x Abu Dhabi, UAEFriday 28 July 2017

Productivity is the key to competitiveness

Industrialisation is an expensive process where a myriad hidden costs must be factored in. But efficient production, among other things, can ease the pain.

How expensive is industrialisation? The answer depends on what you measure and how you do it. Last week I was shopping for a bag as a gift. As I peered into a neatly woven leather handbag with an astronomical price tag, I quietly wondered "how competitive is this product?"

With most things we buy only occasionally we take the prevailing price as marker for competitiveness. And in the most basic sense, price is a reflection of how much an item cost to make, plus profit. Countries that produce goods at lower costs, such as China, could simply be doing so because they have lower input costs - labour, capital, technologies, transport to market and many other essential inputs.

This bag was very expensive. Buying it would probably have left me hungry for several weeks. So what can this bag do? Reflect envious female eyes along any mall, no doubt. Even the sales assistant didn't hesitate to correct my ill-informed tastes and assure me that this was a must-have. The basic function was clear: it could carry things. And the trademark was clearly foreign. What if it were made in the UAE? How would it be priced then? The same, no doubt. But would that make it exotic or desirable?

The truth is, the bag is like most things we buy: imported. Why can't such things be produced here? Or cars, aeroplanes, ships, consumer goods of all shapes and sizes, glass, smelted aluminium, and so on? At first glance, the engineering and design challenges are surmountable but at what cost? Taking a closer look requires deconstructing the elements of the "industrialised" handbag. Quality and quantity questions aside for now, most leather can be provided by cattle in farms, and there are lots of them along the road from Abu Dhabi to Al Ain.

The tanning, buffing, cutting, stitching and weaving of the bag could be done by most skilled machinists from South Asia. There are many of them here to do that, too. And we have enough malls to sell them in. So how much would this cost? The answer is a lot. The UAE and its gulf neighbours have one thing in common: all commercial and residential existence depends on finite energy resource. Desalination uses energy. Food production (and for the handbag, that would be for cattle) uses desalinated water, given that groundwater is so scarce.

The input cost of any product made in the UAE therefore depends on how much energy we are willing to allocate for industrial use. Or should we say, the actual price of the handbag is its price compared with money that could have been gained from exporting crude oil (opportunity cost). In my example, I'm going to assume one mature cow could yield four great handbags, with the possibility of more. The water input (assuming a healthy cow consumes 7,000 cubic metres of water over its life), at current tariffs, would cost Dh61,000 (US$16,606).

Combine this with up to 15 man days of labour (cutting, weaving and so on), and we have a final price of Dh65,000 for four bags or Dh16,250 a bag - before marketing, distribution and sale costs. The profit margins are thin. The cost of producing the handbag is close to the price of buying one from the shop. So what can the UAE do to make this bag competitively? One option would be to alter the final price of the bag, at least in dollar terms.

The conventional response in the GCC, until now, has been to subsidise the price of inputs. For example, water and electricity in Abu Dhabi are a fraction of world prices and this makes a difference to the final price of the bag. The snag is that as the scale of industrial production rises, the subsidy rises and someone has to pay. World energy prices are not going down. If anything, they are going up. In the long run it is safer to assume that these input prices will rise to world averages, especially as the GCC's population increases.

Should we want to sell the bag all over the world (which we do, assuming we employ a rational import industrialisation strategy), the other response could be to devalue the exchange rate. This way the bag would be cheaper in dollar terms. Again, that is not likely to happen, at least not in the near future. Making other input costs lower might work, such as more affordable housing for labourers, but how low can this possibly go compared with, say, Thailand or the Philippines? Wages here are unlikely to come down much. Workers still have to eat.

The room for manoeuvre in terms of inputs comes from the more practical options such as buying leather from water-rich countries at lower prices. Commercial and residential existence outside the GCC is different. In these countries, water tends to be an abundant resource that is "mined" for food production. Energy is a secular input and bought at world prices. The final cost of our handbag would be lower, much lower. Importing technologies that improve product quality would also work wonders. But with so many inputs outsourced, almost the entire product is dependent on imports.

What room to manoeuvre is left after this? We could try to differentiate the product through marketing, perhaps. Oddly, the elephant in the room is the fact that we could lower our costs through productivity and quality; how much is being produced with given input constraints? What level of quality are the products being delivered at? Studies have shown the link between productivity and growth. We could make cars, aeroplanes or almost anything else. The differences that make the final product feasible is the productive use of resource, and quality control.

It might come as a surprise to some that this is only half of the story. There are a host of other "soft" activities that encourage enterprise, such as the ease of setting up and closing down a business. For example, the UAE ranked 33rd globally by the World Bank for ease of doing business, and yet 143rd for its efficiency in closing down businesses, taking an average of 5.1 years. Regional service sector efficiencies are hidden inputs of product prices. Even the availability of the right information from the right agencies at the right time has a hidden price. Support from the banking sectors and communications sectors shouldn't be ruled out from a productivity crusade. For example, if it takes several weeks to get an internet connection running, something is clearly not right.

So, how expensive is industrialisation? Well it costs more than the mere energy inputs we can put a price on and perhaps more than the service sector synergies that go along with it. One thing is for sure, lower costs can be achieved through improved productivity. Ikaraam Ullah is an economist and writer based in Abu Dhabi business@thenational.ae