What are the effects of deindustrialization?

By | January 2, 2022

Deindustrialization brings both positive and negative impacts. It could reflect an increase in living standards, so consumers spend more dollars on services. Then, the reduced reduction in environmental degradation is an example of its positive effect. 

However, deindustrialization also has negative consequences such as increased structural unemployment and trade deficits. There are several positive and negative effects of deindustrialization, which will be the main point when you read this article.

Before discussing further, let us briefly describe what deindustrialization is.

Deindustrialization is a shift in the economic structure from manufacturing-based to service-based. It can be a natural phenomenon of economic development.

At the beginning of economic development, the economy will transition from being based on the primary sector to the secondary sector. The economy began to leave agriculture and turn to manufacturing. Various factories were established and created many jobs for households. That’s what economists call industrialization.

The rapid growth of manufacturing takes a country from a developing economy to a developed economy. Advances in technology and production methods increase productivity in the manufacturing sector. It then spurred the service sector to develop.

On the other hand, many manufacturers are replacing their workforce with machines and robots. As a result, job creation in the manufacturing sector is also reduced.

This phenomenon then made the manufacturing sector no longer contribute to dominating the economy. We can see it from two indicators: the value of manufacturing sector output to GDP and employment in this sector to total employment.

However, deindustrialization can also occur not because of a natural phenomenon of economic development, but because of structural problems. We call this negative deindustrialization (or premature industrialization), in which the performance of the manufacturing sector deteriorates. Its productivity has decreased and has resulted in not being able to compete with foreign manufacturers.

The positive impact of deindustrialization

Industrialization can have a positive impact on welfare and income. By shifting to the service sector, the economy produces fewer carbon emissions, reducing the negative impact on the environment.

Better standard of living

Deindustrialization takes place because the economy has matured and has reached the full potential of industrialization. Productivity growth in the manufacturing sectorgrew faster than in the service sector. It brings more prosperity into the economy, as it does in developed countries. In addition, consumers can access cheaper manufactured goods.

An increase in income encourages the demand for services to increase. The service sector such as financial services, tourism, hotels is growing rapidly. As a result, additional dollar spending on manufactured products falls as a % of total GDP as a result of cheaper manufactured goods prices plus increased spending on services.

Encouraging sustainable economic growth

Deindustrialization has important implications for long-term economic growth in developed countries. They have to find new growth engines to grow the economy. Since their capital-labour ratio is already high, they can no longer rely on capital deepening by increasing the capital-labour ratio for growth.

They must invest in technological advances. As in the Solow growth model , technology – a contributing factor to total factor productivity – is a key factor in increasing output.

Thus, developing strategic service industries, such as research and development and education is the key to innovation in technology.

More income in destination countries

Some companies outsource their manufacturing overseas and focus on services because they provide more long-term benefits. They can also save costs by relocating factories to low-wage countries or close to sources of raw materials.

Improvements in welfare also take place abroad. Increased offshoring brings more income and jobs to destination countries, not just profits for manufacturers. Factory relocation brings capital inflows to destination countries.

For example, a US manufacturer shifted its production facilities in Indonesia. This has a positive impact on the Indonesian economy, both on economic growth, employment and income.

More diverse job opportunities

Jobs in the service sector are also considered to be more creative and rely more on knowledge and less physically burdensome. That allows for a greater degree of flexibility. For example, those with physical disabilities cannot work in manufacturing, but may work in the service sector.

In addition, this sector requires a highly variable nature of work and skill levels. It creates more variety from the demand side and work environment, providing more opportunities for workers to choose jobs according to their interests. 

In contrast, the manufacturing sector often requires relatively limited skills such as operating production machinery. In addition, working conditions are also relatively monotonous due to job specialization.

Reduced environmental degradation in the domestic economy

Manufacturing activities contribute to high carbon emissions, which damage the environment. For example, in 2019, they accounted for about 23% of greenhouse gas emissionsin the United States, part of which came from burning fossil fuels for energy. 

