Overcoming The Middle Income Trap

Overcoming the Middle Income Trap: Can
productivity increase employment?
A Masters Thesis submitted to the

University of Applied Sciences (Hochschule fr Technik und Wirtschaft)
in partial fulfillment of the requirements of the
Masters Program in International and Development Economics
Submitted by
Jessie Ruth G. Granadillos
S0546774
Submitted to thesis supervisors

Professor Dr. Heike Joebges
Professor Dr. Ulrich Wurzel
Berlin, Germany
06 July 2015
ABSTRACT
The existence of the Middle Income Trap phenomenon has led many countries to strongly advocate
productivity-enhancing growth strategies. However, existing studies in the EU and US, as well as a
publication from John Maynard Keynes in the 1930s, suggest that too high productivity comes at
the expense of employment a scenario that current middle-income countries cannot afford. Using
9 out of 13 countries that have managed to escape the trap, this thesis aims to clarify if such a tradeoff exists, and the reasons for the observed productivity-employment relationship. Results show
that while TFP and employment decisions may be directly related, policy analysis suggests that
indirect linkage with other macroeconomic variables have greater influence on productivity and
employment growth. Thus, it is completely conceivable that the relationship between the two
remain unstable and indeterminate in the future years.
WAIVER
Relevant portions of this paper may be quoted or used for other research papers provided that the
proper citation is made; however, no photocopies of any section of the thesis will be allowed
without consent from the author.
Jessie Ruth G. Granadillos

06 July 2015, Berlin
TABLE OF CONTENTS
ABSTRACT .................................................................................................................................................................................. 2
WAIVER ....................................................................................................................................................................................... 3
TABLE OF FIGURES................................................................................................................................................................. 5
I.
INTRODUCTION.............................................................................................................................................................. 6
II.
REVIEW OF RELATED LITERATURE ................................................................................................................... 13

A.
There is no long-term relationship between productivity and employment................................. 14
B.
There is a negative long-term relationship between productivity and employment ................. 15
C.
There is a positive long-term relationship between productivity and employment .................. 16
D.
Takeaways from the studied literature ......................................................................................................... 16
III.
THEORETICAL FRAMEWORK ............................................................................................................................ 18
IV.
EMPIRICAL FRAMEWORK................................................................................................................................... 20
A.
Data ............................................................................................................................................................................... 20
B.
Methodology ............................................................................................................................................................. 20
V.
RESULTS AND ANALYSES ........................................................................................................................................ 22

A.
Labor productivity, TFP, and the capital-labor ratio ................................................................................ 22
B.
GDP growth and Productivity growth ............................................................................................................ 24
C.
Productivity growth and employment growth: a quantitative and qualitative analysis........... 25
D.
Instability and causes of instability in the relationship .......................................................................... 27

1.
Spain ........................................................................................................................................................................ 30
2.
Greece...................................................................................................................................................................... 33
3.
Ireland..................................................................................................................................................................... 35
4.
Portugal .................................................................................................................................................................. 37
5.
Hong Kong ............................................................................................................................................................. 40
6.
Taiwan .................................................................................................................................................................... 42
7.
Singapore ............................................................................................................................................................... 44
8.
Japan ........................................................................................................................................................................ 46
9.
Korea ....................................................................................................................................................................... 48
VI.
CONCLUSION ............................................................................................................................................................ 51
VII.
POLICY IMPLICATIONS AND RECOMMENDATIONS FOR FURTHER STUDY ................................. 53
REFERENCES ........................................................................................................................................................................... 54
APPENDIX ................................................................................................................................................................................. 58
TABLE OF FIGURES
Figure 1: GDP per capita growth (%) .............................................................................................................................. 8
Figure 2: Labor Force Participation Rate (left) and Unemployment rate (right) ......................................... 9
Figure 3: Comparison between the change in Employed to Total Population Ratio (in percentage
points, RHS) and GDP per Capita growth rate (in percent, LHS) for MIC and HIC ..................................... 10
Figure 4: Long-run average of labor productivity growth and TFP growth ................................................. 22
Figure 5: Capital-labor ratio, 1950-2011..................................................................................................................... 23
Figure 6: Annual growth rate of capital-labor ratio, 1951-2011 ....................................................................... 24
Figure 7: GDP growth vs labor productivity growth, 1950-2013 ..................................................................... 24
Figure 8: Average labor productivity growth, TFP growth, growth in total hours worked, and
growth in employed persons, 1951-2013 ................................................................................................................... 26
Figure 9: TFP growth and Employment growth (European countries LHS, Asian countries RHS),
1951-2011 ................................................................................................................................................................................ 27
Figure 10: 8-year rolling window correlation between employment and labor productivity .............. 28
Figure 11: 8-year rolling window correlation between employment and TFP ........................................... 28
Figure 12: Spains average productivity growth and employment growth by inflection points from
the rolling correlation.......................................................................................................................................................... 30
Figure 13: Greece's average productivity growth and employment growth by inflection points from
Figure 14: Ireland's average productivity growth and employment growth by inflection points from
Figure 15: Portugal's average productivity growth and employment growth by inflection points
from the rolling correlation............................................................................................................................................... 38
Figure 16: Hong Kong's average productivity growth and employment growth by inflection points
Figure 17: Taiwan's average productivity growth and employment growth by inflection points from
Figure 18: Singapore's average productivity growth and employment growth by inflection points
Figure 19: Japan's average productivity growth and employment growth by inflection points from
Figure 20: Korea's average productivity growth and employment growth by inflection points from
Figure 21: Labor productivity (x-axis) vs TFP (y-axis).......................................................................................... 58
Figure 22: 8-year rolling window correlation between total hours worked and TFP.............................. 59
I.
INTRODUCTION
A large number of countries have moved from low to middle-income category, but only a few
managed to make the transition to high-income based on the World Banks country classification1.
According to The World Bank (2013), out of the 101 middle-income countries (MICs) in 1960, only
13 countries have achieved a high-income status by 2008, and have not fallen into the Middle
Income Trap, a term first used by Gill & Kharas (2007). The curious incident of countries getting
stuck in the middle has been attributed to a prolonged slow growth in GDP following a brief
period of ascent or having a failure of a growth take-off, of which low productivity growth has
been cited as the main obstacle. In fact, Eichengreen, Park, & Shin (2012), in their study using
regression and standard growth accounting methods, claim that 85 percent of the slow GDP growth
is explained by the low growth in Total Factor Productivity (TFP), rather than low levels of capital
accumulation. Classifying 124 countries with data from 1950-2010 to low-income, lower-middleincome, upper-middle-income, and high-income, Felipe, Abdon, & Kumar (2012) find that lowermiddle-income and upper-middle-income countries need an average growth rate of per capita
income of at least 4.7 percent and 3.5 percent per annum, with a threshold of 28 and 14 years,
respectively, to avoid falling in the trap.
Causes of the slow productivity growth in middle-income countries, and therefore, explanations to
the existence of the Middle Income Trap, have been extensively researched in the recent years.
Among the causes are the Lewis-type development process, the complexity and connectivity of
export products, and the diversification of the economy (Agnor, Canuto, & Jelenic, 2012; Felipe et
al., 2012). The Lewis-type development process appears to be the most prominent explanation,
and refers to the move from low- to high- productivity sectors; wherein international
competitiveness and high productivity growth is achieved by low-income countries by mere
allocation of labor from low-productivity to high productivity industries (i.e., agriculture to
manufacturing) and by importing technology from abroad. After years of high growth mainly
through sectoral reallocation, a country eventually reaches the middle-income category, wherein
labor from the less productive sectors is almost exhausted, real wages rise, and technological catchup slows down, leading to an erosion of competitiveness and an overall stagnation in economic
1 For the current 2015 fiscal year, low-income economies are defined as those with a GNI per capita, calculated using the World Bank
Atlas method, of $1,045 or less in 2013; middle-income economies are those with a GNI per capita of more than $1,045 but less than
$12,746; high-income economies are those with a GNI per capita of $12,746 or more. Lower-middle-income and upper-middle-income
economies are separated at a GNI per capita of $4,125.
Source: World Bank website: Country and Lending Groups
growth. Agnor et al. (2012) argue that the source of growth differs for different levels of
development, in a way that lower levels imitate technology to boost productivity and growth,
while higher levels require true innovation the latter being endogenous to an individuals
decision to acquire more advanced skills, which is also determined by the level of infrastructure
development, particularly communication technology, and the relative wage rate. The authors say
that this chain of technological learning causes firms to move from low-technology labor-intensive
activities to more capital-intensive, technologically sophisticated sectors. Failure to achieve such
a transition results in a low-growth equilibrium, much like the case of the Middle Income Trap,
wherein the main characteristic is the misallocation of talent or a number of high skilled
individuals who are unable to move to high productivity sectors end up performing routinary tasks
instead, which, in turn, discourages investments in innovation and dampens growth.
Based on the studies above, policy recommendations toward avoiding the middle income trap have
been heavily focused on increasing productivity. Among the policies are improvements in more
advanced infrastructure to facilitate ease of communication and connectivity, property rights
protection to encourage innovation, and labor market improvements such as ease of hiring and
firing (Agnor et al., 2012); as well as implementing structural reforms, such that countries that
want to move to a high-income level need to acquire comparative advantage of more sophisticated,
diversified, and well connected products (Felipe et al., 2012).
The strong link between productivity and GDP growth, however, does not guarantee the move
toward a higher-income group; the transition being based on a welfare indicator2, and GDP growth
focusing merely on income and production with no regard for equitable distribution and population
growth.
In several cases, jobless growth occurs, wherein positive economic growth and
productivity are accompanied by an increasing rate of unemployment. As a result, GDP per capita
growth becomes, theoretically, unsustainable while output per capita increases, the number of
employed decreases, thereby increasing the number of people dependent on the employed. This
means that, in the case of developing countries with underdeveloped financial systems, the income
of one person is shared by many, thus increasing the share of expenditure toward consumption,
limits savings, and reduces resources for investment in productive assets and technology, leading to
a growth constraint in the long-run. The phenomenon of a jobless growth is currently observed and
GDP per capita
much-talked about in countries that are still in the Middle Income Trap, such as the Philippines,
China, Bangladesh, resulting in the adoption of inclusive growth strategies.
Data from the World Bank3 show that GDP per capita growth has been higher for MICs than High
Income Countries (HICs) (figure 1). The proportion of population in MICs compared to HICs has
almost doubled in the past 50 years, with an average increase of 3.2 percent per year4, which
suggests that GDP growth has been much higher for MICs. However, the labor force participation
rate (LFPR) has consistently declined on average for MICs, while that of the HICs has been
increasing since 19905. Meanwhile, the unemployment rate has shown a flat trend, revolving
around 6 percent for the past 20 years (figure 2). By definition, a reduction in LFPR, ceteris paribus,
should increase the rate of employment (or decrease the unemployment rate). A constant
unemployment rate over a period of declining participation rate, then, suggests an equivalent
reduction in employment as the latter.
Figure 1: GDP per capita growth (%)

8
6
4
2
0
-2
-4
-6
MIC
HIC
Source: World Bank WDI6
World Bank, World Development Indicators, accessed 14 April 2015

