The foreign currency crisis has been deepening in several aspiring developing countries. After showing a sign of reserve growth, there has been a free fall-reaching a crisis level in a few countries. But what are the underlying causes? Will the declining trend continue, and are there options to reverse it? In addition to corruption, mismanagement, and war, experts and the media have already cited many other reasons. For a remedy, several policies and regulatory measures such as increasing interest rates, depreciating the currency, practising austerity, reducing imports, controlling invoices, limiting expenditure, increasing export, earning more remittances, and many more have also been cited. A few of them are being enforced. Of course, they have merit. But are they going to find a long-term solution to helping these countries keep growing while maintaining healthy foreign currency reserves? It depends on how these countries create economic value.
To get insight into this vital issue, let's go to the basics of economic value creation in a globally connected competitive market. Whatever a producer sells contains four major cost components or factors: (i) natural resources, (ii) capital, (iii) labour, and (iv) knowledge and ideas. Yes, by selling natural resources, a few countries have been improving their living standard through imports and maintaining healthy foreign currency reserves. But not all less developed countries are equally blessed with high per capita natural resources. Hence, their next option is to add value to imported ingredients with imported capital, knowledge, and ideas with locally supplied labour. But in many products, perhaps in all, the role of labour has been falling, while the role of capital has been increasing. The question could be-- why?
Consumers have been after getting better quality products at a lower price, and producers are after growing profit. To address this conflicting situation, we need to find a way to keep improving the quality and reducing the cost of production. The solution is to keep adding more knowledge and ideas, such as the better design of products, capital machinery, and processes. But advancement along this line invariably reduces the role of labour. Furthermore, the part of knowledge and ideas during production (replication, manufacturing) also keeps falling when these are supplied by imported capital, intermediary goods, and designs of products, as well as processes.
To remain competitive, aspiring countries have been after importing state-of-the-art physical capital. Such import of capital is not limited to factory machinery. From airports, power plants, bridges, highways, and metro rail, to telecom equipment -- all kinds of physical capital are being imported. Through these items, knowledge and ideas are being increasingly imported. As a result, productivity, measured as units produced per unit of labour or working hour, has been increasing. But that is reducing the role of labour-based value add in making each unit of output. Furthermore, reliance on increasingly sophisticated capital machinery is also reducing the demand for locally supplied skills, knowledge, and ideas in replicating products. As a result, despite the expansion of education and skill development programmes, local value addition through knowledge and ideas in replication is facing difficulty to expand.
Let's go back in history. In the colonial era, aspiring less developed countries were compelled to export natural resources. European producers used to process them with their knowledge, ideas, and labour to produce finished products-- creating a market for their knowledge, ideas, and labour. Colonial countries used to import them with a scanty foreign currency they used to earn from the export of natural resources.
In the post-colonial era, countries like India and Pakistan, and also Bangladesh, after independence in 1971, opted to process locally produced natural resources with locally supplied labour through imported capital machinery, knowledge, and ideas. As a result, the situation started improving as a value addition window out of labour got created. But it started saturating, leading to the very slow growth of these economies. But fortunately, continued advancement of technology reached a state where manufacturing or replication of a growing number of products left only a low-skilled labour role, innate abilities, for humans to supply. Hence, countries with friendly policies, infrastructure, and low-cost surplus labour became export-oriented foreign direct investment beneficiaries. As a result, some of these countries started getting blessed with export-oriented manufacturing jobs. Notable ones are China, Malaysia, Indonesia, Vietnam, and Bangladesh. For example, Bangladesh got 4 million jobs for producing and exporting textiles and apparel. Furthermore, due to the liberalisation of the labour movement to meet the global labour shortage, countries like Bangladesh, India, Pakistan, and the Philippines, among others, also started witnessing growing labour force migration and remittance inflow.
With the success of export-oriented manufacturing jobs and remittance flow, most countries witnessed growing foreign currency reserves and living standards through import-driven consumption. Hence, to accelerate it, they started improving physical capital by importing all kinds of things, from bridges and tunnels to factory machinery. Such import driven agenda kept fueling GDP growth, turning it into an apparent miracle development model. Furthermore, to augment it, most of these countries accelerated the expansion of the education system with the belief that there is a natural correlation between human capital development and economic value creation. But, ironically, these countries have been facing a bleak reality of growing unemployed university graduates and labour shortages in farming. Besides, these countries are after import substitution through tax differential and other incentives to take advantage of growing imports. Unfortunately, due to the growing sophistication of capital machinery and intermediary products due to the increasing role of imported, embedded knowledge and ideas, local value add has reached very low, as low as less than 10 per cent. Hence, incentive-driven production out of labour for local consumption and export has little role in improving the net flow of foreign currency.
It appears that the wave of economic growth out of labour-based value addition-through incentives and capital import-based agenda-- has reached the limit. Furthermore, the expansion of education and skill development has also been failing to add value because the scope of value creation in replication through knowledge and skill has been eroding. Oftentimes, we cite poor quality of education. Of course, quality is a concern, but quality improvement will not do much unless we succeed in creating demand for education. Unfortunately, in the replication of economic activities through the import of capital, there has been decreasing demand for local knowledge and ideas, as the exporting countries are increasingly embedding them in the capital.
Well, what could be the remedy? To find a long-term solution, aspiring countries must upgrade the means of economic value creation. It's time to focus on producing knowledge and ideas locally and integrate them into capital and products so that their producers succeed in improving the quality and reducing the cost of what they produce. And they should do it far better than others to succeed in extracting profitable revenue by trading them in the globally connected competitive market. Of course, it is not an easy path. But that is the only option these countries have to find a way to keep increasing consumption and improving foreign currency reserves simultaneously. Hence, it's time to go back to the basics of economic value creation, change the belief, upgrade the strategy, take decisions, and keep uplifting to migrate to the orbit of economic value creation out of knowledge and ideas.
Rokonuzzaman, Ph.D is academic and researcher on technology, innovation and policy
