The Ideas Exchange: Economic View - Yes, It's Services with a Smile

Article excerpt

What should we do about our two-speed economy? There is an immediate policy dilemma facing the Bank of England. Consumption is racing ahead and, in an ideal world, it needs higher interest rates to curb it. Yet manufacturing is in recession and, in a perfect world, it needs lower interest rates to boost it. But of course you cannot have different interest rates in different parts of the country any more than you can have different interest rates in different parts of the eurozone.

Setting interest rates has inevitably to be an unsatisfactory compromise. There has been considerable concern about the disadvantages of the "one size fits all" interest rate in Europe but the same worry persists here: one size does not fit all in any comfortable manner.

So what's to be done? Wring hands? Try to offset the effect by bringing in other policies to support industry? Or accept it and recognise that this sort of pressure is exactly what is needed to make the economy more productive?

The answer is number three. A bit of hand-wringing may be in order because whenever there is strong pressure on part of the economy, good companies and good people will be hurt. There is also a case for finding out if there are regulation or infrastructure problems damaging manufacturing industry that local and central government could do something about.

But ultimately the shift out of manufacturing and into services is a natural and inevitable aspect of countries getting richer. To try to slow the process down would be to slow the creation of wealth.

The graphs show three aspects of this transfer. On the left is the change in employment in the US over the past 30 years. Despite the resurgence of US manufacturing during the Nineties the proportion of people employed has continued to fall and is around 16 per cent of the workforce. The proportion of people in the services industries has correspondingly soared. That 35 per cent figure is on the narrow definition of the US Bureau of Labor Statistics (BLS). On wider definitions, which include the public sector and other service industries separately classified by the BLS, the proportion is double that.

If you look at the proportion of service industries in the GDP in G7 countries (middle graph) there are two striking features. One is that all the lines go up. The other is that, with the exception of Japan, the higher the proportion of services in the economy the higher the GDP per head. The US is at the top, followed by the UK (yes, our GDP per head is now higher than France and Germany, at least in money terms). Then at the bottom comes Italy. Allow for the over-valuation of the yen, now being corrected and maybe even Japan fits in. A correlation does not mean a causal relationship, but the US position in particular surely tells us that rich economies will inevitably have smaller manufacturing sectors. …