Services versus manufacturing: which matters more for growth and jobs in MENA?

In addition to increasing globalization, which has been key to rapid growth for many countries, an emerging debate is which sector, services or manufacturing, could be the main source of growth for developing countries today. The East Asian middle and high income countries globalized through manufacturing-led activities, having followed the traditional development path from agriculture through manufacturing and only later to services. South Asia (particularly India) on the other hand, appears to be eschewing the traditional path by globalizing through service-led activities. They are also aided by information technology and outsourcing that enable services to overcome their former constraint as non- tradable activities. For the Middle East and North Africa (MENA) countries, which sector path to growth, services or manufacturing, could emerge and be fostered?

A valid question is whether the sector source of growth matters at all, and if so, why? For manufacturing, key advantages include: the possibility of scale economies which drive down production costs; the generally negative correlation between manufactured goods prices and demand; and the possibility to export the sector’s output to richer developed countries, thereby expanding the output base and counteracting the effects of any labor-saving productivity gains.

For services, the conventional wisdom perceives the sector to have limited potential to export or achieve economies of scale, and thus unable to benefit from expanding global trade (haircuts or restaurant meals, for example, can only be consumed locally). Furthermore, consumption of more services was seen linked to a state of affluence rather than to technology-driven price declines.   A characteristic that, in the absence of a global trade outlet, limited the scope of services growth through domestic demand.

The traditional services—trade, hotels, restaurants and public administration—remain largely characterized by the constraints above. Modern services, however, can engage in cross-border trade as well as (in some cases) benefit from scale economies and cost-reducing technological advances. Modern services include business processes which can be outsourced (e.g. insurance claims, transcribing medical records, call centers), as well as transport, logistics and communication services.

The World Bank MENA Economic Development and Prospects (EDP) report of Sept 2011 finds that MENA’s growth and job creation profile is characterized as follows:

• The services sector has been an important source of value added growth and job creation in MENA countries during the latter half of the 2000s, irrespective of whether the country was an oil exporter or importer.
• Manufacturing is starting to make sizable contributions to value added growth in some MENA countries (Jordan, Egypt, Tunisia, Iran and Qatar), but made an impact on job creation in a few countries only (Algeria and Qatar).
• In addition to services, the oil sector (together with electricity, gas and water utilities) was the other major engine of value added growth in 6 of 12 MENA oil exporters,but the sector’s direct job creation impact was negligible. Nonetheless, the oil sector has enabled the growth of the non-oil economy through transfers and public investment programs.
• Agriculture played an important role in value added and employment growth in one developing oil exporting country only (Algeria). It was important for job growth in another MENA developing oil exporter (Iraq), and for value added growth in a few MENA oil importing countries (Morocco, Egypt, Tunisia).
• Construction has less important role in value added growth but is playing an important job creating role in some GCC oil exporters, although it and many of the sector’s jobs have gone to noncitizens.

Decomposing services into traditional and modern components are limited by the available data. A decomposition of services employment into government and nongovernment components serves as a proxy. The EDP report finds that the contribution of non-government services (especially the trade, tourism, logistics and communications sector and, in the case of Egypt, the combined financial, insurance and real estate sector) to value added growth was large relative to the contribution of government services. The same is the case with regards to job creation for most MENA countries, (especially oil importers which have relatively limited fiscal space) which have experienced limited growth in government employment.

The non-government sector created the most services sector jobs, led especially by the trade and tourism sector and, in the case of Qatar and some other GCC countries, the combined financial, insurance and real estate sector. Thus with traditional services leading service sector job creation, MENA is so far not replicating India’s so-called “services revolution.”

With regards to manufacturing, it’s not yet evident that MENA could follow the traditional East Asia path of manufacturing-led growth. However, this assessment bears watching since MENA’s manufacturing sector, although representing a low share of value added, compares favorably in size to East Asian countries at the time of their growth takeoff half a century ago (see figures below).

In the last decade MENA countries have expanded their global trade presence, with an increase in the region’s share of world exports by 20 percent (World Bank, MENA EDP Sustaining the recovery and looking beyond, January 2011). Trade openness alone, however, is insufficient for positive employment impact in the medium and longer run from manufacturing, without accompanying FDI enabling better linkage with global product markets and progression up the product value ladder ( “Making trade work for jobs: international evidence and lessons for MENA,” in Nabli, M. ed.,  Breaking barriers to high Economic Growth: better governance and deeper reforms in the Middle East and North Africa, World Bank, 2008).

Given the importance of broad globalization to a sector’s potential to contribute to sustained long term growth, an interesting finding of the EDP is that while MENA countries attracted relatively little foreign direct investment (FDI) to the manufacturing sector relative to other sectors, this FDI created disproportionately more jobs than FDI in other sectors. This suggests potential for MENA manufacturing growth if the countries become more engaged in global trade and more open to inflows of investments from abroad.

The bottom line? Nongovernment services and manufacturing can serve as engines of both job creation and income growth in MENA. However, the jury is still out on which of the two sectors will emerge as a sustainable source of long term growth. The details of the respective country policy reform programs will determine which, if either, of the two sectors comes out on top.