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Labor intensity, employment growth and technical change
Journal of Development Economics 24 (1986) 111-117. North-Holland
LABOR INTENSITY, EMPLOYMENT GROWTH AND TECHNICAL CHANGE An Example from Starch Processing in Indonesia Gerald C. NELSON* University of Illinois at Urbana-Champaign, Urbana, IL 61801, USA Received July 1984, final version received January 1985 Advocates of 'appropriate' technology in LDCs often argue for encouraging very labor-intensive production methods to generate more employment. The paper demonstrates that it is theoretically possible for a relatively capital-intensive new technique to increase employment and presents empirical evidence of such an occurrence. It also points out the importance to employment generation of disaggregating the production technique to allow the development of enterprises that exploit subprocess economies of scale.
1. Introduction
Because of a growing concern with unemployment and as a backlash to the mixed success of large-scale capital-intensive industrial development strategies of the mid-1960s, many developing countries are beginning efforts to promote small-scale industries using 'appropriate technology' or appropriate techniques of production. Although not always well defined, appropriate technology often means very labor-intensive rural processing activities using locally available raw materials. One of the principal reasons for promoting appropriate technology is to increase employment. Trade economists have long argued that capital-intensive investment strategies in labor surplus economies were inappropriate and policy makers should not be surprised when low rates of employment growth coincide with high rates of expansion in excessively capital-intensive industrial output. This approach defines 'appropriate' technology as the production technique which sets the factor price ratio (using social prices) equal to the ratio of the marginal physical products. *The author would like to thank Laurian Unnevehr and Ponciano Intal for helpful suggestions on earlier drafts. A very early draft was written while the author was a visitor at the Research School of Pacific Studies, Department of Economics, the Australian National University and very useful comments were given by staff members there. Errors and omissions remain the responsibility of the author. 0304-3878/86/$3.50 © 1986, Elsevier Science Publishers B.V. (North-Holland)
112
G.C. Nelson, Labor intensity, employment growth and technical change
In countries with a relatively low capital-labor ratio, the appropriate production technique will be relatively labor intensive. At the same time, it can be easily shown in any particular industry that the most labor-intensive technique is not necessarily appropriate. A well-known example of this was provided by Timmer (1973) [see also Hill (1~80) for a similar example from the Indonesian weaving industry] who demonstrated that the most privately and socially profitable way to mill rice on Java, one of the most labor abundant areas in the world, was with a small, mechanized rice mill rather than the traditional, labor-intensive method of hand pounding. Fig. 1 illustrates these concepts. Points A, B, C and D are four possible processing techniques, each progressively more labor intensive. Cost (private or social) is minimized by producing with the technique identified by the tangency between the production isoquant and the relative (private or social) factor price line. If the ratio of factor prices is steeper than the line connecting C and D, the most appropriate processing technique will not be D, the most labor-intensive one. If fig. 1 illustrates the choice of rice milling technique in Indonesia, Timmer found that the most appropriate technique was point C rather than point D. Governments can cause inappropriate techniques to be adopted by altering relative factor prices faced by producers. In fig. 1, an interest rate subsidy or a wages tax shifts the relative price line from gg to g'g' and processing technique B becomes the private cost minimizing technique. If gg reflects the social opportunity cost of labor and capital, technique C is the most appropriate, and B is not appropriate to the factor proportions prevalent in the economy. Producers must ultimately make positive profits, not simply minimize costs. In fig. 1, the average cost of production is given by the intersection of
K
TC
g\A g
B
L O Fig. 1
G.C. Nelson, Labor intensity, employment growth and technical change
I 13
the horizontal (or the vertical) axis and the relative factor price line tangent to the unit isoquant. If the price (indicated by hh, a line parallel and to the left of the relative factor price line) is less than the average cost, profit is negative and productio n will not occur in the long run. In this situation there is no 'appropriate' technology and all domestic needs should be supplied by imports. Technical change can alter the appropriate technology (fig. 2). Initially there are only two techniques, A and B. In a labor surplus economy (indicated by a fiat relative factor price line, gg), technique B minimizes costs. If a new production technique, C, shifts the isoquant so that it cuts the previous relative price line, the cost minimizing technique shifts to the new process. I call this effective technical change. If the new technique increases productivity sufficiently (say to C'), one (or more in a multitechnique isoquant) of the previous techniques becomes technically inefficient (the new isoquant is defined by AC').
