Structural Changes, Productivity and Foreign Trade

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As part of the economic development process, service sectors in industrialized nations such as Germany have long since established themselves as the most important economic sectors. However, productivity increases in the service sector have been weaker than those in the manufacturing sector. This raises income inequality. Increasing international trade in services could serve to intensify this trend further.

Service sector the largest employer

In this blog post, economic structural change is described using the German economy as an example. The trends presented below pertain to the Federal Republic of Germany (between 1970 and 1991) and reunified Germany (between 1991 and 2006). This analysis focuses on the manufacturing and service sectors.

To begin with, the trend towards a service economy is indicated by changes in employment figures. At the beginning of the 1970s in Germany, both of the aforementioned sectors employed a similar number of people (approximately 12 million each). In 2016, the number of employees working in the entire service sector amounted to over 32 million — around three times higher than the figure for the manufacturing sector. Despite the German population increasing due to reunification, the number of manufacturing sector employees in 2016 (around 10.5 million) was lower than the 1970 figure (see Fig. 1).

Analysis of the annual hours worked confirms this trend. Between 1970 and 2016, the number of working hours performed annually by employees in the manufacturing sector decreased from 23.4 billion to 15.7 billion — a drop of around one third. In the service sector, the volume of work performed annually rose by approximately 80 percent (from 23.7 billion hours to 42.6 billion, see Fig. 2).

Productivity trends weaker in the service sector

Although the number of hours worked in the manufacturing sector sank between 1970 and 2016, gross value added measured in current prices increased five-and-a-half fold from EUR 157 billion to more than EUR 860 billion. Value added rose in the service sector as well, from EUR 157 billion to EUR 1,950 billion (a twelve-and-a-half-fold increase, see Fig. 3).

If the gross value added per hour worked is taken as an indicator of productivity, then the following trend can be observed.

Income gap between manufacturing and service sectors widening

Value added is a crucial criterion in determining the amount of wages that a company pays its employees. Therefore, the fact that the two economic sectors under review here are drifting apart in terms of productivity will result in a growing difference in wages.

An important reason for these wage differences is the fact that capital and technology are used differently in both sectors.

However, it should be pointed out that digital technologies can be deployed in the service sector as well. Examples include online trade, translation programs and many more. This increases productivity and therefore wages.

Services and the role of foreign trade

As can be seen in Fig. 4, gross value added per working hour increased at more or less the same rate across the two sectors between 1970 and the beginning of the 21st century — and this despite the fact machines and technology were used differently in that period as well. I believe this development can be attributed to foreign trade, among other factors.

In the future, pressure on wages in the service sector could become even more intense if services are traded to a greater extent internationally.

Outlook

The above explanation of the significance of foreign trade for trends in service sector wages in developed economies such as Germany is only one conceivable explanation. There is undoubtedly need for further research in this area.

However, if this approach proves correct, this would have far-reaching consequences for trends in income in developed economies. It can be assumed the competition with low-wage countries will not slow down for the time being. So cost pressure will not lessen. As a result, wages in the two sectors under review here will continue to drift apart and therefore there will be growing market income inequality across the entire economy. This could result in increasing social tension which would then have a negative impact on both political and economic stability.

However, another possibility is that wages in the service sector will have to increase more strongly than productivity increases, as otherwise companies will not be able to recruit the employees they need to sustain production. This would have a negative impact on international competitiveness. It could lead to a rise in unemployment, which would also serve to generate social tension.

Either way, differences between the manufacturing sector and the service sector in terms of productivity trends may result in significant challenges — for which socio-political solutions would need to be found — in developed economies.

Bibliography:

Statistisches Bundesamt (2017): Volkswirtschaftliche Gesamtrechnungen — Inlandsproduktberechnung: Lange Reihen ab 1970. Wiesbaden.

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