) basket composed of goods of high income elasticity of demand in the long run. The relevance of the paper for an emerging country like Brazil is that, despite the fact that this country industrialized country in the Kaldorian point of view. That is to say, it has not yet reached the same stage of maturity as developed countries. 8 So, since responding to part of the title of this paper (fiis Brazil catching up or falling behind?fl) has normative implications, the paper can assist policymakers in evaluating whether or not the actual short and long-term economic policies lato sensu (industrial and technological policy, macroeconomic policy and so on) are in tune with each other in order to sustain the long-term economic growth of the Brazilian economy and promote the process of catching up with developed countries.Besides this Introduction and the Conclusion, the paper is organized as follows. Section II presents the main hypothesis and stylized facts on structural change and economic development based on the Kaldor-Thirlwall theories. Section III, by connecting the previous stylized facts and a basic hypothesis on the same theme with empirical evidence on the Brazilian economy based on descriptive statistics into early de-industrialization. 9 condition for sustaining both high rates of productivity and growth in the long run; and second, we will estimate the long-term income elasticities of demand for imports and exports for the Brazilian economy constraints to long-term economic growth or kept more distant from the international technological frontier. II. STRUCTURAL CHANGE AND ECONOMIC DEVELOPMENT: THE THEORETICAL FRAMEWORK Most economists today practically agree with the hypothesis that both innovation and technological spillovers are the main engine for explaining productivity growth. However, while neoclassical economists tend to give all sectors of the economy equal weight for explaining the productivity behaviour of the economy as a whole, structuralist economists, by identifying the manufacturing industry as the main 8 For a discussion about the stages of development of the Brazilian manufacturing industry, see Feijó and Lamonica (2012). 9 Due to unavailability of data, descriptive statistics on the Brazilian manufacturing sector will only cover the period between 1970 and 2008.

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4dynamic increasing returns to scale, argue that the manufacturing sector is the main force for explaining the aggregate productivity. 10The importance given to the maximization of static and dynamic increasing returns to scale as the main explanatory factor for boosting both aggregate productivity and (therefore) economic development is relatively old in economics. The general idea was presented not only by authors like Adam Smith (1776) and Allyn Young (1928), but also by authors like Paul Rosenstein-Rodan (1943), Albert Hirschman (1958) and Gunnar Myrdal (1957), among others. However, it was not until the publication of a set of Kaldor™s sector as the location for most industries subject to increasing returns to scale was so clearly and precisely demonstrated (see Kaldor, 1966, 1967, 1968, 1970 and 1975). Before summarizing Kaldor™s main hypothesis on the relationship between structural change and economic which countries, by having already caught up, are able to exhibit high levels of income per capita and GDP is accompanied by a major participation of the service sector; and second, one could argue that, since a lot (but not the majority) of the new ideas, knowledge and dynamic economies of scale are now being generated in the tradable service sector, the effects of the microelectronic and telecommunication revolution (for most, the third industrial revolution) on the representative role of the manufacturing sector for economic development, as supported by Kaldor (1966), is becoming passé. principal arguments when the service sector was composed basically of nontradables, he certainly would have recognized the role of the tradable services today as additional forces to those coming from the manufacturing sector in accelerating and sustaining the development process; second, even if we take into account the increasing participation of several important tradable services (e.g. software) as being subject to static and dynamic increasing returns to scale in the entire service sector, the fact is that the majority of this latter phenomenon occurs and could continue to occur in the process of manufacturing production; 11 and third, and perhaps more importantly, following the insights pioneered by Young (1928), Kaldor (1966: because so much of the economies of scale emerge as a result of increased differentiation, the emergence of new process and new subsidiary industries, they cannot be discerned adequately by observing the The interpretation of the static and dynamic economies of scale as a fimacro-phenomenonfl is essential for understanding Kaldor™s hypothesis on the importance for developing countries to have a strong and trajectory departing from the immaturity to maturity stage. In addition, it is important to stress that, in a Kaldorian framework, the more a country has its manufacturing industry formed by segments which operate under static and dynamic increasing returns to scale, the more rapid is its catching up process. Then, for Kaldor (1966), economic development is a process through which structural change happens. That is to say, the productive resources are strongly reallocated from the traditional sector (especially agriculture) to the manufacturing sector (mainly those segments of more technological sophistication, 10 (Marx, 1887, especially Vol. I, chapter XV, fiMachinery and Large-Scale Industryfl). Yet, the incorporation of this force 11 To give an example, various activities generated in the conception of goods produced by Apple, such as the creative ideas, knowledge and engineering of projects may be developed in the service sector. However, the majority of Apple family goods (i-pods, i-phones, i-pads and so on) are produced by segments of the manufacturing sector which operate

