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Employment Policyin Developing CountriesA Survey of Issues and Evidence

A World Bank Research Publication

Employment Policy* in Developing Countries

A Survey of Issues and Evidence

Lyn Squire

PUBLISHED FOR THE WORLD BANK

Oxford University Press

Oxford University Press

NEW YORK OXFORD LONDON GLASGOWTORONTO MELBOURNE WELLINGTON HONG KONG

TOKYO KUALA LUMPUR SINGAPORE JAKARTADELHI BOMBAY CALCUTTA MADRAS KARACHI

NAIROBI DAR ES SALAAM CAPE TOWN

© 1981 by the International Bankfor Reconstruction and Development / The World Bank

1818 H Street, N.W., Washington, D.C. 20433 U.S.A.

All rights reserved. No part of this publicationmay be reproduced, stored in a retrieval system,

or transmitted in any form or by any means,electronic, mechanical, photocopying, recording,

or otherwise, without the prior permission ofOxford University Press. Manufactured in the

United States of America.

The views and interpretations in this book are theauthor's and should not be attributed to the World

Bank, to its affiliated organizations, or to anyindividual acting in their behalf.

Library of Congress Cataloging in Publication Data

Squire, Lyn, 1946-Employment policy in developing countries.

Bibliography: p.Includes index.1. Underdeveloped areas-Labor supply.

2. Underdeveloped areas-Manpower policy. 3. Un-derdeveloped areas-Full employment policies.I. World Bank IL Title.HD5852.S65 331.12'042'091724 81-2844ISBN 0-19-520266-X AACR2ISBN 0-19-520267-8 (pbk.)

Foreword

This book was originally written as a background study for theWorld Development Report, 1979, the second of a series of annualreports produced by the World Bank's economic staff. Each yearthe best of these studies are separately published for the use ofscholars and practitioners in specific fields. The present work isone of three monographs dealing with problems of industrializa-tion and urban development, the main themes of the 1979 report.

Low rates of growth in industrial employment, high rates ofunemployment for new entrants to the urban labor market, andlow levels of labor productivity and remuneration are the threeissues addressed in this paper. Squire demonstrates that, in com-parison with historical experience, the sectoral transformation ofthe labor force in developing countries has been retarded by theunusually fast growth of the labor force rather than the slow paceof industrialization. The concentration of high rates of unemploy-ment among young, inexperienced, and first-time entrants to theurban labor market is attributable to the varying rates at whichwages in different segments of the market have adjusted to the un-precedented expansion in the supply of such workers, and to theability of the more affluent families to support their dependentsduring a period of job search.

Low productivity and remuneration are due primarily to in-appropriate macroeconomic policies rather than to labor marketdistortions. Accordingly, Squire's policy discussion is concernedwith identifying the more important determinants of labor de-mand and supply and the extent to which the growth of labordemand has been restrained-and labor supply advanced-by in-appropriate policies. On the demand side, industrial trade policy,agricultural growth, and the operation of capital markets aresingled out for discussion; on the supply side, attention is focusedon population and education policy.

v

vi Foreword

As do other World Bank research studies, Squire takes a broadcomparative view of his subject. His policy recommendations aresoundly based in economic theory but supported as well by awealth of empirical illustrations drawn from the Bank's opera-tional work.

Hollis B. CheneryVice President

Development PolicyWorld Bank

Contents

Foreword v

List of Tables x

1. Introduction 3

Organization 5

Conclusions 6

Part I Statistical Overview 11

2. A Historical Comparison 15

Factors Operating on the Supply Side 15Factors Operating on the Demand Side 20Industrial LaborAbsorption in the 1960s 23Factors Determining Industry 's Share of the Labor Force 26Technical Note 31

3. A Cross-Sectional Analysis 42

Population and Labor Force 42

Sectoral Structure of the Labor Force 47Educational and Occupational Structures of the Labor Force 49Productivity and Real Wage Rates 53Summary 56

4. Unemployment and Underemployment 57

Analytical Content 58Estimates of Unemployment 66Estimates of Underemployment 69

Conclusion 74

Part II. The Operation of Labor Marketsin Economic Development 77

5. Models of the Dual Labor Market 79

6. Determination of Rural Wages 83

Utilization of Rural Labor 83Rural Wage Rates 90

7. Rural-Urban Migration 98

Recent Trends 98

vii

viii Contents

Theories 100Evidence 100Policy Implications 105

8. The Operation of Urban Labor Markets 109Minimum Wage Legislation and Trade Unions 109Hiring Practices of Modern Sector Firms 114Social Security Legislation 117Hiring Practices in the Public Sector 118Labor Heterogeneity 121 ,Market Disequilibrium 122Labor Market Adjustment 123

9. Policy Implications 125Unskilled Labor 125Educated Labor 130Conclusion 132

Part IIL. Policies Affecting Labor Demand 133

10. Labor Absorption in Services and Informal Activities 135Demand for Services 136Productivity in Services 140Informal Sector 140Conclusion 143

11. The Employment Effects of Industrial Trade Policy 144Intercountry Comparisons 144Labor Intensity of Manufactured Tradables 149Conclusion 151

12. Employment in Agriculture 153Internal Terms of Trade 153Farm Size 155Distortions in Factor and Input Markets 157Recent Evidence 162Policy Inference 164

13. Capital Markets 166Capital-Labor Ratios 167Determinants of Saving 170Conclusion 1 72

14. Synthesis 173

Part IV. Policies Affecting Labor Supply 1 75

15. Population Growth in Economic Development 1 77Consequences of Rapid Population Growth 1 77

Contents ix

Population Growth and GNP per Capita 181

Population Growth, Structure

of the Labor Force, and Wage Rates 183Scope for Policy Intervention 185

16. Education Policy 194

Role of Education in Economic Growth 194

Educational Expansion and Its Implications 195

Social and Private Rates of Return 199

Vocational and On-the-Job Training 201Conclusion 204

References 207

Index 223

Figure 1. Wage Employment, Self-Employment, and Underemployment 60

Tables

1. Sectoral Structure of the Labor Force in Developed and DevelopingCountries, 1880-1960 12

2. Sectoral Distribution of the Labor Force for Developed Countries, 1]880,and Developing Countries, 1960 13

3. Average Annual Growth Rates of Population, Labor Force, and Urban-ization in Developing and Developed Countries, 1800-19 70 16

4. Age Structure of the Population in Developed Countries, circa 1900,and Developing Countries, circa 1960 1 7

5. Educational Attainment and Growth Rates for Developed Countries,circa 1900, and Developing Countries, circa 1960 19

6. Crude Estimates of Sectoral Value Added and Productivity Growth Ratesfor Developed Countries, 1880-1900, and Developing Countries,1960-70 20

7. Occupational Structure of the Labor Force in the United States andLatin America 22

8. Average Annual Rates of Growth of the Labor Force by Sector for D)e-veloped Countries, 1880-1900, and Developing Countries, 1960-70 23

9. Crude Estimates of Sectoral Value Added and Productivity for De-veloped Countries, 1880, and Developing Countries, 1960 27

10. Population and Labor Force by Region, 1950-2000 44

11. Sectoral Distribution of the Labor Force by Region, 1950-70 48

12. Educational and Occupational Structures of the Labor Force in SelectedCountries, 1960 49

13. Age-specific Enrollment Ratios by Level of Education and Country In-come Group 50

14. Occupational Structure of the Labor Force by GDP per Capita,1960-70 51

15. Level and Growth Rate of Productivity by Sector and Region 52

16. Average Annual Rates of Change in Wages, Employment, Prices, andGDP per Capita by Region, 1964-72 54

17. Percentage of the Labor Force in Wage Employment in Selected Coun-tries, circa 1970 58

18. Open Unemployment Rates in Selected Economies 67

19. Urban and Rural Unemployment Rates in Selected Economies i58

20. Urban Unemployment by Age and Sex in Selected Countries 70

x

Tables xi

21. Unemployment by Educational Attainment in Selected Countries 71

22. Estimates of Underemployment in Selected Countries 72

23. Hours Worked in Rural Areas in Selected Economies 84

24. Labor Utilization in Three African Countries: Division of Twelve-HourDay among Activities 85

25. Wage Employment and the Agricultural Labor Force in Selected Coun-tries 86

26. Labor Market Participation in Malaysia and Egypt 87

27. Distribution of Employed Labor Force between Agricultural and Non-agricultural Activities in Rural Areas of Selected Economies 88

28. Seasonal Variation in Labor Usage in Three Countries 89

29. Net Rural-Urban Migration in Selected Countries, 1950-70 99

30. Intersectoral Wage Differentials for Low-skill Labor in Selected Coun-tries 102

31. Time Required for Migrants to Find First Job in SelectedCountries 104

32. Wage Differentials and the Share of the Labor Force in Mining for Se-lected Mineral-Producing Countries, circa 1970 116

33. Extent of Public Sector Employment in Selected Countries 11934. Job Preference by Level of Education for Unemployed Urban Males

