Factories or call centres? Asia charts its development path

Asia's industries, primarily manufacturing, fueled phenomenal economic growth and poverty reduction in recent decades. But today many countries are looking to the service sector as an alternative.

Industrialisation underpinned high growth in Asia during the past few decades and the catching-up in living standards in general, but this development path is now increasingly uncommon. Should we dismiss industry as a driver of growth, and could services pick up the slack?

As in other parts of the advanced and developing world, most success stories in Asia were driven by industrialisation—from the post-WWII Japanese Economic Miracle to the success of Singapore, the Republic of Korea, and the People's Republic of China.

As improved regional integration, export orientation, and diversification relaxed the constraints imposed by small domestic markets, industrialisation opened avenues for fast productivity growth and created stable jobs for unskilled workers. The region saw significant shifts in employment and resource allocation from agriculture to industry—particularly manufacturing activities—living standards rose dramatically, and poverty dropped to historic lows.

It is hard to imagine any policymakers in Asia who would not want to follow in the footsteps of the region's fast-growing economies. However, the traditional path of structural transformation is increasingly at odds with current trajectories.

Many Asian economies are now transitioning from being mostly agriculture-based to predominantly services-driven, without developing a sizeable manufacturing sector. In others, such as Indonesia and Malaysia, the process of industrialisation has been short-lived.

The implications are significant. Because of scale effects and learning by doing, industry can produce large productivity gains and, thus, boost workers' incomes. And, by accelerating the creation of good jobs for the relatively unskilled that are high-paying and secure, industrialisation can foster a more equal distribution of development gains.

This contrasts with services where, on average, workers are typically employed in less-productive activities. As such, the lack of a sizeable industrial sector is often seen as a serious drawback for development trajectories and a reason to advocate industrial policy.

Calls for policy action are often warranted. The People's Republic of China and a handful of other economies have a dominant position in global industrial goods markets, and this makes it hard for other economies to follow the same development route. But in many cases industrialisation is also held back by low institutional quality, ineffective productive development policies, labour-market constraints, incomplete trade links.

Significant improvements in these areas could boost industrial activity, even against the backdrop of a fiercely competitive global environment, or at least slow down deindustrialisation. There is, therefore, a need for a deeper understanding of the causes of deindustrialisation, which would enable the design of appropriate policies. Development strategies should not dismiss the role of industry as a driver of growth.

Ultimately, however, if industry continues to increasingly give way to services, the question of whether the services sector can generate many high-productivity jobs—and accordingly fast, and equitable growth—becomes crucial.

The traditional view of the sector lumps all services in the same aggregate category, and this paints a misleading picture. Services activities are very diverse and modern services—such as information and communication technology (ICT), software development, and digital finance—offer similar opportunities for productivity growth as high-productivity industrial activities.

Singapore and Hong Kong, China, for instance, are examples of economies which have successfully moved from an industry-based growth model to one driven by highly productive services. However, notwithstanding their potential, modern services are still not a sizable growth driver in most Asian economies. For instance, despite routinely grabbing headlines, in Armenia the ICT sector accounts for less than 4 per cent of GDP.

Some economies may be better equipped to boost growth via intermediate and other services. Since services are hard to tax at the border, most barriers to service trade depend on domestic regulations. These barriers, however, mostly apply to final services, not intermediate services, which are services provided to a company, not a final costumer. Instead, intermediate services exports are mostly constrained by the technical difficulties of coordinating teams of workers in distant locations.

Technological innovations, such as digitalisation and artificial intelligence, are increasingly relaxing these constraints, opening opportunities for intermediate services exports. India, for example, now employs one third of its workers in consumer services sectors, showing that fast growth can also be achieved by boosting productivity in non-tradable services.

A growing and increasingly modern services sector may also be beneficial for other aspects of development. Services are typically less energy-intensive than industry and more susceptible to digitalisation, so services-biased structural transformation could reduce carbon emissions and facilitate the green transition, even as it fosters more livable urbanisation.

Whichever path it takes, the process of structural transformation will pose significant development challenges in Asia. Different trajectories for the evolution of industry and services could hinder or benefit progress on poverty reduction, income inequality, gender gaps, and other development goals.

Economic policy can play a crucial role in several areas. It can reduce market distortions or market failures to productive development, both of which hamper an efficient reallocation of workers within and across sectors.

It can create jobs in highly productive industrial and services activities, for instance by addressing financial market imperfections and other market failures which limit the birth and growth of innovative activities. Moreover, it can strengthen macroeconomic stability to foster a business environment conducive to effective long-term investment decisions. 

To seize the opportunities offered by the evolving nature of current development trajectories, policy measures will need to be contextualised and account for country-specific factors. This underscores the need to improve our understanding of the prospects for a renewed or different growth paradigm for Asia, in a world transitioning toward a greener and more digital future.

Irfan A Qureshi is an economist of the economic research and regional cooperation department at the ADB. João Pedro Farinha is principal financial sector economist at the central and west Asia department. Matteo Lanzafame is senior economist of the economic research and regional cooperation department.