Deindustrialization: Causes and Implications Robert Rowthorn and Ramana Ramaswamy

IV Deindustrialization: Causes and Implications Robert Rowthorn and Ramana Ramaswamy

The advanced economies have experienced a secular decline in the share of manufacturing employment—a phenomenon referred to as deindustrialization. This paper argues that, contrary to popular perceptions, deindustrialization is not a negative phenomenon, but is the natural consequence of the industrial dynamism in an already developed economy, and that North-South trade has had little to do with deindustrialization. The paper also discusses the implications of deindustrialization for the growth prospects and the nature of labor market arrangements in the advanced economies. [JEL: 01, 03, Fl, F43]

hree broad developments have been of concern to as Lawrence and Slaughter (1993), Krugman and Tthe advanced economies in recent years: the shrink- Lawrence (1994), Bhagwati (1995), and Krugman ing share of manufacturing employment, the stagnation (1996) have argued that the decline in unskilled wages of average real wages and the rise in inequality of earn- and the growing inequality of earnings between skilled ings since 1973 in the United States, and the massive and unskilled labor in the last two decades in the rise in unemployment since the early 1970s in much of United States have little to do with the growing trade Europe.1 These developments have coincided with a pe- links with the developing countries. Their arguments riod of unusually rapid growth in trade and capital are that manufactured imports from the developing movements—particularly between the advanced and countries constitute only a small fraction of U.S. developing countries. The coexistence of these phe- GDP—just over 2 percent in 1994, and that there is nomena has tended to foster the perception of a causal very little evidence of Stolper-Samuelson effects in the link from "globalization" to the labor market problems United States—that is, of a trade-induced decline in the confronting the advanced economies. This paper mainly relative prices of goods whose production uses un- focuses on the causes of the long-term decline in the skilled labor intensively. The inference drawn is that share of manufacturing employment in the advanced other factors, such as skill-biased technological economies—a phenomenon referred to as "deindustrial- change—especially the increased use of computers— ization." It is, however, useful in this context to review provide the main explanation for the widening inequal- briefly the debate on the interrelationships among glob- ity of earnings between skilled and unskilled workers.2 alization, earnings inequality, and unemployment, be- A different viewpoint is that of Wood (1994, 1995) fore moving on to the issue of deindustrialization. and Freeman (1995), who argue that manufactured There has been a wide-ranging academic debate in imports from the developing countries are highly the United States about the extent to which trade with labor intensive and displace many times more workers the developing countries has contributed to the widen- in the advanced economies than their dollar value ing of the earnings inequality between skilled and would suggest. Their argument implies that North- unskilled labor. International trade economists such South trade could result in major job losses for unskilled workers in advanced economies even when the import penetration ratio is low and trade between the Robert Rowthorn is a Professor of Economics, Cambridge Uni- two groups is balanced.3 However, even the econo- versity. Ramana Ramaswamy is an Economist in the Research De- partment, IMF. The authors are grateful to numerous colleagues at the IMF for comments on a previous version of this paper, and to 2Rowthorn (1992), Wood (1994), and Freeman (1995) argue that Michelle Marquardt for research assistance. the rise in unemployment in continental Europe through the 1980s 1 In this paper, "advanced economies" refer in most contexts to the and into the 1990s can be perceived as the mirror image of the ris- group of 23 countries that are classified as "industrial countries" in ing inequality of earnings in the United States, a point that has also the World Economic Outlook. Industrial countries also correspond to frequently been made in the World Economic Outlook. the member countries of the Organization for Economic Cooperation 3Sachs and Shatz (1994) also dispute the proposition that North- and Development (OECD). "Developing countries" include the South trade has had no adverse impact on unskilled labor in the ad- newly industrialized economies. The empirical analysis has been con- vanced economies. They find evidence of Stolper-Samuelson effects ducted on that basis because deindustrialization so far has been most between 1978 and 1989 once computer prices (which fell steeply in pronounced in the industrial economies. However, deindustrialization this period) are excluded from the sample. See also the discussion is a process that is now under way in all advanced economies. by Learner (1996) in this context.

©International Monetary Fund. Not for Redistribution IV DEINDUSTRIALIZATION: CAUSES AND IMPLICATIONS

Figure 1. Employment by Sector as a Share of Total Civilian Employment (In percent)

Manufacturing Services

European Union United States

Japan Industrial countries Japan

European Union Industrial countries

United States

Source: OECD, Historical Statistics 1960-94.

mists who are sympathetic to the hypothesis that foreign trade. The main contribution of Rowthorn and North-South trade did have an adverse impact on the Wells was in arguing that deindustrialization is not demand for unskilled labor in the advanced econo- always a pathological phenomenon but is the normal mies, do not identify it to be the main factor.4 result of industrial dynamism in an already highly Deindustrialization has received relatively little at- developed economy. Baumol, Blackman, and Wolff tention in the academic debate on "globalization." (1989) extended the analysis of deindustrialization For instance, there is little systematic discussion of to explore the implications for economic growth the relationship between trade, growth, and the de- when employment shifts predominantly to the service cline of manufacturing employment in the literature sector. reviewed above. Public debate about deindustrializa- The main propositions of this paper are (1) dein- tion tends in general to be confined to categorizing it dustrialization is primarily a feature of successful eco- as a problem analogous to the widening disparity of nomic development; (2) North-South trade has had lit- earnings and the rising unemployment in advanced tle to do with deindustrialization; (3) the pattern of economies. However, there is a conceptual difference trade specialization among the advanced economies between deindustrialization and these other two de- does, however, explain the wide differences in the velopments. Unemployment, and the widening dis- structure of employment among them; (4) measured in parities in earnings, can be viewed as problems that real terms, the share of domestic expenditure devoted require solutions. This paper argues that deindustrial- to manufactures has been comparatively stable, and ization, in contrast, is not a negative phenomenon in the most important factor accounting for deindustrial- its own right. It is an inevitable feature of the process ization is the systematic tendency of productivity in of economic development, predating the emergence manufacturing to grow faster than in services; (5) the of both rising inequality and unemployment in the ad- growth of living standards as well as industrial rela- vanced economies. tions in the advanced economies are likely to be in- The discussion of deindustrialization in this paper creasingly influenced by developments in the service largely follows the approach in Rowthorn and Wells sector. Annexes I and II provide a formal analysis of (1987). They extended the earlier contributions of these propositions. Lengelle (1966), Baumol (1967), Fuchs (1968), and Singh (1977) to provide a unified and formal analysis of deindustrialization by linking it explicitly to the Deindustrialization: The Evidence process of economic development and the pattern of Manufacturing employment as a share of civilian employment has declined continuously since the be- 4See Slaughter and Swagel (Chapter V in this volume) for a more ginning of the 1970s in most advanced economies detailed review of the debate on trade and wages. (Figure 1). For the group of industrial countries, the

©International Monetary Fund. Not for Redistribution Explaining Deindustrialization: General Arguments

Figure 2. Value Added by Sector as a Share of GDP at Current Prices (In percent)

Manufacturing Services

Japan Industrial United States countries European Union "

European Union Japan

Industrial countries United States

Source: OECD, Historical Statistics 1960-94.

