Journal Issue

Industrialization, Employment, and Urbanization

International Monetary Fund. External Relations Dept.
Published Date:
March 1971
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Helen Hughes

In most developing countries, employment in manufacturing is a small proportion of the total work force. Even in countries such as the Republic of China and Singapore, which have had great success in industrialization, it is still—at some 10 per cent—greatly below the levels in industrialized countries, which range from 20 to 30 per cent. Moreover, even though employment in manufacturing started from a small base in most developing countries in the 1950’s, its rate of growth has been disappointing, and it has lagged considerably behind that of manufacturing production.

Limited Choice of Techniques

The reasons for this disappointing performance are of course complex, but the dominant one is the limited choice of techniques available to a manufacturer who wishes to produce competitively at international prices, or even to compete with other manufacturers in a protected market. It is true that the degree of labor intensiveness in industry is a continuum from industries such as artificial-flower production to those such as iron and steel, but it is also true that, for most industries on this continuum, capital-intensive, modern production methods are so much more economic than labor-intensive ones that the opportunities for the substitution of labor for capital are extremely limited. The labor-intensive industries, or rather parts of industries, such as electronic component assemblies, are the exception. In an increasing majority of industries, capital-intensive methods are more competitive, and this usually implies large-scale production.

Investors in developing countries are accordingly usually faced with three alternatives: competitive, modern, large-scale production, which, however, requires a larger market than domestic demand even with some potential exports indicated; less competitive modern production, which does not fully utilize economies of scale; or small-scale, labor-intensive production, which, however, is frequently also relatively costly. But the choice has to be made under pressure. Technical considerations often demand modern techniques. The quality of a product, the precision with which parts are manufactured, as well as the appearance of the finished good, are very much influenced by the sophistication of the production methods. Where markets have been established by imports of manufactured products, or where imports compete on the domestic market, quality considerations are important. For countries seeking export markets, they are, of course, paramount, but economy-of-scale constraints are then avoided so that modern techniques become economic. Sophisticated production methods usually are also much more economic in the use of raw material than labor-intensive methods. Since capital is scarce and expensive, entrepreneurs are concerned with maximizing its productivity in order to maximize their profits, and this generally means choosing modern technology. The combined advantages of modern production methods and the scarcity of capital thus frequently outweigh the high costs of capital-intensive production on a small scale. In most countries, tariffs or other protective measures protect the manufacturer at this level and diminish his interest in external markets. Thus, relatively small-scale modern manufacturing methods frequently prove to be more economic than labor-intensive manufacturing production in terms of both immediate competitive advantage and capital accumulation.

The availability of plants often poses another problem. Developed countries provide the bulk of demand for manufacturing plants, and plant manufacturers accordingly cater to their needs. Plants specially adapted for labor/cost relationships that are different from those prevailing in developed countries therefore tend to be more costly than the regular plants, even where such adaptations are practicable. Opportunities for using secondhand plants are somewhat more limited than was once generally believed; if they do exist, however, they should, of course, be exploited. Existing equipment should, similarly, not be scrapped prematurely. Investors in developing countries rarely have the knowledge and skill to make or to have fundamental changes made in standard equipment, and they have to rely on equipment manufacturers’ expertise. Foreign investors from developed countries prefer plants that they know, and as they have plants in several countries, there are advantages in uniformity. Sometimes these investors could profitably go further in adapting plants to the factor costs and market scale of developing countries, and some are beginning to do so. However, the prospects for a general adaptation of plants to labor costs in developing countries do not seem very good. Labor costs vary greatly among developing countries, and more importantly, low labor costs are not sufficient to offset the other disadvantages of labor-intensive production.

