Finance: Research, Policy and Anecdotes

Rethinking the effects of deindustrialization

There has been lots of discussion recently on the value of having a large manufacturing industry. High (productivity) growth and export strength of Germany is often associated with its large manufacturing sector, which has shrunk much less over the past decades than in other advanced countries. In the UK there is a lot of angst on the loss of manufacturing jobs in the wake of Brexit. On the other side of the Atlantic, the new U.S. administration wants to regain manufacturing jobs with protectionism and presidential tweets. Beyond politics, there is also an economic argument in that only manufacturing can provide for the necessary productivity gains that fuel economic growth.  Martin Sandbu has recently taken on some of these arguments in the FT Free Lunch

 

But maybe we should stop staring at the forest and focus on the trees! 

 

A just published paper in Economic Policy (for which I was the responsible editor) sheds some new light on this. Andrew B. Bernard, Valerie Smeets and Frederic Warzynski use Danish micro-data to take an in-depth look into the de-industrialization process that has also taken place in Denmark.  The authors show that a non-negligible portion of the deindustrialization is due to firms switching industries, from manufacturing to services.  These firms are small, highly productive, import-intensive firms and grow rapidly in terms of value-added and sales after they switch. By 2007, employment at these former manufacturers equaled 8.7 percent of manufacturing employment, accounting for half the decline in manufacturing employment.

 

There are mainly two types of former manufacturing firms that are relabelled as service firms: firms conducting the traditional activities of wholesalers and firms mostly focused on the design and distribution, but not involved in production. These firms have also upgraded their workforce and employ a larger proportion of high tech workers.  They are generally more productive than firms staying in manufacturing, thus also alleviating concerns that deindustrialization is behind the slow-down in productivity.

 

There is also good news on the labor market front: employees losing their jobs at the switching companies are not worse off than employees at firms in comparable manufacturing companies in the medium- to long-term, five years after losing their jobs their labour market status is actually better than workers at ex-ante comparable firms that remain in manufacturing. In summary, deindustrialization is not a story of disappearing industries or failing firms, but rather of the changing nature of firms, transitioning from focus on production towards services. These findings also suggest that attempts to revive manufacturing might be mis-targeted and might ultimately undermine the global supply chain and innovation in these countries.

 

Now, one might argue that Denmark is a special case, because of its geographic and socio-demographic structure.  At a minimum, however, these findings should prompt economists and policy analyst to take a closer look at the deindustrialization process.  And maybe they should also incentivize policy makers to think more about how to make deindustrialization a success story rather than trying to gain votes with nostalgia.