Following a break in popularity in the 1990s, industrial policy is once again capturing attention around the world as a driver of economic and broader societal goals. This is especially true in lower income countries, where industrialization is still a crucial driver of economic growth.
Moving people out of informal subsistence farming into formal manufacturing jobs improves their productivity, makes the agriculture sector more efficient, and raises government revenues through taxation. Economists of the 20th century noted that a thriving industrial sector was crucial to the development of a modern economy, and in 2010, Cambridge economist Ha-Joon Chang observed that development without industrialization is like Shakespeare’s Hamlet without the Prince of Denmark.1 Beyond its direct economic impact, industrial development also presents a number of complementary social and environmental benefits. The inclusion of industrialization in the 2030 Agenda for Sustainable Development as Sustainable Development Goal 9 (SDG 9) reaffirms its central role in the overall development picture.
The COVID-19 pandemic has plunged the global economy into the deepest recession since the Second World War, affecting amongst others industry, value chains, trade, labour markets, foreign direct investment, and remittance flows. The effects of the pandemic limit the ability of economies to raise real incomes in the long term and create a heavy debt burden. Once the immediate health crisis subsides, economic recovery will become a priority, and inclusive and sustainable industrialization will be critical to building a better future.
Manufacturing drives economic growth
There is clear evidence that a thriving manufacturing sector is key to increased productivity, and thereby economic growth. The advent of manufacturing in the eighteenth and nineteenth centuries revolutionized the productive structure of Europe and the United States, and industrialization has been the driving force behind more recent economic miracles, such as the transformation of East Asian economies since the 1960s.
This is because manufacturing offers several productive advantages. First, mass production entails economies of scale: the more units produced, the lower the per-unit cost, and thereby increasing the value of outputs per input. Second, manufacturing tends to have strong linkages to other parts of the economy, creating demand for skills, inputs, manufacturing components, transportation and storage. This means that growth in manufacturing boosts growth throughout a broader set of activities, including in the service sector. Third, most innovation and technological advances originate in the manufacturing sector, which can then feed into other economic sectors, making them more productive as well.
The relationship between industry and growth generally holds across countries and income levels. International data confirms that the proportion of manufacturing in the economy rises as gross domestic product (GDP) increases for low, lower-middle and upper-middle-income countries. This correlation only reverses once a country becomes a high-income economy, where services start to take a relatively higher share than manufacturing.
This pattern is very pronounced in developing countries, where the manufacturing sector is far more productive than agriculture, and also outperforms the economy as a whole.
The implication is that productivity growth requires a shift away from less productive agriculture towards more productive economic activities. This shift should be considered in light of its complementary benefits for developing countries as well.
Some SDGs, such as poverty reduction, come as a result of economic growth associated with the manufacturing productivity premium. In fact, although country-specific heterogeneity is high, there is a strong relationship between poverty reduction and economic growth when that growth is chiefly driven by manufacturing. Using income growth as an indicator of poverty reduction, growth in manufacturing (and services) has a stronger impact relative to agriculture for the bottom 40 per cent of the income distribution. This is also confirmed by the fact that most fast industrializers in the figure below exhibit higher poverty reduction rates than other countries with same GDP growth.
Social outcomes of industrialization
Aside from the direct economic benefits, manufacturing has beneficial implications for a range of social outcomes too. For example, the higher skills demanded by manufacturing jobs should, in theory, increase participation in education and training. There is also evidence that growth in manufacturing correlates with a decline in the number of people who are neither employed nor in education (NEETs) – a good measure of the economic prospects of young adults. There is also a correlation between manufacturing intensity and participation in formal and non-formal education.
Industrialization has a weaker but direct effect on health, with clear indications in infant mortality and maternal mortality. Industrialization is also somewhat associated with access to decent work, since the majority of manufacturing jobs are in the formal sector, with workplace safety regulations and social protections, such as access to sick leave and pensions. The importance of formal employment and the related social security networks has become evident during the COVID-19 crisis. Data also suggests a link between a growth in manufacturing and a reduction in income inequality (although evidence for other dimensions of inequality is unclear).
At a more diffuse level, a large body of historical evidence shows that structural changes associated with industrialization can transform the social fabric leading to urbanization, positive changes in gender relationships, the rise of labour movements, and the advent of the welfare state.
Environmental sustainability challenges
It is clear that industrial development does not necessarily have to pose environmental concerns. New technologies and processes can make production more resource-efficient, decoupling growth from environmental damage. Latecomer economies may benefit from technological leapfrogging, bypassing investments in older generation technologies.
In addition, industrial development tends to improve the input efficiency of water and energy. A similar pattern applies to emissions efficiency: as the share of manufacturing in the economy rises, CO2 emissions per unit of manufacturing value added decline. This holds true at all income levels. This means that a significant increase in greenhouse gas emissions is not the inevitable result of manufacturing expansion.
Looking forward, new technologies and systems associated with the Fourth Industrial Revolution will further decouple emissions from industrialization. If they can be leveraged, these advances will support developing countries, as they pursue the myriad benefits of manufacturing-led economic growth.
The continued importance of industrial development
The 2030 Agenda and its SDGs reflect the complexity of dimensions comprised in “sustainable development”. SDG 9 sets out its own objectives related to industry, innovation and infrastructure, while it also underpins efforts to eradicate poverty and hunger, promote quality education and good health, improve the climate and environment, and reduce inequalities and advance various social justice objectives. It provides the productive foundation for economic growth and the prosperity of nations, with multiple positive spillovers into other areas of life.
In turn, a successful industrial sector requires a supportive environment in terms of infrastructure, market access, human capital and capacities, and an enabling regulatory regime. In establishing this regime, policymakers will need to ensure that the benefits of industrialization are equitably shared across society and that improvements in material welfare do not come at the expense of the environment. Carefully considering these interactions will help forge a path to prosperity that is both inclusive and sustainable.
Inclusive and sustainable industrialization thus plays a key role in the economic recovery from the COVID-19 crisis and in initiatives to “build back better”. Therefore, we need to ramp up collaboration between all stakeholders, including governments, donors, international organizations, the private sector and civil society, to support the industrial sector in developing countries and economies in transition and prepare it for the challenges associated with the ongoing rapid digital transformation and the much-needed transition towards a more inclusive and sustainable future.
Disclaimer: The views expressed in this article are those of the authors based on their experience and on prior research and do not necessarily reflect the views of UNIDO (read more).