In most manufacturing processes, the opportunities for substituting labor for capital are therefore confined to the preparation and unloading of raw materials into the factory and to the finishing and packaging processes. Here employment is generally more intensive than in developed countries. With unemployed persons waiting at the factory gate, few firms use capital instead of labor where labor would be more profitable. There are, of course, some instances of the use of modern production methods for the sake of being modern, but these have been greatly exaggerated by after-dinner anecdotes. By and large, it is not because manufacturers are bedazzled by the prospects of a modern factory but because this is the most profitable choice of technique.

Influence of Government Policy

Policy measures that distort the relative cost of capital and labor may, however, contribute to the choice of capital-intensive techniques. Cheap credit designed to bring down capital costs to those prevailing in developed countries may lower the cost of capital to those favored borrowers who are able to obtain official loans, and this may distort the relationship between the price of capital and the price of labor. Even so, labor is usually still cheaper in relation to capital than in developed countries. In exceptional cases, however, the price of credit may be permitted to drop to very low levels. For example, in an inflationary economy in which real interest rates are kept low, or even become negative, the relative price of capital may fall below its relative price in developed countries. Tax incentives, such as remissions of duties on capital imports and accelerated depreciation, also lower the cost of plants in relation to labor, although only rarely to ratios below those of developed countries.

High Cost of Labor

There is another factor that tends to push manufacturers toward the use of laborsaving plants. Labor in developing countries is often more expensive than it seems at first sight. Most developing countries are acutely short of skilled labor, wages for skilled workers are relatively high, and this makes labor-intensive methods costly in any but the simplest tasks because labor-intensive techniques often demand more skilled labor than capital-intensive ones. In many developing countries, even the semiskilled and unskilled labor costs are higher than daily wages imply. Productivity is low. Workers are not only mechanically unskilled but also lack discipline; timekeeping tends to be poor and absenteeism is generally high. Wages have been pushed up unduly in some countries by young national governments and militant trade unions, and this is particularly true of indirect wage payments and fringe benefits, which often form a much higher proportion of total labor cost than they do in developed countries. High rates for shift work frequently make multiple shifts uneconomical, although this implies low levels of capital productivity. A prejudice against piecework, and the lack of organizational resources to introduce it satisfactorily, frequently not only raises costs but also limits earnings in simple, repetitive tasks, for low productivity means relatively low remuneration for the worker as well as for the factory. In some countries, poor industrial relations and the political biases of trade unions press investors, particularly foreign ones, toward mechanized processes with few workers.

In the early stages of industrialization, when relatively simple industries are being introduced, the increase in employment is usually higher than in the later stages when employment growth slows down in relation to the growth of value added. Labor discipline improves, skills are accumulated, and, as management improves, “learning by doing” increases productivity. In countries that rely on import substitutes the easy import-substitution opportunities are exhausted, and more complex industries generally require more capital-intensive techniques. In general, the locally manufactured content of manufactured output rises more rapidly than total output. Wages chase increases in labor productivity, and sometimes even exceed them, so that capital-intensive methods become more attractive. A continuously high ratio of employment to value-added growth may thus indicate stagnating labor productivity with consequent cost and capital return problems rather than successful employment creation. Successful industrialization usually means rising capital/labor ratios.

Failure of Small-Scale Industries

The failure of relatively labor-intensive, small-scale industries to play an important role in industrialization has also contributed to disappointed hopes of high industrial employment. There are some exceptions. In South Asia, East Asia, and the Middle East, a long evolution of handicrafts has become, to varying degrees, the foundation of a small-scale manufacturing sector producing consumer goods or industrial components. In many Latin American countries and in Africa south of the Sahara, however, handicrafts have not been strongly developed, and in Southeast Asia they were largely destroyed by the impact of European trade in the nineteenth century. In these areas, therefore, there was little foundation from which small-scale industry could grow, and small-scale industries have made little contribution to industrial production and employment.