Authors own estimate using a simple linear estimation with r-squared equal to 99.5%
5 Earliest available data in the World Development Indicators (WDI) of the World Bank.
6 Accessed on 27 April 2015, http://databank.worldbank.org.
3
4
Figure 2: Labor Force Participation Rate (left) and Unemployment rate (right)
10
74
72
70
68
66
64
62
8
6
4
2
MIC
HIC
MIC
2013
2011
2009
2007
2005
2003
2001
1999
1997
1995
1993
1991
2012
2010
2008
2006
2004
2002
2000
1998
1996
1994
1992
1990
HIC
Furthermore, looking at figure 3, it can be observed that the change in the rate of employment-topopulation ratio8 for MIC has generally always declined from 1990-2013, with only 1992 and 1994
having a positive change; even though GDP per capita growth has been above that of HIC. Two
things can be deduced from this graph: (1) the population growth in MIC is often faster than the
employment growth, and (2) income that is generated by each employed person or labor
productivity is increasing, such that the increase in labor productivity is greater than the increase in
population.
7
8
Ibid.
Refers to the year-on-year difference in the total employment to population ratio, shown in percentage points
Figure 3: Comparison between the change in Employed to Total Population Ratio (in percentage
points, RHS) and GDP per Capita growth rate (in percent, LHS) for MIC and HIC
1.5
8
6
4
0.5
2
0
-2
-0.5
-4
-1
-6
-8
-1.5
HIC-employment to popn ratio (%pt change)
MIC-employment to popn ratio (%pt change)
MIC-gdppcgr
HIC-gdppcgr
The case of high GDP growth coinciding with above-average productivity growth and increasing
unemployment is not confined only to MICs. While the neoclassical growth models do not recognize
the existence of a long-term relationship between productivity and employment, empirical
evidence from OECD countries have shown otherwise (De Michelis, Estevo, & Wilson, 2013; Van
der Horst, Rojas-Romagosa, & Bettendorf, 2009). Empirical analyses, however, did not arrive at a
unanimous conclusion on the direction of the medium to long-term relationship between
productivity and employment; but most, if not all research find robust results and agree that the
relationship is unstable10. Furthermore, there are traces of endogeneity of productivity-enhancing
decisions of firms based on the amount and cost of labor supply a reason presented by De
Michelis, Estevo, & Wilson (2013) for why a long-term trade-off exists between productivity and
employment. The ILOs World Employment Report 2004-200511, in its investigation of the impact of
productivity growth on employment and poverty alleviation, suggests that there are tradeoffs to
be made in striking the right policy balance between employment and income growth, and between
productivity growth and poverty reduction.
Accessed on 27 April 2015, http://databank.worldbank.org.

Structural break is commonly found between 1980 and 1990.
11 Referring to the ILOs website http://www.ilo.org/global/publications/ilo-bookstore/orderonline/books/WCMS_PUBL_9221148130_EN/lang--en/index.htm
9
10
10
In line with the critical interaction between productivity, growth, and employment in overcoming
the middle income trap, this paper intends to focus only on analyzing and answering two main
questions: (1) is productivity growth coinciding with GDP growth in countries that have managed
to escape the Middle Income Trap, and (2) is there an observable long-run relationship between
productivity growth and employment growth, and what explains this relationship? In the event of a
tradeoff too high productivity growth comes at the expense of employment growth current
growth strategies may indeed be unsustainable, thus implying a policy-induced reason for staying
in the Trap.
The approach of the thesis takes a macroeconomic perspective of long-term relationships; wherein
the analysis will be conducted using aggregate data from 1950-2013 sourced from the Total
Economy Database (TED), and the Penn World Tables (PWT). Out of the 13 countries identified by
the World Bank, only 9 are included in this study based on the sufficiency of data. These countries
are Greece, Portugal, Ireland, Spain, Hong Kong SAR, Taiwan, Japan, Republic of Korea (henceforth
Korea), and Singapore. The analysis starts with a description of the productivity and employment
variables, and the capital-labor ratio of countries that have managed to escape the Middle Income
Trap. It, then, continues to justify the productivity-enhancing growth strategies by looking at the
trend between GDP growth and productivity growth. Finally, the relationship between productivity
and employment growth is analyzed in two parts: (1) a quantitative approach using a simple
correlation with an 8-year rolling window, and (2) a qualitative approach using country-specific
growth policies and events to explain the observed relationship.
Results of the study show that there is an observable difference between policies in the European
countries and Asian countries, which has influenced productivity growth through investments in
human capital, R&D, and technological spillovers from capital investment inflows. Furthermore,
employment growth reacts rapidly to macroeconomic shocks such as fiscal and external
imbalances, inflation, and exchange rate crises; but reacts to increases in productivity and GDP
growth with a lag; thus causing an unstable relationship with several inflection points in the
correlation analysis in between years of major policy implementation.
The thesis is structured as follows: section II presents a review of related literature, section III
presents the theoretical framework that shows the linkage between productivity and employment,
section IV presents the empirical framework, section V presents the results and analysis, section VI
11
summarizes the authors conclusions, and finally, the policy implications and recommendations are
discussed in section VII.
12
II.
REVIEW OF RELATED LITERATURE
In 1930, John Maynard Keynes warned of a new disease which he coined as technological
unemployment or unemployment due to our discovery of means of economising the use of labour
outrunning the pace at which we can find new uses for labour (Keynes, 1963). This describes the
fundamental identity of labor productivity as output per worker; by which respecification of the
identity using log approximation and simple arithmetic shows that a faster labor productivity
growth compared to output growth leads to a reduction in employment:
ln
= ln
ln
The identity is further extended by Van Ark & McGuckin (1999) to decompose labor input as the
product of working hours per person employed, the employment rate12, labor force participation
rate13, and the working-age population.
Landmann (2004) highlights two common misinterpretations of the fundamental identity. First,
there is no empirical evidence supporting the notion of too high productivity growth that results in
crowded-out employment, or what he called the Lump of Labor fallacy. This is not the case
when labor is reallocated to more productive sectors (i.e., agriculture to industry). Second, the idea
that excessive unemployment can be resolved by reducing labor supply, either by hours worked or
by lower participation, also lacks empirical basis. In fact, historical trends in the OECD countries
show no correlation between hours worked and employment growth, and a strong positive
correlation between participation and employment rates. According to the author, this suggests
that countries with high unemployment may not have addressed the root of the problem, but rather
only by technical definition, that the unemployed is excluded from the unemployment statistics.
Standard growth theory says that in the steady state, productivity growth depends on the rate of
technological progress, while modern employment theory explains employment growth as a
function of wage-setting and price-setting both of which also react to productivity growth. This
suggests a process of joint determination between output, productivity, and employment.
Landmann, (2004) adds two important points: (1) the channel to equilibrium unemployment is
applicable to any wage-shock, not necessarily productivity-driven disturbances, and (2) the long12
13
Ratio of persons employed to total labor force

Ratio of total labor force to the working-age population
13
term average level of unemployment is determined by the structural and institutional

characteristics of the economy. Therefore, policies leaning toward productivity growth should, by
no means, be discredited on account of prospective loss of jobs in the short run. Similarly, policies
to increase employment should not be shunned based on fear that it might slow down productivity
growth.
In hopes of providing some clarity to the complex and ambiguous relationship between
productivity growth and employment growth, several relevant theoretical and empirical studies
have been summarized in the following subsections of this chapter.
A. There is no long-term relationship between productivity and employment

Neoclassical growth theory says that there is a temporary tradeoff between productivity and
employment because, as more labor input is employed, less capital is available for each person,
therefore reducing the capital-labor ratio and labor productivity. However, as countries become
more integrated, capital will flow from capital-rich countries to capital-scarce countries, thus
demonstrating a trend of convergence over time. This means that in well-integrated capital
markets, the labor market plays less and less of a role in determining labor productivity. In the
long-run, this normalization through convergence leads to the diminishing tradeoff between
employment growth and productivity (Beaudry & Collard, 2002).
Blanchard, Solow, & Wilson (1995) provided empirical evidence using data from Germany and
France that there is no significant long-run relationship between productivity growth and
employment, and thus, no basis for persistent technological unemployment. Developing the
regression equation from the fundamental identity of labor productivity and Okuns Law14, results
show that in the short run, an increase in productivity is likely to coincide with a small and
temporary increase in unemployment, which diminishes and returns to its pre-shock levels after a
few quarters. They conclude that the key to high employment does not lie in the rate of
productivity growth but in a demand for aggregate output that fully uses normal productive
capacity.
14
Okun (1962) shows that a constant elasticity exists between the output gap and deviations of employment to its natural rate
14
B. There is a negative long-term relationship between productivity and

employment
Beaudry & Collard (2002) have observed that there is, contrary to neoclassical growth prediction,
an increasing tradeoff between productivity and employment. Using a rolling window of 19 years15
from 1960-1997 for 18 high-income countries16, the OLS and WLS regressions of output per worker
growth on labor force growth17 show consistent negative coefficients whose magnitude increases
over time, from close to zero in 1960 to more than -0.5 at the end of the sample period, meaning
that the tradeoff between labor and productivity has been more pronounced over time. The results
of the study are robust across different instrumental variables, structural equations, and country
choices; and point to the observation that there is a trend of increasing importance of labor force
growth and a decreasing relevance of convergence in determining labor productivity growth.
De Michelis et al. (2013) also find robust results of a negative correlation, albeit unstable, between
productivity and employment for 20 OECD countries using different measurements of employment
(i.e., total hours worked and persons employed), different sources of data and specification for
TFP18, using labor productivity as an alternative measurement of productive efficiency from 19702007 and for shorter time periods. Results show that, first, the changes in technology, the main
driver of TFP, are generally larger than the changes in output performance. Following the
fundamental identity, a faster TFP growth than output growth causes a negative change in
employment growth. Second, a negative relationship between productivity and employment
persists in the medium- to long-run because of the tradeoff between investing in efficiency gains
and using available labor. This suggests that, contrary to neoclassical growth theory, technology is
not exogenous, but rather, is affected by availability and cost of other inputs to production, i.e.,
labor.
Windows between 15-25 years were also constructed for robustness check
Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Iceland, Italy, Luxembourg, Netherlands, New Zealand,
Norway, Sweden, Switzerland, UK, and US
17 Beaudry and Collard assume an employment trend similar to labor force growth, thus concluding the same relationship between
productivity growth and employment growth. While the two variables are defined differently, there is a strong positive correlation
between participation and employment, as already mentioned in Landmann (2004)
18This includes averaging for over 40 years to eliminate the cyclicality of TFP
15
16
15
C. There is a positive long-term relationship between productivity and

employment
Despite agreeing to De Michelis et al. (2013) that firms decision to innovate is endogenous, Van der
Horst et al. (2009) provides strong empirical evidence of a positive long-run, but still unstable
relationship. Using Three Stage Least Squares (3SLS) on data from 15 OECD countries from 19702003, they arrive at the conclusion that total hours tend to raise productivity, with elasticity that
fluctuates between 0.05 and 0.7. The framework used by the authors is a Cobb Douglas production
function, which introduced several additions including decomposing technological progress to
initial level and trend rate, fixing the capital-income share as in Bernanke and Grkaynak (2001) to
resolve the endogeneity problem between capital and labor productivity, and finally, adding
institutional19 and demographic20 indicators.
The policy recommendation of the OECD in its 1999 employment outlook21 supports a positive
relationship and suggests that a more rapid innovation and diffusion of technological change are
keys to resolving excessive unemployment.
D. Takeaways from the studied literature

