Strengthening the Trade-Growth-Poverty Relationship in Least Developed Countries I: Beyond Supply Capacities: The Role of Productive Capacities (Based on LDC Report 2006) Michael Herrmann Division for Africa, LDCs and Special Programmes UNCTAD, Geneva, Switzerland

The LDCs

This Presentation Introduction The concept of productive capacities –Elements –Development Drivers of productive capacities –Capital accumulation –Technological progress –Structural change Constraints on productive capacities –Infrastructure –Institutions –Demand Policy implications

Introduction

The Concept of Productive Capacities: Elements

The Concept of Productive Capacities: Development Productive capacities are determined by 3 processes –Capital accumulation (physical, financial) –Technological progress (low- to medium-tech) –Structural change (agriculture to industry, low to high productivity jobs) Productive capacities are impeded by 3 constraints –Infrastructure (transport, utilities, etc.) –Institutions (firms, financial institutions, knowledge system) –Demand (external and domestic)

Drivers of Productive Capacities: Overview

Drivers of Productive Capacities Process I: Capital Accumulation

Over the 1990s investment rates declined in many LDCs. –Public fixed investment declined in 8 of 12 LDCs –Private fixed investment also declined in 8 out of 12 LDCs In investment rates were relatively low in LDCs. –Average investment rate was 22 % GDP, –Average savings rate was 14% GDP, –Average resource gap was about 8% of GDP. In almost 40% of investments was financed by external sources –Net FDI inflows to LDCs were about 2.6% of GDP –Net ODA disbursements to LDCs were about 9% of GDP (in 2004).

Drivers of Productive Capacities Process I: Capital Accumulation Aid can be major source for capital formation. –In 2004 it accounted for more than 10% of GDP in 36 out of 43 LDCs. Aid targeted at capital formation has declined over past years. –The share of ODA to LDCs associated with debt relief, emergency assistance and social sectors development increased from 34.6% in to 62.1% in –The share of ODA to LDCs associated with development of economic infrastructure and production sectors decreased from 47.9% to 23.5% over the same period.

Drivers of Productive Capacities Process I: Capital Accumulation Formation of human capital is weakened by low levels of education –In 2000 the average years of schooling of the adult population was only 3 years in the LDCs, less than in other developing countries in –In 2001 technical and vocational education constituted only 2.6% in total secondary enrolment in the LDCs, as against 10.4% in developing countries. –In recent years only 6% of the population aged in LDCs was enrolled in tertiary education, compared with 23% in other developing countries. … and high levels of brain drain –About one in five of the high-skill workers (persons with 13 years schooling and above) were working in OECD countries in 2000 –The intensity of the brain drain from African and Asian LDCs increased significantly in the 1990s

Drivers of Productive Capacities Process II: Technological Progress Limited investment in technological development –In 2003 gross expenditures on R&D were only 0.2% of GDP in the LDCs. Between 1980s and 1990s public expenditures for agricultural R&D declined in 8 out of 13 LDCs. Limited licensing of technology –In recent years only 7% of domestic firms in LDCs licensed foreign technology, compared with 27% of foreign firms, and only 21% of domestic firms in LDCs use a website for business, compared with 44% of foreign firms. Limited import of technology –Firm-Level Investment Climate Surveys (World Bank) show new machinery and equipment is the most important channel of technological acquisition in the LDCs. Yet, they have not increased over the last two decades in real per capita terms.

Drivers of Productive Capacities Process III: Structural Change: Production

Drivers of Productive Capacities Process III: Structural Change: Employment Transition Changing size and locus of labor force

Drivers of Productive Capacities Process III: Structural Change: Labor Productivity Fact 1: –Relatively large increase of labor force in non-agriculture (indicated by large growth of economically active population), Fact 2: –Relatively small expansion of economic activities in non- agriculture (indicate by small growth of value added) Implication: –Decline of non-agricultural labor productivity (indicated by the ratio of value added to labor force).

Drivers of Productive Capacities Process III: Structural Change: Labor Productivity

Drivers of Productive Capacities Process III: Structural Change: Employment Challenge Rapid increase of non-agricultural labor force Push factors: Growth of agricultural labor force > agricultural land. –Land holdings per agriculturalist decline –Dependency on fragile land increases. –Productivity of agricultural workers increase slowly or decrease. –Yield of land increase slowly or decrease. –Few prospects to overcome rural poverty. –Decision to leave rural areas/ agricultural sector. Pull factors: Growth of non-agricultural labor productivity > agricultural labor productivity. –Potential to earn higher wages. –Decision to migrate to urban areas/ non-agricultural sector.

Drivers of Productive Capacities Process III: Structural Change: Employment Challenge Weak absorption of non-agricultural labor force In Tanzania the non-agricultural labor force grew 2.26 million; wage employment outside agriculture grew by 172 thousand between 1990/91 and 2000/01. In Uganda the non-agricultural labor force grew by 428 thousand, wage employment outside agriculture grey by 82 thousand between 1992 and 1999/2000. In Burkina Faso only 5% of males and 3% of females found their first paid job in private formal sector in In sub-Saharan Africa about 93% new employment opportunities are in informal sector, in recent years.

Drivers of Productive Capacities Process III: Structural Change: Employment Challenge

Constraints on Productive Capacities: Overview Weak Infrastructure ICT and beyond Weak Institutions Firms (and farms) Financial institutions Knowledge systems Weak Demand External Domestic

Policy Implications Productive capacities help to strengthen trade performance: –Allow for vertical diversification (upgrading in value chains) –Allow for horizontal diversification (expansion of export baskets). –Support competitiveness (product quality, quantity, price) Productive capacities help to achieve sustained growth –Ensure more stable and remunerable export revenues –Lead to higher revenues from domestic sales Productive capacities help to reduce poverty –Create more productive employment opportunities –Allow for rising household incomes –Enable sustained poverty reduction

Policy Implications Current approach External demand (Liberalization of trade stimulates domestic production) Supply-side constraints (Improvements of transport infrastructure, trade finance and insurance, customs procedures stimulates exports) Framework conditions for investment (Improvement of macroeconomic stability, investment climate, governance helps to promote investment) Consumption (access to cheap, imported consumer goods will help to reduce poverty). Tradables FDI Human and social development (e.g., health and education) International welfare system Current approach PLUS Internal demand (Development of domestic markets, creation of linkages stimulates production) Productive capacities (more and better utilization of productive resources, entrepreneurial capabilities, production linkages results in more competitive exports) Ingredients for investment (Improvements of transport infrastructure and other physical infrastructure, banking system, business-support institutions and knowledge system will help to promote investment) Employment (creation of productive employment opportunities and rising household incomes will reduce poverty). Non-tradables Domestic investment Economic development (i.e., growth, production, employment) National development state

Policy Implications Trade can support the development of productive capacities, but productive capacities are the engine of economic growth. Trade can contribute to the creation of employment opportunities, but only productive capacities can ensure the lucrative and sustainable employment opportunities for people. To strengthen trade-growth-poverty relationship, it is necessary to develop productive capacities. They help to improve trade performance, achieve sustained economic growth and sustainable poverty reduction. Therefore, the development of productive capacities should be at heart of trade, growth and poverty reduction strategies.