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AP Photo / Ajit Solanki
A man works in a textile factory in Ahmadabad, India. An economist asks: Is he being managed well enough to succeed?
MARKET EVOLUTION

Think emerging markets are growing fast? Imagine if they tripled their productivity

By Tim Fernholz in India

In rich countries, managers are expected to know about business process optimization and management techniques. So their emerging-market counterparts might be surprised—and annoyed—to learn that in their case, many economists think management skills don’t really matter. When labor is cheap, goes the received wisdom, improving the process for making widgets is more costly than just paying workers to repair the faulty ones.

Now new research has revealed what might seem obvious: No matter where you are, how you run a business affects its success. And in emerging-market firms, the study suggests, better management could improve productivity by up to 200%.

“Two questions have long haunted economists,” says Nicholas Bloom, a Stanford University economist and the leader of the World Management Survey. “Why are some countries richer than others, and why are some firms more profitable than others?”

American workers are paid about 10 times more than their Indian counterparts, but explaining why isn’t easy. Economists attribute about one-third of that difference to capital investment, education and equipment quality, but the other two-thirds to “productivity” gains—which are driven by everything from technology to the cost of raw materials. Bloom suspects that management practices play a large part, too.

To this end, in 2005 he and other researchers launched the survey, an ongoing effort to develop a comparative data set of management practices in different countries.

All in all, Bloom says, countries with medium and low productivity account for 80% of the world’s population. These countries rely on low labor costs to remain competitive, but as development continues, wages rise. Even Chinese companies are moving factories inland in search of cheaper labor. And at the low end of manufacturing, they are starting to face competition from the next wave of fast-growing economies in Africa and South America.

To establish the causal link between good management and productivity, Bloom set up a controlled trial in 2008 with the help of the World Bank and the consulting firm Accenture. He found 20 large textile plants near Mumbai and convinced them to participate for three years. Of the plants, 14 were randomly selected to receive management consulting from Accenture while the other six acted as controls.

The management practices were what Bloom calls “first-year MBA” material. Managers were taught to monitor performance, set targets, and create incentives for improvement. Changes included carrying out preventive maintenance, cleaning the shop floor, cataloguing inventory, and instituting daily quality-control meetings.

When the study was published in the summer of 2012, the plants with better management practices had become at least 20% more productive and profitable. And Bloom thinks increases of 200% or more are possible. He points to the late 1980s, when American firms were eager to adopt the lean manufacturing processes of Japan.

“If you told an American factory that you could reduce inventory to less than 1% of what you have, they’d say, ‘you have to be nuts,’” he says. But soon firms went from keeping several months of inventory on hand to just half a day, like the efficient Japanese manufacturers. “One of the things you see in modern manufacturing, if you get processes right, you can get massive improvements in productivity,” Bloom says.

The broader question, says David McKenzie, a World Bank economist, is why comparatively well-run firms in countries like India and China haven’t been able to out-compete businesses that operate without basic management practices or even taking the trash out of factories.

Low labor costs are only part of the story. High tariffs and bad infrastructure in poor countries have insulated businesses from competitors. In more competitive markets, poorly-managed firms are more likely to be driven out of business, so they have an incentive to become more efficient. But even in the United States they can thrive in sectors from concrete—where local monopolies are the rule—to politically-protected industries. And in China, where companies like FoxConn have been lauded for their prowess at building high-tech products, there is still a long tail of poorly managed firms that survive thanks to low wages or public-sector backing.

The research is helping the World Bank refine its development agenda. “Given firms are not making these improvements on their own, there appears to be scope for governments to help firms overcome the obstacles that prevent these improvements taking place,” McKenzie says, even if that is just providing more information and exposure to management techniques. The World Bank plans to launch several development projects inspired by the India study, though the participants remain confidential.

For countries like China, India, and Brazil, where the heady growth rates of recent years have begun to slow, these findings suggest there is still scope for boosting growth by improving productivity. As wages rise, that will let them keep their competitive edge over Western firms, while leaving the field open for countries where labor remains really cheap to begin their own emergence.