Service Sector – A Poor Substitute For Manufacturing

Updated on

The recent collapse of British Steel highlights the weakness of neoliberal governments in not appreciating the importance of their manufacturing sector, believing their service sector is a substitute, when it’s nothing of the sort.

The collapse of British Steel recently (22nd May 2019,) having failed to secure a UK government bailout, is a case in point of how governments, particularly those favouring neoliberalism, underestimate the importance of manufacturing. They fail to appreciate the urgent need to protect their manufacturing base.

Get The Full Ray Dalio Series in PDF

Get the entire 10-part series on Ray Dalio in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues

Q1 hedge fund letters, conference, scoops etc

There is a belief, mainly fostered by vested-interest, that developed economies progress from a predominantly manufacturing-base to a service-based economy. While there is a shred of truth to this, to believe that the loss of one’s manufacturing base is a natural progression, is entirely wrong, misleading and damaging to national economies. Vested interests benefit directly by promoting this idea. They benefit by promoting free markets, which enables them to produce anywhere in the world where production costs are low, and then sell it back to us at maximum profit. Globalization is beneficial to vested interests, not national economies or their citizens. Losing ones manufacturing base has many disadvantages, and represents a poor strategy. Vested interests want you to believe there is nothing to worry about the loss of ones manufacturing base as service industries replace them. This is just a ruse to hide the damaging effects of losing ones manufacturing base, which are not replaced by service industries. This is another example of misleading information fed us to further their aims with no regard to the damaging consequences felt by national economies both socially and economically. Like most of their other misleading lies, they promote it extensively until many believe the message to be true. Politicians and other influencers take up the cudgels and fight vested interests cause, ignorant of the damage they are doing to their constituents and economy.

The facts are, we consume, in great measure and will continue to do so. We buy food, clothes, cars, TVs, gadgets, appliances - the list goes on, and on. These products have to be produced somewhere. Much is not produced nationally, but internationally. When we import more than we export, we incur a deficit in our balance of payments. More money leaves the country than enters. This has to be financed. A sustained deficit leads to increased borrowings, which leads to increased costs, which leads to a lowering of the quality-of-life, as governments implement spending cuts to reduce expenditure.

As the industrial base grows, so too does the service sector. Unfortunately, the opposite does not hold true - when the service sector grows, manufacturing does not necessarily grow. This is because services do not induce economic activity to the same degree manufacturing does. Manufacturing offers growth opportunities to service providers through the manufacturing process and their worker needs. It also creates export opportunities by allowing the service sector to acquire knowledge and expertise developed around an industry or industries. This knowledge and expertise can then be exported to other countries in need of it. However, it must be appreciated that it’s far more difficult to export services than manufactured goods. Service exports are limited to highly specialised knowledge and skills, often related to manufacturing. Therefore, a shrinking manufacturing base limits the ability to acquire such knowledge and expertise, resulting in a drop in service exports. It also follows, if the service sector grows from a growing manufacturing base, it will shrink when manufacturing shrinks.

Can services really replace manufacturing?

The big question is, “Can the service sector create enough jobs to replace those lost in the manufacturing sector, and earn enough foreign currency to stop incurring a trade deficits? “Vested interests tell us we can, and not to worry. However, the correct answer is no - never, and we should be very concerned at the loss of manufacturing. To start with, the absolute values of goods and services exported are vastly different. For example, in the UK, where the service sector is strong (80% of GDP), the value of service exports is only about a third of the value of manufactured goods. Therefore, the service sector has to grow significantly to offset any contraction in manufacturing. Furthermore, the UK’s service surplus is limited to financial, engineering and computing services, where current competition is limited, coming only from the US, Germany and Japan. It’s foolish to believe these surpluses will keep making up for deficits in manufacturing. Competition will increase, not only from current competitors but from emerging economies like India as a potential software giant. What’s more, a shrinking manufacturing base limits the development of multi-disciplinary expertise associated with an industry, reducing service exports further. Brexit may also adversely affect the UK’s financial services. Advances in AI (Artificial Intelligence) may negatively impact service exports. Highly technical jobs with numerous inputs and possible outputs, which previously required highly qualified individuals, are ideally suited to AI, as computers can “crunch” far more possibilities, with a higher degree of accuracy. They are also capable of making “intelligent” decisions based on these possibilities. Computers will give us productivity gains humans cannot, thereby reducing service export potential.

There are many disadvantages associated with services, particularly its low tradability and limited productivity growth. Most services are non-tradable so a strong service sector in comparison with manufacturing will mean poor exports and a balance of payment deficit. A balance of payment deficit limits the country’s ability to import technologies which will enable it to compete more effectively, which in turn leads to slower growth.  Manufacturing lends itself to mechanisation and therefore, productivity gains, whereas it’s difficult to improve service productivity without loss of quality. For example, a waiter may serve five tables well but ten poorly. Productivity is gained at the loss of quality. The same applies to exportable services. Markets require productivity gains with no loss in quality. This is difficult to achieve for services. Consequently, when an economy becomes dominated by the service sector,  productivity growth will be low - the whole economy slows down.

Because service exports are limited to specialised fields with limited productivity growth and earned in an uncompetitive market (which will soon become increasingly more competitive,) and with rapidly developing AI technologies, service exports will shrink, not grow. The only question we need to answer is, “by how much?”

Importance of manufacturing.

We are consumers and will remain so. This requires manufacturing. So manufacturing will always play a major role in our economic life. We will either have to make it or import it. The more we produce, the more money remains in the national economy. The more direct and indirect jobs we create. Local service providers spring up around manufacturing facilities. These local service providers, although essential to the economy, have no impact on exports. Services, generally, evolve around manufacturing, so services cannot “overtake” the importance of manufacturing. Services will grow and become more significant, but never in a leading role - that role belongs to manufacturing. This, I believe, is the fundamental relationship between manufacturing and services. Manufacturing provides the leading edge in every economy, and always will. Manufacturing induces economic activity across a broad front. Services don’t. Therefore, to lose ones manufacturing base is a grave mistake. The economy which retains the largest manufacturing base will have the strongest economy, and vice versa.

So, to claim its good for us, and a natural progression (in developed economies) to move from a manufacturing base to a service-base is wrong. Its the language used to promote free markets and globalisation. It’s supposedly “sophisticated and modern” to think in these terms, but it’s extremely misleading and harmful. They paint the picture that manufacturing is a low-level endeavour (dirty, mucky, unsophisticated) better suited to developing countries, not modern, sophisticated countries. Nothing could be further from the truth.

Copyright © 2019 Adrian Mark Dore

Leave a Comment