The fundamental problem of most developing countries is the unemployment and underemployment of an important segment of the labor force. The cause of this problem is the shortage of capital equipment and productive capacity, the latter understood as potential production (Box 2.1). This view is very much consistent with the analyses of the classical authors and with the modern treatment in terms of growth diagnostics of Hausmann, Rodrik, and Velasco (2005). See Box 2.2.

Suppose the quantities produced of two goods x and y might be represented by point p in Figure 2.1, inside the curve. In this case, some of the available resources are clearly not fully utilized (e.g., people are unemployed). Under these circumstances, growth requires higher utilization of the country's production capacity. The country has to try to get closer to the transformation curve. This is the typical problem that most developing countries suffer from.

This does not mean that developing countries do not suffer from inadequacy of effective demand or from allocative efficiency problems. Indeed they do.

The fundamental problem of most developing countries is the unemployment and underemployment of an important segment of the labor force. The cause of this problem is the shortage of capital equipment and productive capacity, the latter understood as potential production (Box 2.1). This view is very much consistent with the analyses of the classical authors and with the modern treatment in terms of growth diagnostics of Hausmann, Rodrik, and Velasco (2005). See Box 2.2.

Suppose the quantities produced of two goods x and y might be represented by point p in Figure 2.1, inside the curve. In this case, some of the available resources are clearly not fully utilized (e.g., people are unemployed). Under these circumstances, growth requires higher utilization of the country's production capacity. The country has to try to get closer to the transformation curve. This is the typical problem that most developing countries suffer from.

This does not mean that developing countries do not suffer from inadequacy of effective demand or from allocative efficiency problems. Indeed they do. The problem of markets—that, because of their small internal demand, there will be no outlet for the products of the newly built factories—may limit developing countries’ growth rate. Hence, industrialization will prove impossible unless it is oriented toward external markets (even though this problem could potentially be solved if investment were sufficiently high, as this would generate demand for consumption goods). Likewise, effective demand problems can become the binding constraint on production in developing countries at a fairly advanced stage of industrialization (e.g., Malaysia, Thailand, the People's Republic of China) as they can be “balanceof- payments constrained” ( McCombie and Thirlwall [1994]; also see section on Export-Led Growth and the Balance-of-Payments Constraint in chapter 16 of this book).

Allocative efficiency problems are also present in developing countries. The combination of goods and services being produced in developing countries is often not the one that maximizes the value of output at the prevailing prices. In Figure 2.2, p’ is on the transformation curve.

In this book, I expand on my previous work (with Rana Hasan) on unemployment and underemployment in developing Asia, Labor Markets in Asia: Issues and Perspectives (2006). Here, I reiterate and stress my view that while economists and social scientists in general have praised developing Asia's unmatched growth record since the mid-1960s, they may have missed the important point that the region is failing to provide employment to its huge and still-growing labor force. Sooner or later this problem will become policy makers' biggest headache. The attainment of full employment, understood amid the problems posed by structural change (or transformation), globalization, and fast technical progress, should be the ultimate goal of economic policy. Figure A reproduces the framework used in Labor Markets in Asia to understand and conceptualize full employment and the policies to achieve it. In this book, I move one step forward and analyze the policies to achieve full employment during fast structural change. I view my work as contributing to the concern among policy makers in the developing world that growth has to be inclusive, that is, that it has to provide equal opportunities. In my view, opportunities come through employment.

In early 2008, the International Labour Organization (ILO) announced that as a result of the expected global economic cooling following the turbulence in financial markets, world unemployment would increase.

In 1919, American President Woodrow Wilson declared ‘self-determination’ the natural right of all would-be nations. However, despite sending delegates, Sinn Féin failed to gain a hearing at the post-war peace conference held that year, putting to rest hopes of securing international support in its campaign for Irish self-government. As O'Hegarty would later write:

Yet unlike many leading Sinn Féiners, O'Hegarty held reservations from the beginning over this abrupt shift in policy, namely for its redirecting Sinn Féin's energies away from the Irish people and outside the national self.

Full employment is a widely used term, although often different people mean different things. There are two important issues to consider. The first one concerns the resource the term refers to. In my discussion, full employment refers to labor. Underutilization of plant and equipment is not the problem that developing countries face, as noted above. The second issue regards the level to which “full” refers to. During the last three decades, the term “full employment,” as used in orthodox circles, refers to the nonaccelerating inflation rate of unemployment (NAIRU), one of the most powerful notions in economic policy since the 1970s. This is the level of unemployment that is associated with price stability, even if many workers ready and willing to work are unemployed. The basic proposition underlying the NAIRU is that policy makers cannot use deficit spending or an increase in the money supply to reduce unemployment below some “equilibrium” rate, except at the cost of accelerating inflation. This is an important departure from the Keynesian view that inflation poses a problem only when the economy approaches full employment.