Even in countries where small-scale industries have some roots in a strong handicraft and small business tradition, the transition to manufacturing, and particularly to supplying industry rather than final consumers, is formidable. Some of the obstacles to the growth of small-scale industry are well known. Entrepreneurs lack technical, purchasing, marketing, organizational, and accounting skills; they are undercapitalized and, lacking access to bank credit, have to rely on the street market.1 There are others. Modern, large-scale industry generally develops on the outskirts of large cities, whereas small-scale industries are usually at town centers. Industrial estates often exclude small-scale industries. Such locational factors can make it extremely difficult for small producers to make a start in subcontracting because their means of transport is a bicycle. Few large firms are prepared to nurture and to assist small suppliers. It is frequently more economic to manufacture their own components, and particularly so where cumulative production taxes encourage vertical integration. In many developing countries, small-scale entrepreneurs are predominantly members of alien minorities; governments discourage rather than promote their interests. Small-scale industries have to be productive and competitive if they are to provide employment in the long run, and this requires a great deal of government effort for limited achievement, because such action must seek a painful weeding out of the less efficient firms.

If population growth continues near its present rate, and urban communities continue to spread along the routes they are now following, by 2100 the world-city-state of high density urban population may have the configuration shown above.

Source: Elastics: the future of human settlements 1969

Handicraft Sector May Also Disappoint

A relatively large handicraft sector does not, moreover, always mean a healthy employment situation. The competitiveness of handicrafts is generally limited to simple products for local markets where transport or other factors make modern plants less competitive, and to specialized exports to developed countries. However, if handicrafts are protected against foreign competition by high tariffs, and against modern industries by special raw material and credit allocations and by capacity restrictions on modern plants, the latter are allowed to become inefficient with detrimental effects on long-term industrial growth. Consumers have to meet high prices so that the markets that such industries serve are artificially constrained. The preservation or creation of employment in handicrafts at high costs of production is thus inimical to long-run employment aims. In fact, both small-scale and handicraft industries tend to shrink in the face of competition from more efficient, modern, relatively large-scale plants, so that some relocation of employment is necessary even if small-scale and handicraft sectors are encouraged.

Failure Not Surprising

The failure of industrialization to solve developing countries’ employment problems is thus not surprising, and their employment experience reflects both their level of industrial development and their industrialization strategy. It is clear that those countries, such as the Republic of China, Korea, and Singapore, which have followed low-key but hard-hitting industrialization strategies—including not only a markedly outward orientation but also other fiscal, monetary, and labor policies leading to competitive cost structures—have experienced higher and more consistent rates of growth of manufacturing employment than those that have relied on import substitution at all costs, stressed basic industries, and failed to take advantage of export possibilities. The choice that a country has in attempting to stimulate manufacturing employment is not one of choosing between a labor-intensive or capital-intensive technique for a given product, as has often been supposed in the past, but rather in selecting policies that will encourage those products and industries that are relatively labor intensive.

Even with policies leading to wise product and industry choices, the direct effect of investment in manufacturing industry on total employment is likely to be small and in most cases will not be able to eliminate existing unemployment or to absorb that owing to population increases. Investment in manufacturing, however, also creates indirect employment to varying degrees. It generates pressure not only for other industrial products but also for agricultural and mineral raw materials, public utilities and services, building and construction, and commercial services; and the employment created has repercussions not only on the demand for consumer goods but also for services and housing. The extent of indirect labor creation is yet to be measured either in total or by type of manufacturing investment, but there is some evidence that the degree to which industrialization is integrated into overall development strategy is critical. Locational planning for industry is a very important factor in such over-all development.

The Urban Concentration of Industry

Urbanization is, of course, not simply, or even largely, the result of industrial development; industrialization, however, accelerates the pace of urban growth. Large cities are the principal markets for industry, and the radial transportation systems of most developing countries make the distribution of goods in the countryside easiest from a large urban center. The transport network similarly favors large city location, particularly where the city is a port and in the early stages of industrialization when many of the inputs into industrial production are imported. Radial transport systems also mean that local raw materials can be most easily assembled at an urban center.

