The services economy: Deindustrialisation & global unbundling
Phuah Eng Chye (19 August 2017)
The greatest challenge ahead is not how manufacturing is being hollowed out in developed countries but rather how technology is changing the traditional role of manufacturing in global economic development. Noting long-standing beliefs that economic advancement occurs through industrialization, Ejaz Ghani and Stephen D. O’Connell observes the “conventional path to development seems to have hit a road block in other regions, especially low income countries in Africa and South Asia…concern about limited industrialization and technological progress. Indeed, in many African economies, manufacturing – the sector that led rapid development in East Asia – is declining as a share of GDP. The worry is that without a major transformation, Africa’s recent growth spurt may soon run out of steam.”
Ejaz Ghani and Stephen D. O’Connell notes several arguments have been advanced for the changing role of manufacturing in economic development. One is that “technological changes have made manufacturing more capital and skill intensive. So, it is creating fewer jobs.” Another is that “consumers and households in developed countries now spend a lot less on manufactured goods than they do on services. This can put a limit to how fast the latecomers to development can grow through industrialization.” In addition, concern was also expressed that the goods market may be saturated which would make “it difficult for new entrants to become large-scale exporters”.
In this context, Dani Rodrik fears developing countries are experiencing “premature deindustrialisation…manufacturing began to shrink…developing countries are turning into service economies without having gone through a proper experience of industrialization…On the economic front, it reduces the economic growth potential and the possibilities for convergence with income levels of the advanced economies…Premature deindustrialization has potentially significant economic and political ramifications, including lower economic growth and democratic failure.”
Another aspect of the changing nature of manufacturing is the unbundling of the production process. Richard Baldwin differentiates between earlier forms of industrialisation which involved “building a supply chain” and the current information-driven form where advanced manufacturing activities could be created “in a developing nation in a matter of months by joining a supply chain.” He explains this is now feasible due to “the radical change in globalization…The ICT revolution made it feasible to spatially separate some stages of production without much loss in efficiency or timeliness.”
Richard Baldwin observes that globalization’s 2nd unbundling where “advanced-nation firms offshored labour-intensive segments of their supply chain to developing nations” changes the “nature of industrialization”. He notes “the 2nd unbundling made industrialization less meaningful. Before the 2nd unbundling, a nation had to have a deep and wide industrial base before it could export…Exporting engines was a sign of victory. Now it is a sign that the nation is located along a particular segment of an international value chain.”
In this context, he advises that “thinking about localization policies without putting global value chains at the heart of the economic logic can lead to some very misguided policies. Today’s nations might do better to look at Thailand starting from the late 1980s, rather than Korea and Taiwan from 1970 to 1997.”
The implications of premature deindustrialisation and global unbundling are significant because manufacturing has historically been an important stepping stone for many countries in their economic evolution. The question arises as to whether developing economies can now realistically bypass the manufacturing phase and leapfrog directly into services sector growth.
In the past, the services sector has never been cast into the central role of a driver of growth as “services have been considered non-tradable, menial, low productivity, and low-innovation.” But Ejaz Ghani and Stephen D. O’Connell suggest this has changed as “technology, trade and supply chains have altered the characteristics of services. Innovations in communication and transport have contributed to global supply chains being extended into services, just as they have been extended into parts and components of manufactured goods.”
In this context, digitalisation has underpinned the rapid expansion of global trade in services. While jobs in the industrial sector are shrinking globally, jobs in services continue to expand. Ejaz Ghani and Stephen D. O’Connell suggest “the globalization of service provides alternative opportunities for low income countries to find niches, beyond manufacturing, where they can specialize, scale up and achieve explosive growth.”
Overall, premature deindustrialisation and global unbundling, combined with hollowing-out in the advanced economies, signals the diminishing role of the manufacturing sector in driving global economic growth in the future. The diminishing influence of manufacturing could have substantial deflationary consequences on trade and growth around the world. This also means that the big question in the coming decades is whether the service sector can replace manufacturing as the engine of growth. I will analyse these issues in greater details starting with a revisit of Baumol’s cost disease.
Dani Rodrik (January 2015 – Draft) “Premature deindustrialisation”. Economics working papers – Paper Number 107. Institute for Advanced Study (IAS) School of Social Science. https://www.sss.ias.edu/files/papers/econpaper107.pdf
Ghani, E and S O’Connell (2014) “Can service be a growth escalator in low-income countries?”. World Bank Policy Research Working Paper Series 6971. http://documents.worldbank.org/curated/en/823731468002999348/pdf/WPS6971.pdf
Richard Baldwin (December 2011) “Trade and industrialisation after globalisation’s 2nd unbundling: How building and joining a supply chain are different and why it matters.” NBER Working Paper No. 17716 http://www.nber.org/papers/w17716
 Ejaz Ghani and Stephen D. O’Connell