Full employment in the framework of the NAIRU obviously places fighting inflation (as a macroeconomic objective) above combating unemployment.

Full employment is a widely used term, although often different people mean different things. There are two important issues to consider. The first one concerns the resource the term refers to. In my discussion, full employment refers to labor. Underutilization of plant and equipment is not the problem that developing countries face, as noted above. The second issue regards the level to which “full” refers to. During the last three decades, the term “full employment,” as used in orthodox circles, refers to the nonaccelerating inflation rate of unemployment (NAIRU), one of the most powerful notions in economic policy since the 1970s. This is the level of unemployment that is associated with price stability, even if many workers ready and willing to work are unemployed. The basic proposition underlying the NAIRU is that policy makers cannot use deficit spending or an increase in the money supply to reduce unemployment below some “equilibrium” rate, except at the cost of accelerating inflation. This is an important departure from the Keynesian view that inflation poses a problem only when the economy approaches full employment.

Full employment in the framework of the NAIRU obviously places fighting inflation (as a macroeconomic objective) above combating unemployment. Indeed, the view that price stability requires maintaining a pool of unemployed means that the fiscal and monetary brakes have to be slammed as soon as economic growth causes unemployment to drop below a certain level. Many policy makers and politicians also seem to have accepted this concept and hold the view that there is a natural rate of unemployment that is invariant to aggregate spending. They argue that this natural rate can be reduced only through supply-side measures: deregulation, privatization, and welfare reforms (e.g., cutting the minimum wage, eliminating unemployment benefits), or upgrading the skills of workers. For those who view the economy through this lens, supply-side measures are the only way to reduce unemployment. Moreover, when this is close to the NAIRU, the monetary authorities must take prompt anti-inflationary measures to prevent the economy from overheating, otherwise inflation will not only grow but will also accelerate (I will take up these issues again in chapters 11 and 12).

This chapter expands the analysis of structural transformation in developing Asia. I rely on recent work on economic diversification, the importance of export sophistication and the product space. All this body of work has very important policy implications.

Comparative Advantage and Diversification

Recent research by Imbs and Wacziarg (2003) suggests that at low levels of income per capita, economies tend to diversify and subsequently, as their income rises, they then specialize: whatever drives economic development, it is not comparative advantage. Figure 10.1 graphs the degree of specialization in the manufacturing sector in the vertical axis vis-à-vis the logarithm of income per capita in the horizontal axis. As noted above, the new literature emphasizes the importance of diversification as opposed to traditional comparative advantage (i.e., the idea that as countries open up trade, they will specialize in those activities that use intensively those factors that are in abundant supply). Graphically, this corresponds to a U-shape relationship between specialization and income per capita, which Figure 10.1 corroborates. The figure shows increasing diversification as income per capita increases (at low levels) in Bangladesh, India, Indonesia, Pakistan, Sri Lanka, and Thailand. None of these economies become more specialized within comparable low-income ranges. Increasing specialization is only detected at higher income levels in the Republic of Korea, Malaysia, and Singapore. Hong Kong, China seems to be increasing its level of diversification.

A transfer to Welshpool from his post in Cobh, possibly because of his Sinn Fein sympathies, did not prevent news of an intended IRB uprising reaching O'Hegarty. Sent by the Supreme Council in May 1915, IRB man Sean McDermott sought out his opinion. O'Hegarty describes below McDermott telling him that:

One of the oldest unresolved dilemmas in economics is whether market economies are naturally stable, or whether they need to be stabilized by policy. Classical and neoclassical models argue that a market economy can look after itself and that, in the absence of egregious government interference, it would gravitate naturally to full employment, greater innovation, and higher growth rates. However, Keynes emphasized the flimsiness of the expectations on which economic activity in decentralized markets is based. While the dominant intellectual paradigm since the 1970s has adhered to the idea that a market economy gravitates toward full employment, the historical record shows that the regime of the 1950s and 1960s was more successful than what followed afterwards. Indeed, other than the exceptions of the People's Republic of China (PRC), and perhaps a few more developing countries recently (e.g., India, Viet Nam), economic growth was faster and much more stable in the Keynesian golden period; its fruits were more equitably distributed and social cohesion and moral habits better maintained.

