The Strategist

Sharp Turn of Economic Growth in Developing Countries

03/10/2015 - 16:28

American economist, Professor at the Institute for Advanced Study in Princeton, Dani Rodrik, noted in his column on the website Project Syndicate that recent discussion about economic growth in developing countries made a sharp turn. Inspiring, which was observed in recent years around the prospects of developing countries, has evaporated.

every one via flickr
every one via flickr
According to him, there are only a few serious economists who still believe that Asian countries will be able to demonstrate the same impressive gains in the coming decades (and most of the Latin American and African countries are just an economic success). Low interest rates, high commodity prices, rapid globalization and stability after World War II, which became the foundation of growth in this period is unlikely to persist.

However, what economists have not realized yet is the fact that developing countries need a new development model. The problem is not only that they must wean itself from dependence on unreliable capital inflows and rising commodity prices, making them vulnerable to shocks and prone to crises.
More importantly, export-oriented industrialization, which is the most trusted path to prosperity in the history, may need to be a growth driver in this case, - says Dani Rodrik.

Premature deindustrialization

The development of industry was the key to rapid economic growth since the industrial revolution. Countries that have caught up and eventually surpassed United Kingdom (such as Germany, US and Japan) have done this by building their own strong manufacturing sector. After the Second World War, the world has seen two waves of rapid economic growth: the first - in the countries of the European periphery in 1950s and 1960s, the second - in East Asia since 1960s.

In both cases, the basis for economic growth was industrial production.

China, which has become the epitome of the development strategy since the 1970s, was on already well-trodden path, says Rodrik. At the same time, production today is no longer is what it was before: it has become much more capital-intensive, requires a highly skilled workforce, and cannot provide jobs for a large number of migrants from the rural environment.

While the development of global supply chains facilitated the development of production, it also reduced the revenue from the added value, which remains in the manufacturer country. Many traditional industries such as textiles and steel are likely to face a contraction of global markets and excess capacity due to changes in demand and rising concern for the environment.
The downside of China's manufacturing success is the fact other countries have difficulties taking more than one niche in the industrial production. As a result, developing countries are beginning to de-industrialize and become more dependent on services that provide them with a much lower level of income than it did in already developed countries. This phenomenon Dani Rodrik calls premature deindustrialization.

Services rather than industry?

Is the service sector today able to play the same role that industry has played in the past?
Services today are making a great contribution to GDP in developing countries, even in low-income countries where agriculture has traditionally played a major role.
Young workers, who leave agriculture and move to the city, are increasingly employed in the services sector rather than in the industrial sector.

Ejaz Ghani and Steven D. O'Connell from the World Bank are among those who believe that the service sector can become a driver of rapid economic growth in developing countries. In a recent article, they argued that the service sector can play the role that has traditionally been played by industry sector. In particular, they show that the service sector has recently demonstrated is what economists call "unconditional convergence" - the tendency to reduce the productivity gap with developed countries.
However, the evidences cited by Gani and O'Connell include data from the beginning of the 1990s, when developing countries have experienced a general economic recovery, caused by capital inflows and unexpected increase in commodity prices. It is unclear whether it is possible to extend their findings to other periods, said Dani Rodrik.

Why services cannot replace industry

Dani Rodrik highlights two important differences between service sector and industrial sector, which allow us to understand why the services sector cannot replace industry.

Firstly, segments of the service sector for foreign markets, which are becoming increasingly important in world trade, as a rule, hire highly skilled workers and employ very few of ordinary employees.

Banking, finance, insurance and other business services, along with information and communication technologies (ICT) – those are all activities with a high level of productivity, which pay high wages. They can be drivers of growth in countries where labor force is properly prepared. However, labor force mainly tend to be low-skilled in developing countries. In such countries, it is possible to employ only a portion of the labor force for producing services that can be exported. That is why, for all its successes, the ICT sector in India has been the main driving force of economic growth, concludes Rodrik.

Traditional production, on the other hand, can offer a large number of jobs for people from rural areas, with labor productivity in 3-4 times higher than in agriculture.