Structural change, productive development, and capital flows: does financial “bonanza” cause premature deindustrialization?

Abstract

Recent contributions to the literature on industrialization and development have confirmed that manufacturing continues to play a key role as a driver of economic development. As a corollary, these contributions highlight the importance of premature industrialization as a barrier to economic development and as one of the main sources of the middle-income trap. In this paper, we analyze the factors that may have hindered industrial development in the past four decades. In particular, we focus on the role of (non-Foreign Direct Investment) net capital inflows as a potential source of premature deindustrialization. We consider a sample of 36 developed and developing countries from 1980 to 2017, with major emphasis on the case of emerging and developing economies (EDEs) in the context of increasing financial integration. We show that periods of abundant capital inflows may have caused a significant contraction of manufacturing share to employment and GDP, as well as the decrease of the economic complexity index. We also show that the phenomena of “perverse” structural changes are significantly more relevant in EDE countries than in advanced ones and that they may similarly occur across EDE countries, regardless of structural differences in the way manufacturing contributed to their development. Based on such evidence, we conclude with some policy suggestions highlighting capital controls and external macroprudential measures taming international capital mobility as useful policy tools for promoting long-run productive development on top of strengthening (short-term) financial and macroeconomic stability.

The Dutch Disease of the Euro Area Peripheral Member States

“…Additionally, the credit expansion arising from external capital inflows contributed to asset price inflation, particularly financial and real estate (Aliber and Kindleberger 2015). As a result, the balance-sheets of firms in non-tradable sectors were "artificially" inflated, which facilitated further financing and a further shift of capital and labor towards these sectors (Botta, Yajima, and Porcile 2022). In this way, financial flows contributed to the increase in the expected return on investments in non-tradable sectors.…”

“…Other literature emphasizes the thesis that there is greater potential for productivity growth in tradable sectors, particularly in manufacturing (e.g., Szirmai 2012;Tregenna 2009;Rocha 2018;Rodrik 2016). Botta, Yajima, and Porcile (2022) empirically analyzed the impact of capital inflows (foremost, portfolio investment and external lending) and argued that the recipient economies could suffer from financial Dutch disease-like transmission mechanism. The capital inflows from abroad would cause the decline in the technological level of the production of goods and the shift of resources towards non-tradable goods, particularly with the deterioration in the production of technological-intensive tradable goods.…”

Premature Deindustrialization Risk in Thailand

“…Ravindran and Babu (2021) identified the rise of income inequality with premature deindustrialization in case that workers are absorbed into low-productive and informal market services. Botta et al (2022) found that net capital inflows are as a potential source of premature deindustrialization.…”

Natural resources, financial development and structural transformation in Sub-Saharan Africa

“…The driving force behind structural transformation is the productivity of the modern sector, which includes manufacturing and services [ 5 ]. According to estimates from the World Bank [ 1 ], the share of manufacturing in GDP, which averaged 16.13% in 1990, declined to 13.93% in 2000 and further decreased to 11.17% in 2020.…”

“…This indicates the presence of productivity gaps in the region. Existing literature suggests that shifting from a subsistence/agrarian and resource-extractive economy to a more manufacturing and services-oriented one plays a crucial role in driving economic growth and enhancing productive capacity [ 5 , 6 ]. Manufacturing, in particular, offers unique advantages such as capital accumulation, economies of scale, and technological advancements, making it a preferred avenue for improving productivity [ 6 ].…”