Industrialization has always been central to poverty reduction. But today’s global and technological context means that economic growth in developing countries is now only possible by increasing productivity in small, informal enterprises that employ the bulk of the poor and lower middle classes.
Illustration of TBS
Illustration of TBS
This is a mistake, because the real determinants of poverty may lie some distance from poor households and communities. Economic development requires productive non-farm jobs.
Increasing employment opportunities in cities and encouraging migration from the countryside to urban areas can raise incomes more effectively than helping people become better farmers or providing them with cash subsidies.
Indeed, industrialization has always been essential to poverty reduction. Of course, the benefits of industrialization-led economic growth often take time to be felt. During the British Industrial Revolution, the living conditions of urban workers improved very slowly, if at all, for almost a century until the rise of unions and other institutional changes corrected the power imbalance with employers.
But the more recent experience of rapid and export-oriented industrialization of East Asian and Chinese tigers has compressed this process and produced miracles of poverty reduction alongside miracles of growth.
There are clear signs that we are now entering a new era in which industrialization will no longer be as effective in diffusing the benefits of economy-wide productivity gains. Global trends in innovation have dramatically reduced the potential of manufacturing industries to absorb low-skilled workers. The share of labor in value added has decreased rapidly in these branches, in particular for these workers.
And while globalization has accelerated the transfer of manufacturing from advanced economies to developing economies, global value chains have proven to be a weak driver at best in creating good jobs, as they are a transmission belt for skills and capital intensive technologies, and because their business model is based on imported inputs and lack of integration with the local economy.
Globally competitive manufacturing industries in developing economies increasingly function as enclaves, much like capital-intensive, export-oriented extractive industries. They can boost exports and higher incomes for a narrow segment of the economy, but they bypass most workers, and especially the less educated.
This growth model is insufficient not only for reasons of equity or poverty reduction; it also fails to promote high growth because higher productivity activities cannot encompass a growing share of the economy.
Just as resource-rich economies rarely develop for long (apart from terms of trade booms), the industrialization model is no longer capable of generating rapid and sustained economic growth.
So what should today’s growth model look like? As always, investments in human capital, infrastructure and better institutions remain essential for long-term economic gains. These are the fundamentals of economic convergence with rich countries.
But a meaningful growth strategy must improve the productivity of the existing workforce, not that which may emerge in the future from such investments.
Developing countries retain significant potential for increasing agricultural productivity and diversifying from traditional crops to cash or export crops. But even with more productive agriculture – and indeed thanks to it – young workers will continue to leave the countryside and flock to urban areas. They will be employed not in factories but in informal micro-enterprises in low productivity services with poor prospects for expansion.
Therefore, next generation growth policies will need to target these services and find ways to increase their productivity. The reality is that few informal businesses will become “national champions”.
But by offering a range of public services – help with technology, business plans, regulations and training for specific skills – governments can unlock the growth potential of the more enterprising among them.
The provision of such services may be made conditional on government oversight and flexible employment targets. This would allow positive self-selection, only micro-enterprises with higher capacities choosing to subscribe to government assistance.
Traditionally, East Asian-style industrial policies target the largest and most productive manufacturers most likely to become exporters. Rather, future “industrial policies” should focus primarily on small service companies, most of which are unlikely to be exporters.
This new generation of industrial policies targeting low productivity segments can both improve the livelihoods of the urban poor and boost productivity in sectors of the economy that absorb labor.
One implication is that social policy and growth policy will increasingly overlap. The best social policy – enabling sustainable poverty reduction and enhanced economic security – is to create more productive and better jobs for workers at the bottom of the skill distribution.
In other words, social policy must focus as much on businesses as it does on households. And the new global and technological context means that economic growth is now only possible by increasing productivity in small, informal enterprises which employ most of the poor and lower middle classes. Development policy can finally unify.
Dani Rodrik, Professor of international political economy at the John F. Kennedy School of Government at Harvard University, he is the author of Straight Talk on Trade: Ideas for a Sane World Economy.
Disclaimer: This article first appeared on Project Syndicate and is published by Special Syndication Agreement.