The author of this thesis finds that the difference in the available literature is mainly driven by the
set of assumptions that the cited authors used, particularly in the key variables involved in the
productivity-employment channel. All except Beaudry & Collard (2002) assumed that in the longrun, capital-labor ratio normalized to its pre-shock level. That means that there is convergence
and a catch-up of growth in capital as a response to the growth in labor input, which their empirical
evidence contradicts. Furthermore, the use of the fundamental identity as in Blanchard et al. (1995)
and Van Ark & McGuckin (1999) has been a source of misinterpretation as clearly pointed out by
Landmann (2004); with the major criticism being the disregard for the interdependence of output,
productivity, and employment.
Despite studying almost the same set of countries in the OECD, studies and theories produced
opposing results. There is, however, a consensus that the relationship between productivity and
Union density, employment protection, unemployment benefit duration, average replacement rate, collective bargaining coverage
Population share of 15-49 and 50-64 years old, dependency ratio
21 Cited in Blanchard et al (1995) paper
19
20
16
employment is unstable in terms of magnitude, and that medium- to long-term unemployment is

affected by labor market institutions and the demographic structure of a country. For some studies,
the direction of correlation also depends on the specific time period studied; hence, identifying
structural breaks in the series is vital for further analysis.
17
III.
THEORETICAL FRAMEWORK
This framework starts with a Cobb-Douglas production function similar to Van der Horst et al.
(2009), and integrates Okuns law, in order to provide a theoretical link and direction of
relationship between productivity and employment in the long-run.
The Cobb-Douglas Production Function is given by equation 1 with a simple algebraic
transformation in equation 2, where
stock,
is aggregate output at time t in country c,
is the level of technology, and
is the stock of labor.

!
=
Let
= % and & =
'
%
is capital
+#
& +
(Equation 1)
+#
(Equation 2)
Applying the assumptions of Van der Horst, Rojas-Romagosa, & Bettendorf (2009) and Bernanke
and Grkaynak (2001), the capital-income share, , for each country is fixed to avoid the
endogeneity problem between labor productivity and capital:
Where () =
+,!
= ()
& +
+#
(Equation 3)
Introducing a simple specification to factor in long-run trends, the author uses Okuns law (Okun,
1962) taken from Ball, Leigh, & Loungani (2012):
/
+ 1 =
234
234
(Equation 4)
Where / > 0, EMP is employment, and * indicates long-run or otherwise referred to as potential
levels. Redefining
= 234, equations 3 and 4 can be combined to
, and assuming
equation 5:
()
&
+7
(Equation 5)
Where 7 = # + 1 . Taking the first difference, the final equation below shows that long-run
employment growth is influenced by the growth of output in the current period, positively related
18
to the growth in potential output, and negatively related to change in capital-labor ratio and
productivity.
= 8- + 1 8
+8
8: & 8;
+ 7
(Equation 6)
In the above equation, 8- is the intercept, 8+ are the parameters with 8 representing the
responsiveness of employment to changes in output, and technology grows at a pace of a countryspecific trend g:
<
19
IV.
EMPIRICAL FRAMEWORK
The chapter presents the method by which the relationships suggested in the theoretical
framework may be empirically analyzed and supported. It is subdivided into two discussion parts:
data and methodology.
A. Data
The data are mainly sourced from the Total Economy Database (TED) and the Penn World Tables
version 8.1 (PWT 8.1) for a maximum range of 1950-2013. Out of the 13 countries identified by the
World Bank to have escaped the Middle Income Trap, only 9 are included in this study based on the
sufficiency of data. These countries are Greece, Portugal, Ireland, Spain, Hong Kong SAR, Taiwan,
Japan, Korea, and Singapore.
Productivity is represented by two variables: labor productivity and TFP. The measure of labor
productivity is taken from TED and is defined as the output per hour worked. The series runs from
1950-2013. On the other hand, TFP is taken from PWT 8.1 due to the availability of a longer series
compared to TED. It is derived through growth decomposition and runs from 1950-2011.
Employment has three measurements: (1) number of persons employed, (2) average hours worked
per person per annum, and (3) total hours worked which is the product of (1) and (2). For this
analysis, we use the data from TED, and focus on persons employed and total hours, and infer
changes in average hours worked per person should there be any discrepancies between the two
employment variables.
Finally, the capital-labor ratio is derived using PWT data on real capital stock divided by total hours
worked.
B. Methodology
Taking off from equation 6 in the previous chapter and keeping in mind the interdependency of the
variables that affect employment growth from the findings in the related literature, a segmented
analysis of the channels by which productivity gains translate to employment gains (or reductions)
is done.
20
= 8- + 1 8
+8
8: & 8;
+ 7
(Equation 6)
First, a descriptive analysis of the variables of employment and productivity is performed: the longrun trend of each of the variables, the difference between labor productivity and TFP, and the
deviations of total hours worked from total employment. The difference in employment
measurements infers the changes in average hours worked per person and the possible
substitution of leisure to work when faced with productivity gains. Further analysis of labor
productivity is accomplished by looking at trends in the capital-labor ratios to determine if
productivity gains are due to improvements in human capital or merely as a result of the
substitution of labor with capital in production.
Second, an analysis of the relationship between changes in productivity and employment is done by
focusing on the productivity-output-employment channel. That is, theoretically, an increase in
productivity shifts the production possibility frontier outward, thus increasing GDP and potential
GDP in the long run; which in turn, influences the demand and supply of labor. Therefore, an
empirical analysis of the relationship between productivity growth and GDP growth is investigated
to justify the rationale behind productivity-led growth strategies. However, given that the link
between GDP growth and employment is unclear, and the transmission channel complex (Ayuso &
Lpez-salido, 2003), the method of this thesis is to describe the end-to-end relationship
(productivity-employment) using a simple correlation with an 8-year rolling window.22 This aims
to show the direction and the stability of the relationship between the two variables. The thesis,
then, bridges the information gap between growth and employment using a qualitative analysis of
country-specific policies and economic events that affect productivity, employment, or growth or
any combination of the three.
Conclusions are made based on both quantitative and qualitative analyses as to whether changes in
productivity move together or against employment growth in countries that have escaped the
middle income trap.
The 8-year window is chosen based on a relatively less volatile trend compared to having less number of years. A 10- and 15- year
rolling window was also done, but with very similar results to the 8-year window.
22
21
V.
RESULTS AND ANALYSES
Following the empirical framework, this chapter presents the quantitative results and uses these
results to proceed with the qualitative policy analysis.
A. Labor productivity, TFP, and the capital-labor ratio

In the theoretical framework of Prados, Escosura, & Ross (2008), the rate of change in TFP is
described as the capital-adjusted labor productivity. Given that labor productivity (measured as
output per hour worked) and TFP (commonly quantified as a residual from growth decomposition
methods) are both widely accepted measures of productivity or efficiency gains, understanding
their difference and how the other factors of production capital and labor affect them are vital to
understanding the relationship between productivity and employment.
Plotting the data points from 1951-2011 for all nine countries show a clear positive relationship
between TFP growth from PWT and labor productivity growth from TED.23 However, interesting to
note is that the rate of change in labor productivity is generally higher than TFP growth, both for
periods when the rate of productivity is positive and negative. The average productivity growth and
the difference between both measures of productivity are shown in figure 4.
Figure 4: Long-run average of labor productivity growth and TFP growth24
6
5.59
4.86
5
4
4.23
3.80
3.91
4.21
3.46
3.29
3.32
3
2
1.14
0.99
1.34
0.98
1.31
0.90
1.23
1.16
1.22
0
Spain
Greece
Hong Kong
Ireland
Japan
LP
Korea
Portugal Singapore
TFP
Source: TED, PWT

23
24
See appendix
Simple average of output per hour worked from TED from 1951-2013, and TFP growth from PWT from 1951-2011
22
Taiwan
One of the possible reasons for the higher rate of labor productivity compared to TFP growth is that
the former could be induced by the widening gap between employment and capital growth. Capital
deepening that is faster than the growth in labor input results in an increase in labor productivity,
even with a stagnating TFP growth by mathematical definition. Given that the observation that TFP
growth and labor productivity growth are highly correlated, this suggests that the growth in
capital-labor ratio has been relatively flat within the sample years (as supported by figure 6)25, and
variations in labor productivity growth are mainly caused by improvements in productive
efficiency of both capital and labor.
Figure 5 shows that for the past 60 years, the capital-labor ratio increased moderately for the first
20 years, and accelerated after 1970, where the Asian countries have started to abandon import
substitution policies, and the European countries have moved toward a more capitalist economy
with the changes in political regimes, the move to democracy, and market liberalization strategies.
As will be seen in the latter part of this chapter where the country-specific policies are further
discussed, the countries in the sample have achieved increasing GDP growth rates by having more
capital-intensive economic activities, brought about by industrialization and modernization of
traditional industries, and opening up to international markets.
Figure 5: Capital-labor ratio, 1950-2011
350,000
300,000
250,000
Spain
Greece
Hong Kong
Ireland
Japan
South Korea
Portugal
Singapore
Taiwan
200,000
150,000
100,000
50,000
0
50
55
60
65
70
75
80
85
90
95
00
05
10
Source: Authors own computation using PWT data

25 Average growth rate of capital-labor ratio for the European countries are as follows: Spain (4.35%), Greece (2.91%), Ireland (4.08%),
Portugal (4.10%); for the Asian countries: Hong Kong (2.96%), Japan (5.56%), South Korea (6.44%), Singapore (4.2%), and Taiwan
(6.71%).
23
Figure 6: Annual growth rate of capital-labor ratio, 1951-2011

20
15
10
Year
Year
Year
Year
Year
Year
Year
Year
Year
5
0
-5
%
%
%
%
%
%
%
%
%
Change
Change
Change
Change
Change
Change
Change
Change
Change
KLRATIO_ESP
KLRATIO_GRC
KLRATIO_HK
KLRATIO_IRL
KLRATIO_JPN
KLRATIO_KOR
KLRATIO_PRT
KLRATIO_SGP
KLRATIO_TWN
-10
-15
50
55
60
65
70
75
80
85
90
95
00
05
10
Source: Authors own computation using PWT data
B. GDP growth and Productivity growth

Overcoming the middle income trap has been much accounted to the successful growth take-offs
induced by continuous and strong productivity growth. While the growth rate of GDP and
productivity are volatile from 1950-2013, the rationale behind this growth strategy is supported by
figure 7, where there is a clear positive trend between the two. A similar trend can be observed
when TFP is used.
Figure 7: GDP growth vs labor productivity growth, 1950-2013
28
24
20
16
(Greece (GDP gr),Greece (LP gr))