Limited transport facilities, although generally a more important consideration in developing than developed countries, are, however, by no means the most important consideration in industry’s choice of existing urban location. The scarcest factor of production in developing, as in developed, countries is management, and this is generally to be found only in existing urban centers. Good managers, moreover, are generally not prepared to move to small, and often isolated, rural centers that lack such facilities as schools. Skilled workers similarly prefer urban facilities and are difficult to attract away from them.

The absence of utilities such as water, power, and communications, industrial services such as galvanizing and enameling, and commercial services such as banking, printing, and advertising are commonly the greatest problems for newly established industries in developing countries, and they are generally minimized in urban centers. As industry grows, it not only gives more economic opportunities for such services so that they can benefit from advantages of scale, but also creates the possibilities of new ones more specially geared to an industrial group. Thus, for example, a group of textile mills will benefit from a pool of skilled and supervisory textile labor, of importers specializing in textile dyes or eventually producing them locally, and may even be able to borrow and lend specialized equipment such as loom attachments, cutting down on stocks. Equipment leasing and subcontracting become feasible because firms can change from client to client as the fortunes of business change.

Thus, for the individual firm, costs of production continue to fall for a long time with the growth of cities, and this is why manufacturers tend to congregate in large urban centers. The growth of manufacturing and associated employment opportunities attract workers, for earnings, following relatively high productivity, are higher than in the countryside. For those workers who find employment, the amenities of life increase with urban growth.

Social costs, on the other hand, may begin to rise with relatively low levels of urban concentration, and this is particularly so in unplanned cities. (The size of cities varies considerably in developing countries, and the largest do not necessarily have the greatest problems.) New industrial plants are generally located on the outskirts of cities, creating urban traffic problems for materials, products, and employees. While the private costs of the ensuing congestion are generally exceeded for the manufacturer and the worker by the benefits of large-city location, for the city as a whole social costs can be high. Thus, at some point, as social costs increase, the private and social costs and benefits of industrial concentration no longer coincide, and there is a strong argument for alternative policies.

In most countries, there are in any case strong political pressures for regional development from local politicians, and when urban concentration becomes high and its social costs grow, the alternative of decentralizing industrial development appears at first sight attractive in economic terms as well. On closer examination, however, this is rarely true.

Regional Development

All the advantages that draw industries to existing urban centers are missing from the small rural towns that planners generally have in mind when they speak of regional development. Public utilities are poor, there is no market, and transport is inadequate. There is an absence of industrial and commercial facilities and services, and this is underlined by poor communications. Provincial centers dozing in the sun do not attract skilled managers and their families. Wages tend to be lower, but so are skills, particularly at the supervisory level, and labor costs may be as high, if not higher, than in a more established labor market. Raw-material-oriented industries, such as agriculture, forestry, and mineral processing, of course do settle in the countryside but, no matter how efficiently managed and how large scale, generally remain oases in a predominantly rural area. There are, it is true, few urban problems, but also little employment is created because there is insufficient concentration to create a demand for urban facilities and services. Spreading investment in public utilities thin and wide is expensive, and attempts to stimulate regional development by industrial growth are therefore usually very costly in terms of national development. Even with a great deal of such investment, moreover, it is usually impossible to make rural centers as attractive to labor and management as large cities.

Planning Industrial Urban Development

Given a situation in which the social costs of unplanned industrial concentration require mitigation, the choice does not appear to be so much between urban concentration and decentralization in the sense of spreading industry throughout the countryside as in planned urban development that encompasses industrial as well as other forms of economic and social growth. This usually means concentrating on existing industrial centers, although in large and in relatively developed countries the stimulation of a limited number of growth poles, or “concentrated decentralization,” may also be appropriate. In addition, small-scale industries can often be stimulated in provincial centers, and some of these centers may in due course become new growth poles.

