HOW TO MOTIVATE FASTER
GROWTH IN COLOMBIA: THE
LEADING SECTOR STRATEGY
REVISITED
ROGER J. SANDILANDS*
Roger Sandilands is a Reader in Economics. A graduate of Strathclyde and Simon Fraser
Universities, he has held university posts in the United Kingdom, Canada, Singapore, Sweden
and Peru, and has worked as an economic consultant to the United Nations, the Colombian
Agricultural Research Institute, and the Colombian National Planning Office. His books
include Monetary Correction and Housing Finance in Latin America (Gower, 1980): The Life
and Political Economy of Lauchlin Currie: New Dealer, Presidential Adviser, and Development
Economist (Duke University Press, 1990); and Money and Growth: Selected Paper of Allyn
Abbott Young (Routledge, 1999).
Fecha de recepción: 21-10-2002 Fecha de aceptación: 16-12-2002
*His published papers deal with international trade, housing finance, land value taxation,
monetary policy, growth theory, agricultural modernization, industrialization, and the
economic history of the Great Depression. He has also been Managing Editor of the Journal
of Economic Studies.
ABSTRAC
This paper reproduces two public lectures
given at an Incolda conference
in Bogota, October 1, 2002 on "La
Realidad de la Economía Colombiana". It reviews the great structural
changes in output and employment
over recent decades and how macroeconomic
policies can strengthen or
weaken the natural forces underlying
these changes. It distinguishes
between potentially inflationary policies
designed to increase demand in
a monetary sense, and those that focus
on institutional changes that enhance
competition and mobility. It
explains how inflation distorts the
allocation of resources, and why it
especially harms long-term housing
finance and exports. It explains the
logic of Lauchlin Currie´s leading sector
theory of growth and shows why
and how housing and exports can be
given special protection to accelerate
development.
KEY WORDS
Colombia, growth, structural changes,
inflationary policies, leading sector
theory of growth, housing sector,
exports sector, development.
Clasification: B
It has been a few years since I worked
serioly on the details of the Colombian
economy, so I am a little divorced
from the contemporary reality, which
I do understand is extremely complex
and fragile at the moment. But I hope
that the work that I have done in and
on Colombia since I first came here
in 1968 gives me a long-term perspective
that will justify my addressing
this distinguished audience today.
When I first arrived here in the late
1960s the structure of the Colombian
economy was very different from what
it is today. The population was "only"
17 millions. This was up from 10 millions
in 1950 when the first World
Bank Mission arrived, and even then
the mission report complained of an
excessively high birth rate. This was
the mission headed by Lauchlin Currie,
and the health expert on the team,
Dr Joseph Mountin of the US Public
Health Service, later initiated work in
the National Health Service in Washington
that led eventually to the pill.1
Currie remained in Colombia after
delivering his famous Informe Currie
-the World Bank Report of 1950-
and he played a very important -and,
naturally, very controversial- part in
guiding Colombia´s economic development
in the following four decades. I
was a student of Lauchlin Currie´s in
graduate school in Canada and what
I have to say today owes much to his
influence and to the work I have done
here in Colombia in association with
him at Planeación Nacional and other
places.
When the first World Bank Mission
arrived here in 1950, about 70 percent
of the Colombian population lived in
rural areas; by the late 1960s this proportion
had fallen to less than 40 percent.
Today it is around 25 percent.
There was always an imbalance between
the proportion of the work force
engaged in agriculture and the proportion
of the GDP generated by that
sector -around a third in 1950, a
quarter in the late 1960s and around
13 percent today. A simple arithmetic
calculation shows you that this puts
average rural output and incomes per
worker significantly below the incomes
of workers in the urban sectors.
Urban workers -in manufacturing,
commerce, construction and services-
are much more productive than
their rural counterparts in terms of
the value of what they can produce.
This is the most powerful reason for
the continuing mass migration from
village to town and from town to city
in Colombia over the past 50 years.
This process has been powerfully reinforced
by the continuing process of
technification of agriculture that displaces
rural labour in the face of low
elasticity of demand for the products
of this sector. This process of technification
still has a long way to go before
productivity levels approach
those in North America and Europe
where barely 2 percent of the active
population now work in agriculture.
Of course, rural violence is another
factor but this is nothing new in Colombia,
though there has recently
been a tragic increase in this expulsion
factor.
