კონფერენცია

∘ Vano Benidze ∘
THE ROLE OF MANUFACTURING IN ECONOMIC DEVELOPMENT

Summary

Throughout the history of mankind, economic growth has always been associated with progress and prosperity. However, the fast rates of economic growth around the world is a recent phenomenon, as by all estimates, economic growth rates must have been very low through most history before the 18^th century (Kuznets, 1996). Starting from the 1760s, changes in agriculture, manufacturing and technology had a pronounced positive effect on the lives of many. This process, also known as the “Industrial Revolution”, first spread in Great Britain, France, Germany, United States, Spain and other European countries, later followed by Asian, African and Latin American countries in the beginning of the 19^th century (Allen, 2017).

The world, so far, has been through three industrial revolutions, each having different characteristics and consequences. The 1^st Industrial Revolution used steam-powered engines that significantly increased labor productivity in agriculture. The 2^nd Industrial Revolution used electric power that led to the creation of mass production. The 3^rd Industrial Revolution used internet, computers and information technologies to automate production, reducing the role of humans in the production process.

These three industrial revolutions also reflect the everchanging balance between three main sectors of the economy: primary (mining, fishing and agriculture), secondary (manufacturing, construction and electricity) and tertiary (services). The term “sectors” was first used in 1935 by Alan Fisher in his book “The Clash of Progress and Security”. According to (Fisher, 1935) three-sector-model, economic progress that would be the result of the development of primary and secondary sectors, would lead to the emergence and strengthening of the tertiary sector of the economy.

Later, (Clark 1940) developed Fisher’s model to create Clark-Fisher model of development. According to the model a country goes through three stages of development (see Fig. №1). In the pre-industrial stage, most people are employed in agriculture, followed by industry and services, living standards are low and there is a minimal use of technology. In the in industrial stage, advancements in technology makes agriculture less labor-intensive, people move mainly to manufacturing sector and living standards start to rise. In the post-industrial phase, further technological advancements make automation possible in manufacturing or manufacturing activities move to other developing countries, therefore, the workforce moves to services sector and the country starts to de-industrialize. This process of structural transformation, especially the process of industrialization (an increase of the share of manufacturing in GDP), is regarded by many economists as the main engine of growth in economic development (Kuznets, 1996).

(Rodrik, 2013) suggest that there are two ways a country can achieve economic growth. The first is by investing in and improving fundamental factors such as education, healthcare, infrastructure and institutions. The second is by promoting a structural transformation of the economy – a process when new industries emerge, and the labor moves from low-productivity industries (e.g. agriculture) to the high-productivity ones (e.g. manufacturing). Rodrik states that the fast and high economic growth rates in both developed and developing countries (excluding resource-rich countries) have always been a result of structural transformation, especially industrialization. The rapid development of East Asian countries in the late 19^th century is a good testament to that (see Fig. №2). Rodrik also notes that structural transformation should eventually be backed up by fundamental factors, otherwise the growth could fizzle out (see Table №1).

Recent scientific literature also argues that industrialization has lost its role in economic development and that it is no longer important for the developing countries to follow the same path of development as high-income countries did long time ago (Bhagwati, 2010). As many developing countries (e.g. India) are increasingly moving to service-led growth model by fully or partially skipping the industrial phase of development, it is tempting to believe that manufacturing has lost its significance. It is worth noting, however, that this process of premature de-industrialization does not diminish the role of manufacturing in economic growth, but rather indicates the failure of industrialization in those countries, as manufacturing activities only concentrated in few other developing countries (e.g. China, South Korea). It is true that some service activities (e.g. insurance, IT, financial services) could potentially be engines of growth in developing countries, but as in most developing countries the majority of labor is employed in agriculture and lack the necessary skills, it is doubtful whether they are fit for those activities. For the most part, low skilled workers in these countries (if manufacturing jobs are not available) either remain in agriculture or move to low-productivity service activities (e.g. retail trade, hospitality), which will not guarantee long and sustained growth. Chinese and Indian experience is a good testament to that – China chose manufacturing led-growth model, while India opted for service-led growth. If we judge their economic performance by GDP per capita (PPP), it is clear that the Chinese development model is superior to that of India (see Fig. №3).