Aged 15-24 with No Previous Work Experience, Sri Lanka, 1968 12035. Non-Estate Labor Force by Education and Age, Sri Lanka,

1969-70 124

36. Numerical Simulations of the Effect of Minimum Wage ]Legislation onthe Structure of the Labor Force and on Productivity 126

37. Employment in New and Old Services in Developed and DevelopingCountries 137

38. Employment in Intermediate Services in Developed and DevelopingCountries 139

39. Variation in Sectoral Productivity with Level of Development 141

40. Share of Industry in Total Labor Force by Development Pattern andGDP per Capita for Selected Countries, 1970 146

* 41. Wage Rates, Unemployment and the Sectoral Structure of the LaborForce in Four Countries, 1950-70 148

42. Ratio of Labor Coefficients in Exportables and Import Substitutes inSelected Countries 150

43. Contribution of Agriculture and Manufacturing to GDP and GDP Growthunder Different Assumptions about Protection in SelectedEconomies 154

44. Relative Yields and Labor Intensity by Farm Size in Colombia and Paki-stan, 1960 155

45. Average Farm Size and Farm Size Distribution in Selected Economies,1960 156

xii Tables

46. Sources of Agricultural Loans in Selected Economies 15847. Percentage Distribution of Institutional Credit by Farm Size in Selected

Economies 160

48. Formal and Informal Rural Interest Ratesin Selected Economies 161

49. Recent Agricultural Development in Japan, Taiwan, and Mexico 16250. Fixed Assets per Job in Direct Employment for Four Countries 168

51. Capital Productivity by Size of Enterprise for Five Countries 169

52. Estimated Age Structure of the Population by Region, 1975 1 7853. Gross Domestic Investment per New Labor Market Entrant in Selected

Countries, 1975 17954. Average Annual Growth Rates of Crop Area and Agricultural Population

for Selected Countries, 1970-75 180

55. Percentage Decline in Crude Birthrate by Social Setting and ProgramEffort, 1965-75 186

56. Total and per Capita Funds for Family Planning Programs in SelectedAreas 191

57. Comparison of Gross Discounted Lifetime Earnings among EducationalLevels in Selected Countries 196

58. Average Social Rates of Return by Educational Level in Developed andDeveloping Countries 197

59. Comparison of Modem Sector Job Vacancies and Educated Labor Mar-ket Entrants in Selected Countries, 1973 198

60. Educational Expenditure by Region 201

Acknowledgment

Helpful comments on early drafts of this book were received from ShankarAcharya, Suman Bery, Roberto Cuca, Alan Gelb, Peter Hazell, Don Keesing,Timothy King, Deepak Lal, Mark Leiserson, Johannes Linn, Dipak Mazum-dar, Guy Pfeffermann, Garry Pursell, Graham Pyatt, Frances Stewart, RichardWebb, and Manuel Zymelman. Frequent discussions with Mark Leisersonwere especially instructive.

Nancy Enikeieff and Ben Sands provided highly competent research as-sistance. The entire manuscript was expertly typed by Banjonglak Duangrat,and it was edited for publication by Jane Carroll. Brian J. Svikhart super-vised production of the book, Raphael Blow prepared the figure, ChrisJerome read and corected proofs, andJames Silvan and Ralph Ward providedthe index.

xiii

4

It

I

Employment Policyin Developing Countries

A Survey of Issues and Evidence

1

Introduction

This survey is concerned with three issues: the sectoral structureof the labor force, unemployment, and underemployment.

It is frequently claimed that the industrial sector's absorptionof labor in developing countries has been inadequate in the sensethat only a small proportion of the incremental labor force hasobtained industrial jobs, the remainder being forced to acceptlow-productivity jobs in agriculture and services. It is shownhere, however, that industrial employment in developing countrieshas increased at almost twice the historical rate of the developedcountries and that, in relation to the existing labor force, industryin developing countries has absorbed labor at about the same rateas in the developed countries during the late nineteenth century.These results reflect the rapid growth of industrial output in cur-rently developing countries. Nevertheless, changes in technologyand unprecedented increases in the labor force combined to limitindustry's share of the labor force in the developing countries of1960 to less than half of that in developed countries at the turn ofthe century.

Of itself, this need not be a matter for concern. To the extentthat it reflects a suboptimal use of resources, however, it becomesof major importance. Once attention is focused firmly on resource

* allocation rather than on the sectoral distribution of the laborforce, it is conceivable that some policies to improve the allocationof resources may retard the structural transformation of the labor

* force. For example, agricultural labor demand in many countrieshas been suppressed by inappropriate pricing policies and anunequal and inefficient distribution of investable resources. Elimi-nating these biases may improve resource allocation and incomedistribution but may reduce industry's share of the labor force.

Unemployment is measured by the number of people activelyseeking jobs. This implies that two conditions must be fulfilled

3

4 Introduction

before positive unemployment rates can be expected in developingcountries: first, the financial return to job search must be positive,which, in turn, requires the existence of wage differentials andimperfect information; and second, nonlabor income must beavailable to finance the unemployed. It follows that the con-centration of high rates of unemployment among young, in-experienced but educated, first-time entrants to the urban labormarket can be attributed to the varying rates at which wages indifferent segments of the market have adjusted to the unprece-dented expansion in the supply of such workers, and to the abilityof relatively rich families to support their dependents during aperiod of unemployment.

Wage differentials for unskilled, uneducated labor have alsoattracted considerable attention, not because unemploymentrates are correspondingly high, the poor being unable to financea prolonged job search, but because of the implied misallocation oflabor resources. Minimum wage and social security legislation,trade union activity, and the hiring practices of large-scale fimis-so-called institutional factors-are often alleged to have created"high-wage" sectors, with the result that the sectoral allocationof labor is less than optimal. It is argued here, however, that theextent of institutional wage determination has been exaggeratedand that, to the extent that such distortions do exist, their re-moval would have little effect on the economy-wide marginalproduct of labor.

The concept of underemployment has suffered from a be-wildering variety of definitions. It is defined here as the existenceof workers whose earnings from wage or self-employment liebelow a given cutoff, this being the approach most frequentlyadopted in the recent literature. It is therefore conceptually simi-lar to measures of the extent of poverty. Concern for the under-employed, thus defined, can arise for two reasons: first, becausetheir low earnings are thought to be the consequence of frag-mented factor markets, distorted product markets, and otherdivergences between social and private measures of costs andbenefits; and second, because society may consider the achieve-ment of a more equal distribution of income a legitimate goal.In this book attention is directed to the first reason, and policyconclusions are drawn accordingly. Conclusions for a more egali-

Introduction 5

tarian approach, though remaining implicit, can be deduced fromthe discussion in many instances.

Within these limits, the obvious policy prescription is theremoval of distortions in the labor market. The premise of thisbook, however, is that this is unlikely to increase labor productiv-ity significantly. Much of this study, therefore, is concerned withthe identification of the more important determinants of labordemand and supply and with the extent to which the developmentof labor demand has been restrained, and that of labor supplyadvanced, by inappropriate or inadequate policies. On the de-mand side, industrial trade policy, agricultural growth, and theoperation of capital markets are singled out for discussion, and onthe supply side attention is focused on population and educationpolicy.

Organization

The book comprises four sections. Part I provides a statisticaloverview of the three issues identified above. Historical and cross-sectional comparisons are used to place in perspective the quanti-tative dimensions of the growth of population, labor force,sectoral employment, and the supply of educated labor. Recenttrends in labor productivity, developments in real wages, andestimates of unemployment and underemployment are also re-viewed in Part I.

The operation of labor markets and the determination of wagesare discussed in Part II. The determination of rural wage ratesand the causes and consequences of rural-urban migration areexamined first. The bulk of Part II, however, is concerned with theoperation of urban labor markets. Simple numerical exercisesillustrate the quantitative significance of the elimination of institu-tionally induced distortions in the market for unskilled labor.The causes of educated unemployment are also examined.

In Parts III and IV selected policies affecting, respectively,labor demand and supply are reviewed. On the demand side threepolicies are considered: the promotion of manufacturing, thedevelopment of agriculture, and efforts to increase the efficiencyof capital markets. On the supply side, population programs areobviously relevant; education policy is also considered because ofthe high rates of unemployment recorded for educated labor.

6 Introduction

Conclusions

The policy conclusions relate mainly to factors influencinglabor demand and supply, and not to factors influencing theoperation of labor markets. This reflects a major proposition ofthis study-namely, that labor markets work reasonably well.This is not to deny the significance of labor market imperfectionsin certain instances; it is to suggest, however, that the condition ofthe underemployed will not be significantly improved by increas-ing the efficiency of labor markets unless policies are implementedto increase labor demand and reduce labor supply. Accordingly,labor market policies are treated relatively briefly, with moreattention given to policies affecting labor demand and supply.