share of manufacturing employment fell from about nessing virtually continuous increases in the share of 28 percent in 1970 to about 18 percent in 1994. There services employment since 1960. The United States have, of course, been differences among the advanced has been one of the pioneers in this context—it started economies in the extent to which the share of manu- off with a much larger service sector (about 56 percent facturing employment has declined, and in when the of civilian employment in 1960) and has currently a process of deindustrialization got started. Deindustri- higher share of employment in services than any other alization began in earnest as early as the mid-1960s in advanced economy (about 73 percent in 1994). De- the United States, which has experienced one of the spite these differences, the overall picture in the past steepest declines in the share of manufacturing em- two decades is similar in most advanced economies: ployment—from about 28 percent in 1965 to 16 per- continuous declines in the share of employment in cent in 1994. In Japan, in contrast, the share of manu- manufacturing and a corresponding large rise in the facturing employment began declining later, and has share of services. fallen less precipitously than in the United States— from a high of 27.4 percent in 1973 to about 23 percent in 1994. The share of manufacturing employment Explaining Deindustrialization: was comparatively high in 1970 (slightly over 30 per- General Arguments cent) in the European Union (EU) countries, but the decline since then has been steep—and only 20 per- What accounts for deindustrialization? The analysis cent of total civilian employment of this group was in will follow a two-step procedure. First, a broad 5 manufacturing in 1994. overview of the main factors that account for deindus- The other side of this development has been a con- trialization is provided. This is followed by a more de- tinuous increase in the share of employment in ser- tailed regression analysis that quantifies the impor- vices in the advanced economies. The increase has tance of the different factors accounting for the been fairly uniform, with all advanced economies wit- observed trends in manufacturing employment in the advanced economies. In Figures 1 and 2, the declining share of manufacturing employment appears to mirror the decline in the 5The focus of the analysis is on "manufacturing" rather than "industry." The latter definition encompasses, in addition to manufac- share of manufacturing value added in GDP. That is, turing, both mining and construction. The empirical analysis focuses deindustrialization appears at first glance to reflect a on manufacturing because much of the debate about deindustrial- shift in the pattern of expenditure from manufacturing ization has been about the loss of manufacturing jobs. Moreover, to services. Rowthorn and Wells (1987) and Baumol, mining is of importance in only a small number of the advanced economies, and employment in the construction sector is volatile, Blackman, and Wolff (1989) argued against the hy- which makes international comparisons of the industrial sector pothesis that such a shift provides the main explana- difficult. tion for deindustrialization. They demonstrated that

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Figure 3. Value Added in Manufacturing, Figure 4. Balance of Trade in Constant Prices Manufactured Goods (In percent of real GDP; purchasing power parity weights) (In percent of real GDP; purchasing power parity weights)

Japan Japan

European Union European Union Industrial countries

Industrial countries

United States United States*

Source: OECD, Historical Statistics 1960-94 and National Accounts, Source: OECD, Analytical Database. Vol. 2.

the growing current price share of services in value However, unlike the case for the entire group of in- added reflected the impact of differential productivity dustrial countries, the constant price share of manu- growth—labor productivity has grown more slowly in facturing value added in GDP exhibits a trend for both services than in manufacturing. This has pushed up Japan and the United States (Figure 3). That is, there their relative price, tending to raise the service sector's appears at first sight to have been a significant shift in share of current price output. However, when output the pattern of expenditure—from services to manufac- in the two sectors is measured in constant prices, there turing in Japan and from manufacturing to services in does not appear to be evidence of a shift in expendi- the United States—that offers a potential explanation ture from manufacturing to services that corresponds for the differences in the evolution of the share of to the magnitude of the shifts in employment that have manufacturing employment in these countries noted taken place between these two sectors in the advanced earlier. Figures 3 and 4, however, indicate that in both economies. Figure 3 bears this stylized fact out.6 For cases domestic expenditure shifts were not the main the group of industrial countries, the constant price driving force. The rise in the constant price share of share of manufacturing value added in GDP is roughly manufacturing value added in Japan and the fall in this unchanged between 1970 and 1994, in contrast to the current price share, which fell steeply during this 7 period. stimulated by falling relative prices due to relatively rapid productivity growth in the manufacturing sector. This paper does not seek to disentangle such effects, but takes their combined effect as 6It is shown below that the structure of foreign trade in manufac- given. (It may be noted, however, that an international cross- tures for the group of industrial countries has been relatively stable section study of expenditure patterns by Summers (1985) showed over time. Consequently, observed trends in manufacturing output that, after correcting for international differences in relative prices, in this context broadly reflect expenditure shares. rich countries spend no greater share of their incomes on services 7The observed stability of the real output share of manufacturing than do poor countries. A more recent study by Falvey and Gem- is likely to be the outcome of offsetting income and price effects on mell (1996) using cross-section data confirms Summers' finding demand. The income elasticity of demand for manufactures may be that services overall have an income elasticity of approximately somewhat less than unity, but real expenditure on such goods is unity.)

©International Monetary Fund. Not for Redistribution Explaining Deindustrialization: General Arguments

share in the United States appear to reflect changes in Table 1. Industrial Countries: Growth of Output net exports of manufactures in these countries—the and Employment rising manufacturing trade surplus in Japan and the 1960-70 1971-94 1960-94 growing trade deficits in manufacturing in the United States. A more systematic analysis is provided below, Output Manufacturing 6.3 2.5 3.6 using regression analysis, to argue that the pattern of Services 5.3 3.3 3.8 trade specialization in manufacturing among the advanced countries is an important factor that accounts Output per person employed Manufacturing 4.6 3.1 3.6 for the variation in the structure of employment from Services 3.0 1.1 1.6 one advanced country to another. This analysis also helps to explain why the United States has deindustri- Employment Manufacturing 1.7 -0.6 0.0 alized faster than Japan. Services 2.4 2.2 2.2 If a shift in domestic expenditure from manufacturing to services has not been a major determinant of Source: Organization for Economic Cooperation and Develop- deindustrialization, what then are the main explana- ment, OECD Historical Statistics, 1960-1994. tions for this phenomenon? More specifically, there is a need to account for two features that can be observed from Figure 1: (1) the rise in the share of The secular shift in employment from manufactur- manufacturing employment in most advanced econo- ing to services since the early 1970s, as noted earlier, mies until the late 1960s, and the continuous decline has not been associated with any significant shift in in this share thereafter; and (2) the sustained increase the pattern of expenditures between these two sectors. in the share of services employment throughout this Instead, deindustrialization appears to reflect mainly period. the impact of differential productivity growth between The rising share of employment in manufacturing manufacturing and services. It is clear that if there is in the industrialization stage of development repre- no long-term tendency for the real output of services sents to a large degree the movement of employment to grow faster than manufactured goods, but produc- from agriculture to industry. Two factors explain this tivity in manufacturing increases consistently faster shift. The first is the operation of Engel's law— than in services, then the pattern of employment will the proportion of income spent on food declines as shift away from manufacturing and into services. The per capita income rises—which leads to a shift in service sector will have to absorb an ever greater pro- the pattern of demand from agricultural products to portion of total employment just to keep its output ris- manufactured products and services with economic ing in line with that of manufacturing. Table 1 shows growth.8 The second factor, on the supply side, is that these long-term trends do appear to hold broadly the rapid growth of labor productivity in agriculture for the industrial countries as a whole. The average due to a whole range of innovations. The combined annual growth rates of output have been roughly sim- effect of the demand and supply side factors is a ilar in services and manufacturing between 1960 and large-scale shift of employment from agriculture to 1994 for the group of industrial countries. However, industry (as well as to services), accounting for the labor productivity in manufacturing has consistently rising share of employment in manufacturing in outpaced that of services during this period. While the industrialization phase of the development there are variations to this pattern in various subperi- process. The declines in agricultural employment ods (Table 1), the productivity growth differentials (both in absolute and relative terms) were quite dra- between manufacturing and services have consistently matic in the industrialization phase. In the mid-1970s, been much larger than the differences in output agriculture accounted for just over 11 percent of the growth between these sectors in the different subperi- total civilian employment in the group of industrial ods, indicating the important role played by produc- countries, down from over 20 percent in the early tivity differentials in explaining deindustrialization. 9 1960s. Given the scale of the contraction that had al- It is, of course, well known that there are many data ready taken place in the agricultural sector, a further and conceptual problems in the measurement of out- expansion in the share of services employment had put in services. These could affect both the recorded subsequently to be at the expense of manufacturing level of productivity in services, and its growth rate employment. over time. It is possible that the measured slow growth of productivity in services partly arises from the undermeasurement of output growth in this sector. Some of these issues are discussed in Baumol, Black- 8See Rowthorn and Wells (1987) for evidence on the operation of man, and Wolff (1989), and at greater length in Engel's law in agriculture in the advanced economies. 9 Griliches (1992). These studies suggest that any mea- The corresponding figure for the United States in 1970 was 4 percent. The United Kingdom, the first country to go through the in- surement bias in the growth rate of service productiv- dustrial revolution, had reached this share by the 1950s. ity is small compared with the larger recorded differ-

