Which Sectors Make the Poor Countries so Unproductive?

One of the major challenges in economics is to account for the huge international disparity in income. Standard growth accounting exercises (pdf) find that cross-country differences in aggregate total factor productivity (TFP) cause a sizeable part of the differences in GDP per capita. A growing literature addresses this issue and shows that cross-country differences in the institutional environment, in policies, or in human capital can cause differences in TFP. In a recent paper[1], Berthold Herrendorf and Ákos Valentinyi argue that information about the sectoral performance of TFP differences can help to discriminate among the existing theories.

The literature typically considers only two sectors: growth theorists distinguish between consumption and investment while trade theorists distinguish between tradables and nontradables. Herrendorf and Valentinyi argue that in order to understand sectoral TFP patterns, it is important to disaggregate to four sectors, viz. services (nontradable consumption), consumption goods (tradable consumption), construction (nontradable investment), and machinery and equipment (tradable investment).

Interacting the data from the 1996 benchmark study of the PWTs with economic theory*, they find that the TFP differences across countries are much larger in the two tradable sectors than in the two nontradable sectors. This is consistent with the Balassa-Samuelson hypothesis (pdf). They also find that within the tradable sectors the TFP differences are much larger in machinery and equipment than in consumption goods. "We think that a successful theory of aggregate TFP ought to be consistent with the finding that the tradable sectors are the problem sectors. At this stage, it not clear to us how well the existing theories do in this respect. For example, one hypothesis is that poor countries have low TFPs because they have bad institutions. But this raises the question why these bad institutions do so much more damage in the tradable sectors. A different hypothesis is that poorer countries are plagued by entry barriers and monopoly rights. Again, this raises the question why monopoly rights are more prevalent in the tradable sectors. Resolving these important issues is beyond the scope of the present paper. We suggest it as a fruitful and important area of future research."

Click here to watch the CES lecture series "Using the Penn World Tables to learn about Developmet" by Berthold Herrendorf. The first two lectures are nicely done but cover very elementary concepts. Herrendorf presents his paper in the third lecture (@32:30).

[1] Which Sectors Make the Poor Countries so Unproductive?, Berthold Herrendorf and Ákos Valentinyi, November 2005

*Their approach follows Hsieh and Klenow (2003) in that it utilizes that differences between sector TFPs lead to differences in the observable corresponding (adjusted) relative prices.