Productivity, Learning and Industrial Development

The East Asian countries have been growing more than twice as fast as the rest of the world for twenty-five years. While East Asia has grown continuously, the Middle East and North Africa region has faced a real crisis of growth. For the last ten years, average per capita incomes have declined in the major Middle East economies, which gives an urgency to the question of how to renew economic growth.

Economists tend to think that there are two sources of growth: 1) the accumulation of both physical and human capital assets; and 2) the efficiency with which those assets are used. We have attempted to estimate how much of the difference between the spectacular East Asian growth and the rather dull Middle East growth is due simply to more physical and human capital in East Asia, and how much can be attributed to the efficiency with which these assets are used. The findings are astonishing.

In 1960, the eight major Mashreq and Maghreb economies had a higher per capita income than the East Asian "superstars." By 1991, Middle East incomes had risen from about US$1,600 to US$3,300 (in dollars corrected for purchasing power differences among countries). In the eight East Asian "superstars," incomes had risen to about US$8,000. If during that time the investment rate in MENA were to have increased from its 25 percent average to the East Asian average of 35 percent, these countries’ economies would have gained about US$500 of per capita income. If the average level of education per person in MENA had been at the level of East Asia, income would have increased by an additional US$1,300. But there is still an income gap of nearly US$3,000. The gap cannot be explained by differences in human or physical capital. It is due to productivity differences — the efficiency with which production factors are employed. In fact, while productivity growth in East Asia has been positive, it has been negative in the Middle East and North Africa over the last 25 years.

These estimates of the total factor of production (TFP) give a simple way to look at international competitiveness: Differences in TFP settled differences in production unit-costs between economies, and the higher the productivity growth rate, the faster the decline of economy-wide unit-costs of production. In the world productivity table, East Asia is the leader — ahead of the OECD. Latin America's track record over the last 30 years has not been as remarkable, but at least TFP growth has been positive. In MENA, in contrast, unit-costs of production have been rising over the last 30 years.

To illustrate the difficulty of trying to catch up economically with negative productivity growth, imagine seeing a friend on an escalator going up while you are on the down escalator. The only way to catch up would be to turn around and run as fast as possible up the down elevator to the top — an exhausting task. In economic terms, this is the equivalent of growing only through increased investment. It is therefore no wonder that many are concerned by the lagging productivity change.

How can the kinds of innovations and learning be encouraged to move the region from negative to positive TFP growth? It would be disingenuous to say that economists agree on the sources of productivity change, but there is at least one view that is generally shared. There is tremendous potential for poorer countries to have more rapid productivity change because they do not need to invent; they can simply import and adapt technologies from the rest of the world. Historically, the poorer a country, the faster its productivity growth rate. In the 19th century, France, Germany and the United States borrowed technology from the productivity leader, the United Kingdom. For the "rich man's club" — OECD — there has been a process of productivity convergence over the last thirty years. In the contemporary developing world, however, many believe that there is something unsettling; it is not true. Productivity change is all over the map.

Some East Asian economies have recorded rates of productivity change equal to the OECD. Most developing economies lag behind the advanced economies, and there are a number of these countries — Algeria, Iran and Iraq — that have had negative productivity change. Developing countries are clearly not catching up technologically, despite their potential to borrow and adapt technology. This suggests that there is nothing automatic about this process, and it raises the question of the government's role.

Government’s role in promoting productivity growth depends on how economies and firms learn. Michael Porter is famous for saying that it is no longer countries, but firms that compete in the world economy. In other words, it is the productivity change at the level of the firm that is important. But countries can facilitate the process of learning.

The East Asian countries have, in one way or another, tried to approach learning, productivity change and technology issues through an active role by the state in encouraging industrial growth and development. And the great success of these economies has led many to argue that public policies to improve productivity in industry — industrial policies — are needed. Do the MENA countries need an industrial policy?

When I think of industrial policy, a phrase uttered by Ross Perot during the US presidential debates of 1992 comes to mind: "It makes a difference whether a country makes potato chips or computer chips." That is a one line definition of industrial policy: the belief that transforming the structure of industry to more and more technologically intensive sectors hastens learning and productivity change.

Of the five East Asian superstars, some have followed industrial policies; others have not. Japan and Korea were clearly pushing computer chips over potato chips. Singapore had an approach to export promotion and foreign investment that would, again, suggest an industrial policy. Hong Kong, on the other hand, is a favorite example of a complete laissez faire economy, letting the chips fall where they may. This makes it hard to generalize about whether industrial policies made a difference for East Asia, much less if they will make a difference for countries in the MENA region.