The most frequently invoked labor market policy is minimumwage legislation. It should be recognized that such legislation canserve a useful purpose, especially where oligopsonistic conditionsallow employers to take advantage of unorganized workers. As a"floor," legislated minimum wages are to be encouraged, but asa standard-setting rate for a significant part of the unskilled laborforce, they serve only to disrupt the efficient allocation of laborresources. The salary structure adopted by the public sector is theother major mechanism the state can use to determine wages.Frequently, the public sector is the main employer of educatedlabor and can therefore exercise considerable influence over thestructure of salaries. The high rates of educated unemploymentobserved in many countries indicate that adjustments in the labormarket have been inadequate. In part, this may reflect the failureof recent school leavers to recognize and accept changes in labormarket conditions; in part, however, it also reflects the failure ofsalary structures to adjust to changed conditions of labor supply.The first failure indicates the need to improve information flowsin the labor market-information services, labor exchanges, andjob-placement agencies-and the second, the need to increaseflexibility in the public sector's salary structure.

Labor mobility is essential for a well-functioning labor market,but current rates of rural-urban migration are frequently describedas excessive. The roots of this problem are shown here to lie notin the labor market, but in policies that suppress the demand foragricultural labor by bringing about excessive protection for

Introduction 7

industry in relation to agriculture and capital market imperfec-tions, and in policies that increase the costs of urbanization byproviding free or subsidized public services. The solution, there-

fore, is to be found not in the imposition of quantitative restric-tions on rural-urban migration, but in the reformulation of pricingand investment policies.

The discussion of labor demand issues is confined to an analysisof policies that improve the efficiency of resource allocation. Thisexercise, therefore, may be viewed as an attempt to identify thosepolicies that not only yield greater efficiency but also substantiallyincrease the demand for labor. On the assumption that labor mar-kets operate reasonably well, efforts to expand labor demand ina given sector can be expected to exert upward pressure on wagesin other sectors.

Industrial trade policy is considered first. Manufactured exportsare usually more labor intensive than import substitutes, so thatthe removal of the bias against exports implicit in many import-substitution policies can be expected to increase labor demand inthe short run. Of more importance, however, are the potentiallong-run benefits. The change in policy can be expected to in-crease both the gross domestic product (GDP) and the return toinvestment, particularly in the industrial sector, because such apolicy switch redresses the balance between imports and exportsand usually implies a movement away from quantitative restric-tions. In the long run, therefore, an increase in the economy-widerate of investment and a reallocation of investable resources infavor of industry can be expected. The resulting increase in thecapital stock will allow an expansion in labor demand, and thereallocation of investment flows will hasten the transformation ofthe sectoral structure of the labor force.

Although the direction of the change appears clear, the quanti-tative impact on labor demand is more difficult to discern. Ingeneral, the impact will be large if existing policies are severelybiased against exports and reliance on quantitative restrictions isheavy; if complementary factors-physical and human capital-are in elastic supply; and if the initial size of the industrial sectoris significant in relation to the rest of the domestic economy butnot in relation to the international economy. This suggests that,for one reason or another, the rationalization of industrial tradepolicy, although it would improve efficiency, is unlikely to have

8 Introduction

a significant effect on labor demand in most low-income Asianand African countries. The consequences for employment will be(and in several cases have been) more substantial in the middle-income countries.

The low-income countries have more to gain from redressing thebalance between agriculture and industry and encouraging small-scale agriculture. Agriculture can be highly labor intensive; it alsoremains the most important source of employment in low-incomecountries. Agricultural growth, therefore, can be expected toincrease considerably the demand for labor. Pricing policies whichdiscriminate against agriculture in general, and agricultural labor inparticular, should be modified. This includes policies which haveturned the internal terms of trade against agriculture as well aspolicies which have reduced the cost of capital, especially tractors,in relation to wages. At the same time, small-scale agriculture imustbe assured stability of tenure and equal access to credit, the water-seed-fertilizer technology, and markets. Finally, the need forfurther technological advances suggests that research efforts willhave to be redoubled.

Serious efforts to promote agricultural growth in the low-income countries will, of course, retard the transformation in thesectoral structure of the labor force. They will do so, however,,only to the extent that they raise labor's supply price to the in-dustrial sector. This is desirable since it would improve both ef-ficiency and equity.

The final factor examined on the demand side is the efficiencyof capital markets. In the short run, the elimination of policy-induced distortions such as interest rate ceilings and subsidizeclcredit will improve the efficiency of resource allocation. This canbe expected to have a substantial effect on the demand for agricul-tural labor. The effect on industrial labor demand, however, isambiguous; it will depend on the technological characteristics ofproduction in the previously segmented markets. In the longrun, the improvement in resource allocation will yield an increasein GDP, which in turn will result in higher levels of saving. Savingsmobilization can also be improved by expanding the array offinancial assets and services and reducing transaction costs in thecapital markets. An expansion of saving will allow a correspondingexpansion in the capital stock and should therefore unambiguous-ly increase labor demand.

Introduction 9

Much of the discussion of demand factors is concerned with thedynamic consequences of improvements in resource allocation.Improvements in the allocation of resources within agriculturemay well be the only potentially substantial benefit to employ-ment in the short run, especially in the low-income countries.Apart from this, labor demand will benefit from a more efficientallocation of resources, not so much because of sectoral changesin the distribution of a given quantity of investable resources, butmainly because of the dynamic ramifications of the resulting in-creased rate of capital accumulation. This in tum will redress thecurrent imbalance between rates of capital accumulation and laborforce growth.

On the supply side, population programs are frequently ignoredin discussions of employment issues on the ground that for short-term policymaking the future labor force can be treated as given.For example, if a country's fertility rate had been halved in 1975,the male labor force would not have been affected for fifteenyears and by 2000 would have been reduced by only one-eighth.The reduction, however, would be concentrated in the under-twenty-five age group, which by 2000 would have been halved,and it is precisely this group which has suffered most from un-employment. In the medium and long term, population policy iscrucial.

Unfortunately, many of the countries with high rates of popula-tion growth are among the poorest in the world and seem leastinclined to initiate population programs. Most low-income Africanand Asian countries (with the notable exceptions of India, Indone-sia, and Sri Lanka) have hardly begun to implement family plan-ning programs. Of the middle-income countries, many in LatinAmerica are without population programs despite annual popula-tion growth rates close to or in excess of 3 percent. Obviously,the costs and benefits of these programs can be identified only inthe context of each country. Nevertheless, in the aggregate, popu-lation control emerges as an important long-run means of in-creasing the return to labor and advancing the transformation inthe industrial structure of the labor force.

Developments in the markets both for educated labor andfor education itself are also important. The former has beencharacterized by excess supply and the latter by excess demand.The excess supply of educated labor reflects the slow adjustment

10 Introduction

of the labor market to the rapidly changing supply conditions.Wage rate adjustments and a downward revision of job expecta-tions may gradually eliminate the excess, but only at the cost ofreducing the return to education. The excess demand for educa-tion reflects the general government practice of subsidizing thesector as well as education's dual role as a consumption and aninvestment good.

These arguments suggest that plans for the expansion of sec-ondary education should be carefully reviewed in the light of theexpected decline in future returns. The gap between formalsecondary education and specific job requirements should bebridged by the provision of vocational training establishmentswhich are responsive to labor market developments. Curtailingthe expansion of secondary education, however, will exacerbatethe problem of excess demand for it. The use of the pricemechanism (school fees) may be politically acceptable in somecountries, but even full-cost pricing may be insufficient to elirni-nate all excess demand if education really is a consumption good.In most countries, nonprice rationing of limited secondary schoolplaces will be necessary for many years to come.

Implementation of the above policies can be expected to im-prove resource allocation, increase the demand for labor, raise thelevels of skill and education of the labor force, and in the long runreduce the supply of labor. The degree of success, as measured byincreases in labor's supply price, will vary among countries, de-pending on their resource and other constraints. In some countriesthe optimal package of policies, even if it could be defined andimplemented, would not be enough to increase labor's supplyprice substantially; countries are poor not only because of inap-propriate policies. Nevertheless, whatever the magnitude of theimprovement, the recommended policies can be expected to yieldsome improvement in the return to labor and should therefore bepursued.

PART I

Statistical Overview

The process of economic development in the now developed coun-tries was characterized by a major transformation in the sectoralstructure of the labor force. As shown in table 1, the share of thelabor force employed in agriculture declined from more than55 percent in 1880 to about 20 percent in 1960. In addition toa corresponding increase in the total share of the nonagriculturallabor force, the share of services expanded in relation to that ofindustry; thus in 1880, 24 and 20 percent of the labor force werein industry and services respectively compared with 36 and 41percent in 1960.1 Clark (1957) has attributed this pattern ofstructural transformation to underlying changes in the composi-tion of demand associated with increasing incomes and to inter-

sectoral variations in the rate of growth of labor productivity.In short, Clark argued that as income per capita increases, "therelative demand for agricultural products falls all the time, and. . . the relative demand for manufacture first rises, and then fallsin favor of services," and that "real product per man-hour inmanufacture . . . nearly always advances at a greater rate than realproduct per man-hour in other sectors of the economy" (Clark,1957, pp. 493-94). Together, the two tendencies adequately ac-

count for the observed change in the structure of the labor force.2

1. The statistics reported in this paragraph and table 1 are from Bairoch and Limbor

(1968). As the authors make clear, the data, drawn from a variety of sources, are subject

to considerable margins of error and should be used only to indicate broad trends. The

details of estimation and the sources used are reported fully in Bairoch and others

(1968). For this analysis, agriculture also includes forestry, hunting, and fishing; industry

covers mining and quarrying, manufacturing, construction, and utilities; and services

covers commerce, transport, storage, communications, and services proper.

