A Fresh Look at De-Industrialisation

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Manufacturing is still the driver of productivity and thus of overall economic growth. We do not live in a post-industrial world. Decline in relative competitiveness of the manufacturing sector is bad for advanced countries and positively detrimental for developing economies.

Most estimates show that the rise of China as the new workshop of the world can explain only around 20 per cent of de-industrialization in the rich countries that has happened so far. Many people think that the remaining 80 per cent or so can be largely explained by the natural tendency of the (relative) demand for manufactured goods to fall with rising prosperity. However, a closer look reveals that this demand effect is actually very small. It looks as if we are spending ever higher shares of our income on services not because we are consuming ever more services in absolute terms but mainly because services are becoming ever more expensive in relative terms.

With the (inflation-adjusted) amount of money you paid to get a PC ten years ago, today you can probably buy three, if not four, computers of equal or even greater computing power (and certainly smaller size). As a result, you probably have two, rather than just one, computers. But, even with two computers, the portion of your income that you spend on computers has gone down quite a lot (for the sake of argument, I am assuming that your income, after adjusting for inflation, is the same). In contrast, you are probably getting the same number of haircuts as you did ten years ago (if you haven’t gone thin on top, that is). The price of haircuts has probably gone up somewhat, so the proportion of your income that goes to your haircuts is greater than it was ten years ago. The result is that it looks as if you are spending a greater (smaller) portion of your income on haircuts (computers) than before, but the reality is that you are actually consuming more computers than before, while your consumption of haircuts is the same.

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... why are the relative prices of manufactured goods falling? It is because manufacturing  industries tend to have faster productivity growth than services. As the output of the manufacturing sector increases faster than the output of the service sector, the prices of the manufactured goods relative to those of services fall. In manufacturing, where  mechanization and the use of chemical  processes are much easier, it is easier to raise productivity than in services. In contrast, by their very nature, many service activities are inherently impervious to productivity increase without diluting the quality of the product. In some cases, the very attempt to increase productivity will destroy the product itself. If a string quartet trots through a twenty-seven-minute piece in nine minutes, would you say that its productivity has trebled?

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But if de-industrialization is due to the very dynamism of a country’s manufacturing sector, isn’t it a good thing?

Not necessarily. The fact that de-industrialization is mainly caused by the comparative dynamism of the manufacturing sector vis-à-vis the service sector does not tell us anything about how well it is doing compared to its counterparts in other countries. If a country’s manufacturing sector has slower productivity growth than its counterparts in other countries, it will become internationally uncompetitive, leading to balance of payments problems in the short run and falling standards of living in the long term. In other words, de-industrialization may be accompanied by either economic success or failure.

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De-industrialization also has a negative effect on a country’s balance of payments because services are inherently more difficult to export than manufactured goods. A balance of payments deficit means that the country cannot ‘pay its way’ in the world. Of course, a country can plug the hole through foreign borrowing for a while, but eventually it will have to lower the value of its currency, thereby reducing its ability to import and thus its living standard.

At the root of the low ‘tradability’ of services lies the fact that, unlike manufactured goods that can be shipped anywhere in the world, most services require their providers and consumers to be in the same location. No one has yet invented ways to provide a haircut or house-cleaning long-distance.

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[I]t is a fantasy to think that a poor country can develop mainly on the basis of the service sector. As pointed out earlier, the manufacturing sector has an inherently faster productivity growth than the service sector. To be sure, there are some service industries that have rapid productivity growth potential, notably the knowledge-based services that I mentioned above. However, these are service activities that mainly serve manufacturing firms, so it is very difficult to develop those industries without first developing a strong manufacturing base. If you base your development largely on services from early on, your longterm productivity growth rate is going to be much slower than when you base it on manufacturing.

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[M]any people think that Switzerland lives off the stolen money deposited in its banks by Third World dictators or by selling cowbells and cuckoo clocks to Japanese and American tourists, but it is actually one of the most industrialized economies in the world. We don’t see many Swiss manufactured products around because the country is small (around 7 million people), which makes the total amount of Swiss manufactured goods rather small, and because its producers specialize in producer goods, such as machinery and industrial chemicals, rather than consumer goods that are more visible. But in per capita terms, Switzerland has the highest industrial output in the world (it could come second after Japan, depending on the year and the data you look at). Singapore is also one of the five most industrialized economies in the world (once again, measured in terms of manufacturing value-added per head). Finland and Sweden make up the rest of the top five. Indeed, except for a few places such as the Seychelles that has a very small population and exceptional resources for tourism (85,000 people with around $9,000 per capita income), no country has so far achieved even a decent (not to speak of high) living standard by relying on services and none will do so in the future.

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