Modern analysis of economic growth started with the so-called Harrod -Domar model (Harrod 1939, Domar 1946). This model has Keynesian and classical (mostly Ricardian) features. It is important to understand this model because subsequent modern growth models provide different solutions to the so-called Harrod- Domar knife-edge problem (discussed below).

Any discussion of development must start with a consideration of the state and prospects of agriculture. If this sector cannot be transformed, there can be no genuine revolution of economic growth. The World Bank's (2008) World Development Report highlights the importance of this sector for development. As the food crisis that erupted in early 2008 (labeled “a silent tsunami” by the United Nations’ World Food Programme) showed, the international community cannot neglect agriculture, for this crisis may bring obstacles to globalization (food markets are in turmoil, protests are growing, and trade and openness can be undermined).

Agriculture is still the largest employer in many developing countries in Asia, including Bangladesh, Cambodia, the People's Republic of China (PRC), India, Indonesia, Pakistan, Papua New Guinea, Thailand, and Viet Nam (in 2000–2004, agriculture was still the largest employer in developing Asia in 12 out of 23 countries for which data were available). And in many other countries in the region, although it is not the largest employer, it still employs a very significant share of the labor force.

Figure 5.1 shows the generalized tendency for agricultural output and employment shares to decline as countries become richer. This is also the case across much of developing Asia. Especially significant have been the declines in output that occurred in the PRC and India: in the former from about 32% in the 1970s to about 13% in 2000–2004, and in India from about 42% to about 23% during the same period. The share of employment in agriculture has also declined across most of developing Asia, except in Central and West Asia. This is the result of the convulsion that this region underwent after the collapse of the Soviet Union. Figure 5.1 also indicates that, in general, the decline in agricultural employment has occurred at a much slower pace than that in output. Tables A5.1 and A5.2 at the end of the chapter provide total and sector growth rates and output and employment shares.

As stated above, the objective of development has to be the increase in productive capacity; but this occurs during the structural transformation of the economy, that is, the shift of resources (e.g., labor) from activities with low productivity, traditionally agriculture, into activities with high productivity, such as industry and services (Asian Development Bank 2007b; Felipe and Estrada 2008; Felipe et al. 2007).

In this chapter, I address the question of how a country can induce structural change and diversification, and plan transitions to higher growth rates. This is a fundamental aspect of the problem of developing countries, namely, the need to increase productive capacity. Indeed, the transition from agriculture into a modern industrial and service economy, and decisions about how much to invest and where, can be viewed as problems of self-discovery and of understanding the externalities that lessen incentives for productive diversification. Today's developed countries directed policies to industrialize. Chang (2002) argues that today's developed countries—such as the United Kingdom, Germany, France, the United States, Sweden, and Japan—used industrial, trade, and technological policies when they were developing and catching up. They used some form of infant-industry policy or tariff protection. More recently, the Republic of Korea is the clearest case of successful economic development achieved through infant-industry protection measures.

Industrial policy has traditionally been understood as any type of selective intervention or government policy that attempts to alter the structure of production toward sectors that are expected to offer better prospects for economic growth than without such intervention. This type of intervention has its adherents-those who believe in market failures—and its detractors—those who believe in the efficient working of markets. The latter argue that industrial policy interventions have often degenerated into an exercise in “picking winners,” a game played by government officials deciding what activities and sectors to promote and to spend public money on.

One important implication of the discussion in the previous chapters is that, in general, many developing countries find it difficult to run on a balanced development path. Achieving structural equilibrium between investment and consumption and noninflationary economic development is vital for developing countries, although virtually impossible. For developing countries under pressure to accept the effects (good and bad) of globalization, introduce market reforms, and reduce the role of government, the political obstacles to development are phenomenal. Achieving inclusive growth in these circumstances is not easy. Amsden (2007) argues provocatively that the more freedom a developing country has to shape its own policies, the faster its economy will grow.

As Keynes (1936, 320) argued, “the duty of ordering the current volume of investment cannot safely be left in private hands.” For this reason, the strategy of full employment based on stepping up investment requires “planning”, a term that, unfortunately, has acquired a bad name (see, for example, Easterly 2006, 2008), although it is done everywhere. Indeed, most, if not all, medium- and long-term development plans of both developed and developing countries specify the amount of total (public) investment as well as the allocation across sectors. For example, Malaysia's Ninth Five-Year Plan, 2006–2010, and the Third Industrial Master Plan, 2006–2020, contain policies to push its industry up the value chain and have well-defined targets in terms of growth rates and sectors’ shares in output. Through the Malaysian Industrial Development Authority, the government executes policies and initiatives intended to shape an industrial base to face the future challenges of the country. The authority assumes the key roles of planning, coordinating, and promoting the growth of industries in the manufacturing sector (also, Pakistan Institute of Development Economics [PIDE 2006] for a development plan for Pakistan).