Fig. №4, that shows the relationship between manufacturing value added growth and GDP per capita growth for the period of 1990-2018, leads us to the same conclusion - there is a statistically significant relationship between industrialization and economic growth, and manufacturing can still be considered as the main engine of fast growth. Moreover, even though some high-income countries are currently in the post-industrial phase of development from the employment perspective, their manufacturing value-added (% GDP) still remains quite large (see Fig. №5).

There are some other reasons why manufacturing sector development is important for the economic growth of developing countries. Firstly, almost every industry needs manufactured products – the travel industry needs planes, the hospitality industry needs furniture, and agriculture needs fertilizers and machinery. Therefore, the development of other sectors of the economy highly depends on manufacturing.

Secondly, because so many other industries depend heavily on manufactured goods, manufacturing has a very high employment multiplier, meaning each new job in manufacturing creates a large number of indirect jobs in other industries (Robert and Ward, 2012). Therefore, the development of manufacturing can lead to a rapid decline in unemployment in developing countries.

Thirdly, manufacturing spurs technological progress. Most technological breakthroughs have been associated with the manufacturing sector, such as airplanes, ships and semiconductors. Therefore, technology spillover effect from manufacturing is quite large (Tregenna, 2018). (Jones and Olken, 2015) argue that the best way for developing countries to adopt technology from the developed ones is though manufacturing.

Lastly, it is without a doubt that an increase in exports is directly linked to economic growth (Tyler, 1981; Ram, 1987; Sengupta and Espana, 1994; Balassa, 1978). As 80% of the world trade is in goods, manufacturing has more export potential than other sectors of the economy, and therefore, its development can lead to economic growth.

All things considered, the development of the manufacturing sector is of critical importance for developing countries. It is also clear that without industrialization convergence of developing countries with developed ones in terms of per capita income is unlikely – so far, the world has never seen such a case. Therefore, today’s developing countries should reshape their economic policies in ways that favor manufacturing development. This is especially relevant for Georgia, where poverty and unemployment could be directly linked to country’s inability to ignite structural transformation (Benidze, 2019).

Keywords: Manufacturing, Economic Growth, Structural Transformation, Industrialization.

Ivane Javakhishvili Tbilisi State University Paata Gugushvili Institute of Economics International Scientific C O N F E R E N C E S "ECONOMY – XXI CENTURY"