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Figure 5. Employment (In thousands)

Total Civilian

European Union

United States

Japan

Manufacturing

European Union

United States

Japan

Source: OECD, Historical Statistics 1960-94.

ences in productivity growth between manufacturing eventual deindustrialization and transition to a service and services.10 economy in the later stages. The model is particularly Thus, the continuous increase in the share of em- useful for illustrating how deindustrialization can ployment in the service sector throughout this period occur purely as the product of successful economic reflects both the shift in employment from agriculture development, even in the absence of foreign trade. to services in the industrialization stage of develop- An important implication of this discussion is that ment, and later, from manufacturing to services. deindustrialization is not necessarily a symptom of the Annex I provides a simple model to show how the failure of a country's manufacturing sector, or for that process of economic growth leads both to an increase matter, of the economy as a whole. On the contrary, in the share of industrial employment in the early deindustrialization is simply the natural outcome of the phase of economic development, as well as to the process of successful economic development and is, in general associated with rising living standards. How- ever, this is not to deny that deindustrialization can, at l0Note that quality biases may also result in the undermeasure- times, be associated with difficulties in the manufac- ment of output growth in the manufacturing sector (Boskin and oth- turing sector or the economy as a whole. A country can ers, 1996). It is possible that productivity growth is underestimated lose manufacturing jobs as a result of an adverse shock more in services than in manufacturing, but this is not certain. In- deed, a study reported by Murray (1992) suggests that there was an (such as from a large real exchange rate appreciation), unrecorded decline in productivity in public services in Sweden dur- and the service sector may be unable to fully absorb the ing 1960-90, and the same may also be true in some other countries. labor released. In this case, deindustrialization may be However, since measured growth of productivity in services is sig- associated with rising unemployment and either a slow nificantly lower than in manufacturing, a more than proportionate mismeasurement of productivity growth in services will have a rel- or even falling growth in living standards. atively smaller impact on the differential productivity growth be- Figure 5 shows the contrasts between the United tween manufacturing and services. States and the group of 15 EU countries. Despite the

©International Monetary Fund. Not for Redistribution Accounting for Deindustrialization: Specific Factors

Figure 6. Selected East Asian Economies: Share of It is interesting, in this context, to examine the na- Manufacturing in Employment ture of structural change that has been taking place in (In percent) the advanced east Asian economies. Figure 6 shows that both Korea and Taiwan Province of China began the process of deindustrialization around the latter half of the 1980s, as their per capita incomes rose rapidly and surpassed the levels achieved by the advanced , Hong Kong, China \ countries in the early 1970s. There has, however, been a marked difference during recent decades between these two economies on the one hand, and Hong Taiwan Province of China Kong, China and Singapore on the other hand. While the share of manufacturing employment rose rapidly until the mid-1980s in both Korea and Taiwan Singapore Province of China, this share has exhibited no clear- cut trend in Singapore, and has been falling since the 1970s in Hong Kong, China. This difference, however, appears to be primarily on account of Singapore Korea and Hong Kong, China being city states, with no large agricultural sector. Consequently, they did not experience the shift in employment from agriculture to industry that is associated with the phase of industrialization. The changes in the structure of employment in the deindustrialization phase are, however, likely to follow a similar pattern in all these countries. The experience of deindustrialization in these advanced east Asian economies appears, at least up until now, to have been predominantly positive. Sources: ILO, Yearbook of Labour Statistics and the Statistical Year- book of Republic of China. Accounting for Deindustrialization: Specific Factors steep fall in the share of manufacturing employment in This section draws on the regression results in the United States, the absolute numbers employed in Annex II to provide a rough quantification of the im- manufacturing have remained roughly constant since portance of the different factors in accounting for dein- 1970, alongside a large increase in total civilian em- dustrialization. To get an idea of the importance of the ployment. These developments, however, have been relative productivity effects in accounting for the de- associated with stagnant earnings and the widening of clining share of manufacturing employment, it was income disparities that was discussed earlier. The ex- assumed, in a simulation exercise for the group of in- perience of the EU countries has been different. The dustrial countries, that the ratio of real output in man- falling share of manufacturing employment for this ufacturing to that in services remains constant, but that group of countries has been associated with a sharp de- productivity in the two sectors grows at the rates actu- cline in the absolute numbers employed in manufac- ally observed between 1970 and 1994. Table 2, which turing. Moreover, unlike in the United States, there reports the results of the simulations, shows that for the was only a relatively small increase in total employ- industrial countries as a whole, the share of manufac- ment between 1970 and 1994, which is reflected in the turing employment would have fallen by 6.3 percent- current high rates of unemployment in the EU. Hence, age points during this period under these assumptions. while economic dynamism explains a large part of the That is, about two-thirds of the actual decline in the in- decline in the share of manufacturing employment in dustrial countries' share of manufacturing employment both the United States and Europe, the process of dein- during this period can be accounted for by pure relative dustrialization has been associated with some negative productivity effects. This implies that about one-third features—stagnant earnings and widening income dis- of the decline in the share of manufacturing employ- parities in one case, and high unemployment in the ment for the industrial countries as a group has to be other. However, the point is that even if these countries accounted for by relative output changes—that is, by had grown faster than they actually did during this pe- the fact that output in the two sectors did not in prac- riod, deindustrialization would still have occurred, tice grow at exactly the same rate. though with more favorable effects on living standards The fact that the measured output of manufactures and employment during the adjustment period. grew more slowly than that of services over the period