But there are at least two areas in which some form of industrial policy is important for MENA. First, the region’s governments should use the world economy through activist strategies for technological acquisition, export promotion and direct foreign investment. Clearly, if most productivity growth comes mainly from using and adopting foreign ideas, economies must be open to them and attract them aggressively. There is also the potential for economies to learn through exporting. Exporting embodies knowledge about marketing, technology and information from purchasers, which makes economies more competitive. While it is my view that this was one of the keys to East Asia’s success, this view is not universally accepted. Still, if one looks at the simple correlation between exposure to the world economy and productivity change, it is significant and positive. East Asia and Latin America lead the world in terms of integration into the global market. South Asia, the Middle East and Sub Saharan Africa lag behind. Productivity change is fastest in the former regions and slowest in the latter.

The same is true for foreign direct investment. The regions of the world that have been most successful at attracting FDI have been most successful at attracting new technologies and at productivity change. The regions that have failed to attract FDI have tended to lag behind.

Thus, the first element of a competitiveness strategy — or an industrial policy — for any country in the Southern Mediterranean region should be a strategy to expand exports and foreign investment directed to the external economy. Why investments for imports? The few studies on FDI’s impact on productivity change in the region suggests that when foreign investors come to serve the local market they do not bring state-of-the-art technology. They bring technology that is just good enough for the local competition.

A second element is needed for those countries entering into free trade agreements with the European Union — a strategy for industrial competitiveness. Existing industries confront the reality that within 12 years, prices in every Mediterranean country that is part of this agreement will have reached European levels, implying a very substantial reduction in the current level of protection of domestic industry. The experience of the rapidly opening Latin American economies has shown that this process always involves adjustment by existing firms, but that intelligent public policies to support the transition can ease adjustment. Firms adapted, as was demonstrated in the example of Mexico entering North America Free Trade Agreement (NAFTA). But they did not do it alone.

In Mexico, the Commerce and Industry Ministry and the Finance Ministry developed a strategy of building public-private partnerships for restructuring industry. It was quite a different strategy from the example of Tunisia today. It was a strategy that relied on the public provision of information. Mexican firms lacked familiarity with the state-of-the-art in their sector: They do not know what markets they could penetrate in North America or what technologies were needed to be competitive. In short, they did not know how to restructure. Moreover, their banks did not know if proposals for restructuring were a learnable idea. Mexico therefore built a public-private partnership among firms, banks and the government in key sectors. These partners searched the world for information to support strategic planning in their sectors and made that information available to every firm. It was not a directive policy, but an information policy which addressed the problem that no one Mexican firm was large enough to carry out the search alone.

There are also two areas of industrial policy that I believe offer small promise in the region. I am not keen on picking computer chips over potato chips — selective industrial promotion of the Japanese type. I would suggest that most Mediterranean governments do not have the institutional capacity to administer the kind of specific industrial policies that were popular in Japan during its rapid growth period. Even in the United States these policies have failed. Its one attempt was the "world car," a "C+" effort using public subsidies to bring the aerospace industry and the big three automakers together to make a technologically advanced automobile. It failed for two reasons: 1) there was no market test; and 2) there were no sanctions for non-performance. The big three automakers received a generous subsidy, and the world car remains to be built. The moral of the story is that selecting an industrial policy requires a strong referee to enforce the rules and to make the private sector perform. Even today in Japan, the Ministry of Industry and Trade is reluctant to use the strategy of picking-winners that was popular in the 1960s. The history of unproductive subsidies to industry in many developing countries suggests that governments in the region should be equally cautious.

Second, national technology policies in every country in the region need serious reform. These policies tend to be focused on university research with no linkage to the private sector. This is not a strategy for industrial learning; it is sponsorship of academic work that is largely irrelevant to the technological needs of industry. The countries in the region need to give up or rethink technology policy to put it at the service of the industrial sector, as Asia has done.

In summary, there are four messages. First, the region is turning around economically, but it will not be able to sustain high rates of growth without rapid productivity growth. Second, there is an important role for government in promoting productivity growth by following the example of the East Asian countries: using the world economy, and promoting exports and FDI. Third, there is a role for intelligent industrial restructuring in the face of the Euro-Med agreement. Finally, governments in the region should be careful to avoid specific industrial and technology policies.

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