Deindustrialization–Its Causes and Implications

This article is interesting read in that we get a look into the minds of the IMF( an important organization to know of for general knowledge) and what their thoughts are relevant to deindustrialization. You don't have to read the entire article, but check out the first section deindustrialization–its causes and complications, and the section on implications, and finally, the conclusions. For the record, I think their conclusions were largely wrong(specifically, that deindustrialization is a positive phenomenon.) ------lee

Robert Rowthorn
Ramana Ramaswamy
©1997 International Monetary Fund
September 1997

Preface
The Economic Issues series aims to make available to a broad readership of nonspecialists some of the economic research being produced in the International Monetary Fund on topical issues. The raw material of the series is drawn mainly from IMF Working Papers, technical papers produced by Fund staff members and visiting scholars, as well as from policy-related research papers. This material is refined for the general readership by editing and partial redrafting.

The following paper draws on material originally contained in IMF Working Paper 97/42, "Deindustrialization: Causes and Implications," by Robert Rowthorn, Professor of Economics, Cambridge University, and Ramana Ramaswamy of the IMF’s Research Department. Neil Wilson prepared the present version. Readers interested in the original Working Paper may purchase a copy from IMF Publication Services ($7.00).

Deindustrialization–Its Causes and Implications
During the past 25 years, employment in manufacturing as a share of total employment has fallen dramatically in the world’s most advanced economies, a phenomenon widely referred to as "deindustrialization." The trend, particularly evident in the United States and Europe, is also apparent in Japan and has been observed most recently in the Four Tiger economies of East Asia (Hong Kong, China, Korea, Singapore, and Taiwan Province of China). Not surprisingly, deindustrialization has caused considerable concern in the affected economies and has given rise to a vigorous debate about its causes and likely implications. Many regard deindustrialization with alarm and suspect it has contributed to widening income inequality in the United States and high unemployment in Europe. Some suggest that deindustrialization is a result of the globalization of markets and has been fostered by the rapid growth of North-South trade (trade between the advanced economies and the developing world). These critics argue that the fast growth of labor-intensive manufacturing industries in the developing world is displacing the jobs of workers in the advanced economies.

This paper maintains that deindustrialization is primarily a feature of successful economic development and that North-South trade has very little to do with it. Measured in real terms, the share of domestic expenditure on manufactured goods has been comparatively stable over the two past decades. Consequently, deindustrialization is principally the result of higher productivity in manufacturing than in services. The pattern of trade specialization among the advanced economies explains why some countries deindustrialize faster than others. Finally, the paper suggests that advances in the service sector, rather than in the manufacturing sector, are likely to encourage the growth of living standards in the advanced economies in the future.

The Evidence
In the 23 most advanced economies, employment in manufacturing declined from about 28 percent of the workforce in 1970 to about 18 percent in 1994. Among individual economies, deindustrialization started at different times and has progressed at varying speeds. It started earliest in the United States, with the share of manufacturing employment falling from a peak of 28 percent in 1965 to only 16 percent in 1994. In Japan, by contrast, the process started later and has been less dramatic, with manufacturing employment peaking at 27 percent of total employment in 1973 (eight years after the peak in the United States) and then slipping back to about 23 percent in 1994. In the 15 countries of the European Union, the share of manufacturing employment stood at a comparatively high level of more than 30 percent in 1970 but then fell steeply to only 20 percent by 1994.

On the other side of the coin, the share of employment accounted for by services in the advanced economies has increased fairly uniformly, with all advanced economies witnessing growth in service employment since 1960. The United States has led the way here too, with about 56 percent of the workforce employed in services in 1960 and about 73 percent in 1994, a higher share of employment in services than in any other advanced economy. The rise in employment in services has been accompanied by a decline in employment in manufacturing in all advanced economies.

General Explanation
During deindustrialization, the declining share of employment in manufacturing appears to mirror a decline in the share of manufacturing value added in GDP. At first glance, this decline would suggest that domestic expenditure on manufactures has decreased while expenditure on services has increased.