©International Monetary Fund. Not for Redistribution IV DEINDUSTRIALIZATION: CAUSES AND IMPLICATIONS

Table 2. Factors Responsible for for the presence of these effects. The results indicate Deindustrialization, 1970-94 that contrary to popular perceptions, North-South trade probably had only a small impact on the process Industrial European United 12 Countries Union1 States Japan of deindustrialization. Using the regression results from Annex II, which Share of manufacturing employment (in percent) indicate that a 1 percentage point reduction in the 1970 27.6 30.4 26.4 27.0 manufacturing trade balance to GDP leads to a fall of 1994 18.0 20.2 16.0 23.2 0.37 point in the share of manufacturing employment, Change -9.6 -10.2 -10.4 -3.8 it is found that for the industrial countries as a group the trade balance effect had only a small role in ac- Due to: Relative productivity counting for the changes in the share of manufacturing growth -6.3 -6.1 -6.8 -6.0 employment during 1970-94 (Table 2). This is, of Trade balance2 0.2 0.3 -1.0 1.8 course, consistent with the fact that the balance of Investment -1.8 -2.1 -0.4 -2.7 trade in manufactures for the industrial countries as a Other factors -1.7 -2.3 -2.2 3.1 whole did not change much in this period (Figure 4).13 Notes: Estimates for the effect of relative productivity growth as- However, the trade balance effects have been much sume that productivity in manufacturing and services grows at the stronger for both the United States and Japan than for rates actually observed over the period 1970-94, while the ratio of the EU countries. In the United States, the growing output in the two sectors remains constant; the employment share trade deficits in manufactures accounted, under these of agriculture and other industry (mining, construction, electricity, water, and gas) is assumed to be unaffected. Trade balance esti- assumptions, for a 1 percentage point decline in the mates assume that a reduction of 1 percentage point in the ratio of share of manufacturing employment between 1970 this balance to GDP leads to a fall of 0.37 point in the share of man- and 1994. In Japan, in contrast, the growing trade sur- ufacturing employment; investment estimates assume that a fall of pluses in manufacturing offset to a significant extent 1 percentage point in the ratio of gross fixed capital formation to GDP causes the manufacturing share to fall by 0.39 point. These co- the tendency to deindustrialize as a consequence of efficients are based on equation (9) of Table A5 and weighted by the the relative productivity effects (Table 2). 1970 employment shares of each country. The decline in the rate of investment in this period, 1West Germany only. 2 on the basis of the coefficients derived from Annex II, West Germany up to 1990 only. appears to have played a role in accounting for deindustrialization in most countries, with the possible exception of the United States (Table 2). "Other factors" 1970-94 may reflect a variety of influences. In addi- encompass the influences from variables such as tion to some shift in the pattern of consumers' expen- possible shifts in the pattern of consumption, the con- diture, the demand for manufactures may have been tracting out of activities formerly done in the manu- depressed by other factors, such as changes in the facturing sector to the service sector, possible North- structure of net exports and a decline in the rate of in- South effects, and unidentified influences. The vestment in advanced economies. Finally, certain ac- simulations indicate that these other factors also ap- tivities previously conducted "in-house" by manufac- pear to have some role in explaining the evolution of turing firms may have been hived off to specialist the share of manufacturing employment in the ad- subcontractors, and hence reclassified as part of ser- vanced economies (about 18 percent of the deindustri- vice output. The regression results in Annex II point to alization in the group of industrial countries). How- a role for both the overall manufacturing trade balance ever, the crucial finding from the simulations reported and investment in explaining the trends in the share of in Table 2 is that the relative productivity effects are manufacturing employment. The overall trade balance the most important—they account for more than 60 in manufactures appears to have been an important de- percent of deindustrialization in all the different terminant of cross-country differences in the share of groupings of the advanced economies. manufacturing employment, but is of less importance An interesting exercise, in this context, is to exam- in explaining changes in this share over time for indi- ine the implications for the future pattern of employ- vidual countries.11 As discussed in the introduction, ment if these trends continue. The simulations indicate the Wood hypothesis presumes that a balanced in- that if past trends in productivity growth continue to crease in North-South trade will tend to reduce manu- hold in the future, then the share of manufacturing em- facturing employment in the advanced economies. The regression analysis in Annex II specifically tests l2See also, in this context, United Nations Conference on Trade and Development (1995). 11 Note that a few individual countries have experienced a signifi- l3In this regard, the claim by Brown and Julius (1993) that dein- cant deterioration in their manufacturing trade balance owing to the dustrialization in the advanced economies is due to the relocation of discovery of oil and gas, and this contributed to a decline in manu- manufacturing activity to poorer countries, and its replacement by facturing employment. This phenomenon is referred to as "Dutch production of services for export, does not appear to be consistent disease" in the literature. with the empirical evidence.

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ployment in the industrial countries as a group will can be illustrated with a simple example. Consider the decline to 12 percent 20 years from now. In the United computer industry. Suppose that hardware production States, the corresponding figure will be about 10 per- is technologically progressive and software produc- cent. For both Japan and the EU, the share of manu- tion technologically stagnant. Then, the computer in- facturing employment, under these assumptions, will dustry will be asymptotically stagnant, in the sense decline to about 14 percent in 20 years' time—that is, that productivity growth in the industry as a whole roughly to where the United States is today. The cur- will asymptotically approach productivity growth in rent price share of manufacturing value added will also software production. The intuition is that over time the fall in a similar fashion in the advanced economies. ratio of software to hardware producers will increase to such an extent that even extremely high rates of productivity growth in hardware production will have Deindustrialization: Implications only a negligible impact on overall productivity growth in this industry. What are the implications of continued deindustri- The analogy holds for the economy too. If manu- alization for long-term growth prospects and indus- facturing is technologically progressive and services trial relations in the advanced economies? A useful technologically stagnant, then the economy as a whole framework for analyzing issues of growth in the con- is asymptotically stagnant—that is, the growth rate text of deindustrialization is the one provided by Bau- over the long run will be determined to a large extent mol, Blackman, and Wolff (1989). Their starting point by the growth of productivity in the services sector is the observation that productivity growth is persis- (this proposition is mathematically demonstrated in tently faster in some activities than in others. To de- Annex I).15 The theory of asymptotic stagnancy has scribe activities that experience relatively high rates of important implications for an understanding of the re- productivity growth, Baumol, Blackman, and Wolff lationship between competitiveness, productivity, and use the term "technologically progressive," while living standards—a theme popularized by Krugman activities experiencing relatively lower rates of pro- (1994). It essentially states that contrary to popular ductivity growth are described as "technologically perceptions, productivity growth in manufacturing is stagnant."14 likely to be less important than it used to be for in- Manufacturing, in general, is technologically pro- creasing the overall growth of productivity and living gressive. This characteristic, as argued earlier, has standards in the advanced economies. As the process been the basis for deindustrialization. The reason why of deindustrialization continues, the overall growth of manufacturing is technologically progressive has to productivity will increasingly depend on productivity do with its intrinsic attributes—production in this sec- developments in the service sector. The evolution of tor can be readily standardized, and consequently, the productivity growth in the service sector will depend information required for production can be formalized on future developments in areas such as information in a set of instructions that can then be easily repli- technology, as well as changes in the competitive cated. In the case of services, there are large differ- structures in this sector. New technological develop- ences between various activities in their amenability ments will make it feasible for some services to grow to productivity growth. Some services that are imper- faster than others, and thus the service sector will un- sonal, as in telecommunications, have attributes simi- dergo significant internal structural changes over time. lar to manufacturing, and hence, can be technologi- However, product innovation in manufacturing will cally progressive. However, personal services, such as continue to be important because of the spillovers to certain types of medical care, cannot be easily stan- productivity growth in services. dardized and subject to the same mass production Deindustrialization is also likely to have important methods used in manufacturing. These types of ser- implications for industrial relations in the advanced vices, therefore, will be technologically stagnant. economies. The role played by trade unions in the In general, if there are two activities, one of which economy, for instance, is likely to change over time. is technologically progressive and the other techno- Trade unions have traditionally derived their strength logically stagnant, then in the long term the average from industry, where the mode of organizing produc- rate of growth will be determined by the activity in tion and the nature of work make it easier for unions which productivity growth is slowest. The intuition to organize workers. Unionization is less prevalent for this proposition—termed the theory of "asymp- and typically more difficult to organize in the service totic stagnancy" by Baumol, Blackman, and Wolff— sector (with public services possibly being a notable