E ISSN 2587 - 4691	∘ Vano Benidze ∘ THE ROLE OF MANUFACTURING IN ECONOMIC DEVELOPMENT Summary Throughout the history of mankind, economic growth has always been associated with progress and prosperity. However, the fast rates of economic growth around the world is a recent phenomenon, as by all estimates, economic growth rates must have been very low through most history before the 18^th century (Kuznets, 1996). Starting from the 1760s, changes in agriculture, manufacturing and technology had a pronounced positive effect on the lives of many. This process, also known as the “Industrial Revolution”, first spread in Great Britain, France, Germany, United States, Spain and other European countries, later followed by Asian, African and Latin American countries in the beginning of the 19^th century (Allen, 2017). The world, so far, has been through three industrial revolutions, each having different characteristics and consequences. The 1^st Industrial Revolution used steam-powered engines that significantly increased labor productivity in agriculture. The 2^nd Industrial Revolution used electric power that led to the creation of mass production. The 3^rd Industrial Revolution used internet, computers and information technologies to automate production, reducing the role of humans in the production process. These three industrial revolutions also reflect the everchanging balance between three main sectors of the economy: primary (mining, fishing and agriculture), secondary (manufacturing, construction and electricity) and tertiary (services). The term “sectors” was first used in 1935 by Alan Fisher in his book “The Clash of Progress and Security”. According to (Fisher, 1935) three-sector-model, economic progress that would be the result of the development of primary and secondary sectors, would lead to the emergence and strengthening of the tertiary sector of the economy. Later, (Clark 1940) developed Fisher’s model to create Clark-Fisher model of development. According to the model a country goes through three stages of development (see Fig. №1). In the pre-industrial stage, most people are employed in agriculture, followed by industry and services, living standards are low and there is a minimal use of technology. In the in industrial stage, advancements in technology makes agriculture less labor-intensive, people move mainly to manufacturing sector and living standards start to rise. In the post-industrial phase, further technological advancements make automation possible in manufacturing or manufacturing activities move to other developing countries, therefore, the workforce moves to services sector and the country starts to de-industrialize. This process of structural transformation, especially the process of industrialization (an increase of the share of manufacturing in GDP), is regarded by many economists as the main engine of growth in economic development (Kuznets, 1996). (Rodrik, 2013) suggest that there are two ways a country can achieve economic growth. The first is by investing in and improving fundamental factors such as education, healthcare, infrastructure and institutions. The second is by promoting a structural transformation of the economy – a process when new industries emerge, and the labor moves from low-productivity industries (e.g. agriculture) to the high-productivity ones (e.g. manufacturing). Rodrik states that the fast and high economic growth rates in both developed and developing countries (excluding resource-rich countries) have always been a result of structural transformation, especially industrialization. The rapid development of East Asian countries in the late 19^th century is a good testament to that (see Fig. №2). Rodrik also notes that structural transformation should eventually be backed up by fundamental factors, otherwise the growth could fizzle out (see Table №1). Recent scientific literature also argues that industrialization has lost its role in economic development and that it is no longer important for the developing countries to follow the same path of development as high-income countries did long time ago (Bhagwati, 2010). As many developing countries (e.g. India) are increasingly moving to service-led growth model by fully or partially skipping the industrial phase of development, it is tempting to believe that manufacturing has lost its significance. It is worth noting, however, that this process of premature de-industrialization does not diminish the role of manufacturing in economic growth, but rather indicates the failure of industrialization in those countries, as manufacturing activities only concentrated in few other developing countries (e.g. China, South Korea). It is true that some service activities (e.g. insurance, IT, financial services) could potentially be engines of growth in developing countries, but as in most developing countries the majority of labor is employed in agriculture and lack the necessary skills, it is doubtful whether they are fit for those activities. For the most part, low skilled workers in these countries (if manufacturing jobs are not available) either remain in agriculture or move to low-productivity service activities (e.g. retail trade, hospitality), which will not guarantee long and sustained growth. Chinese and Indian experience is a good testament to that – China chose manufacturing led-growth model, while India opted for service-led growth. If we judge their economic performance by GDP per capita (PPP), it is clear that the Chinese development model is superior to that of India (see Fig. №3). Fig. №4, that shows the relationship between manufacturing value added growth and GDP per capita growth for the period of 1990-2018, leads us to the same conclusion - there is a statistically significant relationship between industrialization and economic growth, and manufacturing can still be considered as the main engine of fast growth. Moreover, even though some high-income countries are currently in the post-industrial phase of development from the employment perspective, their manufacturing value-added (% GDP) still remains quite large (see Fig. №5). There are some other reasons why manufacturing sector development is important for the economic growth of developing countries. Firstly, almost every industry needs manufactured products – the travel industry needs planes, the hospitality industry needs furniture, and agriculture needs fertilizers and machinery. Therefore, the development of other sectors of the economy highly depends on manufacturing. Secondly, because so many other industries depend heavily on manufactured goods, manufacturing has a very high employment multiplier, meaning each new job in manufacturing creates a large number of indirect jobs in other industries (Robert and Ward, 2012). Therefore, the development of manufacturing can lead to a rapid decline in unemployment in developing countries. Thirdly, manufacturing spurs technological progress. Most technological breakthroughs have been associated with the manufacturing sector, such as airplanes, ships and semiconductors. Therefore, technology spillover effect from manufacturing is quite large (Tregenna, 2018). (Jones and Olken, 2015) argue that the best way for developing countries to adopt technology from the developed ones is though manufacturing. Lastly, it is without a doubt that an increase in exports is directly linked to economic growth (Tyler, 1981; Ram, 1987; Sengupta and Espana, 1994; Balassa, 1978). As 80% of the world trade is in goods, manufacturing has more export potential than other sectors of the economy, and therefore, its development can lead to economic growth. All things considered, the development of the manufacturing sector is of critical importance for developing countries. It is also clear that without industrialization convergence of developing countries with developed ones in terms of per capita income is unlikely – so far, the world has never seen such a case. Therefore, today’s developing countries should reshape their economic policies in ways that favor manufacturing development. This is especially relevant for Georgia, where poverty and unemployment could be directly linked to country’s inability to ignite structural transformation (Benidze, 2019). *Keywords:* Manufacturing, Economic Growth, Structural Transformation, Industrialization.