Modern sector development: The role of exports and institutions in developing countries

• Date: 01 May 2020
• Author: Thomas Gries,Rainer Grundmann
• Published date: 01 May 2020
• DOI: http://doi.org/10.1111/rode.12663

644

|

Rev Dev Econ. 2020;24:644–667.

wileyonlinelibrary.com/journal/rode

Received: 3 December 2015

|

Revised: 21 February 2020

|

Accepted: 24 February 2020

DOI: 10.1111/rode.12663

REGULAR ARTICLE

Modern sector development: The role of exports and

institutions in developing countries

ThomasGries

|

RainerGrundmann

University of Paderborn, Paderborn,

Germany

Correspondence

Thomas Gries, University of Paderborn,

Paderborn, Germany.

Email: thomas.gries@upb.de

Abstract

A prospering modern sector is crucial for the successful

long-term development in developing countries as it pro-

vides income and job growth for large shares of society.

While this idea is widely accepted, there is, perhaps sur-

prisingly, far less analysis about the exact determinants of

this economic modernization process. In this article we em-

pirically investigate whether international trade and institu-

tions, both much discussed in the debates on general growth

and development, are particularly important for the diffu-

sion of production in the modern sector within developing

societies. In a large cross section time-series sample, we

provide robust estimation results that point to an important

role of institutions and to a nonlinear impact of manufactur-

ing exports. Our results, which are derived using a range of

estimators and are ultimately less susceptible to endogene-

ity concerns, also provide interesting insights into the role

of natural resources and official development aid.

KEYWORDS

developing countries, institutions, international trade, manufacturing

growth, panel analysis

JEL CLASSIFICATION

C23; O11; O14; F15

This is an open access article under the terms of the Creative Commons Attribution-NonCommercial-NoDerivs License, which permits use and

distribution in any medium, provided the original work is properly cited, the use is non-commercial and no modifications or adaptations are made.

© 2020 The Authors. Review of Development Economics published by John Wiley & Sons Ltd

|

645

GRIES and GRUndMann

1

|

INTRODUCTION

A thriving modern sector is of major importance for a country’s long-term and sustainable develop-

ment. The historical experience of today’s advanced economies suggests that the path to growth in

these countries was accompanied by a structural shift toward a modern manufacturing sector. While

Western countries already industrialized as early as the mid-19th century, newly industrialized coun-

tries such as South Korea or Taiwan massively expanded their manufacturing sectors in the mid- to

late 20th century. Moreover, recently we have been witnessing the emergence of a strong Chinese

manufacturing sector that drives the overall economic performance of the whole country. In addition

to such anecdotal evidence, recent research by Rodrik (2013) on labor productivity in manufacturing

underlines the importance of understanding the mechanisms that drive development in the modern, in

particular, the manufacturing, sector.1

In the literature, a number of empirical and theoretical studies emphasize the importance of a

modern sector for overall economic performance. While some contributions (e.g., De Vries, Erumban,

Timmer, & Voskoboynikov, 2012; Peneder, 2003; Rodrik, 2009; Szirmai, 2012; Timmer & De Vries,

2009) empirically document the positive impacts of the dynamics of the modern sector on the over-

all economic development,2

others suggest, by using an analytical framework, that there are links

between sectoral and general productivity or development (e.g., Duarte & Restuccia, 2010; Dekle &

Vandenbroucke, 2012; Kuralbayeva & Stefanski, 2013). Figure 1 illustrates the correlation between

overall and sectoral growth using data from the sample examined in this study. We map growth rates

of the manufacturing sector (upper panel) and growth rates of GDP in developing countries over two

time periods between 1980 and 2010. In comparison we relate growth rates of the agricultural sector

(lower panel) and growth rates of GDP. While both sectors appear to be positively correlated with

per-capita GDP growth, there is a clear relatively stronger association of the modern sector in these

countries. Figure 2 illustrates how important a focus is on the modern manufacturing sector. By using

data from the 10-sector database, we relate overall employment growth with sectoral employment

growth by income group. Again the top panel shows figures for the manufacturing sector, whereas

the bottom panel shows figures for the agricultural sector. While the relation between manufacturing

employment growth and the overall employment growth is stable across income groups, this does not

hold true for agricultural sector employment growth for the higher-income group. In other words, the

opportunity to further enjoy employment growth becomes more viable with the manufacturing sector

than with the agricultural sector after a certain level of income and development is reached.

However, although the positive relationship between manufacturing activities and the overall

growth achieves consensus among economists, naturally the question arises as to what exactly makes

a country’s (modern) manufacturing sector grow. What drives the economic dynamics in this im-

portant sector? Surprisingly, there is little evidence provided in the literature and, to the best of our

knowledge, no comprehensive empirical estimation of a modern sector’s development drivers. A pos-

sible reason may be that the literature about structural change has received considerable attention

lately and focused on descriptions and benefits. For example, Fagerberg (2000) shows that structural

change occurs when within manufacturing economies focus on the technologically most progressive

subsectors. This lets manufacturing sector’s productivity grow faster. Similarly, Peneder (2003) shows

that greater shares in high-tech industries positively influence income growth. In addition, explicitly

for developing regions, McMillan and Rodrik (2011) show that structural change is conducive to de-

velopment if labor shifts to higher-productivity sectors.3

Our question of driving factors is connected

to the literature that documents the importance of structural change but is still distinctly different.

While we take the sector’s importance for long-run development4

as given (as thoroughly argued),

we ask what promotes this sector and thus what are the determinants to modernize the economy by