Rethinking manufacturing-led growth | Sunday Observer

Rethinking manufacturing-led growth

The manufacturing sector has become the primary means of labour absorption and has helped promote the structural transformation of the Sri Lankan economy since the 1980s. File pic: Lake House Media Library
The manufacturing sector has become the primary means of labour absorption and has helped promote the structural transformation of the Sri Lankan economy since the 1980s. File pic: Lake House Media Library

World production and trading structures are undergoing profound changes. The Manufacturing sector has been the primary channel for much of the trade-led development and structural transformation in many developing and emerging countries since the 1980s, creating vast numbers of job opportunities, especially for unskilled labor, set to undergo significant transformation. A new wave of technological developments, characterized by Internet driven services (such as cloud computing and big-data analysis), robotics and 3-D printing, combined with the transformation of globalisation patterns — suggests that ‘business as usual’ is not likely to lead to the same types of gains in the past and may, instead, leave some behind.

The role of manufacturing in economic growth and development has been realised due to its tradability in international markets and associated low protection rates across its value chain, has provided greater opportunities to access demand beyond the domestic market allowing the expansion of productive capacity and employment in developing countries.

This has enabled the achievement of scale economies (the cost advantage that arises with increased production) and other dynamic spillover benefits, including knowledge and technology diffusion, contributing significantly to the upgrading of capacities and skills.

Although agriculture commodities are also traded internationally, as per capita incomes rise, the share of agricultural products in total expenditure declines, while the share of manufactured goods increases, giving rise to greater demand not only from developed countries but increasing demand from other developing countries.

Evidence shows that manufacturing growth in Sri Lanka is consistent with the above international experience. The manufacturing sector has become the primary means of labour absorption and has helped promote the structural transformation of the Sri Lankan economy since the 1980s. Manufacturing contributed to more than half of total employment growth from the 1980s and two-thirds of new jobs created in Sri Lanka from the 1990s and 2000s. Manufacturing has played a pivotal role in the reallocation from less productive agriculture, boosting labor productivity as it did in much of the developing world, and creating opportunities for new entrants into labor force, especially women. Manufacturing now accounts for 17 percent of national income and absorbs 17.5% of employment. On the downside, much of the exports have been dominated by garment assembly, a segment with relatively low value-added per worker and low productivity spillovers, which will continue to face significant competitive pressures, favoring lower cost locations. Sri Lanka, like other developing countries outside East Asia, by and large, missed out on growth-enhancing segments of manufacturing value chains due to market dynamics and technological and policy deficits.

Industrial Revolution 4.0

Since the global financial crisis, world trade has experienced weak growth due to cyclical factors, notably slowing import demand from developed countries due to weak income growth, but also structural factors—namely, lower growth elasticity of trade to income (people are buying less as a share of increasing incomes). These trends have been further complicated in recent months, with a retreat from global trade and engagement, with Brexit and the new US Administration’s more protectionist policy leanings, contributing not only to further reductions in demand, but also to increased uncertainty within global trading system. Global value chains (GVCs)--the medium through which manufacturing trade has proliferated--has been in decline since the global financial crisis and appears to have “plateaued” in recent years.

Meanwhile, a new wave of disruptive technologies, collectively termed as “Industrial Revolution 4.0”, has emerged—from the Internet of Things (IoT) to advanced robotics to 3-D printing—are dramatically changing the way in which goods are manufactured. These new technologies are mostly labor-saving, efficiency enhancing tools that are likely to narrow the path for less developed countries to realize the pro-development characteristics that manufacturing has traditionally offered, i.e. job creation, particularly for lower skilled workers. Increased automation in high-income countries due to the use of robotics and other efficient techniques like smart factories have already enabled some leading firms reshore historically labor-intensive manufacturing activities back to high-income economies and closer to the final consumers. This transformation is not confined to manufacturing, as discovered by India, which until recently was the leading producer of cashew, losing out to the ingenuity of automation in Vietnam.

Despite these warning signs the World Bank estimates suggest the threat to existing jobs losses from the changing manufacturing landscape may be around 2 to 8 percent. The production of textiles, garments, and footwear for example continue to be labor-intensive and has not seen significant degree of automation yet. The ‘lead goose”, China likely to shed some of the production as wage pressure rises, but, Africa is likely to be favored destinations for FDI due to its better market access conditions to EU and US.

