Windfalls, Structural Transformation and Specialization

Macro cross-country data and micro US country data indicate that resource rich regions have small and productive manufacturing sectors and large and unproductive non-manufacturing sectors. We suggest a process of specialization to explain these facts. Windfall revenue induces labor to move from the (traded) manufacturing sector to the (non-traded) non-manufacturing sector. A self selection of workers takes place. Only those most skilled in manufacturing sector work remain in manufacturing. Workers that move to non-manufacturing however, will be less skilled at non-manufacturing sector work than those who were already employed there. Resource induced structural transformation thus results in higher productivity in manufacturing and lower productivity in non-manufacturing. We construct and calibrate a two sector, open economy model of self-selection and show that exogenous cross-country variation in natural resource endowments is large enough to explain the direction and magnitude of sectoral employment and productivity difference between resource rich and resource poor regions. The model implies that low aggregate productivity found in some resource rich countries is not caused by a resource induced decline of a relatively productive manufacturing sector. Rather, the higher manufacturing producvity in those countries is a consequence of manufacturing's smaller size.