Trading population for productivity

Oded Galor, Andrew Mountford

The last 200 years saw a ‘Great Divergence’ in per capita income, as some countries industrialised while others remained less developed. This column attributes the divergence to international trade. Comparative advantage encouraged industrialising economies to invest in human capital, while non-industrial economies experienced population growth.

The past two centuries have not only seen a `Great Divergence’ in the levels of income per capita across countries; they have also witnessed a dramatic change in the distribution of population across the globe. In the time period 1820-1998, the ratio between income per capita in Western Europe and Asia grew nearly three-fold, whereas the ratio between the Asian population and the Western European population grew nearly two-fold (Maddison 2001). This striking contrast between the development paths of large subsets of the world economy gives rise to fundamental questions about the growth process and its implications for current and historical development patterns. Notably, has the pace of transition to sustained economic growth in advanced economies adversely affected the process of development in less-developed economies? Have the forces of international trade contributed to the divergence in the timing of the demographic transition and the emergence of sustained economic growth across countries?

The origin of the `Great Divergence' in income per capita (Pritchett 1997) has been the subject of an intense debate, with notable advocates for the importance of geographical and institutional factors, human capital formation, ethnic, linguistic and religious fractionalisation, colonialism and globalisation.1 In recent research, we suggest that international trade has played a significant role in the differential timing and pace of the demographic transitions across countries and has been a major determinant of the distribution of world population as well as the `Great Divergence' in income per capita across countries.2 International trade has an asymmetrical effect on the evolution of industrial and non-industrial economies: While in the industrial nations the gains from trade have been directed primarily towards investment in education and growth in output per capita, a greater portion of the gains from trade in non-industrial nations has been channelled towards population growth.

Trade-driven divergence

The expansion of international trade has enhanced the specialisation of industrial economies in the production of industrial, skilled intensive, goods. The associated rise in the demand for skilled labour has induced a gradual investment in the quality of the population, expediting a demographic transition, stimulating technological progress and further enhancing the comparative advantage of these industrial economies in the production of skilled intensive goods. In non-industrial economies, in contrast, international trade has generated an incentive to specialise in the production of unskilled intensive, non-industrial, goods. The absence of significant demand for human capital has provided limited incentives to invest in the quality of the population and the gains from trade have been utilised primarily for a further increase in the size of the population, rather than the income of the existing population. The demographic transition in these non-industrial economies has been significantly delayed, increasing further their relative abundance of unskilled labour, enhancing their comparative disadvantage in the production of skilled intensive goods and delaying their process of development. This implies that international trade has persistently affected the distribution of population, skills, and technologies in the world economy, and has been a significant force behind the `Great Divergence' in income per capita across countries.

In contrast to the existing literature on the dynamics of comparative advantage, our theory suggests that even if trade equalises output growth in the trading countries, (due to the terms of trade effect), income per capita of developed and less developed economies will diverge, since in developed economies the growth of total output will be generated primarily by an increase in output per capita, whereas in less developed economies the contribution of population growth to the growth of total output will be more significant.

Empirical evidence

In accordance with this theory, cross country regressions support the hypothesis that international trade generates opposing effects on fertility rates and human capital formation in developed and less developed economies. We examine the effect of the share of trade in GDP in 1985 on total fertility rate and on the change in the average years of schooling in industrial and non-industrial economies over the time period 1985-2000. As shown in Figures 1 and 2, a larger share of trade in GDP per capita has a positive effect on fertility rates and a negative effect on the average years of education in non-OECD economies, whereas in OECD economies, trade triggers a decline in fertility and an increase in education. Thus, international trade accentuates the initial patterns of comparative advantage and is likely to affect differently the growth trajectory of population, human capital, and income per capita of developed and less developed economies.

Figure 1a. The partial effect of trade on fertility in non-OECD economies

Figure 1b. The partial effect of trade on fertility in OECD economies

Figure 2a. The partial effect of trade on education in non-OECD economies

Figure 2b. The partial effect of trade on education in OECD economies

Historical evidence also indicates that the fundamental hypothesis of this research is consistent with the process of development of the last two centuries. It suggests that the asymmetric effect of international trade on the timing of the demographic transition in developed and less-developed economies, and its persistent effect, therefore, on the initial patterns of comparative advantage may be an important element behind the Great Divergence over the last two centuries.

In particular, the analysis is consistent with the diverging experience in terms of the levels of income per capita and population growth rates of the UK and India since the nineteenth century. Industrialisation in India regressed over the 19th century whereas industrialisation in the UK accelerated. The process of industrialisation in the UK led to a significant increase in the demand for skilled labour in the second phase of the industrial revolution, triggering a demographic transition and a transition to a state of sustained economic growth. In India, in contrast, the lack of demand for skilled labour delayed the demographic transition and the process of development. Thus, while the gains from trade were utilised in the UK primarily towards an increase in output per capita, in India they were more biased towards an increase in the size of the population.

Policy concerns

Thus, our research suggests that policy makers ought to consider the dynamic effects of international trade on factor endowments and therefore on the patterns of comparative advantage in the long run. These effects may generate differential long-run growth trajectories in the currently developed and less developed economies.

References

Acemoglu, D., Johnson S. and Robinson J.A. (2005), "Institutions as the Fundamental Cause of Long-Run Growth", in Aghion, P. and Durlauf, S. (eds.) Handbook of Economic Growth (Amsterdam: North-Holland).

Ashraf, Q. and Galor, O. (2007), "Cultural Assimilation, Cultural Diffusion and the Origin of the Wealth of Nations" (CEPR Discussion Papers 6444).

Baldwin, R. E., Martin, P. and Ottaviano, G. I. P. (2001), "Global Income Divergence, Trade and Industrialisation: The Geography of Growth Take-Offs", Journal of Economic Growth, 6, 5-37.

Galor, O. (2005), "Unified Growth Theory: From Stagnation to Growth," in Aghion, P. and Durlauf, S. (eds.) Handbook of Economic Growth (Amsterdam: North-Holland), 171-293.

Glaeser, E.L., La Porta, R. Lopez-de-Silanes, F. and Shleifer, A. (2004), "Do Institutions Cause Growth?", Journal of Economic Growth, 9, 271-303.

Jones, E. L. (1981), The European Miracle: Environments, Economies and Geopolitics in the History of Europe and Asia (Cambridge: Cambridge University Press).

Landes, D. S. (1998), The Wealth and Poverty of Nations (New York: Norton).

Maddison, A. (2001), The World Economy (Paris : OECD).

North, D.C. (1981), Structure and Change in Economic History (New York: Norton).

Pritchett, L. (1997), “Divergence, Big Time”, Journal of Economic Perspectives, 11, 3-17.

Footnotes

1 See North (1981), Jones (1981), Landes (1998), Baldwin et al. (2001), Glaeser et al. (2004), Acemoglu, et al. (2005), Galor (2005), and Ashraf and Galor (2007).

2 Oded Galor and Andrew Mountford, “Trading Population for Productivity: Theory and Evidence,” CEPR Discussion Paper 6678, February 2008