A balanced development path requires coherent planning, not only of the forthcoming volume of investment but also of the composition of investment (sectors and types of goods), which must be directed purposefully toward the breaking of bottlenecks in supply.

This book discusses the implications for macroeconomic policy of the term inclusive growth, understood as growth with equal opportunities. This is a term that, in different ways (e.g., harmonious society, sufficient economy), is making its way into the policy discourse in many countries in Asia, and multilateral organizations such as the World Bank and the Asian Development Bank have also started using it. To achieve inclusive growth, Asian governments must commit efforts and resources to the pursuit of the full employment of labor to provide jobs to the 500 million unemployed and/or underemployed people in the region. The book discusses the different aspects of the link between inclusive growth and full employment, and offers a menu of policies that will have to be tailored to each country's circumstances.

A summary of the main arguments is as follows:

• (i) The most salient feature of developing Asia's labor markets is the considerable underutilization of labor, which manifests itself in unemployment and underemployment. Having a job that pays a decent salary is the most basic measure of a person's living standard. For this reason, Felipe and Hasan (2006, 2) argue that “improving labor market opportunities for workers is the key to reducing poverty and improving standards of living for the large majority of Asia's workers and their families. Poverty reduction requires helping people as workers.” A high-employment economy is the best single tool for fighting poverty.

• (ii) The main cause of unemployment and underemployment in developing countries is lack of capital equipment and productive capacity. Therefore, the purpose of development must be to increase a country's productive capacity. Only sound policies geared toward full employment will create the foundation for inclusive growth.

• (iii) Unemployment and underemployment as the fundamental causes of lack of inclusiveness are unethical states of a malfunctioning economy. They ultimately are the result of a lack of collective will to make political choices that favor maintaining adequate levels of demand.

• (iv) The most important way in which a person can participate in society and contribute to its progress is through a productive and decent job.

In this book, I expand on my previous work (with Rana Hasan) on unemployment and underemployment in developing Asia, Labor Markets in Asia: Issues and Perspectives (2006). Here, I reiterate and stress my view that while economists and social scientists in general have praised developing Asia's unmatched growth record since the mid-1960s, they may have missed the important point that the region is failing to provide employment to its huge and still-growing labor force. Sooner or later this problem will become policy makers’ biggest headache. The attainment of full employment, understood amid the problems posed by structural change (or transformation), globalization, and fast technical progress, should be the ultimate goal of economic policy. Figure A reproduces the framework used in Labor Markets in Asia to understand and conceptualize full employment and the policies to achieve it. In this book, I move one step forward and analyze the policies to achieve full employment during fast structural change. I view my work as contributing to the concern among policy makers in the developing world that growth has to be inclusive, that is, that it has to provide equal opportunities. In my view, opportunities come through employment.

In early 2008, the International Labour Organization (ILO) announced that as a result of the expected global economic cooling following the turbulence in financial markets, world unemployment would increase. Policy makers have to be aware of this problem and start implementing policies to tackle unemployment as soon as possible. This will require substantial changes in policies and priorities. In my view, this is the biggest challenge that policy makers across much of the region will face in the coming decades. Growth will be useless if it is not accompanied by employment opportunities.

I concluded a few years ago that the “development problem,” from the point of view of development policy, is an embarrassment, a puzzle that economists have failed to complete and even understand (Felipe 2006). Growth theory adds more and more variables to the discussion, but at the end of the day we do not know how to put all the pieces together.

In reacting adversely to plays thought unduly unfavourable to the nation, its language and people, nationalists found much that was offensive in the staged works of the Anglo-Irish literary tradition that, with the Gaelic League, inspired Ireland's cultural revival during a richly creative era in its history. Yet despite enjoying early successes like its Gaelic League counterpart, Ireland's literary revival was eyed with suspicion, even outright hostility by many cultural nationalists. Chief among them in his 1905 The Philosophy of Irish Ireland (a book consisting of articles fi rst appearing in the New Ireland Review during 1898–1900), D. P. Moran gave voice to that side of cultural nationalism, which saw Irish identity as exclusively Catholic and Gaelic. In his view, not only did the literary revival add nothing to Irish culture, but, more correctly, it represented the last expiratory gasp of the Protestant Ascendancy in Ireland.