Production-based development, not service-based development, is still king – Georgios Ardavanis (Ph.D.)

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Laborers are usually transferred from low-productivity industries, including subsistence farming, to high-productivity industries as part of development. This suggests a move toward manufacturing since it allows for economies of scale and specialization, both of which are necessary for increasing output per worker. As evidenced by Japan, Taiwan, South Korea, and now China, manufacturing can expedite development as well because its products can be exported to wealthy nations.

In contrast, services seem to be a productivity graveyard. There is very little opportunity to take advantage of economies of scale and export as a haircut or a meal at a restaurant must be delivered in person. When affluence reaches a point where most of their other wants are met, rather than when technology advances and services become more affordable, people start consuming more of them. William Baumol made the well-known claim in the 1960s that productivity growth would ultimately slow down as nations became wealthier and their people became more averse to paying for services.

This common thinking is currently being questioned in a book published by Ejaz Ghani of the World Bank and a companion piece he co-wrote on the VOXEAU website with Homi Kharas of the Brooking Institution and Arti Grover of the World Bank. The authors contend that the traditional limitations still heavily influence technology and outsourcing-enabling activities including trade, lodging, dining, and public administration. However, modern services can be exported, involve specialized labor, take advantage of economies of scale, and include software development, contact centers, and outsourced corporate processes (from insurance claims to medical record transcription). Stated differently, they are analogous to manufacturing. If that’s the case, developing nations ought to be able to skip manufacturing altogether and move directly from agriculture to services.

Services are superior to production in several ways. They are less likely to pollute the environment and can hire women more easily. Their large urban locations hasten the process of urbanization. It can be argued that modern services are less susceptible to protectionism than goods or conventional services like legal representation, which both need physical access to foreign markets. But not every nation will benefit equally from services. Much good fortune favored South Asia. The top software exporters from India were started by engineers who had studied in the United States and had returned home. In the USA, the large English-speaking population aids with service sales. Numerous other emerging nations do not possess these benefits. It’s also critical to note that the success of services in many nations is a reflection of their manufacturing failures. Restrictive labor rules in Sri Lanka and India have hindered the development of a more competitive industrial base. On the other hand, India supported its IT industry by designating it as a critical industry and removing state-level bans on 24-hour operations. The number of phone lines and personal computers per 100 inhabitants in South Asia indicates that the region has profited from investments in telecom infrastructure, although manufacturing is hampered by a lack of paved roads.

This shows that the traditional wisdom—that manufacturing has the most promise for millions of moderately well-paying jobs—is still valid for nations that avoid those issues. At least there is an option for people who are not as fortunate.


Georgios Ardavanis – 10/11/2023

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