23 Things They Don't Tell You About Capitalism

The predominant opinion is that there is nothing to worry about. To begin with, it is not as if Britain is the only country in which these things have happened. The declining shares of manufacturing in total output and employment – a phenomenon known as de-industrialization – is a natural occurrence, many commentators argue, common to all rich countries (accelerated in the British case by the finding of North Sea oil). This is widely believed to be because, as they become richer, people begin to demand more services than manufactured goods. With falling demand, it is natural that the manufacturing sector shrinks and the country enters the post-industrial stage. Many people actually celebrate the rise of services. According to them, the recent expansion of knowledge-based services with rapid productivity growth – such as finance, consulting, design, computing and information services, R&D – means that services have replaced manufacturing as the engine of growth, at least in the rich countries. Manufacturing is now a low-grade activity that developing countries such as China perform.

Computers and haircuts: why de-industrialization happens

Have we really entered the post-industrial age? Is manufacturing irrelevant now? The answers are: ‘only in some ways’, and ‘no’.

It is indisputable that much lower proportions of people in the rich countries work in factories than used to be the case. There was a time in the late nineteenth and early twentieth centuries when in some countries (notably Britain and Belgium) around 40 per cent of those employed worked in the manufacturing industry. Today, the ratio is at most 25 per cent, and in some countries (especially the US, Canada and Britain) barely 15 per cent.

With so much fewer people (in proportional terms) working in factories, the nature of society has changed. We are partly formed by our work experiences (a point which most economists fail to recognize), so where and how we work influences who we are. Compared to factory workers, office workers and shop assistants do much less physical work and, not having to work with conveyor belts and other machines, have more control over their labour process. Factory workers cooperate more closely with their colleagues during work and outside work, especially through trade union activities. In contrast, people working in shops and offices tend to work on more individual bases and are not very unionized. Shop assistants and some office workers interact directly with customers, whereas factory workers never see their customers. I am not enough of a sociologist or a psychologist to say anything profound in this regard, but all this means that people in today’s rich countries not only work differently from but are different from their parents and grandparents. In this way, today’s rich countries have become post- industrial societies in the social sense.

However, they have notbecome post-industrial in the economic sense. Manufacturing still plays the leading role in their economies. In order to see this point, we first need to understand why de-industrialization has happened in the rich countries.

A small, but not negligible, part of de-industrialization is due to optical illusions, in the sense that it reflects changes in statistical classification rather than changes in real activities. One such illusion is due to the outsourcing of some activities that are really services in their physical nature but used to be provided in-house by manufacturing firms and thus classified as manufacturing output (e.g., catering, cleaning, technical supports). When they are outsourced, recorded service outputs increase without a real increase in service activities. Even though there is no reliable estimate of its magnitude, experts agree that outsourcing has been a significant source of de- industrialization in the US and Britain, especially during the 1980s. In addition to the outsourcing effect, the extent of manufacturing contraction is exaggerated by what is called the ‘reclassification effect’.[2] A UK government report estimates that up to 10 per cent of the fall in manufacturing employment between 1998 and 2006 in the UK may be accounted for by some manufacturing firms, seeing their service activities becoming predominant, applying to the government statistical agency to be reclassified as service firms, even when they are still engaged in some manufacturing activities.

One cause of genuine de-industrialization has recently attracted a lot of attention. It is the rise of manufacturing imports from low-cost developing countries, especially China. However dramatic it may look, it is not the main explanation for de-industrialization in the rich countries. China’s exports did not make a real impact until the late 1990s, but the de-industrialization process had already started in the 1970s in most rich countries. Most estimates show that the rise of China as the new workshop of the world can explain only around 20 per cent of de- industrialization in the rich countries that has happened so far.

Many people think that the remaining 80 per cent or so can be largely explained by the natural tendency of the (relative) demand for manufactured goods to fall with rising prosperity. However, a closer look reveals that this demand effect is actually very small. It looks as if we are spending ever higher shares of our income on services not because we are consuming ever more services in absolute terms but mainly because services are becoming ever more expensive in relative terms.

With the (inflation-adjusted) amount of money you paid to get a PC ten years ago, today you can probably buy three, if not four, computers of equal or even greater computing power (and certainly smaller size). As a result, you probably have two, rather than just one, computers. But, even with two computers, the portion of your income that you spend on computers has gone down quite a lot (for the sake of argument, I am assuming that your income, after adjusting for inflation, is the same). In contrast, you are probably getting the same number of haircuts as you did ten years ago (if you haven’t gone thin on top, that is). The price of haircuts has probably gone up somewhat, so the proportion of your income that goes to your haircuts is greater than it was ten years ago. The result is that it looks as if you are spending a greater (smaller) portion of your income on haircuts (computers) than before, but the reality is that you are actually consuming more computers than before, while your consumption of haircuts is the same.

Indeed, if you adjust for the changes in relative prices (or, to use technical jargon, if you measure things in constantprices), the decline of manufacturing in the rich countries has been far less steep than it appears to be. For example, in the case of Britain, the share of manufacturing in total output, without counting the relative price effects (to use the jargon, in currentprices), fell by over40 per cent between 1955 and 1990 (from 37 per cent to 21 per cent). However, when taking the relative price effects into account, the fall was only by just over 10 per cent (from 27 per cent to 24 per cent).[3] In other words, the realdemand effect – that is the demand effect after taking relative price changes into account – is small.

Then why are the relative prices of manufactured goods falling? It is because manufacturing industries tend to have faster productivity growth than services. As the output of the manufacturing sector increases faster than the output of the service sector, the prices of the manufactured goods relative to those of services fall. In manufacturing, where mechanization and the use of chemical processes are much easier, it is easier to raise productivity than in services. In contrast, by their very nature, many service activities are inherently impervious to productivity increase without diluting the quality of the product.

In some cases, the very attempt to increase productivity will destroy the product itself. If a string quartet trots through a twenty-seven-minute piece in nine minutes, would you say that its productivity has trebled?

For some other services, the apparent higher productivity is due to the debasement of the product. A teacher can raise her apparent productivity by four times by having four times as many pupils in her classroom, but the quality of her ‘product’ has been diluted by the fact that she cannot pay as much individual attention as before. A lot of the increases in retail service productivity in countries such as the US and Britain has been bought by lowering the quality of the retail service itself while ostensibly offering cheaper shoes, sofas and apples: there are fewer sales assistants at shoe stores, so you wait twenty minutes instead of five; you have to wait four weeks, rather than two, for the delivery of your new sofa and probably also have to take a day off work because they will only deliver ‘sometime between 8 a.m. and 6 p.m.’; you spend much more time than before driving to the new supermarket and walking through the now longer aisles when you get there, because those apples are cheaper than in the old supermarket only because the new supermarket is in the middle of nowhere and thus can have more floor space.

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

To sum up, the fall in the share of manufacturing in total output in the rich countries is notlargely due to the fall in (relative) demand for manufactured goods, as many people think. Nor is it due mainly to the rise of manufactured exports from China and other developing countries, although