g
,It
L Fig. 2
There are two possible effects of a new technology. First, it can shift the factor intensity of production given current factor prices. In fig. 2, C is more capital intensive than B. Second, it can reduce the minimum cost of production. Hence it is possible that for a given output price, production at C is profitable while production at B is not. The impact of government policies and technical change on employment growth depends on both the induced shift in factor intensity and minimum cost technique. Government policies usually cause private and social factor prices to diverge, often in the direction of increased capital intensity. In this case, employment per unit of output will be decreased. Unless the government subsidizes production simultaneously, employment will fall. Effective technical change reduces the minimum cost of production, increasing the returns to production. Production will increase if demand is
114
G.C. Nelson, Labor intensity, employment growth and technical change
not perfectly inelastic. Effective technical change can either increase or decrease capital intensity. If it decreases capital intensity (and production is profitable), employment increases unambiguously. If capital intensity is increased, the impact on employment depends upon whether or not the decrease in employment per unit is offset by the increase in labor demand due to increased product output. In the case where a capital intensive effective technical change causes production to become profitable, employment increases unambiguously.
2. Small-scale cassava starch processing in Java
An example that illustrates these points can be found in the changes in the cassava starch making industry in Indonesia in the 1970s. To make cassava starch, the cassava root is peeled and grated into a mash. The starch is washed from the mash and then separated from the water. If sun-dried, the starch must also be powdered or 'bolted'. The Indonesian starch making industry is characterized by four distinct processing techniques that differ by capital intensity, size of operation, and degree of vertical integration. Two of the techniques are performed in rural households and are true 'backyard' operations. Labor is supplied by household members or hired neighbors. Cassava starch making is seasonal and coincides with the seasonal low in demand for agricultural labor. The two household techniques differ in the way the root is grated into a mash. The more labor-intensive technique uses a bicycle mechanism to drive a large wheel covered with a grating surface. In the early 1970s, small (3 to 7 horsepower) gasoline and diesel engines became available in the countryside, and the second household technique uses a grating wheel modified so that it can be driven mechanically. Household starch is sun-dried and must be sent to a bolting mill for final processing. The medium scale technique automates much of the labor-using activities of the household techniques. Starch made using the medium scale technique is also sun-dried and must be sent to the bolting mill. In the large-scale capital-intensive processing, cassava roots go in one end of the equipment and dried powdered starch comes out the other end. Household firms typically make 200 kg of starch per day, i00 days per year. A medium scale firm might make 5 tons of starch, 120 days per year. A large-scale firm can make 30 tons or more of starch per day, 200 days per year. [See Nelson (1984) for a discussion of the Indonesian starch making industry]. Until the early 1970s, household processing was a relatively minor activity in the countryside. Most starch was made by medium-scale firms. The introduction of small motors into the countryside, however, initiated a rapid growth in household processing. With the bicycle grater, a man could grate
G.C. Nelson, Labor intensity, employment growth and technical change
115
100 kg of peeled roots in about two hours, but with a small engine driving a grating wheel, 100 kg could be grated in 15 minutes. The cost of labor for bicycle grating 100kg was about 200 rupiah (100 rupiah cash and a meal) in 1980. The cost of using a mechanical grater was 50 rupiah. In 1980, the net return (the value of output less processing costs) for the typical household starch factory using mechanized grating was 1.6 rupiah per kilogram of roots [Nelson (1982)]. With the bicycle grater, it was only 0.1 rupiah, less than the opportunity cost of the capital invested. Without the savings provided by the mechanical grater, household processing would have been unprofitable in 1980. The relatively high profitability of the household technique using mechanized grating caused a rapid growth of household starch making in the 1970s. Virtually without exception, small processors in both East and West Java reported that the graters almost entirely displaced the older, more labor-intensive methods. Owners of medium-scale firms also reported increased competition from household processing in the late 1970s. The introduction of the mechanized grater reduced employment per day of starch making by about 30 percent (from 10.8 days per ton of fresh roots to 7.5 days), but profitability