25 May 2017

Studies have not been able to conclusively prove that structural change drives economic growth. In his paper Structural change and economic growth: Empirical evidence and policy insights from Asian economies, Dr Vu Minh Khuong of the Lee Kuan Yew School of Public Policy at the National University of Singapore proposes a new measure of structural change that can deepen our understanding of how the phenomenon influences economic growth.

Finding a better way to examine growth effects of structural change

Structural change is a shift in the fundamental ways in which an economy functions. The expected nature of structural change dynamics is that factor inputs such as labour and capital continuously move from lower- to higher-productivity sectors, thus increasing productivity at an aggregate level.

In Asia, for example, authors van Ark and Timmer show that the reallocation of resources from agriculture towards industry has led to significant economic growth in countries with lower incomes. In more advanced economies, the shift of labour towards the service sector has led to overall productivity growth.

However, although structural change is based on the hypothesis that the movement of productive inputs among sectors drives economic growth, several studies show that there is no conclusive evidence of this. Additionally, according to Vu, the existing measures have some limitations that may compromise the accuracy of results.

Vu hence introduces a new approach to measure structural change called effective structural change (ESC). This specifically takes into account the effectiveness of the shift of labour among sectors and how it contributes to overall growth of labour productivity.

Effective structural change impacts productivity and economic growth

Using data from 19 Asian countries for the period from 1970 to 2012, Vu's research found that both the contemporaneous and delayed effects of ESC have a much greater impact on wages and labour productivity, compared to other growth variables. This implies that ESC not only enhances competitiveness of the business sector, but also improves living standards.

ESC is shown to contribute to labour productivity growth by fostering efficiency improvement a decrease in the number of labour hours needed to produce the same level of output. This is much more effective than promoting capital deepening, which refers to the increase in capital stock per worker.

It was also found that ESC strongly boosts GDP growth in a manner whereby the contemporaneous effect is larger than its delayed effect on all growth variables. This could encourage policymakers to implement decisive actions to encourage ESC, as it yields quick results.

However, there appears to be one short-term concern to accelerating ESC. Although it leads to sizeable growth benefits, there tends to be a significant negative impact on employment growth. The cost of rising unemployment could be why policymakers are reluctant to adopt structural reforms, hence causing growth to remain sluggish in many countries. However, this negative effect on employment appears to become insignificant in the long run.

What policymakers can take away from the ESC approach

>According to Vu, policymakers should prepare for the cost of rising unemployment in the short term.

He suggests that they first raise awareness and understanding among the public especially workers who might be affected about the benefits of a structural change. Additionally, policymakers must formulate plans to upskill workers who risk losing their jobs, so they can be trained to take on new roles.

Singapore, for example, is currently seeing slower growth and increased unemployment as the country undergoes a structural transition. Recognising these challenges, the government has allocated a significant amount of the 2017 Budget to incentives and schemes that ease companies' and workers' short-term hardships as well as encourage capacity building and skills upgrading.

It should be noted that ESC should also be promoted by implementing a series of systematic and continuous policy initiatives instead of a one-time effort at reform. Singapore's Industry Transformation Maps, for instance, consist of long-term strategies to transform industries by improving productivity, developing workers' skills, using research and development to encourage innovation, and helping companies expand overseas.

The ESC measure will likely become an important tool in understanding the evolution of the global economy. Although Vu's study has mainly focused on structural change in Asia, future research could test this methodology in other geographical contexts such as Africa, where rapid structural transformation is occurring.

Read the paper on Structural change and economic growth: Empirical evidence and policy insights from Asian economies for more details on the study's methodology and findings.