2. Clark's analysis is essentially confirmed by the subsequent study undertaken by

Kuznets (1966).

11

12 Statistical Overview

Table 1. Sectoral Structure of the Labor Forcein Developed and Developing Countries, 1880-1960(percentage of total labor force)

Sector 1880 1900 1920 1930 1950 1960

AgricultureDevelopingcountnesa n.a. 77.9 77.6 76.6 73.3 70.7Developed countriesb 56.2 48.1 39.9 36.2 30.7 22.9

IndustryDeveloping countries n.a. 9.8 9.9 10.0 9.9 11.5Developed countries 24.1 28.7 31.3 30.5 32.9 36.0

ServicesDeveloping countries n.a. 12.3 12.5 13.4 16.7 17.8Developed countries 19.5 23.3 28.8 33.3 36.5 41.1

n.a. Not available.Note: All estimates are subject to considerable margins of errors.a. Developing countries include the countries of Africa except South Africa; Latin

America; Asia with the exception of Japan, China, the Democratic Republic of Korea,Mongolia, and North Vietnam; and Oceania with the exception of Australia and NewZealand.

b. Developed countries include Japan, Australia, New Zealand, South Africa,Canada, the United States, and countries in Western Europe.

Source: Bairoch and Limbor (1968), tables IV and VL

The recent historical experience of the now developing COUnI-tries, however, is different in two respects. First, agriculture ac-counts for a much larger, albeit declining, share of the total laborforce; table 1 reveals that as late as 1960 agriculture still ac-counted for more than 70 percent of the labor force.3 Andsecond, within the nonagricultural sector, services have con-sistently accounted for a considerably larger proportion of thelabor force than has industry. For example, in 1950 services emn-ployed 63 percent of the nonagricultural labor force comparedwith 3 7 percent in industry. Table 1 shows that the share of thelabor force in services in the developing countries in 1960 wassimilar to that of the developed countries in 1880. A more de-tailed breakdown of the labor force, shown in table 2, revealsclearly that the distribution of labor within services as well as thetotal share of the labor force in the service sector in the develo,p-ing countries of 1960 are similar to those of the developed coun-tries in 1880. There are marked differences, however, with respect

3. A comparable division of the labor force between agriculture and nonagriculturewas recorded in the developed countries of Western Europe and North America arotnd1800 (Bairoch and Limbor, 1968, p. 325).

Statistical Overview 13

Table 2. Sectoral Distribution of the Labor Forcefor Developed Countries, 1880, and Developing Countries, 1960(percent)

Developed Developingcountries, a countries,a

Sector 1880 1960

Agriculture 56.2 70.7Industry 24.1 11.5

Mining and quarrying 1.7 0.6Manufacturing 18.8 8.9Construction 3.6 2.0

Services 19.5 17.8Commerce 5.0 5.9Transport, storage,

and communications 2.8 2.2Other services 11.7 9.6

a. Defined as in table 1.Source: Bairoch and Limbor (1968), tables IV and V.

to their industrial labor forces: whereas the developed countrieshad almost 25 percent of their labor force in industry in 1880,the developing countries had less than 12 percent in 1960. Thusthe main structural difference lies in the relatively immaturedevelopment of the industrial sector in general and manufacturingin particular in the developing countries of today. From table 2it can be seen that a transfer of 10 percent of the labor force indeveloping countries from agriculture to manufacturing wouldyield a sectoral distribution almost identical to that of the de-veloped countries in 1880.

The relatively small proportion of the labor force in industry isoften regarded as a failure of the development process by thosewho consider agriculture and services to be low-productivitysectors. 4 Moreover, many of the developing countries are alsoexperiencing unusually high rates of open unemployment. Anextensive study of the data available in 1970 indicates rates ofurban unemployment in excess of 10 percent in several developingcountries in Asia, Africa, and Latin America (Turnham, 1971).

These high rates of unemployment, with large numbers ofworkers remaining in the low-productivity sectors, are generally

4. Services are not necessarily a low-productivity sector; see chapter 1 0.


attributed to the failure of the high-productivity industrial sectorto provide adequate employment opportunities. 5 This sectionpresents a statistical overview of these issues with the specificobjectives of both assessing their dimensions and identifying theirunderlying causes. The analysis proceeds by means of a compari-son initially between developed countries circa 1900 and develop-ing countries circa 1960 and then among groups of developingcountries today.' The first comparison pinpoints the majorfactors which could account for the differences in the structuralchanges experienced by developed countries historically and bydeveloping countries currently, while the second comparisonemphasizes the variation of experience among developing coun-tries. The available evidence on unemployment is then examined,and the analytical significance of different concepts of under-employment is discussed.

5. This view has been expressed by, among others, Baer and Herve' (1966) and Mora-wetz (1974).

6. It is not claimed that the years chosen necessarily correspond to similar stages ofdevelopment or industrialization. Indeed, differences in the overall level of developmentare treated as potentially important factors underlying the observed differences in therates of structural transformation of the labor force.

2

A Historical Comparison

Much can be gleaned from a comparison of the industrializationexperience of the now developed countries with the currentsituation of today's developing countries. The main lessons emergenot from the similarities of experience but from the major con-trasts. On the supply side, the evidence reveals marked differencesin population growth rates and educational attainments. As aresult, today's development efforts must contend with high ratesof labor force growth, increasingly better educated new entrantsto the labor market, higher dependency ratios, and rapid rates ofurbanization. And on the demand side, the high-productivitysector in today's developing countries has several characteristics-especially its much faster growth of output and productivity,and its relative skill intensity-that differ noticeably from thehistorical experience of the developed countries. These differencesare documented below.

Factors Operating on the Supply Side

Table 3 records growth rates for total population, labor force,and urban population for developing and developed countriessince 1800. The single most important conclusion to be drawnfrom this table is that the developing countries are experiencingpopulation growth rates three times as large as those encounteredby the developed countries. Thus, throughout the nineteenth cen-tury annual population growth was only 0.8 percent in developedcountries compared with 2.4 percent in developing countries for1950-70. A population growing at an annual rate of 0.8 percentdoubles in eighty-seven years; a population growing at 2.4 percenta year doubles in only twenty-nine years.

Different population growth rates have different implicationsfor labor force participation. As a result of the low birthrates and

15


Table 3. Average Annual Growth Rates of Population,Labor Force, and Urbanization in Developingand Developed Countries, 1800-1970(percent)

Item 1800-1900 1900-50 1950-70

Total populationDeveloping countriesa 0.4 1.1 2.4Developed countriesb 0.8 0.8 1.2

Labor forceDeveloping countries (0.4) 0.8 1.7Developed countries (0.9) 0.7 1.1

Urban population 1850-1920 1920-60

Developing countnes n.a. 4.0Developed countries 2.5 1.9

n.a. Not available.Note: AU estimates are subject to considerable margins of errors, especially those in

parentheses.a. Defined as in table 1.b. Defined as in table 1 with the inclusion of the U.S.S.R.Source: Bairoch (1973), tables 1, 2, and 6.

deathrates in the developed countries, for example, their popula-tion has been aging. This, together with the extension of retire-ment schemes and the rise in school attendance rates, has led toa declining participation rate. The decline, however, has beenslight: from 45 percent in 1900 to 40 percent in 1960. In thedeveloping countries, however, low mortality rates are coupledwith extremely high fertility rates and a consequent broadening ofthe base of the age pyramid (see table 4). While variation amongdeveloping countries is marked, the overall result has also been adecline in the participation rate from 43 percent in 1900 to 38percent in 1960, reflecting the increasing share of inactive childrenin the total population.'

The declining participation rates during the twentieth centuryare reflected in growth rates of the labor force (shown in table 3),which are consistently below the corresponding population growthrates. Nevertheless, during the 1950-70 period the annual rate of

1. Bairoch and Limbor (1968), table 1. Participation rates in the developing countriesare subject to considerable margins of error, mainly as a result of differences among coun-tries in the treatment of unpaid family workers, especially females. This point is examinedbelow (see chapter 3).

A Historical Comparison 1 7

Table 4. Age Structure of the Populationin Developed Countries, circa 1900,and Developing Countries, circa 1960(percent)

Developed Developing* countries,a countries,b

Age at last birthday circa 1900 circa 1960

0-14 30.9 42.115-24 17.9 18.725-44 28.9 24.645-64 16.8 11.365+ 5.5 3.3Dependency ratioC 0.57 0.83

a. The developed countries and dates of observation are: United States, 1919-21;Belgium, 1900; France, 1899-1903; Netherlands, 1901; Sweden, 1903-07; United King-dom, 1901;Australia, 1911.

b. Defined as in table 1.c. The dependency ratio shows the number of dependents (those under 15 or over

65) per member of the population of working age (15 to 65).Sources: ILO (1977), vol. 5; and Keyfitz and Flieger (1968).

growth of the labor force in the developing countries was 1.7percent compared with a rate of about 0.9 percent experiencedby the developed countries throughout the nineteenth century.Thus, the developing countries have to cope with a rate of growthof the labor force almost twice as large as that of the developedcountries during their period of industrialization.

