AI and Slovakia: Labor cost to become less important

Artificial intelligence (AI) fueling 4.0 Industrial Revolution has put on center stage several questions in the context of a converging economy, such as the one of Slovakia. Will the introduction of AI help the main pillars of the Slovak economy such as FDI-owned manufacturing industries? Which policy challenges and risks will it bring to the fore?

In a nutshell, for Slovakia AI introduction will likely be good and bad news at the same time. Coming introduction of AI technologies will drive down labor to output ratios on a company level and will thus mean that the labor cost will become much less important for investment decisions. On one hand, it will be good news because AI introduction will lead to a reduction of the importance of labor costs in certain sectors as the competitive factor and will blunt incentives for the existing manufacturing plants to leave Slovakia and move eastward driven by convergence– as it might be happening otherwise.

However, it also means that for a country such as Slovakia it will likely be much harder to acquire future FDI since the advantage of low labor cost as a competitive factor will be significantly reduced in AI intensive sectors. Things like quality of the business environment, tax regime or reduction of country risk through a better institutional environment will matter relatively more. More generally, it means we might thus move into the world where soft factors such as business/institutional environment matter more for investment decisions than the labor cost.

Sector-level wise, at the national policy level in Slovakia, one should focus efforts to attract FDI in areas where AI will not make much difference and a ratio of wage bill to output remains significant (such as tourism, hospitality, some other services). This is because attempts to lure FDI – bar strong improvements in the institutional arena – where wages do not constitute a high share of output anymore would likely prove futile.

AI likely to suppress incentives for FDI

More generally, the application of AI to manufacturing will likely lead to a reduction of downhill FDIs globally in the future. A little speculatively, pending AI machines installation projects may even already explain some of the recent fall in cross-border FDI in 2018. The world with much less FDI puts a premium on domestic economic policies to nurture home companies and fuel domestic economic growth.

The quality of human capital will continue to matter and its relatively low cost may be a driver for certain inward investments (such as shared services) in sectors where there is still a high share of labor compensation on output. Investment in the country’s human capital should thus remain important – after-all, AI machines dominated factories will require the presence of super-sophisticated managers/engineers. Tax incentives, among other reform measures, for support of the sector of lifelong learning, would go a long way towards further beefing up the domestic educational sector which should educate such experts.

Given that future incoming FDI will likely slow down – at least in those sectors where robots can replace humans – much higher effort should be focused on building a domestic enterprise sector via start-ups support and different schemes of nurturing domestic entrepreneurship.

Less developed world: Convergence endangered?

If the simplified discourse above is correct, implications of it do not seem necessarily only positive for less developed countries and challenges they are facing. Given that their business and institutional environments are relatively weak and the labor cost is a primary competitive advantage factor, FDI in sectors where robots can replace humans will likely be not lured to such areas to the same extent as before. Some FDI factories might even migrate uphill to areas with better business, tax and institutional environment since the importance of labor cost will be so drastically reduced. Bottlenecks on markets with super-sophisticated managers/engineers to run such AI-intensive factories may contribute to that as well. It could also lead to the race to the bottom regarding environmental standards as less developed countries try to compete on non-labor cost factors. Whether AI heavily applied to the manufacturing sector also means a higher probability of middle-income trap incidence for countries such as Slovakia is worth pondering too. Focusing on substantially upgrading the business and institutional environment and supporting domestic start-up scene in middle-income countries like Slovakia could certainly help avert such scenarios.

Vladimir Zlacky,
Bratislava, 26 JUne 2019

It is brands, Economist !

It is brands, Economist !

Typically, many economists have not always fully appreciated business disciplines of softer nature – marketing as a field quickly comes to one’s mind. Yet, it is enormous how significant is the value astute marketing people can create for the national economy. They not only help salespeople of companies penetrate markets home and far abroad but through strategic brand-building enormously enhance the economic value of production.

It is not rare that a branded product – a product which carries a recognized and reputed brand – can sell for a multiple of price of a generic product. This is typically a result of concerted brand-building efforts by and within a given organization. Consistent and attractive visuals and designs of products, thought-out media advertising, marketing events of many kinds, aligned organizational behavior – these all can come under a rubric of brand-building. Yes, brand-building also entails a cost but typically astute marketing people can create the brand where a brand price premium can exceed the incurred cost substantially.

When the national economy has many high-quality brands this might also have macroeconomic implications. It can mean that countries with the most astute marketing people can see their GDP enhanced by these strategic marketing efforts more than others. This is something not completely obvious when one thinks about the role and the effect of marketing in the economy (one would think perhaps, in a first cut, of mostly zero-sum game when analyzing marketing effects within a sector). Furthermore, branded products command a much higher degree of customer loyalty – this has implications for competitiveness of the national economies. Just think what a 20% appreciation of domestic currency does with the competitiveness/profit margins of commodities exporting countries vs. highly branded products exporting countries. The latter economy is clearly much more robust to currency value shocks.

When looking at this issue via the glasses of somebody born and living in a Central-Eastern European (CEE) country one has to appreciate the road traveled since the inception of transformation of these economies to a market model also in case of local marketing activities. The marketing area was extremely neglected during the socialism regime as very little advertising and brand-building took place. During the last 30 years enormous progress was achieved as demonstrated by springing up of many attractive brands in these economies, although most of them are only of local significance. Obviously, not all progress was domestically driven but rather the effect of inflow of FDI, which brought some marketing practices, and of other foreign influences cannot be underestimated.

Yet, while the marketing expertise in the CEE economies has advanced, further improvement could be achieved by bringing business education closer to business people in these countries. Offshoots of Western business schools could perhaps find this high growth terrain of converging economies of CEE a very lucrative base for spreading their influence. If establishing their branches in CEE, they could further nurture Western management practices and culture in these countries. Besides so important marketing field as noted above, other creative areas such as general/strategic management, leadership and people management or entrepreneurship could thus be supported in CEE too. By means of not only degree programs but of various executive and evening/weekend programs such schools could help local business people grow in expertise. Spearheading entrepreneurial and start-ups culture in countries where FDIs have been a typical engine of development to date should also be commended if such school(s) appeared in the region.

Given that human capital – also that entailing best business practices – seems one of the bottlenecks of further economic development in CEE, the government could also contribute by introducing tax incentives for the whole sector of lifelong learning, including business school education.

Vladimir Zlacky
May 4, 2019

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