Many economists characterize developing countries' growth as the expansion of a modern, capital-intensive and large-scale sector which eventually drives the traditional, labour-intensive and small-scale sector out of business. Import-substitution policies, which direct scarce inputs to the modern sector on favourable terms, aim to facilitate this structural transformation; advocates of `strategic' trade and industrial policies, which aim to reap scale economies and positive externalities, also take the superior economic performance of large-scale modern manufacturing for granted. In Discussion Paper No. 861, Research Fellow Magnus Blomström and Edward Wolff examine Mexican data on productivity growth and domestic diffusion of technology in manufacturing industries with dual production structures for 1970-5 (and also less detailed data for 1965-75). They find no evidence that growth and structural transformation reflect expansion of the `modern' relative to the `traditional' sector. Labour productivity levels vary almost directly with establishment size, but its growth is the same in small and large establishments, which partly reflects the exit of low-productivity small firms. Most variation in labour productivity levels across plant size reflects differences in capital intensity. Levels of total factor productivity display little variation.

Blomström and Wolff also examine industry level data, which again reveal no systematic relation between productivity growth and plant size. Their regression analysis suggests rather that rapid output growth and the exit of inefficient firms underpin rapid labour productivity growth at the industry level, while the diffusion of US technology (the `catch-up' effect) also plays a major role for large plants but not for traditional ones. The strong growth performance of small firms, despite the unfavourable conditions resulting from the policy of import substitution, undermines the case for favouring the modern sector in the allocation of scarce inputs.

Growth in a Dual Economy
Magnus Blomström and Edward N Wolff

Discussion Paper No. 861, January 1994 (IT)