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The manufacturing conundrum

Aashish Mehta's picture

Jesus Felipe is an Advisor in the economics and research department at the Asian Development Bank.
Aashish Mehta is an Associate Professor of Global and International studies at UC-Santa Barbara.
Changyong Rhee is a Director in the Asia and Pacific Department at the International Monetary Fund.

In a recently released working paper, we have analyzed data on manufacturing employment and output levels from developing and developed countries.  We show that historical manufacturing employment levels are much better predictors of subsequent prosperity than historical manufacturing output levels. Unfortunately, we also find that late industrializers are likely to face significant difficulty achieving high manufacturing employment shares, even if they are successful in spurring high levels of manufacturing activity. Therefore, while manufacturing jobs are key, it will be difficult for today’s late industrializers to replicate past success with development through manufacturing job creation.

A long tradition in development economics treats manufacturing as special.  Some of the development benefits the sector provides rely on large and growing numbers of manufacturing jobs, not just rising levels of manufacturing output. Labor productivity in manufacturing converges rapidly towards international norms. This gives aggregate productivity a bigger boost; the larger the share of the workforce that is in manufacturing, the greater the boost. The more rapid the manufacturing employment growth, the faster workers move out of low-productivity, low-wage agriculture and traditional services. 

Unfortunately, cross-country analysis of the connections between manufacturing employment and levels of development has been restricted to OECD countries. This matters because many developing country governments have large programs to stimulate manufacturing activity, on the understanding that jobs and higher incomes will follow.  Ambitious job targets are announced - such as 100 million new manufacturing jobs by 2022 in India. These are typically justified with reference to the experiences of earlier industrializers, like Korea and Taiwan.  Public budgets, land and labor regulations, and even education policy are being modified to pursue these manufacturing jobs.  We can see why developing countries want these manufacturing jobs: our data show that a country’s peak manufacturing employment share between 1970 and 2010 rather than is its peak manufacturing output share, is a much better predictor of its average per capita GDP in 2005-2010.  Controlling for peak manufacturing employment shares and the date that manufacturing activity peaked, peak output shares are insignificant predictors of subsequent prosperity.  This suggests that manufacturing output matters for prosperity only insofar as it comes with jobs. Moreover, we show that every country that is rich today, by any reasonable standard, had more than an 18-20% manufacturing employment share sometime since 1970. 

It is important to note that industrial activity typically grows with income in poorer countries, peaks, and then falls with income and wages in richer (deindustrializing) countries.  There are two reasons we think that manufacturing employment-led development is becoming more challenging.

  1. Labor productivity has risen faster in manufacturing than in the wider economy. Higher levels of manufacturing output are now compatible with lower levels of manufacturing employment. Figure 1 confirms this, showing that peak manufacturing employment shares have fallen over time. Peak output shares have not.

    Figure 1: Manufacturing Employment Shares Have Declined, Output Shares Have Not
    Figure 1: Manufacturing Employment Shares Have Declined, Output Shares Have Not

     
  2. Manufacturing activity is now more apt to leave for other countries as labor costs rise. Therefore deindustrialization kicks in at lower income levels. Moreover, this premature deindustrialization is more apparent in employment than in output data. Output can be sustained in the face of rising labor costs by replacing workers with machinery. (Arvind Subramaniam and Amrit Amirapu show similar trends in industrial (manufacturing plus mining, utilities and construction) employment using repeated cross-sections of countries.)

Countries still industrialize and then deindustrialize as they become richer.  However, industrial employment shares for today’s late industrializers such as China, India and Bangladesh are all below 16%, and on today’s trends seem unlikely to rise much further. Moreover, the per capita income levels at which deindustrialization kicks in have fallen from $34,000 in 1970 to around $9,000 in 2010. 

These results urge a balanced approach to industrialization. They confirm that industrialization matters – when it brings jobs; but they also confirm that this is less and less likely to happen. Governments must not neglect manufacturing. Nor can they rely as heavily on it as they once did.

Comments

Submitted by Selina Carter on

While the authors' usage of the OECD manufacturing data is helpful, this analysis is far from complete and raises more doubts than concrete new policy steps.

To what extent are manufacturing jobs/output causing "prosperity" (i.e., rising incomes), as opposed to running in tandem with one another? An analysis using "probabilities of being rich" equates to an analysis of statistical correlations between variables (comparing manufacturing output/job share and per capita GDP), which is insufficient to give certain policy advice without substantial caution. Although theory is useful when data is inconclusive, the authors need to elaborate further on the data's limitations for non-PhD audiences. Otherwise, the paper creates the risk that policymakers will:
a.) assume that prioritizing manufacturing jobs, ceteris paribus, is indeed a path to "prosperity", albeit a "harder" path than previously;
b.) assume that the number of jobs created is more beneficial for "prosperity" than rising productivity (greater output). However, since productivity is what ultimately makes countries competitive, this leads to confusion: if rising productivity is necessary for countries to compete, and if rising productivity often means less emphasis on maximizing employment, is it wise for countries to focus on increasing employment share in manufacturing?

I recommend that the authors consider adding an addendum to the paper that includes a more elaborate set of policy ideas, or in the very least a discussion about resolving the "catch-22" scenario of point (b) above.

Submitted by Tom Berliner on

Great paper guys.

I have discussed, more briefly, some of the other causes of deindustrialization in this blog - http://www.developmentprogress.org/blog/2015/03/04/where-will-all-jobs-come
It also outlines what are possible policy-responses should be to industry's growing inability to create jobs.

I hope it adds to the debate.

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