Thus, reduced manufacturing activities reduce pollution and carbon emissions to the environment. But, it actually only happened in the home country. If a manufacturing company moves its production facilities overseas, it means moving carbon emissions from the country of origin to the country of destination.

Creating more benefits from specialization

Relocation is a common common practice and reflects attempts to specialize. Firms in developed countries specialize in services and move their production facilities to developing countries, where wages are low. On the other hand, developing countries spur their growth through foreign investment in the manufacturing sector, taking advantage of cheap labor. Thus, in the end, each country specializes in producing goods and services in which they have a comparative advantage.

Specialization lowers the cost of producing goods and services. Finally, we can import cheaper goods from abroad instead of producing them domestically at a high cost.

The negative impact of deindustrialization

Shifts in economic structure also come with costs. Rising structural unemployment is an example. Another impact is environmental degradation in manufacturing investment destination countries. A persistent current account deficit is another cost.

Rising structural unemployment

Some jobs in certain manufactures were lost. Indeed, other jobs in particular, in the service sector, are available. However, factors such as specialization, hinder labor mobility.

Manufacturing workers do not have alternative skills when they are unemployed. Specialization makes them experts for their current job, but not skills in other occupations.

Thus, when employers move manufacturing locations overseas, it is difficult for manufacturing workers to find new jobs. Their expertise is no longer up to market demand.

Then, the service sector does offer alternative jobs, but, requires very diverse skills. In contrast, manufacturing requires relatively less diverse types of jobs and skills than the service sector.

Many jobs in the manufacturing sector are unskilled and monotonous manual work. However, jobs in the service sector rely more on non-physical activities, knowledge and skills using technology such as computers. For example, skills in hotel and restaurant services will be very much different from financial services.

In the end, the gap between the supply and demand for skills, makes the capacity of the service sector to absorb workers relatively limited. Workers who lose their jobs in manufacturing can be unemployed for quite a long time. The impact on structural unemployment is even more significant if, for example, it is not supported by an adequate education or training system.

Persistent current account deficit

Finally, deindustrialized countries may experience persistent current account deficits. The decline in manufacturing sector output forced the economy to import various products from abroad. On the other hand, product exports tend to shrink as manufacturing output decreases.

The impact is even more significant if the supply chain in the service sector also relies on imported supplies. For example, some industries require goods such as technology equipment and office equipment, which cannot be produced domestically. So, if their business grows high, it also increases the demand for imported goods.

Reduced tax potential in the manufacturing sector

Some regions rely on manufacturing to support their economic growth. If many factories moved to other countries, they could become a dead city.

Large-scale factory closures also have a ripple effect. Many businesses are connected to them in the supply chain. Thus, their closures prompt other businesses to close and in turn, lay off workers.

Such a phenomenon raises structural problems such as rising unemployment. It also reduces potential sources of government tax collection. That in turn could lead to cuts in public services in the region.

Environmental threats in destination countries for manufacturing investments

When manufacturers move their factories overseas, it means they move pollution to the destination country, usually a developing country. Problems can become serious for two reasons.

First, the destination country does not have adequate environmental policies or regulations. Because managing pollution incurs costs, loose environmental policies give manufacturers more flexibility.

Then, on the other hand, the destination country encourages investment from foreign manufacturers to continue to enter. They seek to promote economic growth and create more jobs for their citizens. Due to the low capital per worker ratio, foreign inflows allow them to enjoy high economic growth. But, it can also accelerate environmental degradation due to weak oversight and regulation.

Increasing income inequality

The service sector has not only more diverse jobs but also a higher salary gapthan manufacturing. For example, the salaries of retail and restaurant workers and lawyers or stockbrokers can be vastly different.

In contrast, workers in the manufacturing sector tend to have a more even distribution of salaries. For example, workers in textile manufacturing receive salaries and benefits not much different from workers in food and beverage manufacturing.

As a consequence, as the economy transitions from manufacturing to services, income inequality also grows.


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