Structural transformation has been at the heart of many successful economic development strategies. Export-oriented industrialization provided a way for unskilled agricultural workers to join the global economy. Connecting these workers with capital, knowledge, and ultimately international markets was considered the tried and tested pathway towards convergence.
But these dynamics are increasingly failing to deliver. Even where industrial output is rising, job creation in manufacturing is limited and productivity growth in manufacturing is outpacing demand. Large companies in developing economies have been adopting capital-intensive technologies similar to their peers in advanced markets. Where jobs are being created, it is usually by small, less productive, and often informal manufacturing companies. Moreover, job creation is switching towards the service sector at a lower level of prosperity. These service sector jobs tend to be less productive and focused on serving domestic demand. Growth is harder to achieve without the leverage of serving foreign markets. And where natural resource exports or capital inflows provide external fuel to growth, growth dynamics tend to be fragile and exposed to global market shocks.
How do development strategies have to change given these new circumstances? Dani Rodrik has outlined a path forward in a number of recent talks. He takes a new look at which sectors to prioritize to drive growth and frames the appropriate target as “middle-productivity” production activities. This, he argues, is a set of activities where jobs for low-skilled workers can be created while leveraging the potential of global export markets.
There is second part of Rodrik’s argument that gets often overlooked.In terms of firms, SMEs become the critical focus of attention, not simply instead of, but alongside the large multinational firms and leading national companies that have dominated much of the traditional industrialization discussion. In terms of policies, a mix of ’softer’ policy interventions from market intelligence, vocational training, technical advice, mentoring, networking structures, common services and other customized business incentives becomes key. These are the tools needed to enable SMEs to create jobs that are increasingly productive and part of the formal competitive economy.
This set of policies also stands in contrast to the mix of subsidies, tax breaks and targeted trade protection that has characterized traditional industrial policies. These new competitiveness policies are more complex than just giving small grants for SME development. They require government capacity to identify market failures and address them without creating market distortions. And they require implementation models that can have impact at scale, which many traditional SME policies have struggled with.
A third dimension implicit in this approach is that required policies become more location specific. The specific upgrading needs of SMEs are to a significant degree shaped by their location. This is a change from the traditional policies geared toward accelerating structural change, which tend to be controlled at the national level.
At the intersection of sector, SMEs, and location, this new approach to drive structural transformation can build on a significant history of research, conceptual thinking, and policy practice in cluster-based economic development. Cluster-based approaches are no simple panacea: a lot depends on how these programs are structured. But they can be a useful tool for analyzing the growth opportunities and barriers that groups of SMEs in specific locations face. Cluster approaches can help policymakers design and cost-effectively implement coherent action plans and policies that can unlock opportunities. And our understanding of ‘what works’ is now dramatically richer than in the early 1990s, when Michael Porter’s work triggered a first wave of cluster efforts. The examples for these policies come from places without a tradition of government driven industrial policies like Catalonia, the Basque Country, Denmark but also in Chile, Colombia or Mexico.
The World Bank, and its clients in developing and emerging countries, have been designing new tools to support structural transformation under these changing global economic realities. Building on the cluster-based development experiences from the past 25 years, the World Bank has been adapting them to match the circumstances in the countries it is serving. The World Bank has been testing the use of advance technologies, like blockchain and smart contracts, to reach small farmers and link them to logistics and financial service providers to equilibrate market power and build trust in very fragile environments like in Haiti; helped government officials to engage in a more productive dialog with innovative entrepreneurs in countries with a history of state control like Croatia; and used a cluster based approach to fine tune national policies and redefine their reform matrixes, like in Jordan.
Cluster-based approaches provide unique tools to map entrepreneurial ecosystems, perform industry and value chain analysis, design sector specific policies to support SMEs indirectly by addressing common market failures, and implement them in a cost-effective, at-scale manner. Cluster-based approaches are primarily sector-specific in their policy focus to enhance productivity, not sector-picking in artificially raising the profitability of specific sectors. It is at this sectoral level that efforts to address market failures, for example investing in skills, technology, and common infrastructure and to ensure that markets operate effectively, such as balancing existing market dominance through blockchain and other technologies, can be more effective than cross-cutting policies alone. The World Bank has a powerful role to play in ensuring that this new era of sector specific and location specific efforts takes advantage of the best evidence and thinking available, overcoming some of the challenges that have hampered their predecessors in the past.