The window for developing countries to progress by relying on cheap workforces to drive export growth is closing, according to the McKinsey Global Institute.
The think-tank fears that structural shifts in global trade patterns will make it ever harder for poorer countries to pursue rapid catch-up economic growth via industrialisation, the model followed by virtually every nation to have reached developed status, as well as the likes of China and Vietnam that are part way through the same process.
“For decades, fostering labour-intensive manufacturing for export was seen as the best strategy for low-income countries to climb the economic ladder. Now the window of opportunity is narrowing,” said Susan Lund, a partner at the McKinsey Global Institute.
“I don’t think the window has completely closed for this development path, but it is closing and in 10 years from now it’s going to be very small,” she added. “The advantage of having a large low-wage workforce is eroding.”
As a result, countries that have only just started to pursue labour-intensive manufacturing for export, such as Tanzania and Ethiopia, may need to “ramp it up immediately” before the window of opportunity slams shut.
The warning follows that of Eric Lueth, global emerging markets economist at Legal & General Investment Management, who said last month that “a lot of countries are being left behind,” as they succumb to “premature deindustrialisation”.
McKinsey’s research suggests that the importance of labour-cost arbitrage is declining in the most labour-intensive goods manufacturing sectors, such as textiles and apparel, furniture and toys, areas where more than two-thirds of income goes to labour, most of which is low skilled.
It found that just 43 per cent of trade in textiles and apparel was based on labour-cost arbitrage in 2017 (defined as exports from countries whose GDP per capita is a fifth or less than that of the importing country), compared with 55 per cent in 2009, as the first chart shows.
For furniture, toys and other labour-intensive goods, there has been a decline from 43 per cent to 35 per cent over the same period. Ms Lund said the erosion on the importance of labour-cost arbitrage was “a surprising finding but it sits very well with what we hear from companies on the ground.”
She cited the example of Lincoln Electric, an Ohio-based manufacturer of welding products, which has operations in China but, as it has adopted more automated production technology, has opted to expand in Ohio instead.
“As it is very automated, the labour costs are a small part,” Ms Lund said. “Although there is still a wage differential, the cost is basically the same in Ohio.”
Similarly Adidas, the German sportswear company, has redesigned its footwear to make production less labour intensive and opened high-tech “Speedfactories”, encompassing 3D printing, robotic arms, and computerised knitting in the US and Germany, reversing the trend whereby footwear manufacturing was largely offshored to low-wage producers such as China, Indonesia and Vietnam.
“Labour costs are not as important. What companies are focusing on is speed to market, particularly in textiles and apparel, in an era of fast fashion,” Ms Lund said. “It’s a blow to developing countries.”
Reshoring work back to the west also allows companies to have closer relationships with their suppliers in order to collaborate on materials and production processes, while integrating the work of multiple suppliers for just-in-time sequencing becomes less fraught as well.
With China also bringing more of its supply chains inside its borders, the net impact is that the importance of international trade has fallen.
McKinsey calculated that trade intensity (the ratio of gross exports to gross input) rose rapidly from 1995 to 2007, when it peaked at 28.1 per cent. It has since fallen back to 22.5 per cent.
In addition to this, trade has become more regional. The share of goods traded within the same region fell from 51 per cent in 2000 to 45 per cent in 2012, MGI said, but has rebounded to 47.7 per cent, led by Asia and Europe. This reduces the scope for emerging countries to sell to the rich west.
The benefits of a large, low-cost workforce are also being eroded by the increasingly knowledge-intensive nature of global value chains, McKinsey said.
Across all value chains, capitalised spending on research and development and intangible assets such as brands, software and intellectual property has risen from 5.4 per cent of revenue in 2000 to 13.1 per cent in 2016, it found. This greater emphasis on knowledge and intangibles favours countries with highly skilled labour forces.
An incremental shift in the global economy away from physical goods to services is another headwind for emerging markets.
While goods still dominate, with gross trade of $17.3tn in 2017, compared to $5.1tn for services, the latter has grown 60 per cent faster over the past decade. Moreover, McKinsey argued this understated the importance of services, given they account for about a third of the value that goes into traded manufactured goods, in areas such as R&D, sales and marketing, finance and human resources.
Again this favours developed countries, which ran a combined $479bn trade surplus in services in 2017, double that of a decade earlier, as the second chart illustrates.
Ms Lund argued that while the trends were problematic for emerging markets as a whole, some countries have been able to find a profitable niche.
Some, such as Costa Rica, India and the Philippines have “excelled” at exporting services. However, even this may not be enough, with much of their success coming in automatable services such as call centres, “so I don’t think that’s very sustainable,” Ms Lund said. She believed these countries would need to move into solving more complex customer problems if they wanted to maintain market share.
Some other countries, notably Vietnam, have succeeded in increasing labour-intensive exports, even as they has become less important on a global basis.
The greatest difficulties, though, may be faced in Africa and Latin America, Ms Lund argued, given low levels of intra-regional trend in those continents, in a world where supply chains are increasingly regionalised.
“Their challenge is to create markets with more economies of scale,” she said. “In Africa that needs to be centred on regional blocs, eg a west Africa bloc centred on Nigeria and a southern one centred on South Africa. East Africa has gone the furthest in terms of creating a tariff-free union.
“I think that is going to be a big part of the solution for Africa, that and getting their birth rate down because they still have a young and rapidly growing population in many countries, and then your GDP growth has to be so much higher to get people out of poverty.”
One glimmer of hope may be the progress some north African countries, such as Morocco are making in labour-intensive manufacturing, such as in automotive parts, for the European market. Just as the original North American Free Trade Agreement helped spur the growth of Mexico-bound supply chains in central American countries outside of the Nafta bloc, Ms Lund was hopeful that sub-Saharan African countries could one day become suppliers to north African manufacturers producing goods for the European market. —Financial Times