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Rethinking traditional structural transformation

How much will the old patterns of economic growth explain the experience of tomorrow’s growing economies? While the evolution of an economy into different sectors is a natural process of development, the fourth blog in this series examines how the composition of growth could look very different in the future.

The shift of labour from the countryside into higher productivity jobs in urban areas is an inevitable fact of development. So far, no country without an abundance of natural resources or land has become rich without industrialising first. With subsistence agriculture behind them, workers chase higher wages in the form of manufacturing jobs or services. As labour leaves rural areas, real wages in these areas rise, encouraging the adoption of new technologies and machinery which drive increases in agricultural productivity. In cities, labour-hungry industries pull in workers, providing simple but stable jobs and raising relative incomes. Over time, as capital and skills accumulate, a further shift into more advanced production with higher value-added takes place. To date, this has been the mainstream narrative of progress.

Structural transformation is an organic process that reflects evolutionary changes in the make-up of an economy. However, the speed at which these transformations take place are not immune to external forces. Shocks like natural disasters or conflict can have dramatic effects on the structure of the economy. Policies can coax labour to flow in certain directions or prop up favoured industries, for good or for worse.

Future growth could rely on a different blueprint

By definition, the export-for-growth model rests on the rapid development of the manufacturing sector. Failure to do so, representing inadequate structural transformation, means poor prospects for growth. This characterises much of sub-Saharan Africa where the process of industrial upgrading has stalled and in some cases gone in reverse.

However, unorthodox times force us to rethink whether the same diagnosis will be applied in the future. The core reason is that the prospects for a rapid transition into low-cost manufacturing are gloomier, putting into question how quickly countries should try to induce a rapid structural transformation into industry. Future growth stars might follow a very different blueprint in a digitalised, automated world. This is not an argument for suppressing the natural evolution that takes place; instead, it is a cautionary note on the pursuit of building up manufacturing industries that has characterised standard development policy.

In light of a wild trade environment, the subject of our previous post, manufacturing industries may struggle to get their feet off the ground. The nature of production is also changing: automation of routine production tasks mean low labour costs are no longer sufficient for ensuring competitiveness in the global market. Instead, due to better infrastructure for capital-intensive production and domestic pressures against globalisation, automation might lead to a reshoring of manufacturing away from emerging economies back to developed ones. The speed at which these new technologies are adopted determines the window of time that countries have to adapt to this new wave of production. As automated production becomes more prevalent, the focus will shift towards increasing complementarities between labour and capital, shifts which require different sets of skills for workers. Investments into human capital will duly pay off. Therefore, while manufacturing plays a key role in all economies for its ability to absorb large amounts of labour at enticing wages, these trends suggest it would be wiser to not put all eggs into one basket.

Time to get agriculture right

A fresh look at improving agriculture and services is warranted. Despite terrific technological advances in the past half century, agricultural productivity remains weak for many. Nowhere is the challenge greater than in sub-Saharan Africa. A renewed focus on increasing incomes in agriculture as a first step can lay the foundation for growth. Over time, as the natural process of urbanisation occurs, agricultural productivity must continue to rise to feed a larger share of the population not engaged in the sector. Of course, countries can and do import food, with the evidence mostly pointing towards no meaningful impact on food security as the share of labour in agriculture falls. However, if more protectionist policies and risks of conflict continue to cause the trade environment to deteriorate a greater focus on food self-sufficiency is warranted. The threat of climate change reinforces these arguments. Resilience in the sector is necessary to ensure livelihoods.

Services should be harnessed creatively to facilitate growth

Services benefit from an urban, digitalised world. The challenge thus far has been whether the services sector can maintain the rapid levels of job creation boosted by industry. India benefited from its sizeable population of skilled workers, allowing it to sustain job creation in tradable services. However, this focus on skilled services meant India faced difficulties absorbing the vast amounts of lesser-skilled labour. Efforts to boost firm productivity have historically focused on traditional manufacturing industries, and with good reason. However, the unintended consequence has been that the services sector is relatively understudied. While artificial intelligence poses similar risks for routine services as automation does for manufacturing, the benefit of a digitalised world is extraordinary. At a near-zero marginal cost, businesses can instantly tap into a massive market. Building up a successful services sector will require heavy investments in human capital; do not expect immediate results. In the long-term, however, governments should think creatively about how they can use the sector as another core component for growth.

Editor’s Note: This blog is part of a 5-part series on unorthodox policies for unorthodox times

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