14It is important to note that "progressive" and "stagnant," as used 15It is again important to emphasize that the term asymptotic stag- in this context, refer to relative attributes. A technologically stagnant nancy does not have any normative connotations. It does not, for in- activity need not necessarily have to experience a low growth of stance, imply that the rate of productivity growth in the service sec- productivity in absolute terms. This is discussed in more detail tor and the economy as a whole will necessarily have to be low in below. absolute terms over the long run.

©International Monetary Fund. Not for Redistribution IV DEINDUSTRIALIZATION: CAUSES AND IMPLICATIONS

exception), owing to the wide differences in the nature employment from one developed country to another, of work and the size of enterprises across different ac- although this factor appears to be of less importance in tivities. In particular, countries with centralized wage explaining changes over time for individual countries. bargaining arrangements are likely to face serious Deindustrialization has far-reaching implications challenges as a consequence of deindustrialization. for growth and industrial relations in the advanced The reason is that centralized wage bargaining has in economies. The growth of living standards in the ad- practice been associated with a conscious attempt to vanced economies is likely to be increasingly influ- narrow wage differentials between different groups of enced by productivity developments in the service workers. Such a policy may have proved benign in a sector. Deindustrialization also implies that the role of period when traditional manufacturing, with roughly trade unions is likely to change over time in the ad- similar work requirements across activities, provided vanced economies. the major source of employment. However, a bargaining arrangement that compresses wage differentials is likely to prove problematic as employment shifts in- Annex I. A Simple Model of creasingly toward the service sector. As noted above, Deindustrialization the nature of work in the service sector varies consid- erably among activities. Some service jobs, such as This annex presents a simple model that demon- those in financial services, require relatively high strates how deindustrialization is a natural outcome of skills, whereas others, for instance in certain types of economic growth in a mature economy and may occur retailing, are likely to require lower levels of skill. Job independently of trade with other countries. It is based security in the service sector also varies widely. Em- on the following stylized facts: ployment in public services is in general more secure (1) The demand for food is income-inelastic (Engel's than employment in many retail services. Conse- law). quently, appropriate wage differentials are needed to (2) The real demand for services rises roughly in compensate for differences in skills and intensity of line with real national income. work. It is, in general, difficult for a centralized union (3) Labor productivity rises more slowly in ser- to decide on appropriate wage differentials in a fast- vices than in manufacturing or industry as a changing environment. Centralized wage bargaining whole. in a service economy could therefore have adverse consequences for the growth of productivity.16 The model shows how these propositions suffice to explain both the rising importance of industrial output and employment during the industrialization phase of economic development, and the eventual transition to Conclusions a "service" economy in which the employment share The advanced economies have witnessed a virtually of industry declines. continuous decline in the share of employment in manufacturing in the past two decades and a continuous The Model rise in the share of employment in the service sector. Employment in manufacturing now constitutes only a The model assumes the following. The economy is small fraction of civilian employment in most of the closed and real output is given by "old" industrial economies. The dynamic economies of East Asia also appear to have embarked on the process of deindustrialization in recent years. An important where Ya, Yi, and Ys stand for output, measured at con- conclusion of this paper is that deindustrialization, un- stant prices, in agriculture, industry, and services, re- like the problems of rising income inequalities and un- spectively. Consumption of the agricultural product, employment, is not a negative phenomenon, but a nat- food, per head of population is fixed. Population is ural consequence of the process of economic also fixed and is equal to L; everyone is employed. development in an already highly developed economy. Since the economy is closed, it is implied that The most important factor that accounts for deindustri- Ya = bL, (2) alization is the systematic tendency for productivity in manufacturing to grow faster than in services. North- where b is a constant. The output of services is a con- South trade has played only a small role in deindustri- stant fraction of real output: alization. Trade among the advanced economies ap- Ys = cY. (3) pears to account for the variation in the structure of Labor Productivity l6These issues are explored in more detail in Ramaswamy and It is assumed that labor productivity grows more Rowthorn (1993) and Ramaswamy (1994). slowly in services than in industry and also that labor

©International Monetary Fund. Not for Redistribution Annex I. A Simple Model of Deindustrialization

productivity grows at the same rate in agriculture as in La Pa = industry. This greatly simplifies the analysis without L affecting the main conclusions. Productivity growth rates remain constant through time, and output per (10) Pi = k worker is the same in each sector of the economy at L time zero. Thus, 4. Ps = y = yOeXat L

y. = yOe^t (4) It can be shown that

ys = yOeat^ J> e-Xat pa = where ya, yh and ys stand for output per worker in agri- y° (11) C

culture, industry, and services, respectively, and X > 1, Ps = at y° > 0 and a > 0 are constants. The parameter X is an c + (1 -c)e-^-^ index of uneven productivity growth. The share of industrial employment is given by Output per worker in each sector is as follows: Pi=\-Pa-Ps (12) Ya_ ya = and hence La be~Xat c XL (5) Pi = 1 - (13) yt = at U y° c + (l -c)e-^~^ It is clear from equations (11) and (12) that, as t tends

ys = H. to infinity, Ls where L denotes employment. Total employment is Pa"** given by P/->0

L = La + Li + Ls. (6) p,-l. Using equations (2)-(5), it can be shown that For agriculture and services, convergence to the final limit is uniform: the share of agriculture in total at Xat L = x_[ce~ + (1 -c)e~ ], (7) employment falls steadily to zero, while that of ser- y() vices rises steadily to 1. However, the case of industry which implies that requires further analysis.