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5namely those that are engineering-, science- and knowledge-based). 12 Only when a country has already above the world average) could the loss of the participation of the manufacturing industry in total GDP be accepted as natural. In his seminal paper, Kaldor (1966) enumerated the following hypotheses on structural change and economic development as well as giving the econometric evidence which supports them:13 of its manufacturing industry. Not only due to its high capacity for generating innovation and disseminating technological spillovers throughout the economy as a whole, but also by virtue of its above mentioned presence in static and dynamic increasing returns to scale, the manufacturing sector dictates the dynamism of aggregate productivity growth.(ii) Insofar as the static and dynamic economies of scale presented in the manufacturing sector are understood as a fimacro-phenomenonfl, once economic development is sustained, the synergies between the increase in productivity in the manufacturing industry and the positive changes in productivity in the economy as a whole make aggregate productivity become largely associated with the increase in total output. This result, which is known as the Kaldor-Verdoorn Law, is largely explained by dynamic economies of scale. 14, 15 By associating the different levels of per capita income reached by a country with a minor or major propensity to consume manufacturing goods, Kaldor de-industrialization, especially at the stage during which it has reached a level of income per capita close to the world average. In fact, since at this stage societies tend to have a high propensity to growth in the long run.(iii) As if anticipating Thirlwall™s (1979) model of the balance-of-payment constraint to growth, Kaldor (1966) suggested that, mainly in either intermediate or relatively advanced stages of development, goods. The important question that could be raised as to this point is as follows: if it is a high demand increase in the manufacturing sector which governs the pace of growth in the economy as a whole, why should a weak foreign demand for exports constrain economic development even in large economies like the United States, China or Brazil? The answer is far from being associated with supporting an export-led growth strategy for these countries, insofar as the large size of their domestic market is perhaps more important than exports for boosting the advantages of economies of scale in the manufacturing sector. The main reason is that the more a country can augment and diversify its exports through a major composition of goods with high income elasticity of demand, the less will be the external constraint to economic growth in the long run. In fact, if one observes 12 In our empirical analysis ahead, we will break down the manufacturing sector into three groups: labour intensive; natural resource-based; and engineering-, science- and knowledge-based.13 McCombie and Thirlwall (1994) call these hypotheses Kaldor™s Laws. 14 15 Kaldor (1966) showed econometric evidence on this relationship (see table 2: 107). As McCombie and Thirlwall (1994, chap. 2) summarized, despite a variety of empirical works attempted to validate or not the Kaldor-Verdoorn Law for a group of countries in the long run, the results, in principle, seemed not to be conclusive. However, since Kaldor (1970) later argued that it is more appropriate to estimate the fidifferences in firegionalfl growth rates [taking into account the] different areas within the same country [–], for there are few, if any, economic barriers to the interregional mobility of capital and to interstate migrationfl, McCombie and Thirlwall (1994: 209) also summarized the estimates of the Kaldor- Verdoorn Law respecting Kaldor™s suggestion and concluded that fithe assumption of output growth is fundamentally demand, rather than supply, determined more plausible at both the international and the regional levelfl.

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