Productivity and development: Competitive services can help, but can’t do everything

Cover-PGD_2014To mark the start of OECD Development Week, today we’re publishing an article by Martin Wermelinger of the OECD Development Centre

Strong growth over much of the past decade, particularly in China, has substantially boosted developing countries’ share of the global economy. In 2010, the share of global GDP of non-OECD countries overtook that of OECD countries, when measured in terms of purchasing power parity. But will this process of “shifting wealth” allow these countries to eventually converge with advanced country per capita incomes?

The 2014 edition of OECD Development Centre’s Perspectives on Global Development shows that, at their average growth rates over 2000-12, several middle-income countries will fail to reach the average OECD income level by 2050.Their challenge is deepened by the slowdown in China, where rapid growth has up to now benefited its suppliers, in particular natural-resource exporters. Boosting productivity growth will be the key for middle-income countries to stem this trend and help them sustain the transition towards high income levels.

During the transition away from being a low-income economy, productivity is boosted by shifting labour from lower to higher productivity sectors. This shift can continue to be an important factor even in middle-income countries, for example India and Indonesia. But once this process slows down, the focus needs to turn increasingly to productivity gains within sectors. This shift is evident in overall productivity growth in OECD countries. It is also evident in China, which has raised productivity in many manufacturing industries by tapping global knowledge through foreign direct investment and by importing capital goods and components.

For sustained convergence, productivity growth needs to accelerate. Over the past decade, productivity growth made only a marginal contribution to economic growth in many middle-income countries. The report shows that it was also insufficient to significantly reduce the very large gap in productivity with advanced countries. In Brazil, Mexico and Turkey, the gap even widened. By contrast, China recorded impressive growth in productivity: around 10% annually in labour productivity in manufacturing and services. Nonetheless, China’s labour productivity remains below one tenth of the levels of the United States.

Productivity slowdowns in middle-income countries can be associated with difficulties to move up the value chain, away from a low labour cost-driven to an innovation-driven growth path. The report argues that countries need to make greater efforts to diversify their economic structure towards higher value activities. To do this they have to increase the levels of educational attainment and skills of their labour force and improve their capability to innovate – to produce goods and services that are new to the economy. They can do the latter by importing new ways of producing and distributing goods and services, as well as by developing their own which can better suit their specific conditions or give them a competitive edge in the international market. There are also opportunities to boost growth and productivity in the economy by advancing better regulation and competition policies, improving capital and labour markets, and facilitating a more effective integration into global value chains.

The report devotes special attention to the services sector that has great potential to boost overall productivity and so support middle-income countries to converge to advanced-country income levels. First, rapid progress in ICT has allowed economies of scale in the production of most services and spillover effects to be realised. For example, countries where manufacturing sectors use outsourced business services are shown to be more productive. Second, the ICT revolution means that services can now be traded across borders, with India being the classic success example of this. And finally, as poor workers swell the ranks of a growing middle-class society, consumption of and demand for variety in products and particularly services will increase. Thus, identifying the emerging demands of domestic consumers and producing the goods and services to meet those new demands can boost growth in middle-income countries.

In fact, services contributed more than half of overall growth over much of the last decade in the BRIICS. Nonetheless, bypassing industrialisation and focusing directly on boosting services is not – or not yet – a proven success strategy for upgrading to middle-income, let alone to high-income, status. Even small, rich service economies like Singapore first industrialised comprehensively.

Although not exclusively, services can also help create jobs and – with their relatively low resource intensity – drive inclusive, sustainable development. Ultimately, however, the most effective combination of policies to reach the target of convergence through inclusive and sustainable growth will depend on the specifics of each country and, importantly, the capability of its governments not only to develop but also to implement their strategies. Governments need to obtain support for necessary reforms through consultation processes where key stakeholders – including private businesses, local communities and civil society – can voice their opinion and help formulate and implement strategies.

Useful links

Global Forum on Development

International Economic Forum on Latin American and the Caribbean

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