(Hong Kong (GDP gr),Hong Kong (LP gr))
(Ireland (GDP gr),Ireland (LP gr))
(Japan (GDP gr),Japan (LP gr))
(Portugal (GDP gr),Portugal (LP gr))
(Singapore (GDP gr),Singapore (LP gr))
(South Korea (GDP gr),South Korea (LP gr))
(Spain (GDP gr),Spain (LP gr))
(Taiwan (GDP gr),Taiwan (LP gr))
12
8
4
0
-4
-8
-12
-10
10
20
30
Source: TED
24
C. Productivity growth and employment growth: a quantitative and qualitative

analysis
For all nine countries, average annual labor productivity growth has been above 3 percent. An
interesting difference is that of employment and total hours worked, particularly between countries
within Europe and Asia (figure 8).
The four EU countries had the lowest, however still positive, long-run average employment growth
rate among all the countries in the sample. Except for Ireland with a 0.01% average growth rate, the
other three EU countries had a negative average change in total hours worked. These two indicators
interpreted together imply that the negative rate of change in total hours worked was caused by a
significant contraction in annual hours worked per employed person in the EU countries.
Intuitively, this suggests that the increase in productivity has led European workers to substitute
more leisure to work. Furthermore, it also suggests that the result of a study of the relation
between productivity heavily depends on the choice of variables i.e., using total hours worked or
annual hours worked per person as the measure of employment may result in a trade-off
relationship; whereas the use of persons employed may produce positive correlations.
Looking at trends in the Asian countries, positive productivity growth corresponded with an
increased number of persons employed and increased total hours worked, except for Hong Kong.
Notably, the growth rate of employed persons is higher than total hours, suggesting that annual
hours worked per person employed also trended downward over time, but the rate of decline is
much less than that of the European countries. An aggregate analysis of the long-run relationship
between productivity growth and employment growth in Asian countries suggest a positive
correlation, but a closer look at yearly data points for each of the two variables show that the
relationship is uncertain, and almost undecipherable.
25
Figure 8: Average labor productivity growth, TFP growth, growth in total hours worked, and growth in
employed persons, 1951-201326
6
5
4
3
2
1
0
-1
-2
-3
-4
Greece
Ireland
Portugal
TFPgr
Spain
LPgr
Hong Kong
EMPgr
Japan
Singapore
South
Korea
Taiwan
TOTHRSgr
Source: TED
Figure 9 below shows the corresponding percent change in employed persons with the percent
change in TFP. The scatter plot for Asian countries shows a somewhat positive trend, however, the
goodness-of-fit is unsatisfactory; while that of the European countries does not show any
conclusive trends. The lack of trend simply could be explained by the length of the sample period
(60 years), where political regimes and major economic policies have influenced productivity and
employment, at times independently, thus making the relationship unstable. That is, for certain
periods in time, the relationship is clear, but not persistent in the long-run.
The next section of this chapter takes a closer look at the stability of the relationship and the major
economic breakpoints that may have caused the shifts in the relationship.
26
Simple averaging of the growth rates applied to the full sample; Labor productivity defined as output per hour worked
26
Figure 9: TFP growth and Employment growth (European countries LHS, Asian countries RHS),
1951-2011
25
12
20
15
4
10
-4
-8
-5
-10
-10.0 -7.5 -5.0 -2.5
-12
-10
-5
10
15
0.0
2.5
5.0
7.5 10.0
20
(Year % Change RTFPNA_ESP,Year % Change EMP_ESP)

(Year % Change RTFPNA_GRC,Year % Change EMP_GRC)
(Year % Change RTFPNA_IRL,Year % Change EMP_IRL)
(Year % Change RTFPNA_PRT,Year % Change EMP_PRT)
(Year % Change RTFPNA_HK,Year % Change EMP_HK)

(Year % Change RTFPNA_JPN,Year % Change EMP_JPN)
(Year % Change RTFPNA_KOR,Year % Change EMP_KOR)
(Year % Change RTFPNA_SGP,Year % Change EMP_SGP)
(Year % Change RTFPNA_TWN,Year % Change EMP_TWN)
Source: PWT
D. Instability and causes of instability in the relationship

Figures 10 and 11 present the results of the 8-year rolling window correlation between the growth
rates of productivity (labor productivity and TFP) and the number of persons employed. Growth in
total hours worked was also correlated with TFP growth and produced the same results.27 It is,
however, not used to correlate with labor productivity due to collinearity issues. The varying, and
sometimes low levels of correlation coefficients suggest that other factors affect the movement of
either one of the variables. Based on the previous theoretical and trend analysis, output growth is
one of the indirect channels between the two, and is highly affected by political and economic
policies and events.
The relationship between productivity and employment appears to be unstable, and does not seem
to depend on the magnitude of productivity growth (i.e., a prolonged high TFP or labor productivity
growth does not guarantee consistency in movement with or against employment growth), nor in
the direction of productivity trend (growth or contractions in productivity also does not coincide
consistently with a positive or negative correlation with employment growth).
27
See appendix
27
Figure 10: 8-year rolling window correlation28 between employment and labor productivity
ROLL8EMP_ESP
ROLL8EMP_GRC
ROLL8EMP_HK
0.8
0.8
0.8
0.4
0.4
0.4
0.0
0.0
0.0
-0.4
-0.4
-0.4
-0.8
-0.8
-0.8
-1.2
-1.2
-1.2
50
55 60 65 70
75 80 85
90 95
00 05
10
50 55
60 65
ROLL8EMP_IRL
70 75
80 85 90
95
00 05 10
50 55
60 65
ROLL8EMP_JPN
.8
.8
.4
.4
.0
.0
-.4
-.4
-.8
-.8
70 75
80 85 90
95 00 05 10
ROLL8EMP_KOR
0.8
0.4
0.0
-0.4
50
55 60 65 70
75 80 85
90 95
00 05
10
-0.8
-1.2
50 55
60 65
ROLL8EMP_PRT
70 75
80 85 90
95
00 05 10
50 55
60 65
ROLL8EMP_SGP
0.8
80 85 90
95 00 05 10
ROLL8EMP_TWN
0.4
0.4
70 75
0.8
0.4
0.0
0.0
0.0
-0.4
-0.4
-0.4
-0.8
-0.8
-1.2
-0.8
-1.2
50
55 60 65 70
75 80 85
90 95
00 05
10
-1.2
50 55
60 65
70 75
80 85 90
95
00 05 10
50 55
60 65
70 75
80 85 90
95 00 05 10
Source: Authors own calculation using TED data.

Figure 11: 8-year rolling window correlation29 between employment and TFP
ROLL8EMP_ESP
ROLL8EMP_GRC
ROLL8EMP_HK
1.2
0.8
1.2
0.8
0.4
0.8
0.4
0.0
0.4
0.0
-0.4
0.0
-0.4
-0.8
-0.4
-0.8
-1.2
50
55 60 65
70 75
80 85 90
95 00 05
10
-0.8
50 55
ROLL8EMP_IRL
60 65 70 75 80 85 90 95 00 05 10
50 55 60 65
ROLL8EMP_JPN
1.2
95 00 05
10
95 00 05
10
95 00 05
10
ROLL8EMP_KOR
.8
0.8
70 75 80 85 90
1.2
0.8
.4
0.4
0.4
.0
0.0
0.0
-.4
-0.4
-0.8
-0.4
-.8
50
55 60 65
70 75
80 85 90
95 00 05
10
-0.8
50 55
ROLL8EMP_PRT
60 65 70 75 80 85 90 95 00 05 10
50 55 60 65
ROLL8EMP_SGP
0.8
0.4
70 75 80 85 90
ROLL8EMP_TWN
1.0
1.0
0.5
0.5
0.0
0.0
-0.5
-0.5
0.0
-0.4
-0.8
-1.2
-1.0
50
55 60 65
70 75
80 85 90
95 00 05
10
-1.0
50 55
60 65 70 75 80 85 90 95 00 05 10
Source: Authors own calculation using PWT data.

28
29
Years represent the end of the window

28
50 55 60 65
70 75 80 85 90
The inflection points in the graphs are paired with policies implemented around the same time, as
an attempt to shed light to what may have triggered changes in the behavior of firms in employing
workers and investing in increased technology. The following qualitative analysis shows that major
policies and events such as the change in political structure (i.e., democratization and the move to
capitalism), trade liberalization and global integration, macroeconomic shocks (i.e., oil crises,
external and fiscal imbalance), and productivity-enhancing strategies (i.e., transitioning to
production of higher value-added products) emerge as strong influences to the movement of
productivity growth and employment growth.
The following subsections discuss each of the countries more in depth.
Table 1: Summary of the key policies and events, points of inflection, and the direction of correlation between
productivity growth and employment growth in European countries
Country
Key policy/event
Year of
inflection
Correlation
(EMP, LP)
Correlation
(EMP, TFP)
SPAIN
1950s-1973: El Milagro Espanol
late 1950s
1962
1968
1973
1982
1992
2001
Early 1950s
1967
1970
1978
1981
2009
1949
1960
1966
1968
1973
1981
+
+
+
+
+
+
-
+
+
+
+
+
+
+
+
+
1984
1987
1990
2007
1949
+
-
+
+
+
-
1975-1986: Transition to democracy
GREECE
1986 onwards: European Economic

Community (EEC)
Pre-1973: Period of high growth and low
inflation
Post-1974: Transition to democracy, and
deterioration of macroeconomic situation
IRELAND
1950s-1960s: Tapering-off of benefits from

industrial protectionism
1960s-1973: Abandonment of protectionist
policies and trade liberalization
Late 1970s-1986: Period of high fiscal debt
and unemployment
1987-2006: Celtic Tiger Era
PORTUGAL
2007: Onset of the Global Financial Crisis

1950s-1973: Period of high growth and
29
Country
Key policy/event
Year of
inflection
Correlation
(EMP, LP)
Correlation
(EMP, TFP)
rapid industrialization
1974-1990: Transition to democracy and
structural change
1990s onwards: Period of economic
difficulty
1991
1998
+
2003
+
+
Sources: Authors own computation using TED and PWT data, BBC, and other authors cited in the individual
country texts that follow.
1. Spain
A closer look at Spains growth decomposition between 1950 and 2013, and the causes of the
unstable relationship between productivity growth and employment growth reveal three main
divisions in its economic history: El Milagro Espaol (early 1950-1974), the transition to
democracy (1975-1986), and the period after joining the European Economic Community (EEC)30
(1986 onwards).
Figure 12: Spains average productivity growth and employment growth by inflection points from the rolling
correlation
9.00%
8.00%
7.00%
6.00%
5.00%
4.00%
3.00%
2.00%
1.00%
0.00%
-1.00%
-2.00%
2.50%
2.00%
1.50%
1.00%
0.50%
0.00%
-0.50%
-1.00%
-1.50%
-2.00%
1951-1961 1962-1967 1968-1972 1973-1981 1982-1991 1992-2000 2001-2011
Labor productivity (LHS)
TFP (LHS)
Employed persons (RHS)
Total hours (RHS)
Source: Authors own computation using TED and PWT data
a. 1950s-1974: El Milagro Espaol

