CAMBRIDGE – A year ago, economic analysts were giddy with optimism about the prospects for economic growth in the developing world. In contrast to the United States and Europe, where the growth outlook looked weak at best, emerging markets were expected to sustain their strong performance from the decade preceding the global financial crisis, and thus become the engine of the global economy.
Economists at Citigroup, for example, boldly concluded that circumstances had never been this conducive to broad, sustained growth around the world, and projected rapidly rising global output until 2050, led by developing countries in Asia and Africa. The accounting and consulting firm PwC predicted that per capita GDP growth in China, India, and Nigeria would exceed 4.5% well into the middle of the century. The consulting firm McKinsey & Company christened Africa, long synonymous with economic failure, the land of “lions on the move.”
Today, such talk has been displaced by concern about what The Economist calls “the great slowdown.” Recent economic data in China, India, Brazil, and Turkey point to the weakest growth performance in these countries in years. Optimism has given way to doubt.
Of course, just as it was inappropriate to extrapolate from the previous decade of strong growth, one should not read too much into short-term fluctuations. Nevertheless, there are strong reasons to believe that rapid growth will prove the exception rather than the rule in the decades ahead.
To see why, we need to understand how “growth miracles” are made. Except for a handful of small countries that benefited from natural-resource bonanzas, all of the successful economies of the last six decades owe their growth to rapid industrialization. If there is one thing that everyone agrees on about the East Asian recipe, it is that Japan, South Korea, Singapore, Taiwan, and of course China all were exceptionally good at moving their labor from the countryside (or informal activities) to organized manufacturing. Earlier cases of successful economic catch-up, such as the US or Germany, were no different.
Manufacturing enables rapid catch-up because it is relatively easy to copy and implement foreign production technologies, even in poor countries that suffer from multiple disadvantages. Remarkably, my research shows that manufacturing industries tend to close the gap with the technology frontier at the rate of about 3% per year regardless of policies, institutions, or geography. Consequently, countries that are able to transform farmers into factory workers reap a huge growth bonus.
To be sure, some modern service activities are capable of productivity convergence as well. But most high-productivity services require a wide array of skills and institutional capabilities that developing economies accumulate only gradually. A poor country can easily compete with Sweden in a wide range of manufactures; but it takes many decades, if not centuries, to catch up with Sweden’s institutions.
Consider India, which demonstrates the limitations of relying on services rather than industry in the early stages of development. The country has developed remarkable strengths in IT services, such as software and call centers. But the bulk of the Indian labor force lacks the skills and education to be absorbed into such sectors. In East Asia, unskilled workers were put to work in urban factories, making several times what they earned in the countryside. In India, they remain on the land or move to petty services where their productivity is not much higher.
Successful long-term development therefore requires a two-pronged push. It requires an industrialization drive, accompanied by the steady accumulation of human capital and institutional capabilities to sustain services-driven growth once industrialization reaches its limits. Without the industrialization drive, economic takeoff becomes quite difficult. Without sustained investments in human capital and institution-building, growth is condemned to peter out.
But this time-tested recipe has become a lot less effective these days, owing to changes in manufacturing technologies and the global context. First, technological advances have rendered manufacturing much more skill- and capital-intensive than it was in the past, even at the low-quality end of the spectrum. As a result, the capacity of manufacturing to absorb labor has become much more limited. It will be impossible for the next generation of industrializing countries to move 25% or more of their workforce into manufacturing, as East Asian economies did.
Second, globalization in general, and the rise of China in particular, has greatly increased competition on world markets, making it difficult for newcomers to make space for themselves. Although Chinese labor is becoming more expensive, China remains a formidable competitor for any country contemplating entry into manufactures.
Moreover, rich countries are unlikely to be as permissive towards industrialization policies as they were in the past. Policymakers in the industrial core looked the other way as rapidly growing East Asian countries acquired Western technologies and industrial capabilities through unorthodox policies such as subsidies, local content requirements, reverse engineering, and currency undervaluation. Core countries also kept their domestic markets open, allowing East Asian countries to export freely the manufactured products that resulted.
Now, however, as rich countries struggle under the combined weight of high debt, low growth, unemployment, and inequality, they will apply greater pressure on developing nations to abide by World Trade Organization rules, which narrow the space for industrial subsidies. Currency undervaluation à la China will not go unnoticed. Protectionism, even if not in overt form, will be politically difficult to resist.
Manufacturing industries will remain poor countries’ “escalator industries,” but the escalator will neither move as rapidly, nor go as high. Growth will need to rely to a much greater extent on sustained improvements in human capital, institutions, and governance. And that means that growth will remain slow and difficult at best.