Closer analysis, however, reveals that this conclusion is misleading. Expenditure on services in current price terms has indeed grown in the advanced economies. But this growth can be accounted for by the fact that labor productivity (output per worker) has grown more slowly in services than in manufacturing, pushing up the relative price of services and making manufactures relatively cheaper. When output in the manufacturing and service sectors is measured at constant rather than at current prices, however, the shift in expenditure away from manufacturing to services is nothing like the scale of the shift away from employment in manufacturing to services. Indeed, at constant prices (in contrast to its steeply falling current-price share), the share in GDP of value added by manufacturing in the advanced economies was roughly unchanged between 1970 and 1994.

deindustrialized faster than Japan.

If a shift in domestic expenditure from manufacturing to services has not been a major determinant of deindustrialization, what explains this phenomenon? Two features of the process need to be explained. Why did the share of manufacturing employment in most advanced economies continue to rise until the late 1960s and then decline? Why was an increase in the share of services employment sustained throughout this period?

The rising share of employment in manufacturing in the industrialization stage of development represents to a large degree the movement of employment from agriculture to industry. Two factors explain this shift in employment. One—on the demand side—is what economists call Engel’s law, which states that the relative amount of income that an individual spends on food declines as his income rises. In practice, this means that, as economies industrialize, people spend proportionally less on food and proportionally more on manufactured products and services. The second is on the supply side. The rapid growth of productivity in agriculture, as innovations make it possible to produce more food with ever fewer workers, leads to declining employment in that sector. The combined effect of these demand- and supply-side factors is a large-scale shift of employment from agriculture to manufacturing. Indeed, the overall proportion of employment in agriculture in the advanced economies fell from about 20 percent in the early 1960s to 11 percent in the early 1970s. Given the scale of contraction that has already taken place in the agricultural sector, a further expansion in the share of services employment will subsequently be at the expense of manufacturing employment, just as the earlier shift to manufacturing took place at the expense of the agricultural sector.

It is very difficult to measure precisely productivity in the service sector, and some have argued that the relatively lower rate of productivity growth in services is due to under measurement. Nevertheless, empirical evidence supports the conclusion that productivity in manufacturing has grown faster than productivity in services. Assuming that such productivity patterns continue, the service sector will inevitably have to keep absorbing an ever greater proportion of the workforce just to keep its output rising in line with manufacturing.

An important implication of this analysis is that deindustrialization is not necessarily a symptom of the failure of a country’s manufacturing sector or, for that matter, of the economy as a whole. On the contrary, deindustrialization is simply the natural outcome of successful economic development and is generally associated with rising living standards. This is not to deny, however, that deindustrialization can be linked to difficulties within the manufacturing sector or in the economy as a whole. A country can lose manufacturing jobs directly as a result of such shocks to the system as a large appreciation in the real exchange rate. In these circumstances, the service sector may be unable to absorb a sudden increase in the supply of labor, causing higher unemployment or a fall in the growth of living standards.

The experience of deindustrialization has indeed differed in individual advanced economies. In the United States, the absolute numbers employed in manufacturing have remained roughly constant since 1970, while the overall workforce has grown enormously. In the European Union, by contrast, the absolute numbers employed in manufacturing have fallen sharply, while the total number at work has risen only marginally. There have been negative features of the process in both places, however, with stagnant earnings and widening income disparities in the United States, and rising unemployment in the European Union. Nevertheless, even if these countries had grown faster than they actually did during this period, deindustrialization would still have occurred, though with more favorable effects on living standards and employment during the adjustment period.

Deindustrialization has also varied in timing and in extent among the advanced economies of East Asia. In both Korea and Taiwan Province of China, it began in the mid-1980s after their per capita incomes surpassed the levels achieved by the "old" industrial countries in the early 1970s. In Hong Kong, China, the share of employment in manufacturing reached nearly 45 percent in the mid-1970s but has fallen continuously ever since—to little more than 20 percent by 1993. In Singapore, there has been no clear-cut pattern, with manufacturing employment ranging between 25 percent and 30 percent since the early 1970s. One possible explanation is that Hong Kong, China, and Singapore are both city economies and never had a large agricultural sector from which to draw workers in the first place. It seems clear that the deindustrialization taking place in these Tiger economies, so far at least, has been occurring without the negative effects on employment noted elsewhere.

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