Most developing countries with export-led strategies gained a competitive edge by keeping domestic wages low

The flagship publication of the United Nations Conference on Trade and Development (UNCTAD), Trade and Development Report, 2010 (TDR), was released recently. As would befit a report that has its sub-title ‘Employment, globalisation and development', the TDR reviews the experience of developing countries with export-oriented growth strategies over the past 30 years.

Of special topical interest is the question: do those export-oriented strategies generate sufficient decent jobs to absorb the labour surpluses that are typical of developing countries?

Basic tenets

A review on these lines calls into question some of the basic tenets of growth strategies adopted by many countries.

A number of countries, especially Japan, South Korea and more recently China, have prospered on the back of an export-led strategy. The strategy was considered worthy of emulation by others. In India, not long ago, the slogan ‘export or perish' seemed to convey the urgency to make export promotion one of the top most objectives of macroeconomic policy. A variety of incentives and concessions, duty drawbacks and so on as well as exempting from taxation income earned from exports have been tried. The list is continuously updated through the five-year Foreign Trade Policy with its annual supplements. More recent additions to the list of export promotion measures include special economic zones (SEZs). While few would question the rationale of export promotion measures such as those obtaining in India, the point is that such measures distort macroeconomic policies. Concessions to one sector come at the cost of another. In recent times, countries, which have made exports their overriding priority, have subjugated other macroeconomic policies, notably the subordination of exchange rate policies to the export effort.

China has been accused of keeping the yuan deliberately undervalued to give an edge to its exporters. The country's alleged currency manipulation has sparked fears of retaliation by the U.S.

Focus on wages

The focus of TDR is not on currency war but on wages. After studying the performance of developing countries over 30 years with export-led strategies, the TDR comes to the conclusion that most countries gained a competitive edge by keeping domestic wages low.

Persistently high employment was blamed on labour market rigidities that kept wages from falling to ‘market clearing levels'.

The implication is that a policy that keeps wages low is justified in the context of exports. Labour-intensive industries such as garment manufacture, leather and leather goods, gems and jewellery as well as a whole range of extractive industries (mining) have apparently prospered because of low wages.

However, the TDR repudiates the premise strongly. In a macroeconomic sense, the approach is flawed.

One, wage increases spur growth of domestic demand and boost employment to satisfy that demand.

Two, it is, moreover, the expectation of rising domestic demand and favourable financing conditions rather than a reduction in unit labour costs that drives investment in productive capacity.

Three, an appropriate investment strategy ought to aim at distributing the productivity gains between labour and capital in a way that lifts domestic demand.

Four, monetary and fiscal policies should be reoriented towards strengthening domestic demand.

Towards that end, macroeconomic policy should also include what is known as an ‘income policy' — a set of instruments and institution-building measures that would ensure that mass incomes rise along with average productivity growth. (Example of institution-building measure is strengthening collective bargaining among workers' and employers' associations).

Five, an appropriate income policy must ensure that productivity gains are distributed in such a way that the share of wages in national income does not fall as it has in many countries over the past four decades.

A sustained increase in wages in line with productivity gains will also ensure a sustained rise in domestic consumption which in turn will boost employment.

Six, drawing from the recent global economic and financial crisis, the report observes that counter-cyclical fiscal policy to stabilise demand has been rediscovered by many governments. Such policy will help in less dramatic times.

States should encourage infrastructure and offer other services that would enable profitable investment in productive capacity.

An employment-friendly monetary policy will keep credit costs for investment in fixed capital low and will protect the international competitiveness of domestic firms by preventing currency appreciation.

Finally, in many developing countries, including the poorest, public employment schemes are potential instruments of fighting unemployment and poverty.

In addition to reducing unemployment directly, they generate purchasing power that will have indirect employment effects on the rest of the economy.

C. R. L. NARASIMHAN

For economic growth to be sustained it is essential that investments should result in productivity gains that are equitably shared between labour and capital.