increased substantially. Growth in income and a high income elasticity for starch products [see Unnevehr (1982)] allowed household processing to expand. If household processing tripled in the 1970s due to mechanization (probably a conservative estimate), employment doubled, increasing by roughly one million mandays. (This result is based on an estimated 4,300 household starch makers in Java in 1980, each assumed to process 60 tons of roots per year. It does not take into account employment lost in the more capital-intensive firms.) The growth of household processing illustrates another important element of appropriate technology - rental contracts for those elements of the processing activity with economies of scale. In the case of cassava starch significant economies of scale exist in the use of the grater, and in supply of working capital. The mechanical grater can process 6 to 10 tons of roots per day. A household owning a mechanical grater would need working capital sufficient to buy 40 tons of roots in order to use the grater at full capacity (household starch making takes four days). This amount of capital is rarely available to the typical Indonesian rural household. In order to spread fixed capital costs and reduce the need for working capital in households, grater hire services developed. This reduced the amount of capital necessary to enter the starch processing business and allowed households to specialize in peeling, filtering and drying, activities with no economies of scale. The bolting mill provides a similar service to both households and medium-scale firms. Bolting is a simple and relatively inexpensive operation. Firms specializing in bolting developed, however, because of the need for large amounts of working capital in marketing. The quality of sun-dried
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G.C. Nelson, Labor intensity, employment growth and technical change
starch varies from factory to factory and depends upon drying conditions. Consumers, on the other hand, buy on the basis of brand name and expect a certain standard of quality so the bolting mill must hold large stocks of starch of varying quality. In addition, starch-making enterprises are paid immediately while consumers don't pay until a month after delivery. The basic economic activity of the bolting mill is to supply large amounts of working capital - to buy and hold sufficient quantities of raw starch so that its brand name quality can be met, and to supply consumers on credit. Without the bolting mill and its relatively favorable access to formal credit markets, the existence of household and medium-scale starch making would have been much less likely. 3. Conclusions
The most appropriate starch processing technique is neither the most laborintensive nor the most capital-intensive technique available in Indonesia. As with Timmer's rice mills, an intermediate technique is most profitable. In addition, technical innovation does not necessarily need to be labor intensity-increasing to increase employment. By making a marginal processing activity profitable, the mechanical grater allowed production to expand and more jobs to be created. The development of separate enterprises that exploit economies of scale was central to the success of household and medium-scale processing. The rental market for the graters made household processing profitable. The bolting firm exploits economies of scale in formal credit markets to finance starch trade. Finally, this example indicates the difficulties of trying to legislate into existence the necessary institutions to encourage appropriately laborintensive processing activities. It is very difficult to imagine how anyone could have seen the importance of small engine imports for household starch production in the early 1970s or the role that would be played by already existing bolting mills. Perhaps the most important government activities would have been physical and financial infrastructure improvements improving roads, increasing access to credit and providing price information (since household processing access to these services is usually not good) and possibly standardization of starch grades. But most of these actions should be part of overall policies of economic development, and are not specific to a particular activity or even to encourage a particular combination of factors of production. References Hill, Hal, 1980, The economics of recent changes in the weaving industry, Bulletin of Indonesian Economic Studies XVI, no. 2.
G.C. Nelson, Labor intensity, employment growth and technical change
117
Nelson, Gerald C., 1982, Implications of developed country policies for developing countries: The case of cassava, Ph.D. dissertation (Stanford University, Stanford, CA). Nelson, Gerald C., 1984, Time for tapioca, 1970 to 1980: European demand and world supply of dried cassava, Food Research Institute Studies XIX, no. 1. Timmer, C. Peter, 1973, Choice of technique in rice milling in Java, Bulletin of Indonesian Economic Studies IX, no. 2. Unnevehr, Laurian J., 1982, Cassava marketing and price behavior in Java, Ph.D. dissertation (Stanford University, Stanford, CA).
