I recently came across Dani Rodrik’s piece on The Past, Present, and Future of Economic Growth. As the introduction notes:
The paper emphasizes two key dynamics behind growth. The first is the development of fundamental capabilities in the form of human capital and institutions. Long-term growth ultimately depends on the accumulation of these capabilities–everything from education and health to improved regulatory frameworks and better governance (Acemoglu and Robinson 2012; Allen and others2013; Behrman and Kohler 2013). But fundamental capabilities are multidimensional, have high set-up costs, and exhibit complementarities. Therefore, investments in them tend to yield paltry growth payoffs until a sufficiently broad range of capabilities has already been accumulated–that is, until relatively late in the development process. Growth based on the accumulation of fundamental capabilities is a slow, drawn-out affair.
The second is structural transformation–the birth and expansion of new (higher-productivity) industries and the transfer of labor from traditional or lower-productivity activities to modern ones. With the exception of natural-resource bonanzas, extraordinarily high growth rates are almost always the result of rapid structural transformation, industrialization in particular. Growth miracles are enabled by the fact that industrialization can take place in the presence of a low level of fundamental capabilities: poor economies can experience structural transformation even when skills are low and institutions weak. This process helps explains the rapid take-off of East Asian countries in the postwar period, from Taiwan in the late 1950s to China in the late 1970s.
The policies needed to accumulate fundamental capabilities and those required to foster structural change naturally overlap, but they are distinct. The first types of policies entail a much broader range of investments in skills, education, administrative capacity, and governance; the second can take the form of narrower, targeted remedies. Without some semblance of macroeconomic stability and property rights protection, new industries cannot emerge. But a country does not need to attain Sweden’s level of institutional quality in order to be able to compete with Swedish producers on world markets in many manufactures. Furthermore, as I discuss below, fostering new industries often requires second-best, unconventional policies that are in tension with fundamentals. When successful, heterodox policies work precisely because they compensate for weakness in those fundamentals.
In other words, you need to work on both the fundamentals and the transformation of the economic structure. Both require attention to intangible assets. The fundamentals consist of a nation’s intangible assets, such as the institutional framework and the level of human capital. Structural transformation once meant switch from human and animal energy to mechanical energy. It now means switching from physical capital to knowledge capital.
But even the earlier industrial revolution was driven by intangible assets. As Rodrik points out:
Parts of the world that proved receptive to the forces of the Industrial Revolution shared two advantages. First, they had a large enough stock of relatively educated and skilled workers to fill up and run the new factories. Second, they had sufficiently good institutions–well-functioning legal systems, stable politics, and restraints on expropriations by the state–to generate incentives for private investment and market expansion. With these preconditions, much of continental Europe was ready to absorb the new production techniques developed and applied in Britain. Elsewhere, industrialization depended on “importing” skills and institutions.
. . .
International trade induced industrial countries to keep investing in skills, technology, and other drivers of economic growth. It also encouraged families to have fewer children and to educate them more, in light of the high returns to skills that modern manufacturing industries brought. These effects were reversed in the developing countries of the periphery. Specialization in primary commodities did not encourage skill accumulation, and it delayed the reduction in fertility and population growth: birth rates remained high in the developing world well into the 20th century, unlike in the industrialized countries, which experienced sharp declines in fertility toward the end of the 19th century. In the words of economists Oded Galor and Andrew Mountford (2008), commodity-exporting countries gave up productivity in exchange for population. Developing countries are still trying to break free of the long-term consequences of this division of labor. That escape is possible was shown by the experience of the first non-Western country to industrialize before 1914: Japan.
He goes on to stress the importance of the transformation:
Poor economies are not shrunk versions of rich economies; they are structurally different. This key insight of old-fashioned development economics is often forgotten when modern growth theory is applied to developing economies. Developing countries are characterized by large structural gaps in productivity between traditional and new economic activities. Hence the essence of development is structural change, which entails moving workers from traditional, low-productivity activities to modern, high-productivity activities that are quite different in terms of location, organization, and technological characteristics. Rapidly growing countries are better at removing the bottlenecks that impede this transformation.
I would add a very important point here: transformation is an ongoing process. Yesterday’s “new economic activities” are tomorrow’s “traditional, low productivity activities”. The bar is constantly begin raised and the process of creative destruction continues.
The paper has more to say, especially about the historic and current role of manufacturing as a driver of growth and the role of government intervention (including both government and market failures). He is more sanguine about deindustrialization than I am. Although he notes that while the a shift to tradable services has worked for Hong Kong, the process has not worked well in the US or UK.
I will end with his final prognosis:
In the long run, convergence with wealthy economies requires the accumulation of human capital and the acquisition of high-quality institutions. But the quickest way to become rich is to deploy policies that help build modern industries that employ an increasing share of the economy’s labor resources. Policies of this type overlap with policies needed to build up fundamental capabilities, but they are not one and the same, and they often diverge significantly. An excessive focus on “fundamentals” may slow growth if it distracts policy makers from resorting to the (often unconventional) policies of structural transformation required to get modern industries off the ground. Similarly, excessive focus on industrialization may set the economy up for an eventual downfall if the requisite skills and institutions are not built up over time.
It all comes down to fostering your intangible assets.