Spain experienced high productivity, high employment growth during this period, with the former
reaching its highest average between 1962-1967, while the latter peaks in the next inflection point
30
now the European Union (EU)
30
in 1968-1972. Interesting to note is the gap between TFP and labor productivity, which suggests
capital accumulation played an important role in the latters increase (figure 12).
Spains economic policies were taken in response to global shocks and as a means to recover from
the damages of the war. Its self-imposed economic isolation pre-1950s has led to its exclusion from
the Marshall Plan and several international organizations, and have caused its near collapse in the
1950s. In the late 1950s, an Economic Stabilization Plan was announced to salvage the ailing
economy by encouraging a less restrictive economy and opening up more to international markets
(Barry, 2003).
El Milagro Espaol was the result of this plan, where a period of growth take-off in manufacturing
and tourism industries took place. During this period, GDP per capita increased at a rate of seven
times that of the previous century, capital accumulation accelerated particularly between 19591974, capital quality31 grew above trend when the country completed its electrification and the
replacement of old vintage capital, labor quality improvements contributed immensely to the
growth in the quantity of labor input. The increase in the labor share to GDP was due to the
expansion of human capital and more liberal economic policies that accompanied growth and
structural change (Prados et al., 2008)
b. 1975-1986: Transition to democracy, continued productivity gains, and contraction in

employment
The oil crises in the 1970s and the inflation it caused have driven the sharp decline in employment
growth, but it recovered rapidly and grew above 6 percent in the 1980s and early 1990s.
Productivity growth stayed afloat during the oil crisis and only experienced the slowdown in the
succeeding periods, when employment was booming.
The death of the dictator, Francisco Franco, in 1975 marked the end of the Francoist regime and the
transition to democracy. This transition went together with an expansionary fiscal policy that
lasted until mid-1985, and an accommodative monetary policy that lasted only for two years. With
the oil crisis in 1973 and 1975-1977, a rapid increase in inflation took place until the government
implemented the Pactos de la Moncloa, which included a tripartite agreement between the
government, political parties, and labor unions to increase wages only based on expected inflation
31 Changes in the composition of capital that affect the amount of services provided by capital stock to production, reflected in the change
in the gap between capital input and capital stock
31
rather than historical inflation to break the inertia (Sung & Wong, 2000). During this period, there
was a fall in participation rate and a sharp increase in the unemployment rate, which suggest a
drastic decline in employment rate. The decline in the total annual hours worked per employed
person was a result of the employment restructuring and the trade unions stronger bargaining
power. Since the start of the 70s, capital-to-GDP share seemed to grow at the expense of labor share
(Imai, 2000).
Interestingly, TFP-led growth lasted for both El Milagro Espanol and the period of transition to
democracy. Efficiency gains have prevented GDP to contract despite the sharp employment
contraction in the latter period.
c. Post-1986: Spain joins the EEC: Slowdown in productivity growth, while employment
growth picks up due to policy changes
By the time Spain entered the EEC in 1986, TFP growth had started to taper off and to moderate.
The prospect of Spain joining the Economic and Monetary Union (EMU) and high yields in Spanish
bonds led to large inflows of capital, albeit the quality of capital did not rise above historical trend
(1986-2000), which signal the weak and delayed impact of ICT technologies. Also in this period,
labor market deregulation, increased female participation rate, and inflow of immigrants increased
employment. Similar to capital growth, labor quality barely made a contribution to the growth of
labor input. Both capital and labor growth managed to offset sluggish TFP growth after 1986
(Prados et al., 2008).
Inflation increased again from 1987-1989 due to unsterilized money supply and a continuous fiscal
policy expansion. The peseta was also pegged de-facto starting 1986 and so Spain was losing some
of its monetary policy space. To control for inflation, a devaluation of the currency took place in
1992. By 1993, public debt was about 60% of GDP, inflation moderated, but the peseta appreciated
rapidly. In 1994, the government carried out new anti-inflationary policies: (1) Program of
Convergence aimed to reduce public deficit according to the Maastricht Treaty, (2) more flexibility
for the labor market, and (3) Banco de Espaa gained independence. The new policies led to an
inflation rate of about 2 percent in 1997, and the transfer of Spains monetary policy to the
Eurosystem by 1999 (Ayuso & Lpez-salido, 2003). These developments contributed to the
negative TFP growth during the period.
32
2. Greece
The Greek economy can be separated to two major periods or the two faces of Janus(Alogoskoufis,
1995): pre-1973 and post-1973 attributed to the move from dictatorship to democracy in 1974 and
the apparent deterioration in macroeconomic situation after 1973, which fully manifested around
early 1980s. Maddison (2006) described Greece in the 1950s as the poorest country in the now-EU
members. The country experienced the fastest acceleration in economic growth and standard of
living since then until 1973, but it went back to being the poorest thereafter.
Figure 13: Greece's average productivity growth and employment growth by inflection points from the rolling correlation
10.00%
2.00%
8.00%
1.00%
6.00%
0.00%
4.00%
-1.00%
2.00%
-2.00%
0.00%
-3.00%
-2.00%
-4.00%
-4.00%
-6.00%
-5.00%
1951-1966
1967-1969
1970-1977
1978-1980
TFP (LHS)
1981-2008
2009-2011
Total hours (RHS)
a. Pre-1973: Period of high growth, low inflation, government-controlled Confederation of

Greek Workers (GSEE) and policies that encouraged capital accumulation
Productivity growth peaked in the late 1960s mainly due to trade and capital liberalization, but the
labor market was still very restrictive and did not experience an increase until the early 1970s
when productivity growth was already moderating.
From 1954-1973, the Greek economy was characterized by high growth of 7 percent and low
inflation of 4 percent due to mechanisms that ensure high returns to capital accumulation such as
lifting price and import controls, legislation to protect and encourage foreign capital, control for
bureaucracy (Alogoskoufis, 1995), and the resource reallocation from low-productivity sector to
high-productivity sectors (Bosworth & Kollintzas, 2001). There was a sharp increase in national
33
savings rates and foreign capital that afforded firms a high rate of capital accumulation until 1981,
and aided the boost in productivity. The political regime also prioritized infrastructure and
industrialization through tax and credit policies (Alogoskoufis, 1995). During this time, the labor
union, Confederation of Greek Workers (GSEE), was still controlled by the government, and the
unemployment rate remained low.
b. Post-1974: Transition to democracy and deterioration of macroeconomic situation

Since its peak in the late 1960s, productivity growth continuously slowed down, eventually having
more frequent and large contractions from 1974 onwards. In the same year, the government
implemented policies that were leaning towards employment protection and inflation control.
Greece was declared a democracy in 1974, and several major changes followed suit: (1) the
exchange rate policy moved from pegged-to-the-dollar to an accommodating peg, (2) government
expenditures increased due to public spending on defense and income redistribution, (3) the
average return on equity in manufacturing fell from 6 percent to -6.8 percent in 1976-1980 to
1982-1986, and (4) new labor unions emerged with a strong bargaining power. This led to real
wage increases higher than productivity growth and inflation, such that the real unit labor cost
increased by 30 percent from 1974-1985 (Alogoskoufis, 1995). The government introduced very
strict employment protection legislation (EPL) which lasted until the 1990s, and acted as a strong
barrier against temporary employment and protected those with long tenure to be dismissed. This
did not have major impacts in the unemployment rate, but the OECD32 noted that it had preferences
for a specific demographic for employment. Economic policy also leaned more toward fighting
inflation rather than unemployment. While inflation was being resolved, Greece experienced a
rapidly rising rate of unemployment from 1980s onward. Inflation and the deteriorating
macroeconomic situation also led to smaller profit margins for firms, which resulted in even lesser
private investment. The unattractive investment climate has caused the accession to the EU to have
a negligible effect on Greeces FDI (Alogoskoufis, 1995; Bosworth & Kollintzas, 2001; Mihail, 1996).
Due to uncontrollable public deficit, a balance of payment crisis happened in 1989. Strong efforts to
improve the macroeconomic situation resulted in a reduction in public deficit from 16 percent to
1.8 percent from 1990-1999, reduction in inflation to meet the EMU standards, and financial
market deregulation (Bosworth & Kollintzas, 2001). However, in 2009, Greeces fiscal data were
32
Cited in Alogoskoufis (1995) paper
34
revised and revalidated, and its deficit was found understated. It, then, entered into a crisis with a
ballooning public debt, a credit rating downgrade, and the announcement of a strict program to cut
public spending.
TFP growth from 2007-2011 averaged -3.2 percent, while employment contractions started only in
2009, with an average of -2.8 percent.
3. Ireland
Irelands economic timeline can be divided into (1) the early 1950s when the benefits of industrial
protectionism on employment growth were tapering off, (2) the reversal of the protectionist
policies from 1960s-1973 when productivity growth rapidly increased, (3) the late 1970s to 1986
when growth stagnated, (4) the Celtic Tiger era in 1987-2006 (Barry, 2003), and (5) the onset of
the Global Financial Crisis in 2007.
Figure 14: Ireland's average productivity growth and employment growth by inflection points from the rolling correlation
4.00%
7.00%
6.00%
5.00%
4.00%
3.00%
2.00%
1.00%
0.00%
-1.00%
-2.00%
3.00%
2.00%
1.00%
0.00%
-1.00%
-2.00%
-3.00%
TFP (LHS)
Total hours (RHS)
a. 1950s-1960s Tapering-off of benefits from industrial protectionism

Ireland experienced a slowdown in GDP and employment growth as the effects of industrial
protectionism wore off in the 1950s. An increase in agricultural exports from the post-war boom
35
and an even more rapid increase in imports of capital and consumer goods led to a balance of
payment crisis, which then caused about 13 percent of the population to emigrate.
b. 1960s-1973 Abandonment of protectionist policies and trade liberalization

Productivity growth reacted positively to policies implemented in the early 1960s. Similar to Spain
and Greece, it peaked around late 1960s and declined in the mid 1970s, just when employment
growth picked up.
Sean Lemass, who was appointed as Taoiseach33 in 1959, advocated economic modernization.
Under his leadership, Ireland abandoned protectionist policies, engaged in an FTA with UK in 1966,
implemented zero tax rate on manufacturing exports, and joined the EU in 1973. Unlike Greece,
these policies, including the liberalization of foreign ownership of companies, increased the stock of
FDI in manufacturing exports, and diversified its exports. They also increased productivity growth
even higher than the protectionist era, as well as manufacturing employment growth. Barry (2003)
notes that domestic investment declined during this period and FDI fuelled most of the growth in
manufacturing exports.
c. Late 1970s-1986 Period of high fiscal debt and unemployment

Both employment growth and TFP growth have declined during this period due to difficulties in
macroeconomic conditions following the 1973 oil crisis. Among the reasons for the economic
deterioration are (1) the fiscal policy which increased public debt from interest and social welfare
payments, (2) the increase in world interest rates, and (3) the weaker UK economy that
discouraged migration. From 1980-1986, employment growth contracted by 0.82 percent, with the
largest contraction in 1984, while contractions in TFP started in 1979 to 1983, with an average
growth of -1.35 percent.
When compared with the EU average from 1960-2000, the periods of strong wage growth in
Ireland coincided with high unemployment and high emigration, lower labor productivity growth,
and faster real wage growth, which suggest that real wages were too high for labor-intensive
industries to flourish(Barry, 2003).
33
Prime minister of Ireland
36
d. 1987-2006 Celtic Tiger Era

Ireland prospered from 1987-2006, which was aided by pro-cyclical fiscal policy and returned
current budget deficit to its pre-recession level. This supported an employment boom and net
inflow of migrants from the UK. Resolving the fiscal deficit problem allowed for future tax
reductions, which, together with the social partnership model of wage determination, boosted
competitiveness. Between 1987 and 1999, the number of jobs in foreign-owned industry grew by
40 percent34. The European Commission attributes this period of prosperity to favorable
demographics for labor force participation, and higher educational attainment of the new entrants
compared to the predecessors.35
e. 2007 Global Financial Crisis

