Sunday, 22 May 2016

The Importance of Manufacturing: Productivity Growth or Trade?



In a recent article, Ha-Joon Chang highlights the decline of manufacturing as a source of stagnating living standards in the UK.  I would agree that Britain's manufacturing decline is a cause for concern, but what interested me in the article was the discussion of the role of productivity growth.

The basic argument here is: 1) there is greater scope for productivity growth in manufacturing than in services; 2) greater concentration of economic production in activities with high productivity growth means higher aggregate productivity growth; 3) the higher a country's overall productivity growth, the higher its per capita real income growth.  In fact, for a small open economy like the UK, I think the latter point is a bit more complicated than that.

To help see why, imagine that you were about to choose your future career and had the choice between going to work on a production line making TVs - an area with scope for high future productivity growth - or becoming a hairdresser - an area with little scope for productivity growth.  Now, obviously, there are lots of considerations here.  However, the argument that you could expect to see much higher personal income growth as a production line worker than as a hairdresser because of the productivity issue should sound a little suspect.

What in fact is likely to happen is that, over time, TVs become cheaper relative to haircuts.  The productivity growth in TV production benefits both the production line worker and the hairdresser.  Exactly how much each benefits depends on how the terms of trade develop between the two which depends on various demand and supply elasticities.

In a world with significant global trade, the same point applies to whole economies.  Productivity gains in one country are to the benefit of all countries, even those which are themselves seeing no productivity growth.  Exactly which countries benefit depends on their trading positions - the elasticities in the goods they export and import.

Now, this does not mean that the UK's decline in manufacturing does not matter.  It does matter, but the point is that it matters as much because of the role of manufacturing in providing exports and import substitutes as it does in providing productivity growth.  To benefit from global productivity growth, a country has to be well positioned in traded markets.  Cutting hair is a useful activity, but has limited export potential.  Of course some services can act as exports and, in principle, it is possible for a country which exports the right services to see substantial growth in living standards without any material domestic productivity growth.  But this is probably not an option for the UK.

10 comments:

  1. There's one more thing: rising productivity itself leads to better price competitiveness. So helps exports as well.

    ReplyDelete
    Replies
    1. Maybe. But, if you are competing in an industry where you have scope for high productivity gains, it's likely your direct competitors will also. And benefiting from a competitive edge requires not only that you can produce more efficiently, but that everyone else cannot. If everyone can do so, then it just becomes a question of how the benefit is split between producers and consumers.

      Delete
    2. Following a principle of purchasing power equivalence, falling domestic prices would increase the exchange rate, so leaving the price to the export market unchanged.

      Delete
    3. This comment has been removed by the author.

      Delete
    4. I'll expand on that for clarity,

      With the importer putting the same value on a basket of imports before and after the productivity increase, if the importer values a basket of imports at a certain amount of units of his currency then that will be the same after the productivity increase. If there is decrease of prices in the exporters currency, there is not a price drop to the importer, what changes is the currency exchange rate.

      Delete
    5. Purchasing power parity deals with cases where there is no reason for any change in relative prices (expressed in the same currency), so if domestic prices change the exchange rate needs to change to offset this. But here a change in relative prices (expressed in the same currency) is exactly what we are talking about. We have not said anything about how that change in relative prices comes about. It could be through a change in domestic prices or a change in the exchange rate or some combination of the two.

      Delete
    6. Yes , it certainly is a partial of the total theories about exchange rates, but the interesting point from the perspective of monetary economics is exporters dont gain an export price advantage "price competetiveness" following a productivity increase as in the theory the exchange rates moves in response to the lower price .

      Delete
  2. You've spotted an important point. Ha-Joon Chang simply concentrates on the importance of manufacturing on productivity growth. In that sense his model is still a bit non-heterodox in which productivity drives production.

    In heteredox models, productivity rise is not that important and is due to production rise (Verdoorn's Law). Manufacturing becomes important because of its role in international trade and success of a nation in that leads to higher national production and rises productivity.

    (There is some role from productivity to competitiveness as my first comment, but the above is the main mechanism).

    ReplyDelete
  3. You make a valid point in observing that service industries can not be expected to be the source of the tradeable goods necessary for acquiring resources available only from foreign economies. That leaves the manufacturing and local resource sectors as the only remaining candidates able to provide goods for export.

    It seems to me that there should be a role for national self-sufficiency in discussions of production and productivity. Self-sufficiency would need to be balanced with the need acquire necessary resources such as oil and iron, which are both examples of resources unlikely to available in sufficient quantity in every single nation.

    If we considered the need for both imported resources and self-sufficiency, we are left with a strong impetus toward establishing stable relationships with stable partners, with both partners receiving benefit from the arrangement. The emerging challenge is to find such relationships and to KEEP them stable and enduring.

    ReplyDelete
    Replies
    1. To be clear, I'm not saying that services cannot be a source of exports at all. The UK has substantial service exports. I'm just not sure it could rely entirely on that.

      Delete