yv at y = e The Share of Industry c + (l -c)e^^-\)t (8) Differentiating equation (12), obtains ys a dPj__ dPa dP^ c + (1 -c)e- ^-^ (14) where y = Y/L is average labor productivity in the at at at economy as a whole. Since a > 0 and X > 1, which, from equation (11), can be written as

2—> _L (9) ^=XaPa-(X-l) aPs(l -Ps). (15) ys c at as t tends to infinity. This implies that average pro- Hence, ^i > 0 if and onlv if ductivity growth will eventually decline to the rate of dt productivity growth achieved in the service sector. It XaP >(X-l)aP (l-P ). (16) is an illustration of the theory of asymptotic stagnancy a s s whereby overall growth is constrained by what hap- The term on the left-hand side indicates the rate at pens in the least dynamic sector of the economy (Bau- which the employment share of agriculture is de- mol, Blackman, and Wolff, 1989). creasing and the right-hand side is the rate at which the share of services is increasing. In a poor country, P is large, and the above inequality is therefore sat- Employment Shares a isfied, and the share of industrial employment will The share of the labor force employed in each sec- rise. As Pa falls in the course of development, the tor can be denoted as follows: point will be reached when the inequality is reversed,

Figure 7. The Changing Structure of Employment Figure 8. Industrial Share of Real (Constant Prices) Output

Employment share Real output share

Agriculture

Services

Industry

Time, per capita income Time, per capita income - and the industrial share of employment will start to fall. in this sector declines because of rapid productivity The relation between the three sectors in the course growth. of time is shown in Figure 7. It is clear from the figure that the share of industrial employment is subject to opposing forces. The share of agriculture in total Annex II. Determinants of employment is always falling, while the share of ser- Deindustrialization vices is always rising. The balance between the two forces alters in the course of time, and this explains This annex uses regression analysis to quantify the why the share of industrial employment at first rises impact of various factors on the share of manufac- and then later falls. When development begins, much turing employment in the group of industrial coun- of the country's labor force still works on the land, tries. It follows the general approach of Rowthorn and the exodus of labor from this sector outweighs and Wells (1987), which has been modified to allow any expansion in the services sector, with the result for the effects of capital formation and North-South that industry increases its share of total employment. trade. As development proceeds, however, the balance In the normal course of development, the share of changes. Agriculture declines as a source of labor, manufacturing employment follows a nonlinear trend, while the service sector continues to expand and ab- rising at first and then falling back again as the econ- sorb additional labor. Eventually, there comes a point omy eventually matures. Superimposed on this trend where the shift into services outweighs the shift out is the influence of factors such as foreign trade, fixed of agriculture. At this point, the share of industry capital formation, and the economic cycle. Net manu- starts to fall. factured exports and fixed capital formation increase It can be shown that the share of industry in real the relative demand for manufactured goods, causing output is given by manufacturing employment to be larger than would otherwise be the case. If a developed country exports Y Y YL = skill-intensive manufactures in return for labor-inten-

Y Y Y (17) sive imports from low-wage countries, this will cause at a net reduction in manufacturing employment and the be~ f = 1 -c- [c + (l -c)e-^-V l share of this sector in total employment will fall. Thus, }\) even when imports and exports are equal in value, This share rises rapidly in the initial stage of develop- trade with the developing countries of the South ment, but eventually converges to an upper limit in the should reduce manufacturing employment in the course of time. This is illustrated in Figure 8. Thus, in North. These are the primary considerations that gov- a mature economy, the industrial share of real output ern the choice of variables for the regression analysis. stabilizes, while the proportion of workers employed In addition, the extent to which variations in the man-

Table Al. Cross-Section Estimates of the Manufacturing Share of Employment, 1963-94 Dependent Variable: Manufacturing Share of Employment Data Sample: 21 Industrial Countries 1963 1970 1975 1980 1985 1990 1994 LGDP 78.01 82.48 129.26 -25.12 104.29 -87.03 -112.11 (83.01) (140.10) (155.18) (210.44) (171.90) (218.89) (193.54) LGDPSQ -3.93 -4.21 -6.94 1.28 -5.57 4.39 5.85 (4.72) (7.70) (8.43) (11.26) (9.16) (11.47) (10.11) Overall trade balance 0.61* 0.51* 0.44* 0.36* 0.44* 0.43* 0.31* (0.18) (0.17) (0.11) (0.12) (0.13) (0.11) (0.09) R2 0.651 0.441 0.469 0.247 0.310 0.359 0.337

Notes: The constant term is not reported. Standard errors in parentheses. Coefficients that are statistically significant at the 1 percent level are marked with an asterisk. The data exclude New Zealand for 1963 and Germany for 1994; German data refer to west Germany only. The manufacturing share of employment is measured in percent. LGDP is the log of per capita real GDP in 1986 U.S. dollars at PPP. LGDPSQ is the square of LGDP. Overall trade balance is total exports minus total imports of manufactures (SITC 5-8 less 68) as a percent of GDP at PPP. ufacturing share are associated with unemployment is variables are included for trade between the group of examined. industrial countries and the developing countries. Trade statistics are drawn from the United Nations Conference on Trade and Development database, and The Data the use of the term "developing country" accords with A data set was assembled for the years 1963, 1970, current United Nations practice. Thus, Singapore and 1975, 1980, 1985, 1990, and 1994 covering 21 out of Hong Kong, China are classified as developing coun- the 23 countries classified as industrial countries in tries, although their per capita income is now similar the World Economic Outlook (which corresponds to to the industrial country average and although they are the traditional group of OECD countries); separate now counted as advanced economies in the World data on trade were not available for Luxemburg; Ice- Economic Outlook. Manufactures are goods included land was excluded due to statistical problems arising in SITC sections 5 to 8 excluding division 68 (nonfer- from the central role of fishing in its economy.17 rous metals). Other independent variables are gross The dependent variable in the regressions is the fixed capital formation as a percent of GDP at current share (in percent) of manufacturing in civil employ- prices, which is taken from the OECD National Ac- ment as given in OECD Historical Statistics. A variety counts, and the percent unemployment rate from of independent variables are used. To capture the ef- OECD Labor Force Statistics. Finally, some regres- fect of economic development on the structure of em- sions include dummy variables for countries or years. ployment, all equations use the log and the squared log of real per capita income, converted to 1986 U.S. Income and Trade Balance Effects dollars by means of purchasing power parities in the IMF's World Economic Outlook database. Trade vari- Table Al reports the results of cross-section regres- ables refer to exports or imports of manufactured sions using only per capita income and the global goods in current dollars expressed as a percentage of manufacturing trade balance (total exports minus total GDP in U.S. dollars at purchasing power parity. This imports) as explanatory variables. Apart from two method of normalization avoids distortions caused by cases, the income variables are statistically insignifi- large fluctuations in exchange rates. cant and some times of the wrong sign. On the other To quantify the overall impact of trade on individ- hand, the trade balance variable is always highly sig- ual countries, variables such as a country's total man- nificant, with a coefficient equal to at least three times ufactured exports or imports are used. To identify spe- its standard error in every case. For most of the time cial effects arising from North-South trade, separate this coefficient is around 0.4. These results indicate that international differences in the share of manufacturing employment are mainly explained by patterns 17Fish products, which account for more than 80 percent of Ice- of trade specialization, as indicated by the manufac- landic merchandise exports, are classified as a nonmanufactured turing trade balance item in official trade statistics, whereas fish processing, which is a major employer of labor, is classified as manufacturing in industrial The same variables are used in equation (1) of Table and labor statistics. A2, which is derived by pooling all years in one sam-