The latter is usually most important in least developed countries, and it is the most difficult to accomplish because it depends on the success with which the agricultural products are processed. This generally means increasing the scale of agricultural processing units and improving rural transport and storage, a complex package deal of considerable difficulty. Around such prosperous, successful, rural industry centers based on the satisfaction of real economic needs, it is possible to stimulate limited industrial activity on a small scale because transport and marketing costs protect the local producer. The products that can be produced competitively under such circumstances range from simple, nondurable consumer goods to building materials, such as bricks. The critical factor is entrepreneurship, and while this is fairly readily available in traditionally handicraft-oriented societies, it tends to be lacking in many Latin American, some Asian, and many African countries south of the Sahara.

The planning of industrial growth and associated urban facilities is, of course, most difficult in existing cities. The lack of reasonably priced land for industrial and housing development is often a critical problem and one with which governments have to grapple in any systematic approach to urban development. The pervasiveness of “city beautiful” concepts appropriate to wealthy, highly developed countries with their implications of high direct and indirect urban infrastructural costs are frequently another obstacle. Developing countries need not always lag in comfort and appearance behind the developed, but complex and high-cost development schemes are inimical to rapid industrial and urban development, whereas a more modest and realistic approach promises benefits not only in terms of growth and employment but also in the comfort of the common people.

Industrial Estates and Housing Development

Industrial estates 2 can play an important role in orderly industrial and associated urban growth, for they can assist in solving some of the principal problems associated with it: first, they can eliminate bottlenecks owing to the absence of land and factory space at prices competitive with those in industrialized countries; second, they can make the provision of utilities more economic by concentrating the demand for them spatially and in time; third, they can accelerate the external economies that industries provide for each other; fourth, they can enable industrial location to be planned together with low-cost housing, transport, and other urban facilities, minimizing the cost of urban development.

Industrial estates should be linked to appropriate low-cost housing development. In many countries this will mean the provision of adequately serviced land on low time payments on which workers can build their own houses. In others, private and public housing may be stimulated by appropriate financial arrangements. The construction industries involved in industrial estates, land and housing development, and associated services and utilities are among the most labor-intensive industries, and they create a demand for industrial products. If such development is planned as industry develops, large-scale urban projects will be less costly than a multiplicity of small ones, ensuring maximum returns for a given scale of investment. Urban problems, like many others, become unsolvable only if they are neglected, and planned urban growth can be a tool of economic growth.

Costs and Benefits

Industrialization, of course, creates social benefits other than those of employment and urban development. It brings new technical and managerial skills throughout the economy and puts pressure for science in education to balance literary traditions. Where industrialization is competitive and sustained, it increases the availability of goods for large numbers of people, leads to new patterns of consumption and leisure, and reduces the effort required for everyday survival. Many of these changes also have a cost aspect, but the evaluation of the social costs of industrialization is more difficult because many of the costs lie in the loss of traditional mores and cultural values. In any case, migration to large industrial cities, even when employment opportunities are poor, suggests that among the peoples of developing countries there is a strong preference for industrial cities. For them, at least, the social benefits of industrialization must appear to offset its costs.

UNIDO, Industrialization of Developing Countries: Problems and Prospects, Small-Scale Industry, Monographs on Industrial Development No. 11, New York, 1969, summarizes the difficulties of stimulating the development of small-scale industries. However, though a useful compendium of conventional views, like the other monographs in this recently published series, it fails to indicate some of the real difficulties of expanding small-scale industries.

Industrial estates have a variety of forms and functions. Mixed industrial estates catering to industries ranging from very small-scale enterprises to large-scale heavy industry are the most complex and require the most careful planning. It is particularly important to include provisions for small-scale enterprises, for example, in the form of dwelling-workshops on the outskirts of an estate, if small-scale industries are to be encouraged to subcontract and otherwise serve the estate and its work force. Small entrepreneurs can then use such buildings as collateral for loans. Some estates aim to encourage only small-scale and medium-scale industries by providing utilities and factory buildings, leaving large enterprises, which can make their own investment, to fend for themselves.

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