LABOR INTENSITY, EMPLOYMENT GROWTH AND TECHNICAL CHANGE An Example from Starch Processing in Indonesia Gerald C. NELSON* University of Illinois at Urbana-Champaign, Urbana, IL 61801, USA Received July 1984, final version received January 1985 Advocates of 'appropriate' technology in LDCs often argue for encouraging very labor-intensive production methods to generate more employment. The paper demonstrates that it is theoretically possible for a relatively capital-intensive new technique to increase employment and presents empirical evidence of such an occurrence. It also points out the importance to employment generation of disaggregating the production technique to allow the development of enterprises that exploit subprocess economies of scale.
1. Introduction
Because of a growing concern with unemployment and as a backlash to the mixed success of large-scale capital-intensive industrial development strategies of the mid-1960s, many developing countries are beginning efforts to promote small-scale industries using 'appropriate technology' or appropriate techniques of production. Although not always well defined, appropriate technology often means very labor-intensive rural processing activities using locally available raw materials. One of the principal reasons for promoting appropriate technology is to increase employment. Trade economists have long argued that capital-intensive investment strategies in labor surplus economies were inappropriate and policy makers should not be surprised when low rates of employment growth coincide with high rates of expansion in excessively capital-intensive industrial output. This approach defines 'appropriate' technology as the production technique which sets the factor price ratio (using social prices) equal to the ratio of the marginal physical products. *The author would like to thank Laurian Unnevehr and Ponciano Intal for helpful suggestions on earlier drafts. A very early draft was written while the author was a visitor at the Research School of Pacific Studies, Department of Economics, the Australian National University and very useful comments were given by staff members there. Errors and omissions remain the responsibility of the author. 0304-3878/86/$3.50 © 1986, Elsevier Science Publishers B.V. (North-Holland)
112
G.C. Nelson, Labor intensity, employment growth and technical change
In countries with a relatively low capital-labor ratio, the appropriate production technique will be relatively labor intensive. At the same time, it can be easily shown in any particular industry that the most labor-intensive technique is not necessarily appropriate. A well-known example of this was provided by Timmer (1973) [see also Hill (1~80) for a similar example from the Indonesian weaving industry] who demonstrated that the most privately and socially profitable way to mill rice on Java, one of the most labor abundant areas in the world, was with a small, mechanized rice mill rather than the traditional, labor-intensive method of hand pounding. Fig. 1 illustrates these concepts. Points A, B, C and D are four possible processing techniques, each progressively more labor intensive. Cost (private or social) is minimized by producing with the technique identified by the tangency between the production isoquant and the relative (private or social) factor price line. If the ratio of factor prices is steeper than the line connecting C and D, the most appropriate processing technique will not be D, the most labor-intensive one. If fig. 1 illustrates the choice of rice milling technique in Indonesia, Timmer found that the most appropriate technique was point C rather than point D. Governments can cause inappropriate techniques to be adopted by altering relative factor prices faced by producers. In fig. 1, an interest rate subsidy or a wages tax shifts the relative price line from gg to g'g' and processing technique B becomes the private cost minimizing technique. If gg reflects the social opportunity cost of labor and capital, technique C is the most appropriate, and B is not appropriate to the factor proportions prevalent in the economy. Producers must ultimately make positive profits, not simply minimize costs. In fig. 1, the average cost of production is given by the intersection of
K
TC
g\A g
B
L O Fig. 1
G.C. Nelson, Labor intensity, employment growth and technical change
I 13
the horizontal (or the vertical) axis and the relative factor price line tangent to the unit isoquant. If the price (indicated by hh, a line parallel and to the left of the relative factor price line) is less than the average cost, profit is negative and productio n will not occur in the long run. In this situation there is no 'appropriate' technology and all domestic needs should be supplied by imports. Technical change can alter the appropriate technology (fig. 2). Initially there are only two techniques, A and B. In a labor surplus economy (indicated by a fiat relative factor price line, gg), technique B minimizes costs. If a new production technique, C, shifts the isoquant so that it cuts the previous relative price line, the cost minimizing technique shifts to the new process. I call this effective technical change. If the new technique increases productivity sufficiently (say to C'), one (or more in a multitechnique isoquant) of the previous techniques becomes technically inefficient (the new isoquant is defined by AC').