Rural -urban migration is just one
manifestation of underlying natural
market forces at work-forces that
persuade or compel resources from
sectors where the return is low to
activities where the return is much
higher. When labour and capital
move from the textile sector in Bogota
toward the electronics sector (or to
pharmaceutics or conmmerce or construction)
because of higher returns
in the latter over time, this is a process
that is encouraged. But when
labour and capital move from Boyaca
to Bogota this is often seen as a
cause for regret; as a Bad Thing.
This regret is understandable. The
social, psychological and infrastructural
burdens associated whith the
economic mobility mechanism in the
process of rural-urban migration are
much greater than in the case of urban-
urban mobility. And much greater
than anything experienced in Europe
or North America at comparable
stages of their development. Nevertheless,
the more that these burdens
are assumed and tackled the greater
the efficiency of the economic machine,
and the greater the potential increase
in overall GDP and in average real
incomes and living standards for rural
and urban workers alike. Indeed,
the rewards -in terms of potentially
much higher growth rates than in 19th
century Europe and Nort America-
are also much greater if policy makers
put oil rather than sand into the
mobility mechanism.
It is no accident that compound
growth rates in the Asian tigers
have been as high as 8-10 percent
per year the last few decades. At
these rates there is a doubling of per
capita incomes every 10 years. Thus
in Singapore, for example, a country
that I also first visited in the
1960s and where I have recently
spent 6 years of my working life, living
standards today are about 8
times higher than in the 1960s and
per capita income higher than in
most of Europe.
The problem for Colombia is of course
compounded by the fact that the birth
rate continues to be much higher
than in Europe and North America
in the 19th century, while mortality
rates have come tumbling down.
Thus Colombia´s population today is
more than double what it was when
I first came to Colombia, and more
than 4 times what it was when the
first World Bank Mission launched
Colombia on its first serious development
programme. That is an extra 33
millions, whith nearly a million more
each year or so.
Fortunately, population growth is
slower now than in the 1960s. This
is largely due not so much to the pill
as to the incentive to reduce the birth
rate. This is due to the impact on incentives
of higher rates or urbanization,
higher incomes, greater job opportunities
for women outside of the
home, and higher levels of education,
particularly for girls.
Does Colombia need all these extra
people to fuel its economic development?
Of course most of them will
eventually be members of the work
force. But the productivity of the work
force depends on how disciplined and
educated they are. And, above all, on
how much physical capital and technology
they each will have to work
with. It is the productivity of the work
force, not their number, that makes
for a high per capita level of income,
a high standard of living, and a more
equal distribution.
My own thinking of these issues is, as
mentioned, considerably influenced by
Lauchlin Currie, who in turn was
greatly influenced by his Harvard
mentor, the great American economist
Allyn Young whose most famous writing
was delivered as the presidential
address to the British Association in
1928, on "Increasing Returns and Economic
Progress" while Young was a
visiting professor at the London
School of Economics. (Young had the
unique distinction of being president
of the AEA, the ASA and the BA.) Let
me try to explain the relevance of his
theories to an audience of Colombian
entrepreneurs.
Young´s theme took as its point of
departure Adam Smith´s famous account,
in the opening chapters of The
Wealth of Nations, of the economies
of scale available in a simple pin factory.
This was written in 1776 -a
time when Britain was a developing
country like Colombia today, so
Smith´s writings are still relevant.
The key point was that the opportunities
to exploit the amazing possibilities
of enhanced productivity via
specialization depended on the size
of the market. Hence Smith´s famous
aphorism that "the division of labour
depends on the size of the market."
Young developed this basic insight. He
explained that the form in which specialization
-and hence productivity
growth- occurs in the modern economy
was via specialization by firm as
well as within firms. And accompanying
this specialization was a greater
degree of "roundaboutness" or capitalintensity.
Hence the growing economy
is a more and more complex economy
in which industrial diversification and
sub-division is just as important, or
more important than industrial concentration
and monopoly.
Competition, mobility, and unrestricted
access to the cheapest and
best goods and services available at
home and abroad were the key conditions.
Competition, mobility and
openness increase both the ability to
produce more via specialization, and
to enjoy greater purchasing power, or
increased real incomes. And it was increasing
real incomes (arising from
the ability to use one´s income to buy
the cheapest and best available goods
and services) that represented the increased
real demand or size of the
market.
From these insights it is possible to
construct a theory of cumulative causation
or self sustaining growth. Depending
on the degree of competition
and mobility, falling costs of production
will be passed on to consumers
in the form of lower prices or higher
real wages. This is what increases the
size of the market. This in turn increases
the incentive and the finance
needed to expand output and productive
capacity throughout the economy,
and to adopt productivity-enhancing
technologies and organizations
in existing and new industries.