Apart from differences in the growth rates of the total popula-tion and the labor force, developing and developed countries alsohave very different patterns of change in the spatial distributionof their populations. Froml850 to 1920 the urban population inthe developed countries increased at an annual rate of 2.5 percent,more than three times faster than the rate of increase of the totalpopulation. In 1920-60, however, the urban population of thedeveloping countries increased at an annual rate of more than 4percent. During the decade of the 1950s it increased at the un-precedented rate of 5.1 percent, which, although considerablylarger than the corresponding rate for developed countries, isnevertheless only twice the growth rate of the total populationin developing countries.

A further consequence of the disparity in population growthrates is the difference in the age structure of the population. Table


4 reveals that the developing countries of 1960 had more than 60percent of their population below the age of twenty-five comparedwith less than 50 percent for the developed countries in 1900.Such a young population can be expected to have at least twoeconomic consequences. First, the dependency ratio 2 will belarger; thus, from table 4, everyone of working age in developingcountries has to support 0.8 dependents, whereas their counter-parts in developed countries had less than 0.6 dependents. Second,the new entrants to the labor market will outnumber those in theolder age brackets by an ever larger margin. For example, bothgroups of countries have roughly the same percentage of theirpopulation in the 15-24 age group, the age at which workers firstenter the labor market, but in the developing countries the shareof the population in the 45-64 age group is only 70 percent o[that in the developed countries. It follows that the expansion ofjobs must be much faster in developing than in developed coun-tries if the new entrants to the labor force are to be fully em-ployed.

This last point is, of course, simply another way of saying thatthe rate of growth of the labor force in today's developing coun-tries exceeds that formerly experienced by developed countries.This fact takes on added significance, however, when it is relatedto the rapid growth of educational facilities in developing coun-tries. The evidence in table 5 reveals that in 1900, 15 percent ofthe population of the developed countries attended primaryschool. Compulsory primary education became more or lessgeneral toward the end of the nineteenth century, so that rates ofexpansion (1.6 percent) began to reflect population growth. Inthe developing countries, however, only 8 percent of the 1960population attended primary school, but the annual rate of ex-pansion was more than 5 percent. At the secondary level the situa-tion is very different: although only 0.4 percent of the developedcountries' population attended secondary school in 1900, comi-pared with 1.6 percent in the developing countries of 1960, theirannual rates of expansion (8.0 percent) were very similar. Primaryeducation in the developing countries, therefore, has been increas-

2. The dependency ratio shows the number of dependents (those under 15 or over 65)per member of the population of working age (15 to 65).

A Historical Comparison 19

Table 5. Educational Attainment and Growth Ratesfor Developed Countries, circa 1900,and Developing Countries, circa 1960

Item Primary School Secondary School

Percentage of population attending

Developed countries,19ooa 15.0 0.4

Developing countries,1960b 8.1 1.6

Average annual rate of expansionin attendance

Developed countries,1890-1900C 1.6 8.3

Developing countries,1960-70b 5.4 8.4

a. The developed countries in this table include Japan, Sweden, Italy, France, Nor-way, the United Kingdom, the United States, the Netherlands, and Belgium.

b. All countries with GDP per capita less than US$2,000 in 1975, except countrieswith populations of less than 1 million and centrally planned economies.

c. As in note a. The period covered for Italy is 1901-11, and for the Netherlandsand Belgium, 1900-10.

Sources: Kaser (1966); World Bank data; and World Bank (1980), Annex 2.

ing more rapidly but from a lower base than in the developedcountries, whereas secondary education has been growing at thesame rate but from a higher base.

Clearly, the rapid expansion of education in the developingcountries must be reflected in an increased number of educatedentrants to the labor market. It follows that not only are first-time entrants to the labor market much more numerous thanthose withdrawing from the market, but also they have receivedmuch more formal education. In other words, while the quantityof new jobs required is increasing as a result of population growth,the quality of the required jobs is also likely to be increasing asa result of the expansion in educational facilities. This is becauseeducated entrants to the labor market will expect jobs similar tothose held by comparatively educated workers in the recentpast. On the basis of this analysis, it is not altogether surprisingthat many developing countries are experiencing high rates ofunemployment for those with primary or secondary education(see table 21).


Table 6. Crude Estimates of Sectoral Value Addedand Productivity Growth Rates for Developed Countries,1880-1900, and Developing Countries, 1960-70(percent)

Average annual growth rate by sector

Groupand period Agriculture Industry Services Total

Value addedDeveloped countries,a

1880-1900 1.5 (1.7) 4.1 (1.8) 2.9 (1.0) 2.7 (1.1)Developing countries,b

1960-70 3.2 (1.4) 8.4 (3.8) 6.3 (4.1) 5.6 (2.4)

Labor productivityc

Developed rountries,a1880-1900 1.1 2.0 0.8 1.5

Developing countries,b1960-70 2.1 4.6 2.4 3.7

a. Developed countries include France, Germany, Italy, Sweden, the United King-dom, Canada, the United States, Japan, and Australia. The reported mean is the un-weighted average of individual country growth rates. Standard deviations are reportedin parentheses.

b. Developing countries include all those with a population of more than 20 millionin 1976 except Brazil, Vietnam, and Zaire (lack of data). The reported mean is theunweighted average of individual country growth rates. Standard deviations are reportedin parentheses. The corresponding annual growth rates computed from the World Bankglobal projection model are 2.7 percent for agriculture, 7.6 percent for industry, and 6.7percent for services (World Bank, 1979a).

c. Derived from growth rates of sectoral output and of sectoral labor force reportedin table 8. The growth rates of output reported in note b above and the labor forcegrowth rate reported in the note of table 8 yield growth rates of productivity of 1.5percent for agriculture, 4.6 percent for industry, and 2.2 percent for services. Thus.,although there is some variation, the broad pattern is very similar to that shown above.

Sources: Kuznets (1956), appendix tables 1, 3, 4, 9, 10, 14, 15, 17, and 18; Kuznets(1957), appendix table 2; and World Bank (1979a), table 2.

Factors Operating on the Demand Side

The rate of growth in employment depends on both the rateof growth in output and changes in average labor productivity.Table 6 presents the available evidence on sectoral output andproductivity growth rates. Because the data have been drawnfrom a variety of sources, they are not precisely comparable.Nevertheless, the regularity of growth rate patterns among theindividual countries suggests that the differences in reported


growth rates reflect real phenomena and not merely statisticalquirks. The table reveals that industrial output growth has beenmuch faster in the present developing countries (more than 8percent) than formerly in the developed countries (4 percent).Doubling output in the developing countries takes about tenyears; it took twenty years in the developed countries at theturn of the century.

Table 6 also shows that the rate of growth of labor productivityhas been considerably higher in the developing countries than inthe developed countries in all sectors. The data are consistentwith the view that the technology being adopted by developingcountries is much more advanced than that used by the developedcountries during the late nineteenth century. For example, thedeveloped countries achieved a growth rate for labor productiv-ity in industry of 2 percent, whereas the developing countriesare currently achieving a growth rate of more than 4 percent. 3

If the higher rate of growth in industrial labor productivityachieved by the developing countries can indeed be attributed toimproved technology, the qualitative composition of the in-dustrial labor force can be expected to differ from that of thedeveloped countries in the past; more advanced technologyrequires greater complements of higher quality labor. A compari-son of the occupational structure of the labor force in the twogroups of countries may not be very revealing, however, becauseof the dominance of the agricultural labor force in the developingcountries. For the purpose at hand, therefore, it may be moreappropriate to confine the analysis to Latin American countriesbecause the structure of their labor force is the most advanced.Table 7 presents a comparison between the United States in 1870and Latin America in 1950. The distributions of the broad occupa-tional groups adopted are roughly similar for the two regions atthe stated points in their respective developments. Of significance,however, is the difference in the changes in the composition ofthe labor force. Unlike the United States, in which the number ofblue-collar workers expanded rapidly during 1870-1920, Latin

3. As noted above, historical data must be treated with caution. Other studies, however,confirm the orders of magnitude reported here. For example, Phelps Brown (1973, table II)calculates annual rates of increase in industrial productivity of 2.2, 2.3, 0.36,and 1.6per-cent in Germany, Sweden, the United Kingdom, and the United States respectively circa1900.