In 2007, the onset of the global financial crisis has led to a sudden shock to the banking system of
Ireland, which again, led to a contractionary fiscal policy. Interesting to note is that TFP started to
contract from 2001-2009, while employment growth contracted only from 2008, with the lowest in
2009 (-8.15 percent).
4. Portugal
Portugals economic timeline can be defined by (1) the period of high growth and industrialization
from mid-1950s to 1973, (2) change in the driver of growth from 1974-1990 caused by policies
implemented before and after its democratization in 1974, (3) and economic difficulties brought
about by structural change, the adjustment to the Euro, diminished returns to capital accumulation,
and low competitiveness from 1990s onward.
34Also
35
referred to as the era of Single Market and worldwide tech boom

Source: European Commission
37
Figure 15: Portugal's average productivity growth and employment growth by inflection points from the rolling correlation
5.00%
2.00%
4.00%
1.50%
1.00%
3.00%
0.50%
2.00%
0.00%
1.00%
-0.50%
0.00%
-1.00%
-1.00%
-1.50%
1951-1990
1991-1997
TFP (LHS)
1998-2002
2003-2011
Total hours (RHS)
a. 1950s-1973: Period of high growth and rapid industrialization

Like most of the poorest European countries prior to 1950s, Portugal also experienced rapid
growth and convergence with the rest of the EU from 1950s to mid 1970s. It has moved from a
closed, agrarian economy with low economic growth to an open, high-growth, industrial economy
within a short period of time. In 1960, it entered the European Free Trade Agreement (EFTA) which
broadened its export base and afforded the economy the highest growth rates in the world during
the time. From mid-1950s to 1973, economic growth was driven by TFP growth and capital
accumulation from its rapid industrialization, which significantly increased industrial employment
(Pereira & Lains, 2010). Total employment, however, has remained modest, and did not have large
increases until 1970.
b. 1974-1990: Transition to democracy and structural change

From its democratization in 1974, public expenditure on education accelerated a logical step given
Portugals lower skilled labor compared to the rest of the EU. The contribution of human capital
growth to GDP reached 41 percent, which coincided with a drop in labor productivity caused by an
increase in less capital-intensive activities and the oil crises that led to a decline in economic
growth. Further economic liberalization and privatization, the quick adjustment to growth policies,
and the accession to the EU in 1986 have stabilized the economy in the 1980s (Pereira & Lains,
2010).
38
c. Early-1990 onwards: Period of economic difficulty

In the 1990s, Portugal was faced with high unemployment, high emigration, low productivity
growth, and stagnation due to fiscal and external imbalances, and structural problems attributed to
low rates of human capital accumulation, the difficulty of adjusting to the euro which caused slow
job creation and low export competitiveness, diminishing returns to capital accumulation, and the
dependence on low-skilled labor. While Portuguese exports did have more technological content
from 1990-2006, the share of exports of traditional products to total declined from 62.44% to
34.26% the economy moved from industrial to more service-based wherein a large share of
employment moved to services with minimal gains in productivity. This loss in productivity,
together with wages and nominal unit labor cost rising faster than Portugals export competitors,
led to a loss in competitiveness (Pereira & Lains, 2010).
By late 1990s, employment recovered on account of increased participation of women in the labor
force pushed by gender equality initiatives, such as the establishment of the Ministry of Equality in
1999, and representation of Equal Opportunities in the Economic and Social Council (Rubery,
Grimshaw, & Smith, 2000).
Table 2: Summary of the key policies and events, points of inflection, and the direction of correlation between
productivity growth and employment growth in Asian countries
Country
Key policy/event
1950s-1980s: Post-war manufacturing export
miracle
HONG
KONG
TAIWAN
1985-1997: Period of deindustrialization

1997 onwards: Hong Kongs reunification with
China
1950-1960s: Import substitution to exportoriented policy
1970s: Exhaustion of unskilled labor, and the
shift from labor-intensive light industries to
capital-intensive basic industries
1980s: Shift to high-technology industries
SINGAPORE
1950s-1970s: Shift from entrepot trade to

manufacturing-driven growth
1980s: Loss in competitiveness due to wage
pressures and capital inflows
1990 onwards: Period of high-technology
39
Year of
inflection
1950s
1971
1985
1989
1992
1996
2000
Correlation
(EMP, LP)
+
+
+
Correlation
(EMP, TFP)
+
+
+
+
1950s/1960s
1974
1977
1987
1995
2009
+
+
+
+
+
+
1946
1978
1990
+
+
Year of
Correlation
Correlation
inflection
(EMP, LP)
(EMP, TFP)
industries and global integration
1994
1952
+
+
1960
1964
+
+
1950s-1973: Period of high growth and postwar recovery
1968
1971
+
JAPAN
1974
+
+
1984
Mid-1970s to 1980s: Industrial transition and
the Bubble build up
1990
+
1993
+
+
1992 onwards: The lost decade
2005
+
2009
+
+
1950s
1960s-mid 1990s: Period of economic miracle
1976
+
+
1984
KOREA
1992
+
+
Mid-1990s onwards: wage pressures, current
2006
+
account deficits, and the Asian Financial Crisis
2009
+
+
Sources: Authors own computation using TED and PWT data, BBC, and other authors cited in the individual
country texts that follow.
Country
Key policy/event
5. Hong Kong
Hong Kongs economic timeline is affected by its own domestic policies, policies from its British
colonial period, and largely by events and policies in mainland China: (1) beginning from the
establishment of the Peoples Republic of China (PRC) and the civil wars and Korean War around
1950s, (2) the period of deindustrialization from 1985-1997, and (3) Hong Kongs reunification
with China and the Asian Financial Crisis in 1997. Positive GDP growth, albeit slower in the late
1980s to 1990s, can be attributed to TFP growth (as capital and labor growth seem unchanged in
the long-run) and was largely affected by migration policies between Hong Kong and China, which
in turn, affected the movement of capital, the share of the manufacturing sector to growth, and the
impressive adaptability of Hong Kongs entrepreneurs to recognize and seize business
opportunities.
40
Figure 16: Hong Kong's average productivity growth and employment growth by inflection points from the rolling correlation
4.00%
6.00%
5.00%
4.00%
3.00%
2.00%
1.00%
0.00%
-1.00%
-2.00%
-3.00%
-4.00%
3.50%
3.00%
2.50%
2.00%
1.50%
1.00%
0.50%
0.00%
1951-1970
1971-1984
1985-1988
1989-1991
TFP (LHS)
1992-1995
1996-1999
2000-2011
Total hours (RHS)
a. 1950s-1980s: Post-war manufacturing export miracle

A treaty between Britain, Hong Kongs colonizers pre-1950s, and Chinas Ching government
allowed free movement of people from mainland China to Hong Kong. With the civil wars and the
establishment of the Peoples Republic of China (PRC) in the 1950s, along with the unrest caused by
the Korean War, a large number of refugees, including capitalists and skilled laborers, have moved
to Hong Kong, thus fuelling its post-war, manufacturing export miracle, and boosting Hong Kongs
productivity. China immediately imposed strict emigration restrictions, which were then loosened
after Mao Zedongs death in 1976, and have again caused an inflow of immigrants to Hong Kong.
With high growth and social services in place, unskilled workers were seen as a liability, and thus,
Hong Kong had to deport many illegal migrants. This was supported by China by imposing an exit
quota of 75 migrants per day. As a result, Hong Kongs labor market became highly restrictive,
causing annual unemployment to increase and many manufacturing industries to relocate to
mainland China (Sung & Wong, 2000).
b. 1985-1997: Period of deindustrialization

The large outbound manufacturing investment has started the deindustrialization in mid-1980s,
but was an opportunity to move towards entrepot, service-based economic growth, primarily
through opportunities in shipping, storage, trade, and financial services, among others. From 19851997, the tradable services sector had an average annual growth rate of 9.4 percent, while the
tradable goods sector, which is mostly manufacturing, was reduced from an annual average growth
of 6.9 percent in 1985-1990 to -3.7 percent in 1991-1997. In the same way, the share of
41
employment of manufacturing has also been reduced from 40.2 to 11.6 percent from 1984-1997.
Given that the manufacturing sector accounted for most of the TFP growth in the 1960s and 1970s,
the reduction in its importance has also led to a slowdown in TFP and GDP growth starting in the
mid-1980s (Imai, 2000).
c. 1997 onwards: Hong Kongs reunification with China

In July 1997, Hong Kong reunited with mainland China where it had, at its disposal, a larger market
for its services exports. This economic integration put pressure for the services sector to move to
higher-value activities such as financial, trade, logistic, tourism and professional services (The
Government of Hong Kong Special Administrative Region, 2007), pushing both TFP and
employment up.
6. Taiwan
Taiwan had one of the most impressive development paths and has been said to follow a natural
path of growth throughout the sample period, enjoying continuously high rates of productivity and
employment and managing to be resilient during the Asian Financial crisis. Periods of importance
to this paper are (1) the transition from import substitution in the 1950s to export-oriented growth
in the 1960s, (2) the exhaustion of unskilled labor and the shift from labor-intensive light industries
to capital-intensive basic industries in the 1970s, and (3) the shift to high-technology industries in
the 1980s.
Figure 17: Taiwan's average productivity growth and employment growth by inflection points from the rolling correlation
8.00%
3.50%
3.00%
2.50%
2.00%
1.50%
1.00%
0.50%
0.00%
6.00%
4.00%
2.00%
0.00%
-2.00%
1951-1973
1974-1976
1977-1986
1987-1994
TFP (LHS)
1995-2008
42
2009-2011
Total hours (RHS)
a. 1950-1960s: Import substitution to export promotion

There are three key points that aided Taiwan in maintaining its high productivity growth: (1) its
educated human capital, (2) the unusually equal distribution of land as Ranis (2007) explicitly
described Taiwan in the 1950s, and most of all, (3) the responsiveness and effectiveness of
government intervention throughout all the stages of development in the past 60 years.
The economic development in the 1950s was mainly a product of import substitution policies,
which supported labor-intensive light manufacturing, and only required simple production
technology. Importation of raw materials and other intermediate goods were encouraged for
domestic production to replace imported consumer goods. Programs implemented were "Land to
the Tiller" program, the Medium-term Economic Construction Plan, the privatization of state
enterprises, the Statute for the Encouragement of Investment, tax incentives, and the Small Private
Enterprise Loan Fund, among others (Taiwan Ministry of Economic Affairs)36.
By 1960, the government implemented an export-promotion strategy through the Statute for the
Encouragement of Investment and the Regulations Governing the Establishment of Export
Processing Zones, to which the private producers responded positively. The industry has seen a
shift from food processing to the export of labor-intensive manufacturing products (e.g., textiles,
electronic assembly, electromechanical, electrical appliance and plastics industries, etc), which had
the highest value added and rapid export growth. The smooth transition to non-agriculture
production has been aided by the equal distribution of land as a result of a 3-step land reform in the
early 1950s and the high literacy rate, and has strengthened forward and backward linkages with
the agriculture sector, without much migration away from rural areas (supported by the chimneys
in the countryside program).
b. 1970s: Shift from labor-intensive light industries to capital-intensive basic industries

