The role of unit labor costs in African manufacturing investment and export performance

• Published date: 01 August 2023
• Author: Karmen Naidoo,Léonce Ndikumana
• Date: 01 August 2023
• DOI: http://doi.org/10.1111/rode.13011

REGULAR ARTICLE

The role of unit labor costs

in African manufacturing investment

and export performance

Karmen Naidoo

1

| Léonce Ndikumana

2

1

International Monetary Fund,

Washington, DC, USA

2

Department of Economics, University of

Massachusetts Amherst, Amherst,

Massachusetts, USA

Correspondence

Karmen Naidoo, International Monetary

Fund, 1900 Pennsylvania Avenue NW,

Washington, DC 20431, USA.

Email: knaidoo2@imf.org

Abstract

Several studies have pointed out that manufacturing

wages are relatively higher in African countries than

in other countries at similar levels of development,

and that this contributes to the continent's lower levels

of manufacturing competitiveness. This paper derives

unit labor costs (ULCs)—average wages relative to

productivity—for two-digit manufacturing sectors across

a sample of 79 developed and developing countries,

including 13 African countries, over the 1990–2015

period. We benchmark the ULCs to China and estimate

the relationship between relative ULCs and manufactur-

ing sector investment rates and export performance. We

find that relative ULCs have a smaller association with

exports in Africa relative to other developing regions.

There is some evidence that investment responds to

changes in relative ULCs in Africa; however, the esti-

mated effects are smaller than in the full sample. Further,

we find that for Africa, the level of labor productivity has

a quantitatively stronger and more robust association

with manufacturing performance than the level of real

wages. The results have important implications for indus-

trial policy in African countries.

KEYWORDS

Africa, China, exports, investment, labor costs, manufacturing,

productivity

Received: 14 April 2022 Revised: 12 May 2023 Accepted: 13 May 2023

DOI: 10.1111/rode.13011

1874 © 2023 John Wiley & Sons Ltd. Rev Dev Econ. 2023;27:1874–1909.wileyonlinelibrary.com/journal/rode

JEL CLASSIFICATION

O14, L60, J30, O1

1|INTRODUCTION

For much of Africa, the level of industrialization has lagged behind other developing regions

for decades. The manufacturing sector in Africa accounted for about 12% of the continent's

GDP in 2020, lower than the 1990 level of 17% (World Bank, 2022). Industrial employment in

Africa accounts for just above 14% of total employment, a mere 1% point higher than early 1990

levels (World Bank, 2022). Furthermore, the value of African manufactured exports to the

world remains low in comparison to other developing regions.

1

This study aims to assess

whether and to what extent unit labor costs (ULCs)—average wages relative to labor

productivity—constitute a constraint to Africa's manufacturing industry growth. Specifically,

we benchmark two-digit manufacturing industry ULCs for a wide range of countries in Africa

and other regions to China, to assess how changes in relative unit labor costs (RULCs) impact

manufacturing industry investment and export performance. We control for other important

country-level factors of manufacturing sector performance, including resource dependence and

the quality of infrastructure and institutions.

The manufacturing sector is considered an important engine of sustained growth and tends

to exhibit strong unconditional international convergence in labor productivity (Rodrik, 2013).

In Africa, the small share of the manufacturing sector in overall economic activity is a major

impediment to improving aggregate productivity and achieving higher levels of income.

McMillan et al. (2014) estimate that structural change in Africa between 1990 and 2005 reduced

overall economic growth by as much as 1.3% per annum on average. This negative impact on

growth is mostly due to the shift of labor from the primary sector to a tertiary sector that is

dominated by informal enterprises with low productivity.

2

There is, however, heterogeneity

across the continent, with some countries exhibiting positive structural change over that period,

wherein the share of employment in agriculture declined and that of manufacturing increased

(McMillan et al., 2014).

One of the challenges to industrialization in Africa over the last two decades has been

international competition, especially in the context of the rapid rise of China and other East

Asian economies as global manufacturing powerhouses. China's rapid ascent over the past

two decades has been attributed to several structural and institutional factors, including an

undervalued exchange rate, wage repression, and high productivity.

3

In some African coun-

tries, RULCs have been estimated to be up to three times greater than China (Golub

et al., 2018). In addition, greater trade liberalization in Africa has also meant higher levels of

competition from imported manufactured goods. In this context, RULCs are a useful indicator

of manufacturing competitiveness, as they reflectnotonlyrelativewagesbutalsoadjustlabor

costs to account for productivity levels. Therefore, low wages alone are not a source of com-

parative advantage.

This study aims to investigate the extent to which the poor performance of the manufactur-

ing sector in African countries may be due to low productivity and high labor costs which

undermine global competitiveness, especially in the context of the unprecedented rapid growth

of China as an exporter of manufactured products. The goal of this paper is two-fold. First, it

evaluates how RULCs vary within Africa and compares Africa to other developing regions.

NAIDOO and NDIKUMANA 1875

Second, the paper investigates the relationship between RULCs and the performance of the

manufacturing industry globally and by region, controlling for other important country-level

factors.

This paper uses a novel global manufacturing two-digit industry-level panel database con-

structed from various sources: UNIDO INDUSTAT2, Comtrade, World Development Indicators,

and OECD Data. We construct this novel dataset by creating a crosswalk between the industries

in the UNIDO data and the product-level codes in the Comtrade export data, allowing us to

merge these two sources of data. The data used in the regression analysis covers the 1990–2015

period, for a sample of 79 developed and developing countries, including 13 African countries.

It includes data related to manufacturing output, employment, exports, and a range of country-

level factors. The paper uses a panel fixed-effects estimation approach to investigate how

changes in RULCs and other important indirect costs of production affect manufacturing sector

investment and exports.

The paper makes several contributions to the literature. First, it analyzes manufacturing

performance at the detailed two-digit level, which is not commonly studied in the literature,

particularly for a long time horizon and covering a large sample of developing countries. Sec-

ond, this is one of the first papers to benchmark ULCs to China for a global set of countries.

Over the last decade, there has been considerable attention paid to the impact of China on

developed countries' manufacturing sectors (Acemoglu et al., 2016; Balsvik et al., 2015; Dauth

et al., 2014). This paper sheds light on how the relative competitiveness of different regions has

evolved over time. Third, the paper goes beyond calculating and comparing RULCs or direct

wage costs as done in existing studies (Gelb et al., 2020; Golub et al., 2018), to estimate the

impact of RULCs on two key measures of manufacturing performance, namely exports and

investment. The analysis uses a novel dataset that we construct by merging UNIDO and

Comtrade data.

The rest of the paper is structured as follows. Section 2discusses the existing literature on

the constraints to African manufacturing performance and competitiveness. Section 3presents

the methodology and data, followed by a descriptive analysis in Section 4. The estimation

results are presented and discussed in Section 5, and Section 6concludes.

2|LITERATURE REVIEW: CONSTRAINTS TO

MANUFACTURING GROWTH IN AFRICA

The literature on Africa's uneven economic performance and lackluster manufacturing growth

is now expansive. While early research focused on the macroeconomic environment,

4

as firm-

level data became more readily available, the focus shifted to microeconomic dynamics. This

paper contributes a more detailed analysis of manufacturing industries in the region, of which

there is relatively little. This section first reviews the firm-level empirical evidence on the major

constraints to manufacturing growth in Africa, followed by a discussion of industry-level evi-

dence, focusing on the role of ULCs.

2.1 |Firm-level evidence

Greater access to firm-level survey data in Africa, such as the World Bank's 1990s Regional Pro-

gram on Enterprise Development surveys, Investment Climate and World Business Environment

1876 NAIDOO and NDIKUMANA