Table 7. Occupational Structure of the Labor Forcein the United States and Latin America

Regionand period Unskilled Blue collar White collar

Percentage of labor force

United States, 1870 70.9 18.6 3.5Latin America, 1950 69.7 15.5 5.1

Changes over time(percentage points per decade)

United States,1870-1920 -4.9 +2.0 +2.01920-60 -5.1 +0.6 +3.1

Latin America,1950-61 -3.6 +0.4 +2.2

Note: "White collar" includes professionals, technicians, and administrative and cleri-cal workers; "blue collar" includes craftsmen, operators, transport and communicationsworkers, and miners; "unskilled" includes farmers, service and manual workers, andothers. Percentages do not add to 100 because of the exclusion of managers-owners andsalesmen.

Source: Ramos (1970), table 4-7.

America experienced a very low rate of expansion between 19 50and 1961. In fact, its expansion was more like the recent, ratherthan the historical, experience of the United States. One plausibleexplanation is that Latin America is bypassing the historicalphase of rapid expansion in the number of blue-collar workersbecause its industrialization is based on a very different tech-nology. The proportion of white-collar workers, however, hasexpanded quite rapidly in Latin America, reflecting the increaseduse of high-quality labor, not only in industry but also in services,especially in the public sector.

The historical evidence, then, indicates that the growth of theindustrial sector in both output and productivity has been muchfaster in the developing countries than was ever achieved in thedeveloped countries. Moreover, there is evidence from LatinAmerica, at least, to suggest that the developing countries requirea higher quality of labor than did the developed countries. Botlhthe rapid increase in productivity and the greater skill intensityof industry in developing countries are consistent with the viewthat technological developments have substantially changed thenature of the industrialization process.


Table 8. Average Annual Rates of Growthof the Labor Force by Sector for Developed Countries,1880-1900, and Developing Countries, 1960-70(percent)

Groupand period Agriculture Industry Services Total

Developed countries,a1880-1900 0.4 2.1 2.1 1.2

Developing countries,a1960-70 1.1 3.8 3.9 2.0

a. Defined as in table 1. For all developing countries reported in the World Develop-ment Indicators (World Bank, 1979a), the corresponding growth rates are 1.8 percentfor agriculture, 3.0 percent for industryi and 3.4 percent for services.

Sources: Bairoch and Limbor (1968), table IV; and ILO (1977), vols. 1, 3, and 5.

Industrial Labor Absorption in the 1960s

Against the background of dramatic changes on both the supplyand demand sides, this section presents a brief review of theperformance of industry in absorbing labor in the developingcountries during the decade of the 1960s. As will become ap-parent, different measures of labor absorption yield differentviews regarding the success of the developing countries in thisrespect in relation to that of the developed countries in the latenineteenth century. The data for this analysis are reported intable 8.

The percentage growth rate of industry's share in the totallabor force equals the difference between the percentage growthrate of the industrial labor force and that of the total labor force.From table 8 the share of the labor force in industry is seen to beincreasing more quickly in the developing countries of the 19 60s-1.8 percent a year-than it did in the developed countries in the1880s-0.9 percent a year. Thus, at least by this criterion, trans-formation of the structure of the labor force is currently proceed-ing in the developing countries at a faster rate than formerly in thedeveloped countries.

This result, however, is partly a consequence of the small shareof the labor force in industry in the base year for developingcountries: a low base means that even a small absolute increasetranslates into a large percentage increase. As an alternative mea-


sure, it may be appropriate to examine the increase in the in-dustrial labor force in relation to the existing total labor forcebecause this measure is independent of industry's initial share ofthe labor force.4 Since the share of the labor force in industry indeveloped countries circa 1880 was more than twice that ofdeveloping countries circa 1960 (see table 1), if the incrementalincrease in the industrial labor force in relation to the existingtotal labor force is to be the same in both cases, the growth rateof the industrial labor force in the developing countries must beat least twice that of the developed countries. Table 8 reveals thatthe growth rate of the industrial labor force in developing coun-tries was in fact 80 percent larger than that achieved historicallyby the developed countries. Thus, contrary to popular assertion,the industrial sector of today's developing countries has absorbedlabor at rates only slightly lower than those in the developedcountries of yesterday, despite its substantially lower initialshare of the labor force. Similarly, the relation between the rateof industrial labor absorption and the growth rate of industrialoutput in the developing countries is comparable to that of thedeveloped countries. From tables 6 and 8, the employmentelasticity (that is, the ratio of industrial labor force growth to thatof industrial output growth) is calculated to be 0.45 in thedeveloping countries compared with 0.51 in the developed coun-tries. The success of the developing countries in absorbing laborinto industry, despite that sector's initially low share of thelabor force, is thus a direct reflection of the very high rate ofindustrial output growth-more than twice that of the developedcountries (see table 6). In this respect, the developing countriesare compressing the development process: the growth rates ofindustrial output, productivity, and employment are all well inexcess of those achieved historically.

These relatively favorable assessments of the record have to, bebalanced against the observation that in relation to the annualincrement in the total labor force, the increment in the industriallabor force is substantially smaller in the developing countries

4. This measure can be deduced from tables 1 and 8 by multiplying the share of thelabor force in industry by the growth rate of the industrial labor force. For develcpingcountries the result is 0.44 percent a year compared with 0.51 percent for the developedcountries.


than in the developed countries.5 From tables 1 and 8, industryin the developing countries absorbed 22 percent of the incrementin the total labor force during the decade of the 1960s, whereasindustry in the developed countries absorbed 42 percent duringthe 1880s. In relation to the increment in the labor force, there-fore, the success of developing countries in absorbing labor in theindustrial sector is considerably less than that of the developedcountries. On the basis of this measure, it is frequently arguedthat, had the labor force in the developing countries grown at thehistorical rate of 1.2 percent a year instead of at the observedrate of 2.0 percent a year, industry's share of the labor forcewould have been substantially larger. There is, however, no reasonto suppose that if labor force growth is reduced everything elsewill necessarily remain the same.

The high growth rate of labor productivity in the developingcountries has also been advanced as a factor inhibiting the in-dustrial sector's ability to absorb labor. That is, had productivitygrown at the historical rate of 2 percent a year rather than at theobserved rate of 4.6 percent a year, the rate of growth of theindustrial labor force in the developing countries, it is argued,would have been 2.6 percent a year higher. A lower rate ofproductivity growth, however, does not necessarily mean a higherrate of labor absorption because output growth may be reduced;that is, rapid growth in productivity may be fully consistent withthe efficient allocation of resources.

Despite the success of developing countries by some criteria,critics have argued that high rates of growth in industrial produc-tivity and in the total labor force have limited industrial laborabsorption and thus retarded the structural transformation of thelabor force. As a result, the share of the labor force in industryhas not increased as quickly as it might otherwise have done.Accordingly, the next section presents a preliminary review of thefactors that determine the size of the industrial labor force andintroduces some of the issues addressed in more detail in sub-sequent chapters.

5. This measure is derived from tables 1 and 8 by multiplying the share of the laborforce in industry by the growth rate of the industrial labor force and dividing the resultby the growth rate of the total labor force.


Factors Deterniining Industry's Share of the Labor Force

There are at least three possible, mutually consistent explana-tions of why the industrial share of the labor force in developingcountries in 1960 was smaller than that of the developed countriesin 1880: differences in the level of general development in thetwo groups; differences in rates of capital accumulation and laborforce growth; and differences in the factors governing the relationbetween the composition of output and that of the labor force.These explanations are explored below.6

With regard to the first explanation, the smaller initial value ofindustry's share in the labor force may reflect a lower initial grossdomestic product (GDP) per capita and hence a relatively im-mature pattern of demand as hypothesized by Clark (1957). Itis difficult to test this assertion because of the problems of deriv-ing internationally and intertemporally comparable measures ofreal income. Bairoch (1975, table 52), however, suggests that thenational income per capita of the developing countries in 1960was approximately US$170 (at 1970 prices), whereas the nowdeveloped countries enjoyed a national income per capita of aboutUS$640 (also at 1970 prices) in 1900. On the basis of these ad-mittedly crude calculations, it may be concluded that the devel-oped countries of 1880 probably did have a higher per capita in-come than the developing countries of 1960, and this may implydifferences in the composition of demand.

The evidence in table 9 on the sectoral composition of valueadded is also consistent with the view that GDP per capita in thedeveloping countries of 1960 was less than that in the developedcountries of 1880, although, in this respect, the development ofinternational trade must be assumed to have weakened the linkbetween the composition of demand and that of output.7 To the

6. The arguments developed in this section are reviewed more rigorously by using athree-sector, two-factor model of international trade in the technical note appended to thischapter. Although the model confirms the points made in the text, it is important t:o keep inmind the simplicity of the model's structure when interpreting results. In particular, be-cause the analysis is conducted in terms of comparative statics, dynamic considerationsare excluded. For further discussion of these models, see Kemp (1969) and Komiya(1967).

7. This particular issue is addressed in the technical note, where it is shown that, if alow GDP per capita is assumed to be the consequence of a smaller stock of capital inrelation to the existing labor force, both the demand for and the domestic supply of in-dustrial goods will be lower than at a higher level of GDP per capita.


