Economics Index and Qualifications
By Richard Bruce BA, MA, and PhC in Economics
Former Instructor St. John's University, New York City

Why Low Capital, Labor Intensive Industries are
so often the Key to the Rapid Growth
of Developing Economies

In recent decades, particularly in Asia, low skill, labor intensive, light industry, for example sewing clothing, has been a key to rapid growth. We have seen this in the East Asian Tigers, South Korea, Taiwan, Hong Kong, and Singapore. More recently light industry played a key role in China, and more recently still in Vietnam and even Bangladesh are accelerating. There are many other examples, but perhaps the point is made. The question is why is light industry, frequently reviled as sweat shops, so important.

Because there is little capital invested in light industry it is relatively easy for the factory owner to earn his money back quickly. This is important because if the economy is growing quickly, wages are likely to be growing quickly too. The factory owner's business plan is typically based on cheap labor, but in a rapidly growing economy the cheap wages are temporary, they are likely to double in as little as a decade, and sometimes even more quickly.

Compare for example an apparel factory filled with sewing machines to a steel mill. The steel mill may have to operate for several decades to pay for itself. In a rapidly growing developing economy economic output per worker will often double in a decade or less. The steel mill might need to run for thirty years to pay for itself and make a decent profit. By the end of the thirty years the country's per person output might have doubled three times and therefore be eight times as high. If the steal mill was appropriate for the economy at the beginning of the thirty years, it is not likely to be appropriate at the end of the thirty years. But if it was appropriate for the end of the thirty year period it would be too sophisticated for the workers to operate when it was first built.

Advanced industrial nations like the USA, Japan, Germany, France, and the UK typically grow two percent a year per person, or as economists say per capita. With compounding this means that output doubles roughly every thirty five years. At that rate, it takes about one hundred and five years to double three times. Now imagine a factory in 2015 being run with the equipment of 1910. Or imagine workers in 1910 trying to use the latest equipment that we have today.

If a country is doubling its output every ten years, and China has done it even faster than that, it is growing at three and a half times the typical growth rate for very advanced countries. So in some sense trying to use equipment installed thirty years ago is similar to an advanced country using equipment that is 105 years old.

So the advantage of sewing underwear with sewing machines is clear. When wages rise enough that you need to look for lower wages, you can pack up the sewing machines and move to a new country, or simply junk the sewing machines. Both the moving and the junking is more difficult and expensive if you own a steel mill.

Frequently people think that poor countries emphasize labor intensive light industry because they do not have the savings to invest. However, if the investment is a sound one then the developing country might be able to barrow the money from developed countries, or allow foreign investors to build the factories.

Conservatives in particular often think that capitalists are reluctant to make heavy investments in developing countries because they are worried their investments will be expropriated by the government. If we could simply convince those poor nations to pay the proper respect for property rights then the problem would be solved.

What the above analysis suggests is that while lack of savings, or unstable governments and the fear of expropriation may be part of the story, there is another reason rapidly developing economies avoid heavy investment and it can not be solved by a change in government policy, or a virtuous increase in Third World thrift. It is growth, rapid growth, that is the difficulty that discourages the heavy investment and makes light industry a key element in rapid growth.

Note, the problem is that rapid growth is self limiting. As economic growth increases, wage growth also increases. As wage growth increases the capitalists will consider putting their factories in other developing countries. To the degree they do, this will slow the growth of the economy of the country that lost the factory. This is probably a major reason developing nations can not simply leap up to developed status in one generation.

A key point, at least in the past, is that there were a limited number of these low skilled, light industrial jobs. The people in the First World usually only wear one pair of underwear at a time. This limited the growth of the developing world. It also limited the growth of the countries that were strong in light industry, if they grew too fast they would begin to lose factories to other countries. Furthermore it also limited the growth of the countries that could not compete in light industry, and had to wait their turn.

As China moves up the food chain to more sophisticated industries we are seeing vast numbers of low skilled jobs raining down on the poorer countries. Hopefully, this will relieve the constraints that have held other developing countries back.

How will the 3rd world develop? This popular web page lays out the growth path.

Here is an index to my other pages on economics, and a short review of my qualifications in this field.

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Last updated Jan. 6, 2014