Table A2. Pooled Estimates of the Manufacturing in Employment, 1960-73 Dependent Variable: Manufacturing Share of Employment Data Sample: Panel of 21 Industrial Countries (1) (2) (3) (4) (5) (6) (7) (8) LGDP 180.69* 134.04* 127.47* 135.92 126.45* 136.42* 130.84* 126.83* (33.41) (33.30) (32.50) (33.56) (27.82) (28.58) (27.87) (28.46) LGDPSQ -10.03* -7.40* -7.03* -7.45 -6.71* -7.30* -6.99* -6.73* (1.81) (1.82) (1.77) (1.83) (1.56) (1.56) (1.52) (1.55) Overall trade balance 0.44* 0.30* 0.42 0.40* 0.30* 0.40* (0.06) (0.06) (0.06) (0.05) (0.06) (0.05) Total exports 0.28* 0.27* (0.07) (0.06) Total imports -0.32* -0.31* (0.06) (0.06) Exports to South 1.29* 1.11* 1.15* 0.99* (0.38) (0.33) (0.41) (0.37) Imports from South -2.98* -3.38* -2.84* -0.67 -0.98 -0.05 (0.82) (0.69) (0.70) (0.89) (0.82) (0.74) Time dummies yes yes yes yes Notes: All regressions are based on 145 observations. Total exports and total imports refer to a country's trade in manufactures with the entire world. South refers to all developing countries (UN definition). North refers to the 21 industrial countries in the sample. There is a separate time dummy for each year. For further information see Table A1. ple of 145 observations. All variables are highly sig- on the domestic employment structure. Wood (1994) nificant, the coefficient estimates being many times has vigorously challenged this proposition in the case their standard errors. The income coefficients imply of North-South trade. He argues that a dollar's worth that, other things being equal, the share of manufac- of labor-intensive imports into the North from devel- turing employment will peak at a per capita income of oping countries will destroy far more jobs than are $8,185 (+/-$990) measured in 1986 U.S. dollars.18 generated by a dollar's worth of skill-intensive goods When an economy reaches this point, further growth exported by the North. Thus, a balanced increase in will cause the employment share of manufacturing to North-South trade will reduce manufacturing employ- fall. The estimated turning point is similar to an earlier ment in the North, because the number of low-skill estimate by Rowthorn and Wells (1987), and is around jobs lost in import-competing industries will greatly the level achieved by many European countries in the exceed the new jobs created in the export sector. 1960s and in the United States more than a decade be- One way of testing this proposition is to include ex- fore. The estimated trade balance coefficient implies plicit variables for North-South exports and imports.19 that a fall of 1 percentage point in the ratio of net man- Equation (2) of Table A2 reports the estimates obtained ufactured exports to GDP will cause the employment when total exports and imports, and North-South ex- share of manufacturing to shrink by 0.44 of 1 percent- ports and imports are included separately. In this equa- age point. Although quite large, this estimate is below tion, the North-South coefficients indicate the extent to the figure of 0.69 obtained by Rowthorn and Wells which trade with developing countries has an above- (1987) or that of 0.60 used by Krugman and Lawrence average impact on employment in the North. The esti- (1994). It confirms the cross-section finding concern- mated values of these coefficients are indeed relatively ing the importance of trade specialization as an influ- large and highly significant. For the Wood hypothesis ence on the structure of employment. to hold, the coefficient on imports from the South must be substantially greater in absolute magnitude than the coefficient on exports. A Wald test implies that the two North-South Trade coefficients are different at the 7.3 percent level, which The preceding estimates assume that trade can in- provides some support for the Wood hypothesis. A fur- fluence domestic manufacturing employment only ther Wald test implies that the coefficients for total ex- through an alteration in the balance of trade, so that an ports and total imports are not significantly different in equal change in both exports and imports has no effect

19The idea of modifying the Rowthorn-Wells approach in this 18The limits are two standard errors on each side of the estimate. fashion was first suggested by Saeger (1996).

Table A3. Cross-Section Estimates of the Effect of Imports from the South Dependent Variable: Manufacturing Share of Employment Data Sample: 21 Industrial Countries 1963 1970 1975 1980 1985 1990 1994 LGDP 75.96 107.71 107.99 -65.14 99.26 -89.20 -116.02 (79.45) (136.36) (147.43) (206.41) (174.84) (225.88) (189.51) LGDPSQ -3.77 -5.56 -5.88 3.29 -5.23 4.49 6.13 (4.52) (7.49) (8.00) (11.03) (9.32) (11.83) (9.90) Overall trade balance 0.77* 0.58* 0.49* 0.39* 0.45* 0.43* 0.34* (0.20) (0.17) (0.10) (0.12) (0.14) (0.12) (0.09) Imports from South 14.51 6.96 5.92 4.89 -2.99 -0.17 -1.56 (9.21) (4.67) (3.44) (3.45) (4.40) (1.06) (1.20) R2 0.681 0.479 0.524 0.289 0.288 0.321 0.364

Note: See Tables Al and A2. absolute magnitude, as should be expected given that Table A3 paint a similar picture. The coefficients for most trade occurs between the industrial countries in the overall trade balance are broadly similar across the sample and there is therefore no reason to expect an time and always highly significant, while the coeffi- asymmetry. cients for imports from the South are mostly of the There appears to be stronger support for the Wood wrong sign and have large standard errors. hypothesis in equations (3) and (4), which suggest that Thus, the apparent influence of North-South vari- imports from the South greatly reduce manufacturing ables is absent in the cross-section regressions and employment in the North, even when they are matched disappears in the pooled regression when time dum- by an equal value of exports in the opposite direction. mies are included. This suggests that the North-South However, this conclusion is not robust. Equations (5) coefficients in the earlier equations were accidentally to (8) show what happened when time dummies were capturing the influence of some unidentified time fac- included in the regressions. There is a separate time tor. Thus, North-South trade does not seem to be a dummy for each year whose role is to eliminate effects major factor behind the decline of manufacturing em- that are common to all countries in that year. These ployment in the advanced economies. dummies function in much the same fashion as a time trend, and experiments indicate that the results would Unemployment have been much the same if a trend term had been in- serted instead of dummies. In every case where time In Rowthorn and Wells (1987) the unemployment dummies are included, the North-South trade coeffi- rate was included as a variable to help explain the be- cients shrink dramatically in size and statistical signif- havior of manufacturing employment. It is interesting to icance. The coefficient for imports from the South is reexamine the results obtained when unemployment is never remotely significant, and in one equation is vir- included in the regressions. Table A4 shows the cross- tually zero. The cross-section regressions shown in section estimates. Two things are striking about this

Table A4. Unemployment and the Share of Manufacturing Dependent Variable: Manufacturing Share of Employment Data Sample: 21 Industrial Countries 1963 1970 1975 1980 1985 1990 1994 LGDP 12.55 11.60 73.04 -63.42 153.49 23.16 -6.73 (65.80) (119.53) (139.22) (201.79) (162.96) (227.60) (204.80) LGDPSQ -2.47 -0.39 -3.91 3.23 -8.34 -1.49 0.24 (3.74) (6.56) (7.56) (10.79) (8.69) (11.95) (10.73) Overall trade balance 0.43* 0.50* 0.44* 0.38* 0.45* 0.43* 0.33* (0.14) (0.15) (0.10) (0.11) (0.13) (0.11) (0.09) Unemployment -1.59* -1.25* -0.72 -0.47 -0.28 -0.29 -0.20 (0.45) (0.43) (0.30) (0.29) (0.15) (0.21) (0.15) R2 0.798 0.611 0.595 0.316 0.397 0.392 0.368

Note: Unemployment as a percent of the labor force. For further information see Table Al.