Table 9. Crude Estimates of Sectoral Value Addedand Productivity for Developed-Countries, 1880, and

Developing Countries, 1960

Groupand year Agriculture Industry Services

Composition of value added (percent)

Developed countries,a1880 33.0 24.2 42.7

Developing countnes,b1960 38.4 22.8 38.8

Relative productivityC

Developed countries,a

1880 0.6 1.0 2.2Developing countries,b

1960 0.5 2.0 1.6

a. As in note a to table 6.b. As in note b to table 6.c. Sectoral productivity in relation to economy-wide productivity.Sources: Kuznets (1957), appendix table 2; and World Bank (197 9a),

table 3.

extent that developing countries consume a larger proportion of

imported industrial goods and export a larger proportion of

agricultural output than did the developed countries, the composi-

tion of output will be affected accordingly (Berry, 1978).8 This

could be an additional explanation of agriculture's larger contribu-

tion and industry's smaller contribution to GDP in today's de-

veloping countries compared with yesterday's developed countries.

This in turn may reflect differences in the net barter terms of

trade (the ratio of export prices to import prices) confronting

developed and developing countries. Data to test this assertion,

however, are severely limited in both coverage and reliability.

8. Total trade (exports plus imports) is estimated to approximate 30 percent of GDPfor a group of eight developed countries-Canada, Denmark, France, Germany, Japan,Sweden, the United Kingdom, and the United States-in the late nineteenth century(Kuznets, 1967, appendix table 1) compared with about 45 percent for seventy-two de-veloping countries in or around 1965 (Chenery and Syrquin, 1975, table S3). For thedeveloped countries, primary commodities accounted for more than 90 percent of exportsonly in Denmark and Sweden, and manufactured goods accounted for more than 60 percentof imports only in Canada and Japan (Kuznets, 1967, table 9). In the developing countries,however, primary commodities accounted for more than 90 percent of exports in fifty-five out of seventy-four countries, and manufactured goods accounted for more than 60percent of imports in forty-seven out of sixty-one countries (World Bank, 1979a, tables9 and 10).


Bairoch (1975) presents data to show that the net barter terms oftrade for primary products in relation to manufactures may haveimproved by between 10 and 25 percent between 1872 and 1928.He also shows that several indexes available for 1926-29 to 1950-52 indicate a further improvement of between 15 and 25 percent.Finally, for 1950-70 Bairoch, using U.N. data, reports a declinein the net barter terms of trade of 12 percent. Thus, while theevidence, especially for the early years, must be treated withcaution, it is consistent with the differences in the sectoral com-position of output between developed and developing countriesshown in table 9.

Berry (1978) has also advanced several reasons the contri-bution of services to GDP in relation to that of industry is largerin the developing countries of 1960 than in the developed coun-tries of 1880. The most important causes Berry described arethe larger role of the public sector in many developing countriescompared with the developed countries of the late nineteenthand early twentieth centuries, the greater emphasis on the pro-vision of social services such as education (see table 4), and themore extensive reliance on international trade and the associa-tedneed for transport and commercial services. Berry's argumentswere applied to Latin American developing countries and do notseem to be especially relevant to an understanding of the statisticsreported in table 9, unless it is thought that, in the absence ofthese developments, and given the lower level of GDP per capita,the output of services would have been even smaller.

Differences between the rates of capital accumulation andlabor force growth in developing and developed countries (thesecond explanation) could contribute to the arguments of thepreceding paragraphs. If, because of rapid population growth,the ratio of the rate of capital accumulation to that of labor forcegrowth is smaller in the developing countries than in the developedcountries, the passage of time will increase the disparity betweencapital per worker in the two groups and limit the growth rate ofGDP per capita in developing countries. 9 Crude calculations of

9. Empirical verification of a negative relation between rapid population growth andthe growth rate of GDP per capita, however, has proved elusive. In a dynamic corntext,arguments have been advanced to support the view that rapid population growth can havepositive as well as negative implications for the growth of GDP per capita. The availableevidence and conflicting arguments are reviewed in chapter 15, which also includts a dis-cussion of models that treat population growth in a dynamic context.


the rate of capital formation in relation to the rate of popula-tion growth illustrate this point vividly. For ten developed coun-tries in the late nineteenth century, the ratio of gross capitalformation to the increment in the population was more thanseven times larger than the corresponding ratio for the develop-ing countries in the 1960s, despite similar rates of capital forma-

tion in relation to GDP.10 In part, this reflects the higher level ofGDP per capita in the developed countries, but it is also a productof the high population growth rate-2.4 percent a year-in thedeveloping countries compared with 0.8 percent a year in thedeveloped countries. These results suggest that rapid populationgrowth is a factor limiting the rate at which capital per workercan be increased; developing countries have not been able toincrease their rates of capital accumulation to match their higherrates of population and labor force growth."

With respect to the third explanation, the evidence on relativelevels of sectoral productivity (also shown in table 9) suggeststhat the relation between the structure of output and that of thelabor force has been substantially modified. Compared with theirrespective economy-wide levels of productivity, industrial produc-tivity is higher in the developing countries than it was formerly inthe developed countries, whereas the reverse is true of agricultureand services. As suggested earlier, one possible interpretation isthat developing countries are bypassing the phase of industrializa-tion that relies most heavily on unskilled labor because of tech-nological advances that occurred during the prior industrializationof the developed countries and because of the greater availabilityof skilled manpower.

10. Gross capital formation in relation to the increment in the population is calculatedfrom information on the share of gross capital formation in GDP, GDP per capita, andpopulation growth rates. In reverse order, population growth rates are taken from table 3,and GDP per capita from the discussion at the beginning of this section. GDP per capitafor developed countries in 1880 is derived by application of the GDP per capita growthrate of 1.9 percent a year (see tables 3 and 6) to the 1900 GDP per capita of US$640.This method yields a level of GDP per capita of about US$440 in 1880. Finally, the un-weighted average for the proportion of gross domestic capital formation in GDP is esti-mated to be 0.15 (0.04) for ten developed countries-Australia, Canada, Denmark, Ger-many, Italy,Japan, Norway, Sweden, the United Kingdom, and the United States-in1850-1915, and 0.16 (0.07) in eighty-four developing countries for 1960. Standard devia-tions are reported in parentheses. Data for developed countries are from Kuznets (1961,table 1) and for developing countries from World Bank (1979a, table 5).

11. If industry is assumed to be more capital intensive than either agriculture or ser-vices, an increase in the labor force in relation to the capital stock reduces GDP percapita and industrial output and employment (see the technical note to this chapter).


In an open economy, however, labor-saving technical progressin the industrial sector is likely to affect the size and composi-tionof international trade, and by allowing increased output in theform of import substitutes or additional exports, it may imply theuse of more rather than less labor in industry. Technical or eco-nomic restrictions on the economy's capacity to expand industrialoutput, however, increase the likelihood that labor-saving techni-cal progress will lead to a lower labor input and a higher level oflabor productivity. For example, technical restrictions on thedegree of factor substitution within sectors can limit the scopefor increasing industrial output in response to labor-saving techni-cal advances. Similarly, if the industrial labor market is subject towage legislation and if distortions in product markets for tradablegoods limit the development of export and efficient import-substituting industries, the potential for increasing industrialoutput is reduced." 2 In either event, provided the scope forexpanding output is limited, entrepreneurs can be expected torespond to labor-saving technical improvements by reducing laborinput and thereby increasing labor productivity.

If the expansion of industrial output is constrained by technicalfactors, there is no reason to suppose that the allocation of re-sources is inefficient. But if distortions in factor and productmarkets are constraining the expansion of industrial output, thereis every reason to believe that resources are being allocated in-efficiently. In this event, the high rates of productivity growthmay indicate that labor absorption has been restricted and thatimprovements in resource allocation would increase both in-dustrial output and industrial labor input.

Improvements in the quality of the industrial labor force canalso be assumed to have contributed to the increase in labor'sproductivity in industry. If, as the Latin American experiencesuggests, industry in the developing countries of today requireslarger inputs of skilled labor than was the case in the developedcountries of 1880, productivity in terms of "unskilled laborequivalents" could be more or less the same in the developingand the developed countries, and yet productivity in terms oflaborers would be substantially higher in the former than in thelatter group. Again this difference could be fully consistent with

12. These points are established in the technical note to this chapter.


the efficient allocation of resources in developing countries,provided the markets for both skilled labor and the services oftraining and education are thought to be free of distortion. Atthe same time, a sudden and large increase in the availabilityof educated labor can be expected to exert unusual pressure onthe labor market. Any inflexibility in this market during such aphase of dramatic transformation and development would leadto serious consequences for the employment of educated laborat least in the short run.

Much of the discussion in Parts II, III, and IV further elaboratesthe extent to which the factors identified in this chapter (otherthan the technical characteristics of production and the generallevel of development) may have contributed to the relativelymodest development of the industrial labor force in developingcountries. In particular, chapters 6, 7, and 8 assess the extent towhich labor markets operate efficiently; chapters 11, 12, and 13examine the significance of distortions in product and nonlaborfactor markets; chapter 15 explores the justification and scope forpopulation policies; and the role of education and training in thedevelopment process is reviewed in chapter 16.

