23 Things They Don't Tell You About Capitalism

Not all services are equally non-tradable. The knowledge-based services that I mentioned earlier – banking, consulting, engineering, and so on – are highly tradable. For example, in Britain since the 1990s, exports of knowledge-based services have played a crucial role in plugging the balance of payments gap left behind by de-industrialization (and the fall in North Sea oil exports, which had enabled the country – just – to survive the negative balance of payments consequences of de-industrialization during the 1980s).

However, even in Britain, which is most advanced in the exports of these knowledge-based services, the balance of payments surplus generated by those services is well below 4 per cent of GDP, just enough to cover the country’s manufacturing trade deficits. With the likely strengthening of global financial regulation as a consequence of the 2008 world financial crisis, it is unlikely that Britain can maintain this level of trade surplus in finance and other knowledge-based services in the future. In the case of the US, supposedly another model post-industrial economy, the trade surplus in knowledge-based services is actually less than 1 per cent of GDP – nowhere near enough to make up for its manufacturing trade deficits, which are around 4 per cent of GDP.[4] The US has been able to maintain such a large manufacturing trade deficit only because it could borrow heavily from abroad – an ability that can only shrink in the coming years, given the changes in the world economy – and not because the service sector stepped in to fill the gap, as in the British case. Moreover, it is questionable whether the strengths of the US and Britain in the knowledge-based services can be maintained over time. In services such as engineering and design, where insights gained from the production process are crucial, a continuous shrinkage of the industrial base will lead to a decline in the quality of their (service) products and a consequent loss in export earnings.

If Britain and the US – two countries that are supposed to be the most developed in the knowledge-based services – are unlikely to meet their balance of payments needs in the long run through the exports of these services, it is highly unlikely that other countries can.

Post-industrial fantasies

Believing de-industrialization to be the result of the change of our engine of growth from manufacturing to services, some have argued that developing countries can largely skip industrialization and move directly to the service economy. Especially with the rise of service offshoring, this view has become very popular among some observers of India. Forget all those polluting industries, they say, why not go from agriculture to services directly? If China is the workshop of the world, the argument goes, India should try to become the ‘office of the world’.

However, it 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.

Moreover, we have already seen that, given that services are much less tradable, countries specializing in services are likely to face much more serious balance of payments problems than countries that specialize in manufacturing. This is bad enough for a developed country, where balance of payments problems will lower standards of living in the long run. However, it is seriously detrimental for a developing country. The point is that, in order to develop, a developing country has to import superior technologies from abroad (either in the form of machines or in the form of technology licensing). Therefore, when it has a balance of payments problem, its very ability to upgrade and thus develop its economy by deploying superior technologies is hampered.

As I say these negative things about economic development strategies based on services, some of you may say: what about countries like Switzerland and Singapore? Haven’t they developed on the basis of services?