Increased market size makes for
changes that are both quantitative
and qualitative. The qualitative
changes -new technologies, new
ways of organizing firms and industries,
new skills, new products, new
jobs- engender macroeconomic increasing
returns that are largely automatic,
or the natural result of market
forces.
This has come to be known as the
Young-Currie multiplier. It means
that the growth rate has an endogenous
tendency to continue at the same
rate year after year. For growth means
that the real market size is bigger each
year. Thus growth increases the division
of labour. But increased division
of labour, or specialization, increases
productivity and growth. Thus, in
Young´s words: "the division of labour
is limited by the division of labour";
or growth is limited by growth. This
implies that automatic market forces
may perpetuate a slow as well as a fast
growth rate. The existing growth rate,
whatever it is, has a tendency to continue
at the same rate.
The key problem for policy makers is
how to convert a slow growth trend
into a fast growth trend. Or in other
words, how can policy makers expand
the size of market demand in order
more fully to capture the benefits of
specialization and achieve greater
increasing returns?
The answer does not lie in an increase
in the money supply or in continuous
fiscal deficits. That way there may
indeed be an increase in monetary
demand. And in Colombia there has
never been any difficulty in achieving
that. If that were the solution
Colombia would have had one of the
fastest growth rates in the world in
the past 40 years. Instead it has one
of the slowest -and much slower
than that of the Asian tigers and
much below Colombia´s potential.
This is a country immensely rich in
entrepreneurial and natural resources,
but these resources have been
largely underutilized.
The solution lies in measures that
increase real demand.
But real demand depends on real supply,
and vice versa. How break into
this circle, to ensure that the circle expands
year after as fast as possible?
The answer is that much more attention
needs to be given to the factors
that hold back an increase in real demand
for the goods and services that
Colombia is capable of producing if
only the incentive is given. It is not
just, or mainly, a matter of increasing
the supply of capital, or foreign exchange,
or workers. It is a matter of
how to make it appear worthwhile to
entrepreneurs. Who will use their own
or other people´s money to invest in
new capacity and technology if the
potential increase in supply looks as
if it will outstrip the potential increase
in demand? In those circumstances
and increase in supply at the level of
the individual firm or individual sector
may result in a fall in price that is
faster than the potential cost savings.
The potential result is bankruptcy. So
the individual entrepreneur holds
back and increases output only in line
with the historic trend. And in Colombia
this secular trend has been rather
miserable.
Thus it is incumbent upon policymakers
to get the macroeconomic conditions
right.
In my opinion there have been two
major, related failings here:
(i) The first is the belief that the major
constraint on non-residential business
expansion is a lack of credit and/or interest
rates are too high.
(ii) The second is the belief that devaluation
causes inflation and that
therefore the best way to control inflation
is to control the exchange rate.
Both of these issues are intimately
related to the recent problem of recession
worldwide, and in particular
to Colombia´s recent economic misery.2 After the break I shall go into
these two issues a little more deeply.
But what if the main cause of inflation
is actually an excessive expansion
of the money supply? What if this
is partly brought on by a central bank
upon which strong political pressures
are brought to bear to keep interest
rates low? What if the Banco de la
Republica acts not solely as a central
bank whose prime role is to control
the supply of money in line with the
real growth of the economy but also
as a development bank that provides
development finance and cheap credit
to favoured farmers and industrialists?
In these circumstances there is
a real conflict of objectives; and in the
past the cheap money lobby or the
influence of the spending ministers
has prevailed too often.
The result has been an inflation rate
much higher than the world average.
This has had at least two extremely
damaging effects on investment and
the efficiency of the economy (as well
as noxious effects on the distribution
of income). The first concerns the effect
on trading opportunities with the
rest of the world. The second concerns
the market for housing finance,
and hence investment in building and
related industries.
- FOREIGN TRADE
Let me first discuss the issue of foreign
trade opportunities.
In Colombia the tendency has frequently
been to control the exchange
rate instead of the money supply in
the face of inflation. This has produced
a chronic tendency toward an
overvalued exchange rate. This has
made Colombia´s imports artificially
cheap and her exports artificially
expensive. This means that when trying
to sell their goods and services,
Colombian producers have had to rely
too much on the limited domestic
market and not enough on the potentially
vast world market.
