20th July, 1997

Deindustrialization is a natural consequence of growth

Since the 1970s, the world’s advanced economies (including the traditionally designated “industrial countries” and the newly industrialized economies, as defined in the May 1997 World Economic Outlook, have experienced a virtually continuous decline in the share of employment in manufacturing and an inexorable rise in the share of employment in the service sector.

This phenomenon, referred to as “deindustrialization,” has been linked in the public mind with two other economic developments: the widening disparity of earnings, mainly in the United States, and rising unemployment, mainly in Europe.

But, according to a recent IMF Working Paper, Deindustrialization: Causes and Implications, by Robert Rowthorn and Ramana Ramaswamy, deindus-

trialization is not a negative phenomenon but a natural consequence of the process of economic development in an already highly developed economy.

The most important factor that accounts for deindustrialization is the systematic tendency for productivity in manufacturing to grow faster than in services.

Because it is an inevitable consequence of economic growth, deindustrialization will have important implications for growth and industrial relations.

What is it?

For the industrial countries, the process of economic growth has led, first, to an increase in the share of industrial employment in the early industrializing phase of economic development and then to deindustrialization and transition to a service economy in the later stages. Since the beginning of the late 1970s, manufacturing employment as a share of civilian employment has declined continuously in most advanced economies (see chart).

For the industrial countries, this share fell to about 18 percent in 1994 from about 28 percent in 1970. The other side of this development has been the fairly uniform and virtually continuous increase in the share of employment in services since in 1960. Yet, as the IMF study shows, the shift in employment from manufacturing to services since the early 1970s has not been associated with any significant shift in the pattern of expenditures between these two sectors. How, then, to account for the shift?

A comparison between secular shifts in employment in the industrialization stage of development (that is, from the latter decades of the nineteenth century up to the early 1960s) and in the period since the early 1970s shows that differences in productivity are the prime movers behind the shifts.

In the pre-1960s industrialization stage, the share of employment in manufacturing rose steadily, largely representing the movement of employment from agriculture to industry.

This reflected not only the shift in the pattern of demand from agricultural to manufactured products and services that typically comes with economic growth, but also the rapid growth of labour productivity in agriculture owing to a wide range of innovations.

Similarly, the secular shift in employment from manufacturing to services since the early 1970s mainly reflects the impact of differential productivity growth between manufacturing and services.

For the industrial countries, the average annual growth rates of output were roughly similar in services and manufacturing between 1960 and 1994, but labour productivity in manufacturing consistently outpaced that of services. According to the IMF study, if there is no long-term tendency for the real output of . services to grow faster than that of manufactured goods, but productivity in manufacturing increases consistently faster than in services, then the pattern of employment will shift away from manufacturing and into services.

The service sector will then have to absorb an ever-greater proportion of total employment just to keep its output rising in line with that of manufacturing.

Relative productivity effects, the IMF study finds, account for more than 60 percent of deindustrialization in the industrial countries between 1970 and 1994. Contrary to popular perceptions, North-South trade (that is, trade between the industrial and the developing world) has probably had only a small impact on the process of deindustrialization.

Deindustrialization is not necessarily a symptom of the failure of a country’s manufacturing sector or of the economy as a whole. On the contrary, according to the IMF study, it is simply the natural outcome of the process of successful economic development and is, in general, associated with rising living standards.

Admittedly, deindus-

trialization can, at times, be associated with difficulties in the manufacturing sector or the economy as a whole. For example, although economic dynamism explains a large part of the decline in the share of manufacturing employment in both the United States and Europe between 1970 and 1994, deindustrialization has also been associated with some negative features — stagnant earnings and widening income disparities in the United States, and high unemployment in Europe.

Had these countries grown faster than they did during 1970-94, however, deindustrialization would still have occurred but with more favourable effects on living standards and employment.

Implications

Continued deindus-trialization has important implications for long-term growth prospects in the advanced economies. A starting point for analyzing growth issues, the authors note, is the observation that productivity growth is persistently faster in some activities than in others.

Productivity tends to grow rapidly in manufacturing, because production in this sector can be readily standardized; consequently, the information required for production can be formalized in a set of instructions that can then be easily replicated.

Some services that are impersonal, such as telecommunications, have attributes similar to manufacturing.

But personal services — certain types of medical care, for example - cannot be easily standardized and are not subject to the same mass production methods used in manufacturing; productivity in these services would thus tend to grow more slowly.

Because the share of employment in manufacturing has been declining, the overall rate of growth of productivity in the economy has come to be determined more and more by productivity growth in the service sector.

Contrary to popular perceptions, productivity growth in manufacturing is therefore less important than it used to be in determining the overall growth of productivity and living standards in the advanced economies. As the process of deindustrialization continues, the overall growth of productivity will increasingly depend upon productivity developments in the service sector.

The evolution of productivity growth in this sector will, in turn, depend on future developments in areas such as information technology. Product innovation in manufacturing will continue to be important, however, because of the spillovers to productivity growth in services.

Deindustrialization is also likely to have important implications for industrial relations in the advanced economies. Trade unions, for example, have traditionally derived their strength from industry, where the mode of organizing production and the nature of work make it easier for unions to organize workers.

In the service sector, unionization is less prevalent and more difficult to organize, because of the wide differences in the nature of work and the size of enterprises across different activities.

Countries with centralized wage bargaining arrangements are likely to face particularly serious challenges, because centralized wage bargaining has been associated with a conscious attempt to narrow wage differentials between different groups of workers. This policy had some chance for success in a period when traditional manufacturing — with roughly similar work requirements across activities — provided the major source of employment.

However, as employment shifts increasingly toward the service sector — where the nature of the work, the level of skill required, and the degree of job security vary a lot between activities — a bargaining arrangement that compresses wage differentials is likely to prove problematic.

It is generally difficult for a centralized union to make decisions on the appropriate wage differentials in a fast-changing environment. Centralized wage bargaining in a service economy could therefore have adverse consequences for the growth of productivity.

IMF Survey

President C-Plan Council

Masum Ahmed Chowdhury, High Commissioner of Bangladesh, was unanimously elected president of the Council of the Colombo Plan for Co-operative Economic and Social Development in Asia and the Pacific for 1997/98 at the Council's 220th Session held on July 10, 1997.

He succeeds Junizar Jacub, Ambassador of the Republic of Indonesia in Sri Lanka.

Masum Ahmed Chowdhury - a career Diplomat, served in different capacities in the Ministry of Foreign Affairs, Dhaka, and also in the Bangladesh Missions abroad in Egypt, Iran, the United Arab Emirates, Belgium and the European Union etc.

High Commissioner Chowdhury as a member of the Bangladesh delegation attended a number of major international conferences: the Commonwealth Heads of Government Meeting; Conference of Most Populous Countries; the United Nation's General Assembly; the South Asian Association for Regional Cooperation (SAARC) Summits; Social Summit; the Organisation of Islamic Conference (OIC) etc.

The Colombo Plan embodies the concept of a collective inter-governmental effort towards the economic and social development of member countries in the Asia Pacific Region. Over the last two years the Plan has expanded its programmes and established links with other regional organisations and development banks such as the Asian Productivity Organisation (APO), the South East Asian Fisheries Centre (SEAFDEC), the Asian Development Bank (ADB), the Japan International Cooperation Agency (JICA), and the Korea International Cooperation Agency (KOICA). The Colombo Plan also has links with agencies in non member countries such as the Norwegian International Development Agency.

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