By 1968, unskilled real wages started to increase signaling the exhaustion of unskilled labor, to
which the government responded with a compulsory secondary education policy, the establishment
of the Industrial Technology Research Institute, which has supported the move from laborintensive light manufacturing to capital-intensive basic industries (e.g., iron and steel,
petrochemicals, machinery and auto manufacturing, etc.). Despite having initially high literacy
rates, the government did not depend so much on colonial inheritance, but has exerted conscious
36
Source: Taiwan Ministry of Economic Affairs
43
efforts to invest in education, which went hand-in-hand with their incentives to increase R&D,
production quantity and quality, and overall competitiveness. The budget for education was raised
from 2 percent in 1955 to 5.2 percent of GNP in 1988 (Ranis, 2007).
c. 1980s onward: Shift to high-technology industries

Taiwans high technology industries emerged in the 1980s with the establishment of the Hsinchu
Science-based Industrial Park, and the change in macroeconomic environment wages started to
rise, the New Taiwan dollar appreciated, real estate prices increased, and there had been more
awareness toward environmental issues. The government, then, responded with incentives for
strategic industries characterized by a high level of technology, high value added, and low energy
consumption. It has lost its comparative advantage over labor-intensive, low value-added products
in the 1990s, and has started to move towards knowledge-intensive, technology-intensive and
innovation-intensive industries. It has become more internationally integrated when it joined the
WTO in 2002. Technology-intensive exports increased four times from 1984 to 1994, and the share
of high-technology export products reached 50.6 percent in 2001. Efforts were also exerted to get
back previously brain-drained labor force, such that returning migrants led more than 70 percent
of companies in the Hsinchu Science-based Industrial Park (Ranis, 2007; Taiwan Ministry of
Economic Affairs).
7. Singapore
Much like Taiwan, Singapore's economy has responded strongly to government policies toward
increasing productivity; but unlike Taiwan, it has relied much on foreign investment rather than
domestic savings. The economy, then, could be compartmentalized based on the stage of
development, to which corresponding strategies defined changes in productivity and employment:
(1) shift from entrepot trade as the main driver of growth in the 1950s to pursuing a strategy to
increase its manufacturing industry in the 1960s to 1970s, (2) losing its cost competitiveness in the
1980s due to wage pressures and high capital inflows, and (3) the period of high-technology
industries and global integration from the 1990s onward.
44
Figure 18: Singapore's average productivity growth and employment growth by inflection points from the rolling correlation
6.00%
4.20%
5.00%
4.00%
4.00%
3.80%
3.00%
3.60%
2.00%
3.40%
1.00%
3.20%
0.00%
3.00%
1951-1977
1978-1989
1990-1993
TFP (LHS)
1994-2011
Total hours (RHS)
a. 1950s-1970s: Shift from entrepot trade to manufacturing-driven growth

Singapore shifted from entrepot trading as its main economic activity in the 1950s towards
manufacturing industry, in order to solve its high level of unemployment. Because it needed much
capital to develop such an industry, it established the Economic Development Board (EDB) in 1961
whose purpose was to promote the country as a strategic location to set up a low-cost
manufacturing base and to coordinate the realization of this target through the development of the
Jurong industrial Town. This was followed by the implementation of the Economic Expansion
Incentive Act in 1967, which provided additional incentives for foreign corporations to invest,
including tax incentives that lasted for years. The strategy has effectively cut production costs by 20
percent and has increased investment, technological spillovers, and growth. In the late 70s, the tax
incentive was extended to locally-owned small manufacturing companies, which resulted in a
production cost cut of more than 33 percent (Cahyadi, Kursten, Weiss, & Yang, 2004).
However, unemployment remained around 10 percent in the early 1970s. As a response, the
Singapore government implemented the Employment act, which set employment standards to sort
out any conflicts between employer and employee, and hope to provide a positive environment for
foreign investors. It also established the National Trade Union Congress (NTUC) in charge of
overseeing employment and wage issues. Financial and transportation institutions were also
nationalized to make investment more attractive, such as the Development Bank of Singapore, and
Singapore Airlines. These efforts reduced the unemployment rate to about 3.5 percent, while
increasing the share of manufacturing to GDP to 25 percent (Cahyadi et al., 2004).
45
b. 1980s: Loss in competitiveness due to wage pressures and capital inflows

With high rates of capital inflows and a tight labor market, an upward pressure on workers wages
was experienced by Singapore, and soon, it was at a cost-competitive disadvantage among its other
Southeast Asian neighbors. Thus, it decided to shift to higher value added industries, increase the
skill level of the work force, and move from industry to services, by investing heavily in IT-related
capacity building and forming the National Computer Board (NCB) in 1981. This resulted in an
increase of skilled employees from 11 percent in 1979 to 22 percent in 1985, and IT domestic sales
and exports increased tenfold by 1990 (Cahyadi et al., 2004).
c. 1990 onwards: Period of high-technology industries and global integration

Singapore started to lose competitiveness in low-cost manufacturing in the early 1990s, thus it
strategized toward high-technology industries and has engaged with research institutions in the US,
Australia, and Europe, and an economic cooperation with Indonesia and Malaysia, called the SIJORI
initiative (Singapore-Johor-Riau), with Singapore benefiting from cheaper inputs to production, and
the other two provinces benefiting from knowledge spillovers.
Towards the late 2000s, particularly 2006-2008, employment growth in Singapore increased
substantially37 on account of massive inflow of foreign workers following the employment-driven
growth stance by the policy-makers (Tat & Toh, 2014). However, productivity slowed down due to
the increase in low-skilled workers in the construction sector (Wei & Li, 2014).
8. Japan
The economic timeline of Japan can be subdivided into (1) 1950s to 1973 period of high growth and
post-war recovery, (2) industrial transition and the Bubble build up from mid-1970s to the 80s,
and (3) the lost decade starting with the recession in 1992.
37
Average growth based on PWT data is 9.7%, while TED data shows 8.4%.
46
Figure 19: Japan's average productivity growth and employment growth by inflection points from the rolling correlation
12.00%
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%
-2.00%
3.50%
3.00%
2.50%
2.00%
1.50%
1.00%
0.50%
0.00%
-0.50%
-1.00%
-1.50%
TFP (LHS)
Total hours (RHS)
a. 1950s-1973: Period of high growth and post-war recovery

Much of the GDP growth and productivity gains of Japans economy has been attributed to the
growth in manufacturing. From mid-1950 to 1970s, the share of manufacturing to total GDP
increased from 28 to 36 percent, its total economys productivity reaching above 10 percent38, and
the composition of its exports moving from light manufactured goods to higher value added goods
such as consumer electronics, steel, ships, and sophisticated optical products (Ito, 1996). The
increase in productivity may be attributed to Gorika or a rationalization of industries where
productivity is increased by means of increasing investment in capital and technology, as well as a
reorganization of production and management; and the industrial policy which followed an import
substitution-export promotion path for so-called sunrise industries39. Around this time, the labor
market was also very rigid industries had lifetime employment which prevented them from
laying off workers and kept unemployment low and stable (Ito, 1996; Ohno, 2006).
b. Mid-1970s to 1980s: Industrial transition and the Bubble build up
Japans labor moved from manufacturing to services, despite the lower productivity in the latter. In
the analysis of Ito (1996) on sectoral productivity growth and inflation40, tradable goods
(agriculture, manufacturing) had consistently higher productivity growth than its inflation,
whereas nontradables (which includes services, construction, and finance) only had higher
38 10.2% from 1960-1971 according to Ito (1996), while labor productivity data from TED show an average of 8.8%, with the highest
growth between 1968-1970 averaging 11.1%.
39 The Ministry of International Trade and Industry (MITI) is said to have chosen the industries based on global demand and speed of
productivity increase. The industrial policy, however, is highly contested as a source of growth because high export industries such as
consumer electronics and automobile industries were not included in the list, and some on the list did not manage to flourish.
40 Table 3, p. 237
47
productivity than inflation from 1960-1971 and was causing much of the inflation in the years
hence. Prasad (1997) notes that employment has increased in services, however, the share of
manufacturing employment from 1970 onwards has declined, despite its share of output remaining
at around 30 percent. Among the high productivity sectors from 1956-1973, only manufacturing
showed a positive TFP growth of 2.5 percent from 1974-1993.41
c. 1992 onwards: The lost decade
By the latter half of 1980s, an asset bubble started to build up with rapidly increasing stock and
land prices. Bank lending rates to real estate increased, interest rates were raised five times within
a year from 1989-1990, and a revision on real estate tax and tax on large holdings stopped the
increase in asset prices and popped the bubble. This resulted in a sharp decline in asset prices and
an economic recession in 1992, causing unemployment to rise above 3 percent, of which
manufacturing employment contracted by 7 percent42 from 1992 to 1995 (Ito, 1996). Productivity
growth has not recovered since, while employment growth showed signs of improvement from
2005-2008.
9. Korea
Similar to Japan, Korea has supported manufacturing growth through export promotion and
investment support for priority industries43. The economy can be subdivided to (1) period of
economic miracle which started with Park Chung Hee coming into power in 1961, (2) mid-1990s
when the growth take-off ended and the Asian Financial Crisis happened.
41 Mining, Finance, and Manufacturing had the highest labor productivity growth from 1956-1973 with 14.5, 10.4, and 9.7, respectively.
However, this declined substantially to 3.7, 2.4, and 3.8 percent from 1974-1993.
Coal mining was one of the main industries in Japan during this time, which disappeared due to two things: refusal to rationalize, and the
global markets switching to oil, the cheaper option. This led to massive imports, trade deficits, and, because of the Bretton Woods system,
currency pressures were stabilized through tight monetary policy which increased interest rates and discouraged investment.
42 From 15.7 million to 14.6 million employees
43 Characterized by technological importance, forward and backward linkages, and scale economies
48
Figure 20: Korea's average productivity growth and employment growth by inflection points from the rolling correlation
4.00%
8.00%
7.00%
6.00%
5.00%
4.00%
3.00%
2.00%
1.00%
0.00%
3.00%
2.00%
1.00%
0.00%
-1.00%
1951-1975
1976-1983
1984-1991
1992-2005
2006-2008
TFP (LHS)
2009-2011
Total hours (RHS)
a. 1960s-mid 1990s: Period of economic miracle

