Economic development in resource-rich, labor-abundant economies

Tackling poverty and inequality through appropriate growth strategies is at the core of the World Bank’s mission. In my view, achieving sustainable and inclusive growth depends on a well-functioning market and to a significant extent also the degree to which government policies facilitate private firms’ upgrading and diversification into industries that are aligned with an economy’s comparative advantages.

To smooth the way and allow this dynamic process to function optimally, we need to answer many questions that are unique to different types of economies. For example, how is it possible to successfully tap a developing country’s comparative advantage when it is rich in resources and has an abundant labor supply?

First, some fundamentals of structural transformation must be considered. 
We all know that dynamic growth in the modern world depends on technological innovation and industrial upgrading.  And this technological innovation and industrial upgrading need to be consistent with the country’s comparative advantage in order to be competitive and sustainable.  According to the famous Harvard economist Michael Porter, for a country to achieve competitive advantage internationally, the industries it develops need to follow the following 4 principles: First, they should use intensively those production factors the economy has in abundance; second, they should have large domestic markets; third, they should form clusters and fourth, they should be competitive domestically.

The first condition in fact is just saying that the industries need to follow the country’s comparative advantage, determined by its factor endowments. So the assumption is that those industries that are aligned with the country’s comparative advantage will tend to form clusters and be competitive domestically. Therefore, the two primary conditions for achieving competitive advantage are simple yet powerful. First and foremost, if an industry is consistent with a country’s comparative advantage, it should have the potential to compete in the global as well as in the domestic market. This is why many of the highest income countries in the world are small economies, such as Switzerland, Finland, and Denmark. 

When a labor-abundant developing country follows its comparative advantage to develop labor-intensive industries, it can also exploit the advantage of backwardness to reduce the cost of innovation. Being a bit poorer gives an economy the opportunity of achieving dynamic growth similar to other successful developing countries that have grown at rates of 8 to 10 percent. Such a development strategy will also be pro poor: This is because more jobs will be generated in the manufacturing sectors, quickly absorbing rural surplus labor and allowing the poor, whose income relies predominantly on wage earnings, to be employed. Subsequently, wages will increase once the economy upgrades to more capital-intensive industries. This occurs when an economy’s capital accumulates and its comparative advantage shifts (see further the discussion in my Marshall Lectures, Economic Development and Transition: Thought, Strategy, and Viability. )

But what are the comparative advantages of a resource-rich country with abundant labor supply?  Clearly, a resource-rich country’s comparative advantage lies in developing resource-intensive industries. But, resource-intensive industries, such as extraction, provide very limited job opportunities. When I visited Papua New Guinea (PNG) in 2009, I learned that the country’s famous OK Tedi copper mine generated 40% of public revenues and 80% of exports. However, OK Tedi only provided 2,000 jobs.  Another example is PNG’s new Liquefied Natural Gas Project – it may double GDP in five years, but the project will only create 8,000 jobs. Most of PNG’s 6.6 million people still live on subsistence agriculture and are poor.

Can a resource-rich, labor-abundant economy like PNG develop labor-intensive manufacturing industries?

My answer is yes. The country’s wage rate is low and wages constitute the major cost of production for labor-intensive industries. Therefore, labor-intensive manufacturing industries can be competitive in such country. The development of labor-intensive industries in Indonesia, Thailand, and Cambodia are good examples. Moreover, labor-intensive manufacturing industries not only offer the potential to absorb surplus labor from rural subsistence sector, but the development of such industries can pave the way through continuous upgrading to higher value-added industries. Finland’s Nokia is an example. It started from logging and diversified its operation to labor-intensive business of producing rubber boots and later OEM of household electronics for Phillips before venturing into mobile phones.

The exploitation and exports of natural resources may be accompanied by Dutch Disease in a resource-rich country, as export receipts from, say, oil, natural gas or minerals push up the value of the currency, thus adversely affecting the competitiveness of other exports. Also, if the wealth from natural resources is captured by powerful groups, such as in Nigeria, the resources can become a curse. 
However, Scandinavian countries have demonstrated better stewardship of the wealth they have generated from natural resources. They have shown that transparent management and investing in human capital as well as infrastructure can increase labor productivity, reduce production and transaction costs and offset the adverse effects of Dutch Disease.

The Scandinavian experience holds valuable lessons for labor-abundant, resource-rich economies. As promoted by the World Bank’s Extractive Industries Transparency Initiative Plus Plus (EITI++), if they manage and transform their natural resource wealth to fighting poverty, hunger, malnutrition, illiteracy, and disease, and to support structural transformation along the growth identification and facilitation approach , they can turn resources from a curse to a blessing. This is because such countries have opportunities to accumulate capital, upgrade endowments, improve infrastructure, transform industrial structure, and subsequently raise incomes faster than labor-abundant, resource-poor countries.