Asia’s emerging economies risk being caught in the “middle income trap” if they pursue services at the expense of manufacturing, the Asian Development Bank (ADB) has warned. The latest report from the regional lender came amid increasing capital flight from the region and warnings of another Asian financial crisis, should its leaders fail to learn the lessons of past mistakes.
In its flagship annual report, “Key Indicators for Asia and the Pacific 2013,” the bank said services had the largest share of developing Asia’s output, yet agriculture still employed around 43 percent of Asia’s workers. Only industrialization could ensure countries such as Malaysia, the Philippines and Thailand joined their higher-income peers including Japan and South Korea, it said.
The ADB said a group of economies including China, Malaysia and Thailand were transforming more slowly than their wealthier counterparts, while other emerging nations such as Bangladesh, India, Pakistan and the Philippines “are changing even more slowly, have created few manufacturing jobs, and are shifting from agriculture into services.”
“Historically, no economy has reached high income status without reaching at least 18 percent share of manufacturing in output and employment for a sustained period,” the ADB’s chief economist Changyong Rhee said.
“Right now, as services boom in the region, it’s tempting to shun industrialization, but it will be a serious mistake if a country wants to be prosperous,” he added.
Despite manufacturing’s declining status in advanced economies such as Australia, the report said modern industrial and service economies “have manufacturing at their core.” It said industrialization was essential to a high productivity services sector, technological innovation and agricultural modernization.
“We estimate that an economy where the shares of manufacturing in total employment and output are at least 18 percent has a 42 percent probability of achieving high income levels, but the probability of an economy with a small manufacturing sector (in both output and employment) achieving high-income status is less than 5 percent,” the ADB said.
While agriculture’s share of gross domestic product and employment had declined since the mid-1970s, the report noted that it remained the largest employer in 17 economies, including India, where its proportion of workers was still increasing.
“Many economies are not following a transition from agriculture into industry and finally into services – the path taken by East Asia and before, Japan and the Western countries,” the ADB said, adding that “success in raising agricultural productivity underpins the entire process of industrialization”.
“For middle income economies heavily dependent on labor-intensive sectors or currently bypassing industrialization, the focus should be on upgrading their industrial base. For these nations, good quality education is essential for industrial diversification and reducing the path-dependency nature of structural transformation,” the ADB added.
The bank said China and India had directed their efforts toward “making inexpensive versions of existing goods” but more innovation was needed.
Malaysia warning
Malaysia’s Malay Mail Online said the report’s warning came despite Malaysia’s continued move away from manufacturing toward a “knowledge-based” economy and services. It noted that the nation’s Economic Transformation Plan targeted financial services as the “bedrock” of the economy in its push to achieve high income status by 2020.
“Malaysia made a concerted push towards industrialization during the Mahathir administration but has gradually moved away from manufacturing since then,” the daily said, noting that the services sector accounted for around half its GDP, with manufacturing at 41 percent.
Malaysia’s challenge “will be to upgrade and deepen its already diversified industries, either by developing domestic capabilities or localize technologies from foreign direct investment efforts,” it added. The ADB had warned the nation it could remain stuck in the middle income trap should it fail to produce more technologically advanced products.
Fukuyama: “death of the middle class”
Ironically, the bank’s call for industrialization came after U.S. political commentator Francis Fukuyama claimed he saw the death of the middle class in services-oriented developed nations, such as the United States.
“It’s not just the low-value jobs; it’s jobs higher up the chain which are simply evaporating,” he told a Sydney forum, saying jobs were being exported to low-cost countries or being lost in technological change.
However, nations such as Germany with a large manufacturing base had succeeded in keeping employment and staying competitive through investment in training, he said.
For the ADB, the “full modern development” of Hong Kong, Japan, South Korea, Singapore and Taiwan presented a better model for the region’s new economies. Will they heed the lessons before it is too late?