Technical Note

To illustrate the role of the three factors-the general levelof development, unusually high rates of labor force growth inrelation to the rate of capital accumulation, and rapid rates oftechnical progress-identified as shaping the structure of the laborforce, consider the following model of a three-sector, open econ-omy. 3 When linear, homogeneous production functions areassumed in each sector, the first-order conditions of profit maxi-mization require that

Pifi =P2 f2 =P3 f3 (1)

Pi (fA - ki f)=p 2 (A - k2 f')=p 3 (f3 - k3f3) (2)

where the Pi are output prices, fi describes the technologicalrelations between output per unit of labor (L) and input of capi-tal (K) per unit of labor, f is the marginal product of capital in

13. For further discussion of these models, see Kemp (1969) and Komiya (1967).


the ith sector, and ki equals KiLi .14 Equation 1 imposes the condi-

tion that the marginal product of capital be equal in all uses, whileequation 2 imposes the corresponding condition for the marginalproduct of labor.

Sectors 1 (agriculture) and 2 (industry) are assumed to producetradable commodities, the prices of which are fixed in worldmarkets. The output of sector 3 (services), however, is not tradedinternatonally; its price is determined within the domestic econ-omy. Since the technological relations (f;) are functions ofcapital-labor ratios (ki) only, equations 1 and 2 provide fourindependent equalities that can be solved for the ki and p3, theprice of the nontradable commodity.

Under competitive conditions, both factors of production arefully employed:

ELi = L (3)

I k.L. = K (4)i Z

where L and K are the endowments of capital and labor respec-tively. The supply and demand balance for the nontradable corn-modity requires that

L3 f 3 = D3 (I,Pi) i = 1, 2, 3 (5)

where L3 f3 is total output and D3 denotes demand for serviceswritten as a function of total income (I) and prices. Given that

I= XpiLifi (6)

equations 3, 4, 5, and 6 may be solved for the Li and I in termsof the ki (capital-labor ratios) andp 3 .

The model is completed by introducing the equilibrium condi-tions in the output markets for commodities 1 and 2. Since thesecommodities are traded internationally, supply and demandbalance is represented by

LI f1 - E = DI (I,pi) i = 1, 2, 3 (7)

and L 2 f2 +M=D 2 (I,pi) i= 1, 2, 3 (8)

14. Raw land is not treated explicitly. It is assumed that all available raw land is fullyused for agricultural purposes. Land-improving investments, however, are included in thedefinition of capital.


where E denotes agricultural exports and M industrial imports.Given that the derivation of the demand curves assumes that allincome is spent, z pi Di = I. Together with equations 5, 6, 7, and8 this last result ensures that the economy's external account isbalanced (that is, p1 E = P2 M). Equations 7 and 8 can be usedto solve for E and M, once the previous equations have beensolved. Because the level of exports and imports are not relevantto subsequent discussion, equations 7 and 8 are not referred toagain.

In the ensuing exercise in comparative statics, it is assumedthat k2 > k, and k2 > k 3 ; that is, industry is assumed to be morecapital intensive than both agriculture and services. If a lowerlevel of GDP per capita is equated with a smaller capital stock inrelation to the labor force, then a lower level of GDP per capitaand an unusually high rate of growth in the labor force in rela-tion to the rate of capital accumulation have a similar effect onthe structure of the labor force. That effect can be examined byinvestigating the consequences of an expansion in the labor forcein relation to the existing stock of capital. Accordingly, we firstexamine the effect of an increase in the labor force and then turnto that of a labor-saving technical improvement.

Labor Force Growth

Since equations 1 and 2 are functions of international prices(pi and p2) and technology, a change in the size of the laborforce does not affect the profit-maximizing conditions; there-fore, the capital-labor ratios (ki) and the price (P3) of the non-tradable commodity remain unchanged. Concern now centersexclusively on equations 3, 4, 5, and 6. Totally differentiating thissystem of four equations yields

I dLi= dL (9)

X k dLi ° (10)

f 3 dL 3 -D,d= (11)

e pithe dLta dI= b (12)

where dL is the change in the total labor force. The solution for


dL2 is given by

AL2 = ( 1 1iC3 63 AL (13)\ r2tY2

where C3 = p3 aD3 laI and is the marginal propensity to consumeservices, e3 = L3 a(L3 f3 )/(L3 f3 ) UL3 and is the elasticity ofoutput with respect to labor in the service sector, ir2 = L2 /L andis the share of labor in industry, A denotes percentage change,and ,i = 1 - (ki/k, ), i = 2, 3, and is a measure of relative laborintensity.

Given the assumptions with respect to labor intensity, 72 < 0-It follows that A L2 5 0 as c3 e 3 73 5 1. If services are more capi-tal intensive than agriculture (k3 > k 1 ), then Y3 < 0 and AL2 isunambiguously negative. If, however, k3 < kI, then 0 < 73 < 1,and given the assumptions of constant returns to scale and positivemarginal products 0 < e 3 < 1. Thus, two elements (e3 and '3 ) ofthe term C3 e3 T3 are unambiguously < 1. The third term, C3 , isthe marginal propensity to consume services. Although Y ci mustequal unity, it does not necessarily follow that C3 < 1, since cl orc2 could be negative. Empirical evidence, however, suggests thatthis is highly unlikely for the broad aggregates of commoditiesconsidered here. For example, Lluch, Powell, and Williams (1977)present estimates of the marginal propensity to consume for ser-vices (personal care, transport, recreation, and miscellaneousservices) ranging from 0.266 for Greece to 0.499 for Puerto Ricowith an unweighted mean for nine developing countries of 0.344.It follows that, given the restrictions on 73 and e3 and the likelyrange of values for c3 , the term c3 e3 73 will almost certainlybe less than one and AL2 will be negative even if 73 > 0. More-over, since AlT2 = AL2 - AL and AL > 0, it may be concludedthat the share of the labor force in industry decreases as the totallabor force increases.

This result may be rationalized intuitively as follows. First, asa result of an increase in the labor force, total income (I) increasesby the product of labor's marginal revenue product and the in-crease in the labor force. Second, since all labor intensities and theprice of the nontradable remain unchanged, and since demand forthe nontradable is positively related to income, both output andemployment in services must increase. From equations 9, 10, I 1,and 12 we have dL3 = c3 e3 dL. If, as has been argued, 0 < C3 e3


< 1, the part of dL not absorbed in services must be absorbed ineither agriculture or industry. The problem is now exactly that ofanalyzing the impact of an increase in the labor force in the stan-dard two-sector, two-factor trade model (see Kemp, 1967). In thismodel, because labor intensities remain constant, the extra laborcan be absorbed only by an expansion of the labor-intensive sector(agriculture) and a contraction of the capital-intensive sector(industry). Thus, an increase in the labor force is associated withan increase in the labor force in agriculture and services and adecrease in that in industry.

Labor-Saving Technical Progress

To explore the implications of labor-saving technical progressin industry, we may rewrite the technological relation betweenoutput per unit of labor and capital per unit of labor in industryas

f2 =f 2 (k2/X)

where X is a shift parameter representing labor-saving technicalprogress and is initially set equal to unity. An increase in X allowsthe same level of output to be produced with less labor and thesame amount of capital.

To allow for this change, equations 1 and 2 must be rewrittenas

PI fl = P2 f2 = P3 f3 (14)

Pi (fi -k 1 fi)=P 2 (kf 2 -k 2 f2)=p 3 (f 3 - k 3 f) (15)

Because we are investigating the effect of a change in X, it can nolonger be expected that capital-labor ratios and the price of thenontradable will remain constant. Totally differentiating equations14 and 15 yields

p f, dk1 = P2 f2 dk2 - P2 f2"k2 dX = f3 dp3 + p3 f3"dk3 (16)-Pl fi k, dkl = -P2 f2 k2 dk2 + (P2 f2 - P2 f2 k2 +PZf2"k 2 k 2 ) dX

= -p 3 f3 k3 dk3 +(f3 - k3 f3)dp 3 . (17)


Solving for Ak1 and Ap3 we obtain

U

Aki = X Ax i= 1, 3 (18)

Ak 2 = (1+ 2 k2 ) X (19)62 7Y2 ki

and tP3 = (I e3)y'3 AX (20)Y2

where ai fi (fi- kifi)

ki f- fi i

and is the elasticity of substitution in the ith sector. Given a> 0 and

72 < 0, Ak, and Ak3 are unambiguously negative. Ak2 , however,is negative only if G2 > e2 [1 - (k I /k 2 )] . Since values of aboutunity are frequently cited for a2,15 and since both e2 and1 - (k, /k 2 ) are less than unity, the presumption must be thatAk2 is negative. Finally, Ap3 is negative or positive dependingon whether -y3 is positive or negative; that is, on whether agri-culture or services is the more capital intensive.

Armed with this information, we can now reexamine thetotal differential of equations 3, 4, 5, and 6. Since X must beintroduced into equation 6 to allow for the

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