Manufacturing as the key engine of economic growth for middle-income economies

ABSTRACT

This paper revisits the role of the manufacturing sector during the middle-income stage of development. By exploiting a large dataset that covers different sectors, we find that in the middle-income stage, manufacturing pulls along all the other sectors, including the services sector. A decline in manufacturing growth negatively affects the growth of all the other sectors, in both the short-run and long-run. Additionally, we attempt to identify the underlying mechanisms of the essential role played by manufacturing during this development stage. We find that a larger share of manufacturing in the economy not only promotes gross private saving ratio but also accelerates the pace of technological accumulation. Our empirical findings in this paper indicate that the manufacturing sector is still the key engine of economic growth for middle-income economies.

KEYWORDS:

• Manufacturing
• services
• middle-income trap
• economic growth

JEL classification:

• L16
• O14
• O47

Acknowledgments

We are grateful to Xiang Li, Wenquan Liang, Peter Morgan, and Ha Nguyen, as well as conference and seminar participants at Conference on Escaping the Middle-Income Trap: Urbanization, Structural Change, and Sustainable Development in Asia, and Peking University for helpful comments.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. Additionally, in a recent paper, Amirapu and Subramanian (2015) propose that five essential characteristics allow a sector to serve as an engine of structural transformation and produce sustainable economic growth: high level of productivity, dynamic productivity growth, expansion of the sector in terms of its use of inputs, comparative advantage for the host country, and exportability. Based on the case of India, they suggest that some services branches including finance, insurance and real estate could replace the role of manufacturing sector.

2. Deindustrialization is defined as the steady decline of both manufacturing output as a percentage of GDP (Tregenna 2007) and of manufacturing employment share (Cruz 2015; Palma 2005; Rowthorn and Ramaswamy 1999).

3. There are many theoretical explanations for these structural change patterns, including differences in growth rate across sectors, changes in household preference, and globalization. These works indeed provide convincing explanations for this primary–secondary–tertiary transition. However, there is no theory that informs us that this transition process in detail is closely related to the long-run growth rate of any developing economy.

4. One branch of literature highlights the losses in human capital from deindustrialization. They think the process of learning by doing is another type of human capital accumulation. Since deindustrialization is characterized by the move away from the technological frontier, there will be considerable losses in human capital accumulation due to the slow process of knowledge acquisition.

5. It includes the World Bank World Development Indicators (WDI) database, the World Input-Output Database (WIOD), the World KLEMS Database, the European Union KLEMS Database, the Asian KLEMS Database, the OECD's Structural Analysis Database (STAN), the Groningen Growth and Development Center 10-sector Database, and the UNIDO INDSTAT2 Database.

6. For most economies, the value-added data of manufacturing and services sector starts in 1970s.

7. In the robustness check, we implement the Granger causality test here under the assumption of constancy over time.

8. One possible explanation is cofinance proposed by Aghion et al. (2016). They think that in developing countries, foreign investment in fact requires the involvement of both a foreign investor and a local bank, because the former is familiar with the frontier technology, and the latter can directly monitor local projects. Therefore, in developing countries, local saving matters for innovation, and therefore growth, because it allows the domestic bank to cofinance projects and thus to attract foreign investment.

9. For example, Hall (1978), Bernanke (1984), Hall and Mishkin (1982), and many others have found that shocks to economic growth lead to changes in savings. Meanwhile, a large number of works, including Barro (1991), Gregorio (1992), and Barro and Sala-i-Martin (2004), prove that savings contribute a lot to higher economic growth rate in the short-run.

Additional information

Funding

National Natural Science Foundation of China, project #71573007.

Notes on contributors

Dan Su

Dan Su is currently a first-year Ph.D. student in the Department of Finance at the University of Minnesota. Su holds a B.Sci. in Chemistry and M.A. in Economics from Peking University. His research interests are macroeconomics and financial economics.

Yang Yao

Yang Yao is a professor at the China Center for Economic Research (CCER) and the National School of Development (NSD), Peking University. He currently serves as the director of CCER and the dean of NSD. He is a member of the China Finance 40 Forum. His research interests include economic transition and development in China.