The Role of Labor in Sustainable Development

In 2015, the international community adopted the 2030 Agenda for Sustainable Development to pave the way for a global transformation towards sustainable development – a development path which combines the goals of economic development, social inclusion and environmental sustainability. To this end, 17 sustainable development goals (SDGs) have been adopted by 193 member states of the United Nations. This thesis deals with the transformation towards sustainable development in the context of the developing world and has two foci: In the first and main focus, it addresses the income distribution between capital and labor, since it has a direct impact on inequality and working poverty in these countries. To do so, it measures the labor's income share – the share of national income that is earned by labor – and further analyzes its determinants. The second focus is placed on the transformation of the agricultural sector – which is home to the majority of the poor in developing countries – towards sustainability. At the example of cocoa farmers in Indonesia, it analyzes whether the transition from food to cash crops is a sustainable pathway out of poverty for small-scale farmers. Employment and the quality of employment – decent work – plays a significant role in the promotion of sustainable development. Productive and remunerative work is the main route out of poverty and the creation of decent employment is vitally important to make growth pro-poor. Giving labor a fair share in economic prosperity therefore is key to fighting poverty and further reducing inequality in income. To be able to assess how far an economy spreads its income achievements amongst its working population, overall productivity trends of an economy have to be related to developments in the labor market. The factor (or functional) income distribution enables to do so by measuring how aggregate income is distributed between the factors of production: Labor (including human capital) and capital (including land). The labor's share in income of a country then shows how much of national income is earned by labor. While the relevance of the labor share for sustainable development and especially for a fair and equitable society is straightforward, its assessment is less clear. The second chapter of this dissertation therefore is dedicated to the measurement of the labor income share in developing countries and associated challenges. The poor availability and reliability of national account data as well as the fact that self-employed whose labor income is hard to capture account for a major share of the workforce and often work in the informal sector render its computation difficult. I consult social accounting matrices as additional source of information to construct a labor share data set that is backed up with micro-economic evidence. The final data set covers about 100 developing countries from 1990 to 2011. The data suggests that the finding of declining labor shares of previous studies also applies to the specific sample of low and middle income countries. Furthermore, I find the labor share in developing countries to be about one-half in size and thus less than the standard 'two-thirds' in economic literature. The third chapter builds on the second chapter and reviews the above mentioned data set and other international panel data sets on the labor income share in low and middle income countries. It has two objectives. First, it provides an overview of different measurement approaches and data sources. Given that labor income of the self-employed is not directly observed in these countries, computing the labor share requires several assumptions. Various data sets relying on different assumptions are compared and their strengths and weaknesses discussed. Second, this chapter presents basic statistics on the labor income share and extracts results, which hold true independent of the data set used. Unlike standard propositions, there is evidence that the labor share is neither constant nor does it represent two-thirds of total output. The labor income share has been declining in the developing world since 1990, indicating that labor income has been lagging behind overall productivity increases for the last two decades, and is found to constitute half of total production output at most. There is evidence that not only has the labor share for the self employed declined, but also for wage employees, although they make up an increasing proportion of the labor force in these countries. The decline in the labor share can also be seen in the manufacturing sector since 2000 and has especially affected low-skilled workers, whereas high-skilled workers managed to increase their labor income share in national value added. Decomposing by sector further suggests that not only have sectoral changes driven these findings but also shifts away from labor-intensive agriculture towards more capital-intensive sectors. Finally, there is evidence that the increasing gap between a country's wage rates and productivity – and not changes in employment – is driving these results. The fourth chapter turns to the analysis of the determinants of the labor share. An alarming result of the first two chapters is the substantial downturn of the labor share in the developing world since the early 1990s. The fourth chapter therefore assesses the drivers of this trend. More specifically, it investigates how de facto financial globalization has influenced the labor share in developing countries. The main argument is the need to distinguish between different types of capital in this context, as different forms of foreign investment have different fixed costs and impacts on the host countries' production process and vary concerning their bargaining power vis-a-vis labor. Assuming an aggregate elasticity of substitution between capital and labor would thus be misleading. The econometric analysis of the impact of foreign direct vs. portfolio investment in a sample of about 40 developing and transition countries after 1992 supports this claim. Using different panel data techniques to address potential endogeneity problems, it is found that FDI has a positive effect on the labor share in developing countries, while the impact of portfolio investment is significantly smaller, and potentially negative. The results also highlight that de facto foreign investment cannot explain the decline of the labor share in developing countries over the investigated period. The fifth chapter addresses the second focus of this thesis and contributes to the sustainable development debate by assessing whether cash crop cultivation sustainably reduces poverty amongst smallholders. The diversification into cash crops has a great potential for reducing poverty in the developing world that may not be fully harnessed because many smallholders are inefficient producers. Furthermore, income gains may be only static and poverty and vulnerability of smallholder households may not be reduced sustainably. Instead, cash crop farmers, in particular those without proper farm management skills, may experience boom and bust cycles, caused by volatile world market prices, local weather shocks and pests. To analyze the long-term poverty impacts of cash crop agriculture, this analysis draws on a unique panel data set of smallholder cocoa farmers in Central Sulawesi, Indonesia, covering the years 2000, 2006 and 2013. It is shown that – over the analyzed time horizon of more than 10 years – cocoa cultivation is associated with strong and sustainable poverty reduction. Cocoa farmers fare better than non-cocoa farmers and the welfare gains can mainly be attributed to increasing cocoa yields. Yet, yield gaps remain large and are increasingly heterogeneous. This productivity heterogeneity is traced back to farm management practices. Linking these findings to poverty transitions, it is shown that better management practices facilitate the transition out of poverty and shields against income losses.