g
,It
L Fig. 2
There are two possible effects of a new technology. First, it can shift the factor intensity of production given current factor prices. In fig. 2, C is more capital intensive than B. Second, it can reduce the minimum cost of production. Hence it is possible that for a given output price, production at C is profitable while production at B is not. The impact of government policies and technical change on employment growth depends on both the induced shift in factor intensity and minimum cost technique. Government policies usually cause private and social factor prices to diverge, often in the direction of increased capital intensity. In this case, employment per unit of output will be decreased. Unless the government subsidizes production simultaneously, employment will fall. Effective technical change reduces the minimum cost of production, increasing the returns to production. Production will increase if demand is
114
G.C. Nelson, Labor intensity, employment growth and technical change
not perfectly inelastic. Effective technical change can either increase or decrease capital intensity. If it decreases capital intensity (and production is profitable), employment increases unambiguously. If capital intensity is increased, the impact on employment depends upon whether or not the decrease in employment per unit is offset by the increase in labor demand due to increased product output. In the case where a capital intensive effective technical change causes production to become profitable, employment increases unambiguously.
2. Small-scale cassava starch processing in Java
An example that illustrates these points can be found in the changes in the cassava starch making industry in Indonesia in the 1970s. To make cassava starch, the cassava root is peeled and grated into a mash. The starch is washed from the mash and then separated from the water. If sun-dried, the starch must also be powdered or 'bolted'. The Indonesian starch making industry is characterized by four distinct processing techniques that differ by capital intensity, size of operation, and degree of vertical integration. Two of the techniques are performed in rural households and are true 'backyard' operations. Labor is supplied by household members or hired neighbors. Cassava starch making is seasonal and coincides with the seasonal low in demand for agricultural labor. The two household techniques differ in the way the root is grated into a mash. The more labor-intensive technique uses a bicycle mechanism to drive a large wheel covered with a grating surface. In the early 1970s, small (3 to 7 horsepower) gasoline and diesel engines became available in the countryside, and the second household technique uses a grating wheel modified so that it can be driven mechanically. Household starch is sun-dried and must be sent to a bolting mill for final processing. The medium scale technique automates much of the labor-using activities of the household techniques. Starch made using the medium scale technique is also sun-dried and must be sent to the bolting mill. In the large-scale capital-intensive processing, cassava roots go in one end of the equipment and dried powdered starch comes out the other end. Household firms typically make 200 kg of starch per day, i00 days per year. A medium scale firm might make 5 tons of starch, 120 days per year. A large-scale firm can make 30 tons or more of starch per day, 200 days per year. [See Nelson (1984) for a discussion of the Indonesian starch making industry]. Until the early 1970s, household processing was a relatively minor activity in the countryside. Most starch was made by medium-scale firms. The introduction of small motors into the countryside, however, initiated a rapid growth in household processing. With the bicycle grater, a man could grate
G.C. Nelson, Labor intensity, employment growth and technical change
115
100 kg of peeled roots in about two hours, but with a small engine driving a grating wheel, 100 kg could be grated in 15 minutes. The cost of labor for bicycle grating 100kg was about 200 rupiah (100 rupiah cash and a meal) in 1980. The cost of using a mechanical grater was 50 rupiah. In 1980, the net return (the value of output less processing costs) for the typical household starch factory using mechanized grating was 1.6 rupiah per kilogram of roots [Nelson (1982)]. With the bicycle grater, it was only 0.1 rupiah, less than the opportunity cost of the capital invested. Without the savings provided by the mechanical grater, household processing would have been unprofitable in 1980. The relatively high profitability of the household technique using mechanized grating caused a rapid growth of household starch making in the 1970s. Virtually without exception, small processors in both East and West Java reported that the graters almost entirely displaced the older, more labor-intensive methods. Owners of medium-scale firms also reported increased competition from household processing in the late 1970s. The introduction of the mechanized grater reduced employment per day of starch making by about 30 percent (from 10.8 days per ton of fresh roots to 