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

Rules of the road

taxis take to the streets
Taxis take to the streets

Visitors to Paris may have noticed that it can be hard to find a taxi. Lately, there have been days when it was impossible. The explanation? A strike.

Before you roll your eyes, it’s worth taking a moment to hear what’s riling the taxi-drivers. Yes, in many ways this feels like the sort of dispute we’re used to around here – shouting, blocked streets, frustrated travellers. But it also reflects issues that are playing out in many other parts of the world and that can be summed up in a word: regulation.

The roots of the dispute date back to 2009, when France licensed a new sort of taxi, a “passenger vehicle with chauffeur,” or VTC. These VTCs operate under rules similar to those covering “mini-cabs” in the United Kingdom: You can call one to pick you up at home, but – unlike a regular taxi – you can’t hail one in the street.

Even though VTCs are not full competitors, the taxi drivers don’t like them. They point to the fact that taxi drivers have to pass a test; VTC drivers don’t. But a bigger gripe is money. VTC drivers pay €120 for a licence. By contrast, a taxi licence is free – in theory. In practice, it’s anything but. In Paris, the price currently seems to about €240,000 (around $320,000). The reason it’s so high is that, as Le Parisien (in French) explains, only a very limited number of taxi licences are issued. If you want to secure a free licence you may have to wait 17 years. So, instead, would-be drivers buy licences from drivers who are retiring.

Still, despite their resentment, it’s possible that the taxi drivers might have learned to live with the VTCs – after all, old-style taxis in London seem to do fine despite being vastly outnumbered by mini-cabs. However, the emergence of new technologies has probably put paid to that hope. Using an app on your smartphone, you can order a VTC, provide your location and pay the fee with just a few swipes on your screen. That’s increasingly blurring the distinction between regular taxis and VTCs, and seems to have been the final straw for the taxi drivers. Hence the strike, and an announcement by the government last week that it would work to draft “new rules for balanced competition”.

That could prove challenging. The taxi drivers are angry: “Today, we are facing direct competition from VTCs that work virtually without regulation,” Karim Lalouani, a member of a taxi union, told RFI. “We are not fighting on equal terms.” But for their part, the VTC operators say they’re filling a gap. Certainly, by international standards France is short of taxis. The national total of 55,000 taxis and 12,400 VTCs is below the combined total of 72,000 for London alone. “People in France are fed up with monopolies,” Pierre-Dimitri Gore-Coty of US-based Uber, which operates VTC services in France, told The Economist. “The French now realise that in real life more competition brings innovation and improves the level of service.”

But even when new regulations appear, technology could make them outdated very quickly. After turning VTCs into quasi-taxis, app technologies are now turning anyone with a car, clean licence and a smartphone into a potential taxi driver, according to Stephen Shankland.

If it’s any comfort to the French regulators, they’re not the only ones facing challenges. In the United states, says The New York Times, “regulators, courts and city halls are struggling to define Uber. Is it a taxi company or a technology platform?” And it’s not just taxis. Services like Airbnb and FlipKey now mean that anyone with keys to an apartment can become a hotelier. Some cities aren’t happy. New York has subpoenaed Airbnb. By contrast, Amsterdam, has changed the rules to make Airbnb-style rentals easier.

So, what to make of this particular regulatory debate? Are existing service providers, like hoteliers and taxi drivers, being forced to play on an uneven playing field? Or are they a vested interest defending market rules that don’t serve consumer needs? Or are consumers facing increasing risks from “rogue” operators?

While pondering these questions, you might like to take a broader look at how OECD countries – including France – stand on a wide range of regulatory issues that affect competitiveness in our economies. This new data tool (below) has just been released alongside the latest edition of Going for Growth, the ongoing OECD project that examines the impact of structural policies, including regulation, on growth. The tool compares regulation and competition rules between countries across a wide range of markets, including telecoms, power and legal and other professional services. Ideal for passing the time while you’re waiting for that taxi.

Useful links

Going for Growth

OECD Indicators of Product Market Regulation

Manu-services: best of both worlds

Click to download the report

Today’s post is by Andrew Sissons, from the Work Foundation in the UK. His research focuses on the key sources of growth and new jobs in manufacturing, business services and the digital economy. Andrew will be discussing future of manufacturing in a service economy on October 4that the Northern Ireland Economic Conference.