Import controls and export subsidies
have been employed to try to help
Colombian producers, but these have
created an excessively large bureaucracy.
This is extremely frustrating
to business, wastes productive resources,
and is partial and discriminatory.
It does little to enable Colombia
to increase its world market penetration.
When the demand is limited,
supply has to follow the distorted
and limited pattern of demand. Specialization,
diversification, and the
adoption of new technologies are frustrated.
Increasing returns and fast
growth are sacrificed.
In parenthesis, I may mention a related
problem that Colombian industrialists
face when the exchange rate
is overvalued and the country experiences
chronic balance-of-payments
difficulties. In trying to deal with the
allocation of foreign exchange bureaucratically
rather than through
the market mechanism civil servants
at Incomex tell industrialists what
they can and cannot buy from abroad.
With a chronic unemployment problem
and low wages, you are told by
civil servants to spend your money
(not theirs) on labour-intensive methods
rather than the methods that you
regard as most economic and suited
to your particular needs. The import
of capital-intensive technologies are
discouraged and even prohibited.
Let me give you an example, though I
am sure many of you will have similar
or better examples than mine. I know
an energetic Colombian industrialist
who was denied an import licence for
an advanced German machine that
would produce drip irrigation tubes
rapidly and cheaply. Instead he was
forced to use antiquated second-hand
machinery bought locally. The machine
broke down frequently and was slow.
The up-front capital cost of this machine
was much less than the foreign one;
but what of the overall costs of production
for the tubes? Overall costs included
the costs of slowness and breakdown,
and the labour costs were also higher.
Nevertheless, the increased labour-
intensity of the antiquated, lowproductivity
methods is often been regarded
as an advantage rather than a
disadvantage in the eyes of the economically
illiterate. With higher unit
costs and smaller output, the irrigation
equipment is sold at a higher price to
farmers and flower growers. Ultimately
domestic consumers of food and the
foreign purchasers of flowers face higher
prices. Domestic and foreign sales
are thus lower than would be possible
if the manufacturer had been free to
use his own best technical and economic
judgments when investing his own
money.
The lesson is a universal one. If costs
are artificially raised through protectionism,
the home and foreign markets
available to Colombian producers
generally is lower. Protection for one
group is disprotection for the rest of
the economy. Whith smaller markets,
the incentive for all Colombian producers
to invest and innovate is lower.
Low demand, low incentives, low
growth: A vicious cycle is perpetuated.
Thus there is an intimate connection
between the health of the sectors supplying
foreign markets and those supplying
the home market. They do not
expand at each others´expense. Their
fortunes, and that of the whole economy,
are mutually reinforcing -either
in the upward or in the downward direction.
If, for example, the housing
sector is sick, it will be harder not easier
for exporters to keep their costs low
and to exploit economies of scale.
- THE HOUSING MARKET
This brings me to the second debilitating
effect of inflation (or an excessive
expansion of monetary demand),
namely, its debilitating effect on real
demand in the housing market. Once
again the problem relates to the view
that credit ought to be offered on the
cheapest possible terms to borrowers.
And just as industrialists constantly
lobby the government and central
bank to keep interest rates low and
credit cheap, so in the market for
housing finance the voice of the borrower
has greater political weight
than the voice of the saver.
The result? Big potential demand for
housing finance, but small supply.
And the market always clears at the
short end. A short supply means that
large potential demand becomes
short effective demand. The key problem
for policy-makers is how to convert
potential into actual demand.
The housing finance market is not like
most other credit markets, because it
typically finances an asset whose value
is usually very large relative to the
borrower´s income, and so needs to be
on much longer terms than most.
When inflation is high nominal interest
rates are also high, even when they
are negative in real terms. At high
nominal rates of interest, say 20 percent,
there is a major "front-endloading" or cash squeeze problem for
borrowers. To buy an apartment with
a mortgage of $100.000 requires that
the borrower pay $20.000 in interest
payments alone in the first year. This
may nearly exceed his entire annual
income even though in theory that
apartment should be easily affordable
in the long term to someone with his
income. Furthermore, even if he could
overcome the frontend loading problem,
why would savers bothers to put
their money into the system if inflation
is, say, 22 percent or more? That
is, if interest rates in the corporaciones
de vivienda (CAVs) are negative
in real terms. And they would be doubly
reluctant if the banks specializing
in short-term loans to other types
of borrower are able to offer better
rates to lenders and extract higher
rates from borrowers.
