23 Things They Don't Tell You About Capitalism

There are some service activities, such as banking, which have greater scope for productivity increase than other services. However, as revealed by the 2008 financial crisis, much of the productivity growth in those activities was due not to a real rise in their productivity (e.g., reduction in trading costs due to better computers) but to financial innovations that obscured (rather than genuinely reduced) the riskiness of financial assets, thereby allowing the financial sector to grow at an unsustainably rapid rate (see Thing 22).

To sum up, the fall in the share of manufacturing in total output in the rich countries is notlargely due to the fall in (relative) demand for manufactured goods, as many people think. Nor is it due mainly to the rise of manufactured exports from China and other developing countries, although that has had big impacts on some sectors. It is instead the falling relative prices of the manufactured goods due to faster growth in productivity in the manufacturing sector that is the main driver of the de-industrialization process. Thus, while the citizens of the rich countries may be living in post-industrial societies in terms of their employment, the importance of manufacturing in terms of productionin those economies has not been diminished to the extent that we can declare a post-industrial age.

Should we worry about de-industrialization?

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 comparativedynamism of the manufacturing sector vis-à-visthe 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. Countries should not be lulled into a false sense of security by the fact that de-industrialization is due to comparativedynamism of the manufacturing sector, as even a manufacturing sector that is very undynamic by international standards can be (and usually is) more dynamic than the service sector of the same country.

Whether or not a country’s manufacturing sector is dynamic by international standards, the shrinkage of the relative weight of the manufacturing sector has a negative impact on productivity growth. As the economy becomes dominated by the service sector, where productivity growth is slower, productivity growth for the whole economy will slow down. Unless we believe (as some do) that the countries experiencing de-industrialization are now rich enough not to need more productivity growth, productivity slowdown is something that countries should get worried about – or at least reconcile themselves to.

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. Obviously, this problem will be solved if the service provider (the hairdresser or the cleaner in the above examples) can move to the customer’s country, but that in most cases means immigration, which most countries restrict heavily (see Thing 3). Given this, a rising share of services in the economy means that the country, other things being equal, will have lower export earnings. Unless the exports of manufactured goods rise disproportionately, the country won’t be able to pay for the same amount of imports as before. If its de-industrialization is of a negative kind accompanied by weakening international competitiveness, the balance of payments problem could be even more serious, as the manufacturing sector then won’t be able to increase its exports.