The financial crisis has left behind many lessons for developed economies. Among the most widely accepted is the need for advanced economies to re-balance towards manufacturing and other export-intensive activities, reversing decades of relative decline in manufacturing.

At times, the arguments in favour of manufacturing have taken on a moral character. We are often told that we need to get back to “making things”, replacing the dangerous alchemy of financial services with good, honest graft. This type of hand-wringing is not especially helpful, especially in a modern, diverse economy. Manufacturing is not important because it involves making things, but because it is highly export-intensive, innovative and productive (three things that all advanced economies desperately need at a time like this).

But there is another problem with characterising manufacturing as being about just “making things”: in short, it isn’t. Modern manufacturing is an incredibly complex industry, which includes a wide range of different activities, from design and development to marketing and after-sales care. The Work Foundation’s report More than making things argued that much of the future growth in manufacturing will come from “manu-services”, which involves combining advanced manufacturing with a range of different services.

This might sound far-fetched, but it is part of a trend that has been underway for years. In the UK, just 42% of manufacturing jobs are in production occupations; the rest are in service-related and professional roles. Ground-breaking research from Prof. Andy Neely suggested that almost 60% of US manufacturers now consider themselves to be manu-service firms, selling a combination of goods and services.

So what do these mysterious manu-services actually involve? While the answer seems straightforward – anything which combines manufacturing and services – in reality this encompasses a lot of different trends. Some manu-services involve designing bespoke products around the customer’s needs, so that neither buyer nor seller know what it will look like when they sign the contract (for instance, a defence firm might develop an advanced new system in this way). Others involve selling long-term service contracts, with maintenance and after-sales care guaranteed along with the product (the Rolls-Royce “power by the hour” model is the most famous example of this).

What matters is not which services are provided, but how they benefit the customer. For manufacturers, manu-services is not just a new market; it involves switching to an entirely new business model. Companies no longer sell goods – they sell whole packages, to provide experiences, outcomes or solutions. They develop lasting relationships with their customers, rather than relying on a series of one-off transactions. That means that they have a range of new ways to innovate and differentiate themselves; not only can they develop better and cheaper goods, they can also improve the services they offer.

In fact, we believe that manu-services have replaced “high-tech” manufacturing as the key source of potential comparative advantage for manufacturers within an increasingly competitive global economy. Many emerging economies are expanding rapidly into high-tech manufacturing – defined rather arbitrarily by the proportion of their turnover that companies spend on R&D – while some developed countries – especially Britain – are seeing their high-tech manufacturing base contract faster than low-tech manufacturing. By contrast, manu-services are hard to deliver, and therefore harder to copy. If a country can build up expertise in manu-services, it is likely to be able to hold on to it.

But all this integration of manufacturing and services, and the switch to a radically different business model, is not easy for companies to achieve. Neely’s research suggests that manu-service firms are less profitable, and more likely to go bust than “pure” manufacturers. And as it turns out, it is the biggest firms that appear to struggle most with the switch to manu-services. This is unexpected – you’d expect the most innovative firms to be most profitable – and it isn’t exactly clear what causes it. It may be due to the challenges of coordinating many different service activities, or the initial costs involved in changing business models. But whatever the causes, it is in our interest to help companies overcome these problems.

And this is where government policy comes in. We set out a range of measures that government can put in place to support manu-service companies, above and beyond the policies required to support manufacturing in general. We believe that governments should consider introducing Centres of Excellence for new business models, so that companies can benefit from the latest academic thinking. We’d like to see manu-service firms have access to advice, finance and insurance to help them cope with the extra risks involved in manu-services. We also need a skills agenda that provides graduates with a mix of engineering and business skills. But most of all, we need governments to take manu-services seriously, and embed it at the heart of their economic policies. At present, it is almost impossible to define and measure manu-services, let alone promote its growth.

Useful links

The OECD Innovation Strategy

The OECD Science Technology and Industry Scoreboard 2011

The OECD Employment Outlook 2011

OECD work on new sources of growth