Table A5. Intertemporal and Cross-Country Effects Dependent Variable: Manufacturing Share of Employment Data Sample: Panel of 21 Industrial Countries (1) (2) (3) (4) (5) (6) (7) (8) (9) LGDP 180.69* 126.45* 210.92* 183.76* 151.23* 197.51* 167.72* 126.82* 175.10* (33.41) (27.82) (21.23) (25.55) (26.28) (18.70) (32.13) (27.21) (21.37) LGDPSQ -10.03* -6.71* -11.96* -10.11* -8.14* -11.06* -9.25* -6.70* -9.93* (1.81) (1.51) (1.15) (1.39) (1.43) (1.02) (1.75) (1.48) (1.17) Overall trade balance 0.44* 0.40* 0.21* 0.45* 0.42* 0.33* 0.46* 0.41* 0.37* (0.06) (0.04) (0.08) (0.04) (0.04) (0.07) (0.06) (0.04) (0.08) Unemployment -0.65* -0.39* -0.42* (0.06) (0.08) (0.07) Investment 0.33* 0.20* 0.39* (0.09) (0.07) (0.09) Time dummies yes yes yes Country dummies yes yes yes R2 0.401 0.646 0.807 0.650 0.700 0.852 0.452 0.671 0.823

Notes: There is a separate country dummy for each country. Investment is gross fixed capital formation as a percent of value added. For other notes, see the preceding tables. table. The trade balance coefficients are virtually the differences between countries. When these country same as in Table Al and are again highly significant. dummies are included, the trade balance coefficient The unemployment coefficient is universally negative, falls, although not by a great deal in most cases. The although mostly of quite low statistical significance. In same is true for unemployment, suggesting that this the pooled regressions shown in Table A5, this coeffi- variable also helps to explain international differences cient is negative and highly significant. The evidence in the share of manufacturing employment. On the other for some link between manufacturing employment and hand, the presence of country dummies has little effect unemployment is thus quite strong, although as men- either on the investment coefficient or on the income tioned above the direction of causality is uncertain. coefficients, thereby confirming the cross-section finding that these variables are of less importance in explaining cross-section differences between countries. Investment An interesting feature is the behavior of the trade An important influence on the composition of de- balance coefficient, which is highly significant both in mand is the rate of capital formation. The majority of the cross-section regressions and in the pooled regres- investment expenditure involves the purchase of man- sions, including those with country or time dummies. ufactured goods such as prefabricated buildings, con- Indeed, the trade balance is the only variable for struction materials, and producer durables. Other which this is true. Even so, this variable plays a much things being equal, a high rate of investment should be greater role in explaining cross-country differences in reflected in a high share of manufacturing in both out- employment structure than it does in explaining in- put and employment. This presumption is confirmed tertemporal developments. This is due to the fact that by the pooled regressions shown in Table A5. The in- trade balances exhibit huge differences between coun- vestment variable is always significant even when tries—the spread is well over 20 percent of GDP in time dummies are included. most years—but are comparatively stable through time for individual countries. Countries that enjoyed a large manufacturing trade surplus in the 1960s, such Intertemporal and Cross-Country Effects as Belgium, Germany, and Japan, have continued to The total variation in the manufacturing share over do so right up to the present, while those with a large the sample as a whole is of two kinds: (1) between one deficit in manufactures, such as Australia, Canada, country and another at any given point of time, and (2) and Norway, have remained heavily in deficit. within individual countries over the course of time. It appears from the cross-section regressions that a major Summary of the Results variable explaining differences between countries is the manufacturing trade balance. This impression is to The findings of the regression analysis can be sum- some degree confirmed by those equations in Table marized as follows. There is evidence of a nonlinear A5, which use dummy variables to eliminate persistent relationship between per capita income and the manu-

facturing share of employment. Other things being Fuchs, Victor R., 1968, The Service Economy (New York: equal, this share should, on the basis of the estimation, National Bureau of Economic Research). peak around the level of per capita income achieved Griliches, Zvi, ed., 1992, Output Measurement in the Ser- by many European countries in the 1960s and by the vice Sectors, Studies in Income and Wealth, Vol. 56 United States some time previously. Beyond this (Chicago: University of Chicago Press). Krugman, Paul R., 1994, Peddling Prosperity: Economic level, further economic growth should cause the em- Sense and Nonsense in the Age of Diminished Expec- ployment share of manufacturing to fall. The more ad- tations (New York: W.W. Norton). vanced east Asian economies have surpassed this level , 1996, Pop Internationalism (Cambridge, Massa- of per capita income, and in all of them the share of chusetts: MIT Press). manufacturing employment is falling. The decline has -, and Robert Z. Lawrence, 1994, "Trade, Jobs and been greatest in Hong Kong, China and Taiwan Wages," Scientific American, Vol. 270 (April), pp. Province of China, where the absolute numbers em- 44-49. ployed in manufacturing have fallen. This process has Lawrence, Robert Z., and Matthew J. Slaughter, 1993, "In- been more gradual in Japan, Korea, and Singapore, ternational Trade and American Wages in the 1980s: but will possibly accelerate in the future. These are Giant Sucking Sound or Small Hiccup?" Brookings Papers on Economic Activity: 2, Brookings Institution, clear-cut examples of positive deindustrialization. pp. 161-226. There is strong evidence that the manufacturing share Leamer, Edward E., 1996, "In Search of Stolper-Samuelson of employment is influenced by the trade balance in Effects on U.S. Wages," NBER Working Paper 5427 manufactured goods. The trade balance is easily the (Cambridge, Massachusetts: National Bureau of Eco- most important factor explaining cross-country differ- nomic Research). ences in economic structure, but is of less importance Lengelle, Maurice, 1966, The Growing Importance of the in explaining why the employment share of manufac- Service Sector in Member Countries (Paris: Organiza- turing has declined so dramatically in many countries. tion for Economic Cooperation and Development). These findings are similar to those of Rowthorn and Murray, R., 1992, "Measuring Public Sector Output: The Wells (1987). There is little evidence that North-South Swedish Report," in Output Measurement in the Service Sector, Studies in Income and Wealth, Vol. 56, ed. by trade has been a major factor behind the relative de- Zvi Griliches (Chicago: University of Chicago Press). cline of manufacturing employment. 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