(Incidentally, now that Colombia´s
CAVs have been fused into the banks,
the banks may have less incentive
than when the CAVs were independent
specialist institutions, to use
their funds to finance housing rather
than automobiles and consumer credit.
I well recall Dr Gabriel Rosas presenting
a paper on behalf of Lauchlin
Currie at a convention in Cartagena
in 1991 that warned of the benefits of
financial specialization and the dangers
of multi-banking. A pity his words
have not been heeded.)
The main pint is that inflation introduces
a major distortion into capital
markets by discriminating heavily
against housing. Yet this is the very
sector where potential demand is very
great. It is also a sector with a relatively
low import content. And it has
the potential to employ hundreds of
thousands of workers in relatively
well-paying jobs, even when efficient
capital-intensive building methods
are employed.
A dynamic housing sector is vital also
to the better functioning of the labour
mobility mechanism. Workers moving
from village to town, from town
to city, and from city slums into better
accommodation in the same city
need housing if they are to make the
move easily. Thus housing is a vital
part of a job creation programme. It
employs labour directly in the building
of houses and related infrastructure.
And it plays a crucial indirect
role in making labour available to
other employers in industry, commerce
and services. An increased supply
of housing at lower cost reduces
the cost of an important wage good,
and so enables employers to cut their
own wage costs without reducing the
standard of living of the workers.
Furthermore, by playing this vital
role in oiling the labour-mobility
mechanism, a dynamic construction
sector enables more and more workers
to move from low-to higher-paying
jobs. Ultimately real wages all
round should increase, thanks to the
overall productivity-enhancing effects
of better mobility and the way
in which this in turn increases overall
size of the market, or GDP. This
is what encourages investment and
innovation that would not otherwise
have been worthwhile.
Note too that those idnustrialists who
are producing goods and services that
enter into the building of houses (the
construction sector itself is basically
an assembly industry) see no point
in expanding their operations greatly,
or establishing new specialist
plants that yield big economies of
scale, unless they are happy with the
prospective increase in demand for
their products: bricks, cement, glass,
pipes, sanitary fixtures, furnishings,
paint, etc. They need an incentive;
and the incentive comes from an expansion
in demand, not in terms of
money only, but in real terms.
It is in this sense that for many years
Professor Currie pushed hard for the
adoption of a leading sector strategy
in Colombia, with construction and
exports as the two most important
candidates for this role.
Exports were to be encouraged
through the preservation of a more
permanently competitive exchange
rate. This would be achieved through
policies that ensured that the external
value of the peso kept in line with
its internal value. If domestic inflation
is depreciating the internal value of
the peso then its external value should
be allowed to reflect this. Otherwise a
major distortion is introduced into the
market signaling process.
Housing was to be encouraged
through the valor constante system
that guaranteed savers a fair return
on their savings while at the same
time making it much easier for borrowers
to pay a reasonable real interest
rate to savers without encountering
the crippling cash flow problem
that had artificially restrained
demand for many years.
In the early years of the valor constante
system it operated fairly closely
to a theoretical and practical ideal.
Savings flowed into the system at
a rate that astonished the skeptics;
but demand increased even more rapidly.
Construction boomed without
recourse to massive subsidies or burden
on the taxpayer or the central
bank. Colombia´s growth rate was
higher in this period than before or
since. But sadly, over the years, once
the borrowers had got their mortgages
they formed a powerful pressure
group to persuade the government to
weaken the system by loosening the
index link with inflation. This was to
the detriment of savers and jeopardized
the competitiveness of the housing
finance system vis-a-vis the rest
of the capital markets. As saving declined
the government has had to rely
more and more on "social" housing,
at great fiscal cost and with far less
housing constructed than in the past,
and with a socially and economically
costly pattern of urban development.
Thus, although housing has a great
potential as a leading sector in the
potential acceleration of the rate of
economic growth in Colombia, it also
has the potential to lead the economy
down as well as up. I hope that as
a tribute to the unparalleled efforts
of Lauchlin Currie on behalf of faster
economic growth and social justice
in Colombia from the time of his arrival
here in 1949 right up to his
death in 1993, Colombian policymakers
may make amends and ensure
that his leading sectors strategy
is resurrected. It would be a fitting
way to mark the centenary of his
birth a week from today.
FOOTNOTES
1. However, it takes much more than the availability of the pill to bring the birth rate down - see below
2. Show Sergio Clavijo´s "Index of economy misery", 1967-2001