Koreas economic miracle was fuelled by its industrial policy in the 1960s, mainly through export
promotion. Merchandise exports increased from 2 to about 30 percent of GDP within two decades,
of which the share of manufactured goods to total merchandise exports increased from 35.2
percent in 1960 to 96.9 percent in 1995. According to Connolly & Yi (2009), the increase in trade is
attributable to three policies: (1) tariffs on intermediate and capital goods used for export products
were completely eliminated, (2) general tariff was reduced to 13 from 40 percent, and (3) the
implementation of the Kennedy Round (1968) and Tokyo round (1986) agreements under the
General Agreement on Tariffs and Trade (GATT).
Investment rate and return on investment rose44, leading to an increase in the profit rate that
allowed firms to undergo product innovation, expand to new markets, and acquire new foreign
technologies to improve international competitiveness. The Chaebols, which are large companies
connected in different markets, experienced high profit rates by reinvesting export earnings to
newly promoted and prioritized sectors. These developments were able to sustain Koreas growth
by creating new comparative advantages, and gradually veering away from traditional industries
(Ok, 2004).
44 Ok (2004) referring to Hong (1993): the rate of return on capital in the manufacturing sector increased from about 9-26% in 1962-66,
16-38% in 1967-72, and 17-40% in 1972-76. Profit rate also increased from 28% in 1957-62 to 35% in 1963-70.
49
At the same time, Korea invested in primary education, vocational and technical trainings. By mid1970s, the economy shifted from production of light manufactures to heavy and chemical
industries. Further improvements in productivity were supported by the expansion in higher
education and R&D through the establishment of the National Research and Development Program
in the 1980s.
b. Mid-1990s onwards: wage pressures, current account deficits, and the Asian Financial
Crisis
High-technology production continued in the 1990s, however, domestic wages started to rise, and
the adverse effects of the industrial policy became apparent, leading to chronic current account
pressures. According to Kim (2000), the industrial targeting policy led to overcrowding of
production in a few sectors, which resulted in the overcapacity of industries and a number of
government-supported projects to be discarded. This created both a heavy reliance on foreign
inputs, as well as resource allocation inefficiency that went against goods produced for domestic
consumption.
In 1998, TFP growth contracted by 5.3 percent, total hours worked by 9.6 percent, and employment
by 6.2 percent45. The contractions, however, were only for that year. Among those affected by the
Asian Financial Crisis, Zumkehr & Andriesse (2008) note that Korea has had the most impressive
recovery.
45
Taken from PWT 8.1 database
50
VI.
CONCLUSION
The existence of the Middle Income Trap and the growing evidence of the importance of
productivity growth in escaping this trap have led many researchers and policy-makers to focus on
productivity-enhancing growth strategies. While there is consensus that productivity increases
growth, it does not ensure welfare improvements, as the channel to employment is complex and
uncertain.
This thesis aimed to investigate the relationship between productivity growth and employment
growth in countries that have managed to escape the middle income trap, and to shed light to what
many, including Keynes, have feared if too high productivity may in fact be at the expense of
employment growth.
Results confirm that there is a strong positive correlation between productivity and GDP growth,
but the link to employment growth is unclear; hence rendering the relationship unstable. That is,
the relationship does not depend on the magnitude or the direction of productivity growth, such
that high productivity does not always guarantee employment, while contractions also do not
automatically translate to contractions in employment growth. Furthermore, the policy analysis
shows a trend of what triggers such changes in relationship: for the EU-member countries, major
changes in the behavior of productivity or employment are marked by the post-war economic
miracle (European Golden Age), the move to democracy, the accession to the EU, and the Global
financial crisis; whereas Asian countries changes are characterized by the move from laborintensive manufacturing to capital-intensive to high-technology industries. In the years between
these common economic divisions are more inflection points that, the author observes, are not due
to changes in macroeconomic policies, but simply result from the difference in the pace of change in
productivity and employment. These changes are, of course, affected by macroeconomic policies;
however, it seems that productivity changes are more gradual, while that of employment growth
are faster and more sensitive to macroeconomic shocks related to inflation, exchange rate, and
other indicators such as investor confidence and expectations. These changes in labor input persist
for a few years or what the author considers as medium- to long-term trend in employment, and is
supported by the results of the analyses that the labor input growth does not only rely on
population growth and short-run economic shocks, but also the quality of labor. In some countries
in the sample, this improvement has led to increased participation and quantity of labor employed.
51
There are also observable differences in the policies implemented by European countries and Asian
countries. For all countries, economic miracles, or periods of high GDP growth, high productivity,
and high employment are followed by wage pressures or excessive capital inflows, both of which
tend to lower GDP growth in the succeeding years. This confirms the tendency of countries to fall
into the Middle Income Trap. In European countries, the increase in input prices led to the
deterioration of macroeconomic situation, thus making growth unsustainable as evidenced by the
alarming levels of public deficit and debt, external imbalances, currency devaluations, and
stagnation; which also partially explains the negative average growth in total hours worked.
Meanwhile, Asian countries took the increase in input prices as a signal to increase productivity
further in order to exceed the increase in costs. Government intervention fuelled this productivitydriven growth by providing investment incentives to the private sector whether foreign or
domestic such as tax incentives, pioneer status for foreign companies, etc. This, in parallel with
skills building, has helped the economy move to higher value-added activities more smoothly, thus
making growth more fluid. Thus, its economic breakpoints do not seem to be defined by shocks, but
rather by changes in policies, all of which led to sustained productivity, growth, and employment.
The author concludes that, while TFP and employment decisions may be directly related as
suggested by De Michelis, Estevo, & Wilson (2013), policy analyses seem to suggest that indirect
linkage with other macroeconomic variables have greater weight in determining the growth (or
contraction) in productivity and employment. Thus, it is completely conceivable that the
relationship between the two remain unstable and indeterminate in the future years.
52
VII. POLICY IMPLICATIONS AND RECOMMENDATIONS FOR FURTHER

STUDY
The author agrees with Landmann (2004) in saying that policies toward productivity enhancement
or employment growth should not be hindered by the prospect that growth in one might be at the
expense of the other variable.
However, the analysis also implies strong dependency between the two variables, such that
productivity growth that is not in parallel with improvements in human capital (e.g., higher
education or skills-building) appear to be unsustainable, as high skilled labor is needed to create
new sources of productivity when the benefits of current strategies taper off.
In order to further the knowledge on the subject, the author suggests quantifying the influence of
productivity to employment against other macroeconomic variables using an econometric analysis
that controls for changes in political regimes, fiscal debt and deficit, current account imbalances,
wage and commodity-driven inflation, and union density.
53
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57
APPENDIX
Table 3: TED and PWT data used
SOURCE
1. Total Economy
Database (2014)
2. Penn World
Tables 8.1
DATA USED
(1950-2013)
Total GDP, in millions of 1990 US$ (converted at Geary Khamis PPPs)
Persons employed (in thousands of persons)
Annual hours worked per worker
Total annual hours worked (in thousands)
GDP per capita in 1990 US$ (converted at Geary Khamis PPPs)
Labor productivity per hour worked in 1990 US$ (converted at Geary Khamis PPPs)
(1950-2011)
Number of persons engaged (in millions)
Average annual hours worked by persons engaged
RealGDP at constant 2005 national prices (in mil. 2005US$)
Capital stock at constant 2005 national prices (in mil. 2005US$)
TFP at constant national prices (2005=1)
Figure 21: Labor productivity (x-axis) vs TFP (y-axis)

20
15
(Year % Change LPHR_ESP,Year % Change RTFPNA_ESP)
(Year % Change LPHR_GRC,Year % Change RTFPNA_GRC)
(Year % Change LPHR_HK,Year % Change RTFPNA_HK)
(Year % Change LPHR_IRL,Year % Change RTFPNA_IRL)
(Year % Change LPHR_JPN,Year % Change RTFPNA_JPN)
(Year % Change LPHR_KOR,Year % Change RTFPNA_KOR)
(Year % Change LPHR_PRT,Year % Change RTFPNA_PRT)
(Year % Change LPHR_SGP,Year % Change RTFPNA_SGP)
(Year % Change LPHR_TWN,Year % Change RTFPNA_TWN)
10
-5
-10
-20
-10
10
20
30
Source: TED, PWT
58
Figure 22: 8-year rolling window correlation46 between total hours worked and TFP
ROLL8_ESP
ROLL8_GRC
.8
.4
ROLL8_HK
0.8
1.2
0.4
0.8
0.0
0.4
.0
-.4
-.8
-0.4
0.0
-0.8
-0.4
-1.2
50
55
60
65
70
75
80
85
90
95
00
05
10
-0.8
50
55
60
65
70
ROLL8_IRL
75
80
85
90
95
00
05
10
50
55
60
65
70
ROLL8_JPN
.8
80
85
90
95
00
05
10
90
95
00
05
10
90
95
00
05
10
ROLL8_KOR
1.2
1.00
0.75
0.8
.4
75
0.50
0.4
.0
0.25
0.0
0.00
-.4
-0.4
-.8
-0.25
-0.8
50
55
60
65
70
75
80
85
90
95
00
05
10
-0.50
50
55
60
65
70
ROLL8_PRT
75
80
85
90
95
00
05
10
50
55
60
65
70
ROLL8_SGP
0.8
0.4
75
80
85
ROLL8_TWN
1.0
1.0
0.5
0.5
0.0
0.0
-0.5
-0.5
0.0
-0.4
-0.8
-1.2
-1.0
50
55
60
65
70
75
80
85
90
95
00
05
10
-1.0
50
55
60
65
70
75
80
85
Source: Authors own calculation using PWT data.
46
59
90
95
00
05
10
50
55
60
65
70
75
80
85

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Overcoming the Middle Income Trap: Can

productivity increase employment?

A Masters Thesis submitted to the

Submitted to thesis supervisors

Jessie Ruth G. Granadillos

REVIEW OF RELATED LITERATURE ................................................................................................................... 13

There is no long-term relationship between productivity and employment................................. 14

There is a negative long-term relationship between productivity and employment ................. 15

There is a positive long-term relationship between productivity and employment .................. 16

Takeaways from the studied literature ......................................................................................................... 16

THEORETICAL FRAMEWORK ............................................................................................................................ 18

RESULTS AND ANALYSES ........................................................................................................................................ 22

Labor productivity, TFP, and the capital-labor ratio ................................................................................ 22

GDP growth and Productivity growth ............................................................................................................ 24

Productivity growth and employment growth: a quantitative and qualitative analysis........... 25

Instability and causes of instability in the relationship .......................................................................... 27

Hong Kong ............................................................................................................................................................. 40

POLICY IMPLICATIONS AND RECOMMENDATIONS FOR FURTHER STUDY ................................. 53

GDP per capita

Figure 1: GDP per capita growth (%)

Source: World Bank WDI6

World Bank, World Development Indicators, accessed 14 April 2015

Source: World Bank WDI7

HIC-employment to popn ratio (%pt change)

MIC-employment to popn ratio (%pt change)

Source: World Bank WDI9

Accessed on 27 April 2015, http://databank.worldbank.org.

REVIEW OF RELATED LITERATURE

Ratio of persons employed to total labor force

term average level of unemployment is determined by the structural and institutional

A. There is no long-term relationship between productivity and employment

B. There is a negative long-term relationship between productivity and

C. There is a positive long-term relationship between productivity and

D. Takeaways from the studied literature

employment is unstable in terms of magnitude, and that medium- to long-term unemployment is

is aggregate output at time t in country c,

is the level of technology, and

is the stock of labor.

= 234, equations 3 and 4 can be combined to

RESULTS AND ANALYSES

A. Labor productivity, TFP, and the capital-labor ratio

Source: TED, PWT

Source: Authors own computation using PWT data

Figure 6: Annual growth rate of capital-labor ratio, 1951-2011

Source: Authors own computation using PWT data

B. GDP growth and Productivity growth

(Greece (GDP gr),Greece (LP gr))

C. Productivity growth and employment growth: a quantitative and qualitative

(Year % Change RTFPNA_ESP,Year % Change EMP_ESP)

(Year % Change RTFPNA_HK,Year % Change EMP_HK)

D. Instability and causes of instability in the relationship

Source: Authors own calculation using TED data.

Source: Authors own calculation using PWT data.

Years represent the end of the window

1950s-1973: El Milagro Espanol

1975-1986: Transition to democracy

1986 onwards: European Economic

1950s-1960s: Tapering-off of benefits from

2007: Onset of the Global Financial Crisis

Employed persons (RHS)

Total hours (RHS)

Source: Authors own computation using TED and PWT data

a. 1950s-1974: El Milagro Espaol