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Should we worry about the fall of British industry?

Amongst the many old wounds opened by the recent passing of Baroness Thatcher*, we’ve observed a renewed outlook on the perceived death of British manufacturing, in favour of the oft-maligned service sector (think, financial services, consultancy, hospitality – anything that requires human input at some point or another). Debate on deindustrialisation, however, comes with a number of economic myths and fallacies that need to be debunked before a proper analysis can be made.

*(BBC Radio 4’s More Or Less produced an excellent economic analysis of Thatcher’s time in office, available here)

Economics-schmeconomics! British factories are closing left right and centre, are they not?

A common conception, but not true. In actual fact, we have precisely the opposite – in absolute terms, Britain has never had a higher manufacturing output. What we have instead observed in Britain is known as weak deindustrialisation. Manufacturing output itself isn’t falling, rather it’s share of our total national output (GDP) is falling.

And this isn’t something to worry about?

Not necessarily. We can mostly explain this falling share (around 85% of it, in fact) with basic economics. Note, because we’re dealing in shares of GDP, we have to consider output in manufacturing directly against that of the service sector in order to proceed.

Firstly, manufactured goods tend to have low income elasticities of demand. This is a convoluted term for a basic concept – it simply means that as people’s incomes rise, they tend not to buy proportionally more manufactured goods as a result. You’re unlikely to buy an abundance of ovens as you get richer, though you are likelier to eat out at restaurants more often. Indeed, consumption of services generally tends to increase with income.

Secondly, whilst it’s difficult to make services cheaper (peoples’ wages tend to go up, not down), it’s relatively easy to make manufactured goods more cheaply over time, mostly because of technological innovation on the factory floor. This means that the prices of manufactured goods have decreased substantially more than the prices of services. There’s a good reason that you can buy a fully functional toaster for £4.85, but a hotel room is as expensive as it’s ever been.

Both of these points matter, because when calculating GDP, output of something is measured by the amount spent on it, not the physical amount produced. We should hence expect to see weak industrialisation, the share of our income spent on manufactured goods decreases as we get richer and develop as a country.

So, if British manufacturing is supposedly fine, why has everything got “Made In China” on it?

China exports a lot of goods to Europe and America because it manufactures many goods cheaper than anywhere else. This makes them the obvious manufacturing base for companies all over the world. In fact, cheap overseas competition goes a long way to explain the remaining 15% of weak industrialisation that the economic theory above doesn’t deal with.

But how can anyone compete with a country that pays its workers next to nothing?

This is a classic economic fallacy. A factory making things cheaply DOES NOT equate to the factory paying low wages. China makes things cheaply because their manufacturing methods are incredibly efficient. Textiles manufacturing is a case in point. In 1900, Britain had some 500,000 people employed in textiles manufacturing. Today, it would only take 25,000 Chinese to produce the same amount that those half a million Brits made a century ago. Whilst the majority of British jobs in textiles have indeed disappeared, they have been ‘taken’ predominantly by advances in technology, not by cheap overseas labour.

So there’s nothing to worry about?

Theoretically, no.

Pragmatically speaking, perhaps.

Merely expecting an economic shift away from manufacturing and industry towards the services sector tells us nothing about what to do with manufacturing sector workers who suddenly find themselves unemployed. It’s this aspect of deindustrialisation that causes the biggest headaches for governments – retraining middle aged workers made redundant by gains in industrial productivity is a remarkably difficult exercise. Even taking deindustrialisation as inevitable, a solution is far from obvious. A better focus on vocational education would be a good start – when the labour market falters, it is unskilled workers that suffer disproportionately more.

NB. Many of the assertions made here are made courtesy of this paper co-written by Tim Leunig and Stephen Broadberry of the London School of Economics – indeed, I’d certainly recommend a full read to those of an economic persuasion.

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