7.5 days), but profitability increased substantially. Growth in income and a high income elasticity for starch products [see Unnevehr (1982)] allowed household processing to expand. If household processing tripled in the 1970s due to mechanization (probably a conservative estimate), employment doubled, increasing by roughly one million mandays. (This result is based on an estimated 4,300 household starch makers in Java in 1980, each assumed to process 60 tons of roots per year. It does not take into account employment lost in the more capital-intensive firms.) The growth of household processing illustrates another important element of appropriate technology - rental contracts for those elements of the processing activity with economies of scale. In the case of cassava starch significant economies of scale exist in the use of the grater, and in supply of working capital. The mechanical grater can process 6 to 10 tons of roots per day. A household owning a mechanical grater would need working capital sufficient to buy 40 tons of roots in order to use the grater at full capacity (household starch making takes four days). This amount of capital is rarely available to the typical Indonesian rural household. In order to spread fixed capital costs and reduce the need for working capital in households, grater hire services developed. This reduced the amount of capital necessary to enter the starch processing business and allowed households to specialize in peeling, filtering and drying, activities with no economies of scale. The bolting mill provides a similar service to both households and medium-scale firms. Bolting is a simple and relatively inexpensive operation. Firms specializing in bolting developed, however, because of the need for large amounts of working capital in marketing. The quality of sun-dried
116
G.C. Nelson, Labor intensity, employment growth and technical change
starch varies from factory to factory and depends upon drying conditions. Consumers, on the other hand, buy on the basis of brand name and expect a certain standard of quality so the bolting mill must hold large stocks of starch of varying quality. In addition, starch-making enterprises are paid immediately while consumers don't pay until a month after delivery. The basic economic activity of the bolting mill is to supply large amounts of working capital - to buy and hold sufficient quantities of raw starch so that its brand name quality can be met, and to supply consumers on credit. Without the bolting mill and its relatively favorable access to formal credit markets, the existence of household and medium-scale starch making would have been much less likely. 3. Conclusions
The most appropriate starch processing technique is neither the most laborintensive nor the most capital-intensive technique available in Indonesia. As with Timmer's rice mills, an intermediate technique is most profitable. In addition, technical innovation does not necessarily need to be labor intensity-increasing to increase employment. By making a marginal processing activity profitable, the mechanical grater allowed production to expand and more jobs to be created. The development of separate enterprises that exploit economies of scale was central to the success of household and medium-scale processing. The rental market for the graters made household processing profitable. The bolting firm exploits economies of scale in formal credit markets to finance starch trade. Finally, this example indicates the difficulties of trying to legislate into existence the necessary institutions to encourage appropriately laborintensive processing activities. It is very difficult to imagine how anyone could have seen the importance of small engine imports for household starch production in the early 1970s or the role that would be played by already existing bolting mills. Perhaps the most important government activities would have been physical and financial infrastructure improvements improving roads, increasing access to credit and providing price information (since household processing access to these services is usually not good) and possibly standardization of starch grades. But most of these actions should be part of overall policies of economic development, and are not specific to a particular activity or even to encourage a particular combination of factors of production. References Hill, Hal, 1980, The economics of recent changes in the weaving industry, Bulletin of Indonesian Economic Studies XVI, no. 2.
G.C. Nelson, Labor intensity, employment growth and technical change
117
Nelson, Gerald C., 1982, Implications of developed country policies for developing countries: The case of cassava, Ph.D. dissertation (Stanford University, Stanford, CA). Nelson, Gerald C., 1984, Time for tapioca, 1970 to 1980: European demand and world supply of dried cassava, Food Research Institute Studies XIX, no. 1. Timmer, C. Peter, 1973, Choice of technique in rice milling in Java, Bulletin of Indonesian Economic Studies IX, no. 2. Unnevehr, Laurian J., 1982, Cassava marketing and price behavior in Java, Ph.D. dissertation (Stanford University, Stanford, CA).