Factories are no longer the sure route to prosperity. Here’s why

(Agto Nugroho, Unsplash)

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Arancha González Laya, International Trade Centre

Think about countries growing out of poverty and you probably picture something like this: underemployed workers leaving inefficient farms for factories that make textiles and clothing for domestic and export markets. Over time, this shift raises productivity and wages across the economy, while countries’ production and export baskets diversify into more sophisticated goods and services.

For the past several decades, this image would have been broadly on the mark. South Korea is a prime example: through the 1950s, a large share of its population still worked in the agricultural sector. Its manufactured exports a decade later were mostly textiles, clothing, footwear and wigs. Two generations on, in 2017, Korea was the world’s fifth-largest merchandise exporter and its ninth-largest importer. Even if your mobile phone and household electronics weren’t made by a Korean company, they almost certainly contain integrated circuits that were.

In varied ways, and to differing extents, countries from Bangladesh to Colombia to China have trodden this path. Since the dawn of the Industrial Revolution in late 18th century England, ‘structural transformation’– a term economists use for the process of shifting people and resources out of subsistence work into more productive activities – has begun with labour-intensive manufacturing. And starting in the 1950s, trade has been a key accelerator of structural transformation in developing countries, enabling much faster growth and poverty reduction than would otherwise be possible.

Trade matters in this story because in most developing countries, internationally tradable sectors are typically much more productive than the rest of the economy. Pulling more people and capital out of non-tradable activities and into firms dealing in tradable goods and services therefore makes for better jobs and a more productive economy overall; after all, the global marketplace offers far greater levels of demand than small home markets, and is a source for ideas, inputs, and knowhow. Meanwhile, the discipline of international market competition serves as an ongoing test for businesses’ operational efficiency: to succeed, they need to be good enough to compete.

Beginning in the 1990s, a twist emerged in manufacturing and trade: improved communications technology combined with predictably open markets to spur a dramatic increase in multi-country supply chains. Companies could more easily coordinate operations across far-flung production facilities, and be reasonably confident about the access terms their goods would receive in destination markets. This made it possible to disaggregate activities that used to occur within a single factory across regions and even oceans, locating each step of production wherever it could be done at the best quality and for the best price.

This ‘value chain revolution’ did not just lower costs for businesses and prices for consumers; it lowered the bar for developing countries to break into world markets. Countries and companies no longer needed to produce finished goods: they could tap into the benefits of international trade by producing or processing components within larger value chains.

Trade-led structural transformation can reshape countries’ economic possibilities and prospects for eliminating extreme poverty and creating large numbers of jobs, as envisaged by the Sustainable Development Goals, but today it faces two serious challenges.

First, the open global economy itself is under threat. New trade restrictions have been placed on hundreds of billions of dollars of traded merchandise, and the very notion of rules-based cooperation on trade has come under sustained political attack.

Second, increasingly sophisticated labour-saving automation means that manufacturing does not require as many workers as it used to. This diminishes the importance of labour costs as a factor in where to locate production.

Even in labour-intensive industries like garment manufacturing, changing business models are ‘nearshoring’ some investment back towards advanced economies. For example, in fast fashion, geographic proximity to major markets has become critical: once a dress goes viral on Instagram, companies need to rush new production into stores, a commercial reality at odds with three-week shipping times from factories in South and East Asia.

The response to the first challenge is straightforward: we must make the case for open trade. Willing governments should act to reinforce rules-based cooperation to keep markets open – at home, regionally and around the world.

The second challenge demands a more nuanced response. For countries from India to Ethiopia, Nigeria to Honduras, manufacturing will still be part of the development story. But the goal for developing countries must now be to achieve greater value addition and international competitiveness across the board – in agriculture, industry, and services.

When Kenyan avocado farmers are able to obtain international health and safety certification and connect to foreign retailers, it can translate to four times more money in their pockets for each avocado they sell. For pineapple producers in Benin, better branding, marketing, and packaging – together with improved physical infrastructure – opens the doors to regional and international sales far more lucrative than selling unprocessed fruit in local markets.

As for services, the digital revolution has made cross-border trade feasible for everything from programming to accounting and legal services. But value addition and trade in services aren’t just about technology parks in Bangalore or call centres in Dakar. They’re about hotels in Lao People’s Democratic Republic building commercial ties to local farms and tour operators. They are about young people in refugee camps in Kenya using freelancing platforms like Upwork and Fiverr to do internet ad design for clients in other countries.

The upcoming World Economic Forum on Africa meeting in Cape Town will be looking at how to maximize the contribution of digital trade to growth and job creation in sub-Saharan Africa. Ongoing talks on e-commerce at the World Trade Organization offer the prospect of international rules of the game on digital trade, enhancing predictability and reducing transaction costs for businesses of all sizes.

Ensuring that the benefits of growth and trade are broadly shared across society will be critical for meeting development objectives as well as for maintaining public support for policies that support growth and sustainability. Effective domestic social policy will need to insure workers against displacement from technology or import competition, while equipping all workers – women and men – to be full participants in the economy. Supply-side investments will be necessary to ensure that businesses of all sizes are in a position to add value and connect to international markets.

Allowing global markets to slam shut will diminish growth opportunities around the world, especially for the people and places that need it most. Yet irrespective of what happens to trade, robust manufacturing sectors will now be just one component of economic growth and development. To generate better jobs in the numbers needed, developing countries will need to broaden their growth strategies.