Silver Linings

An important phenomenon in the new manufacturing landscape is services that are embodied in goods (design and branding) or embedded for their customers (such as sales and after-sales services bundled with goods). This process called ‘servicification’ of manufacturing are increasingly a source of manufacturing competitiveness—a process expected to intensify as IT enabled “smart” factories and other processes take hold. Sri Lanka has proved some capability within IT enabled services such automated application testing, infrastructure outsourcing, Enterprise Resource Planning (ERP), Cloud Technology, Mobile Applications and many other Business Solutions, are some trade enabling technologies that can be source of comparative advantage. Services inputs (design and branding of garments, which are value added activities) Sri Lanka has proven capability. More importantly, the service sector has proved as an enabler of manufacturing global manufacturing transactions through port and logistics services, with the prospects of emerging strongly as markets mature around proximity. The increasing manifestation of productivity-enhancing features in services, especially ICT-enabled trading opportunities and demonstrated effects of deregulation, means that services can yield the benefits of scale, greater competition, and technology diffusion similar to what manufacturing offered.

While the links between manufacturing and services are deepening, many developing countries,including Sri Lanka,continue to carry out dualistic policies between manufacturing and services. Protection tends to be stronger against imports of services, even though more-open policies would help countries develop more-competitive and more-productive services sectors, which in turn would feed into more-competitive and more-productive manufacturing sectors. Experiences elsewhere have shown deregulation in air and road transport, the abolition of antitrust exemptions for maritime liner transport, the privatization of ports and port services, and the divestiture and dismantling telecommunications monopolies are the main examples of regulatory measures that have reduced the cost of service delivery across borders.

Opportunities

Layered on top of Industrial Revolution 4.0 and Servicification is the rapidly evolving changes in the geographic orientation of global value chains. Experience has shown that market density and proximity are key to engaging in GVCs, especially in the growth-enhancing segments. India’s signature “Make-in-India” initiative and “Made in China 2025”, sets Colombo potentially at the epicenter of a new production hub.Coupled with the growth of consumer demand in India, China (own rebalancing relative to investment and exports) and other Asian markets, a new center of economic gravity is emerging, likely to bring increased demand for smart manufacturing and, in turn, drive demand for high-skilled, low-cost labor and most importantly for service enablers like transport and logistics and related IT centered service providers. Creating unfettered access to larger markets such as India and along the Indo-Pacific corridor could certainly help prospects of reinforcing Sri Lanka’s existing capabilities within services and manufacturing and generate new ones.

Connectedness

The changing landscape poses new challenges for low and middle-income countries, like Sri Lanka, that have relied, in the past, on light manufacturing to drive trade-led growth. New technologies and shifting patterns of globalization will require Sri Lanka and others to rethink their growth and integration strategies.

For example, if the only way to remain competitive is the adoption of new technologies, manufacturing’s job creation features will not be as pronounced, and manufacturing-led growth may not be able to absorb lower skilled workers in the future. On the flip side, if countries can maintain the use of traditional production processes, increasing their efficiency overtime, job potential would remain. However, the impact on productivity could fall over time, leaving them open to competitive pressures, i.e. “business as usual” is likely to buy some time but, eventually, the future will arrive.

There are still strategic questions on how to strengthen competitiveness, capabilities, and connectedness, (3Cs) including through targeted policies. The focus is on what is new in the debate over horizontal and targeted approaches, including whether it will be possible to leapfrog and use new technologies with a limited manufacturing base. On the one hand, it may be more feasible to meet the more challenging requirements on the 3Cs by targeting locations and sectors. On the other hand, placing bets on a specific sector is fraught with risk, given the uncertain nature of technological change. The increasing interdependence between sectors also means that attempts to support production activities in isolation from complementary services are unlikely to be successful. Similarly, when choosing specific locations for developing production activity, setting up linkages will be more important than in the past, given the premium on technology diffusion and connectivity.

On connectivity, the recently ratified WTO Trade Facilitation Agreement (TFA) provides Sri Lanka a robust, time-sensitive opportunity to address issues on trade facilitation and reduce transactions costs to take advantage of both manufacturing and service sector opportunities.

The disruptive impact of changing technologies and the new globalization patterns could be greatly ameliorated by the extent to which new businesses, jobs, and markets can be developed.

Sri Lanka must take stock, identifying its potential strengths in this newly emerging global economy and shape its policies in a way that enables adaption and mitigates risks.

While an increasingly uncertain and fast-changing global economy puts in question the right way forward, one thing is certain—business as usual is not an option.

The writer is a consultant to the World Bank on trade and development. The views expressed herein are the author’s own and do not necessarily reflect those of the World Bank.

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