Outsourcing to low cost foreign locations has been a major theme in early 21st century corporate strategy. As of 2015, average hourly wages in developing cities are still more than four times lower than in developed ones. However, this gap shrank by 10% in constant value terms since 2010. Real wages are indeed on the rise in the developing world at large, which according to economic theory, should reflect corresponding increases in labour productivity. However, economic reality reveals that real wage growth in developing cities is accompanied by different trends in labour productivity, which provides a valuable insight for business entry or expansion.
Changes (in Constant Value Terms) in Wages and Labour Productivity in Selected Developing Cities 2010-2015
Note 1: Graph features a set of 40 developing cities, for which data on both wages and productivity are available; Guatemala City, with an outlier combination of 36% and 121% rises in productivity and wage per hour, respectively, in 2010-2015, is not shown on the graph.
Note 2: Significant drops in Montevideo and Caracas’ wages (in constant value terms) are a result of elevated inflation in Uruguay and Venezuela, respectively.
Industrial make-up is a part of the story – but only “a part”
A 30-55% rise in real wages over 2010-2015 is well supported by growing labour productivity in the metropolises in Asia Pacific, particularly in China (except for Beijing and Shanghai). The key factor contributing to growing labour productivity is that the large Chinese manufacturing sector is no longer centred on low-end products. High value-added industries – eg automotive, electronics, biotechnology, pharmaceuticals, medical technology, equipment production, aerospace and new generation information technology – increasingly define the manufacturing landscape of Chinese cities. Even the traditional manufacturing “trademark” of Chinese cities – garment production – has been commented to imply a more favourable connotation than before, reflecting decades of technology investments and workforce training.
Developing cities in Eastern Europe and Latin America saw lagging or negative labour productivity growth despite rising real wages in 2010-2015, thus contributing to loss of their competitive advantage. Longer and more pronounced impact of the Great Recession of 2008-2009 was one driver that constrained development of labour productivity in these regions.
Additionally, what sets Eastern European and Latin American cities apart from Chinese, is that the low value-added services, such as trade, hospitality and transport industries, have a much more significant role there than manufacturing. For example, in São Paulo, the commerce activities made up 38% of GVA in 2015, while manufacturing and mining accounted only for 14%. Service industries, in turn, are not as suitable to productivity enhancements as physical production, and this fact contributed to stagnating labour productivity growth. However, major cities in Eastern Europe and Latin America are trying to reposition themselves by promoting their advantages to host higher value-added business services. São Paulo and Moscow, for example, made it to the list of top 20 start-up cities in the Global Startup Ecosystem Ranking 2015 by Compass, dominated by developed North American and European cities.
Political and economic stability is another checkmark to score
If the labour productivity potential of a city were solely determined by its industrial composition, it would be disappointing to hope for changes since the industrial make-up is historically shaped and not so quickly amenable to alterations. However, cities, as drivers of growth, operate in the wider macroeconomic and political context of their countries, which although challenging to manage, can provide additional ways to manoeuvre towards higher productivity gains.
In particular, undermining safety, following bombings and attacks, is what is holding back Bangkok(which due to a large manufacturing base could explore higher end production) or indeed otherwise thriving high-tech Israeli hubs of Jerusalem and Tel Aviv. A destabilising security situation in Ukraine has been a major blow to the potential of both Ukrainian and Russian cities. Meanwhile, political uncertainty, structural economic struggles and weak business confidence in Latin America’s largest economy Brazil represent a major drag for key cities São Paulo, Rio de Janeiro and Salvador.