Windfalls, Structural Transformation and Specialization

Macro cross-country data and micro US county data indicate that resource-rich regions have small but relatively productive manufacturing sectors and large but relatively unproductive non-manufacturing sectors. We suggest a process of specialization to explain these facts. Windfall revenue induces labor to move from the (traded) manufacturing to the (nontraded) 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 nonmanufacturing 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 differences 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 productivity in those countries is a consequence of manufacturing’s smaller size.