Which Economy Do We Want?

The dash to become a service-based economy shouldn’t come at the expense of developing our manufacturing sector.

The Economist- Yusuf Mansur


Every now and then a government official with something to do with running the economy states that Jordan should focus more on services, which already make up two-thirds of the economy, than on manufacturing, as Jordan is resource poor. Such assertions should really be tamed. Better still, revised and even retracted.

Research shows that service industries account for two-thirds of world economic output, and even more in developed countries. And already services make up one-third of world employment and 20 percent of global trade. So the fact that services make up 70 percent of the economy in Jordan doesn’t make Jordan unique vis-à-vis the rest of the world.

Success or failure of an economy is based more on achieving greater productivity (more output or product from your inputs) and not on rentierism (selling natural resources or geopolitical position for rent/income). Productivity can only be achieved through greater specialization.

The need to improve productivity in the goods market is similar to the need in services. However, as American economist W.J. Baumol pointed out in a famous research paper, enhancing productivity in services is more difficult than in manufacturing.

Baumol put production activities into two categories: technology progressive activities, which enable further advances and increases in labor productivity; and activities that fundamentally resist sustained labor productivity growth.

Service industries, as Baumol pointed out, tend to fall into the growth-resisting activities because in service industries the labor input and its interaction with the customers is an important part of the output. A certain restaurant chef or hairdresser may become indispensible to the customer. The customer in manufacturing is shielded from that. Furthermore, a decrease in the quantity of labor in services may reduce the quality of the output (the number of workers per hotel room cannot be easily reduced, for instance). This isn’t the case in manufacturing where decreasing the number of workers is a result of intensive capital investment that leads to greater enhancements in quality.

In services, the customer’s labor (such as travel from one country to Jordan to consume our tourism services) is a very important input that the tourism firm has little control over, which makes the management of the process more cumbersome than in manufacturing. Moreover, service offerings are usually customized, which reduces scale economies, while in manufacturing offerings are mass produced—this is still the case in spite of what has become known as “mass customization” through the use of IT. Also, output in services can be difficult to measure, while it’s very easy to do so in the case of manufacturing. So if one is to focus an economy more and more on services, one needs to be able to measure productivity that requires more sophistication than in the case of manufacturing.

It’s been well established that productivity growth is larger in the goods sector than in the services sector. And even though the gap between goods and services has narrowed in recent years, it still remains. The way forward, in terms of enhancing productivity in services, hinges upon the country’s ability to establish service industries that can (through technology) replace labor and/or enhance labor productivity; and make labor more efficient through improvements in the institutional setup and a more enabling business environment. Both requirements have proven illusive to many developing economies, yet I believe that Dubai has proven a leader to follow and learn from in this regard.

In summary, adopting a service economy mantra isn’t a panacea. Focusing on the manufacturing industry and making it knowledge-intensive to enhance its value added is the easier solution.