Which Industrial Policy Should We Bet On?

The heated discussion about deindustrialization, the size, and relevance of the manufacturing industry usually relies on metrics such as the sector's share of GDP or employment. These indicators show that these shares have been declining in almost all countries over the past decades, although the movement is not uniform across countries.

It turns out that these metrics may not be adequate to capture the actual size and influence of the industrial sector in today's economy. This is because economies have been undergoing profound technological transformations and changes in industrial business models. In fact, a process has emerged in which several industrial activities have gradually been outsourced. As a result, activities that were previously classified as industry would now be categorized as services, fostering increasing and deep interdependence between the sectors. These include R&D, design, marketing, maintenance services, logistics services, among many other activities. Brands, royalties, distribution networks, software, financial services, and a wide variety of activities that are fundamental to industrial competitiveness today would also gain importance. The increasingly intensive use of digitalization, robots, and other advanced technologies in factories would help explain the decline in industrial employment. These transformations vary by sector, company size, capital nature, and structure, among other factors, but the direction has been common.

Evidence shows that the share of services and innovations "embedded" in manufactured goods is expected to continue growing not only due to the change in business models but especially because of the secular trend of shifting relative prices in favor of services and against industry. All of the above helps explain the shrinking size of industrial activity in conventional metrics.

Let's take the case of the iPhone. A fundamental part of the value addition to the phone is due to brands, platforms, customized software, pre- and post-sale services, connectivity, and various digital security and convenience services that make the product more attractive, valuable, and distinguishable to consumers. It is estimated that the "non-hard" parts of the phone account for at least 80% of the final value. So, is the iPhone a good or a service? It is both, in a symbiotic and synergistic relationship where the tangible part requires the intangible to gain value and market access, and vice versa. However, the control of the value chain lies in Apple's offices, not in the offices of the outsourced factories that produce parts or assemble the final product.

But is industrial activity really losing importance and influence? Consider the case of the United States. The industrial sector's share is currently 11% of GDP, about half of what it was five decades ago. Meanwhile, employment has dropped from 21% of the total to 8% today. The supposed shrinking of the industry helps underpin America First, Make America Great Again, reshoring, or the policy of bringing back industrial plants previously located in China, among other protectionist measures. However, when we take into account the services anchored in industrial value chains, the "extended" industrial activity reaches at least 29% of GDP, highlighting the sector's relevance to the country.

In China, industry accounted for 40% of GDP five decades ago and today represents 26%, still a high figure. The country has immensely benefited from offshoring to advance, that is, the American policy of transferring factories to locations with low labor costs and other benefits. But time has passed, offshoring has ended, and China is moving from being a large maquiladora to becoming a genuine industrial protagonist, where locally developed R&D and other sophisticated services gain focus.

And Latin America? Consider the cases of Mexico and Brazil, the countries with the two largest industrial parks in the region. Although Mexico has a thriving industrial sector that accounts for 20% of GDP and a significant share of exports, the country adds relatively little value to the manufacturing it produces due to the division of labor model with the United States, where it plays, roughly speaking, the role of the maquiladora. Most of the value addition to cars and other manufactured goods that the country exports goes to the United States. This helps explain why, despite its size, the industry has not yet positively influenced the country's productivity and economic growth. In light of the Chinese experience, betting on policies that promote value addition, densification of production chains, services, and investments in knowledge and R&D may be promising steps to consolidate the industry and transform the economy.

In Brazil, the industry accounts for 11% of GDP, almost one-third of what it once was. Beyond the methodological issues already discussed, Brazil is a notable case of deindustrialization. At this point, to have a strong and thriving industry, as public policy advocates, it will be necessary to invest, among other things, in the industrial support ecosystem, especially in R&D and other services that, directly or indirectly, determine industrial competitiveness. Another good bet is to industrialize the unique comparative advantages that the country has and that can become the great engine of growth, productivity, and integration of the country into the international economy. With a large energy production base, especially renewable energy, many strategic minerals for the transition, extensive biofuel production capacity, vast food production capacity, rich biodiversity, and large forests, the country can, through strategies such as powershoring, attract substantial industrial investments to help the world decarbonize and feed itself. And to maximize this strategy, it will be important to associate with international capital and focus on knowledge, science, and technology.

Jorge Arbache is a professor of economics at the University of Brasília. This article was originally published in Valor Econ?mico, on August 15, 2024.