The decision of the Tata group to divest its steel business in the UK has reignited an old debate on the impact of globalization on manufacturing jobs in advanced economies. While intuition may suggest that advanced economies are at risk of losing manufacturing business and employment to the developing world, economic research over the past three decades suggests that may not be the case.

In a 1993 National Bureau of Economic Research (NBER) paper, Nobel Prize-winning economist Paul Krugman, then at the Massachusetts Institute of Technology, and Robert Z. Lawrence of Harvard University questioned the wisdom that rising trade deficit, a loss in international competitiveness and a surge in imports from less developed countries were to blame for America’s economic problems due to their adverse impact on domestic manufacturing.

Krugman and Lawrence argued that the increase in the US’s trade deficit in manufacturing could only be used to explain a small part of the loss of manufacturing activity. According to their estimates, even if the US had maintained balanced trade in manufacturing between 1970 and 1990, it would still have suffered 86% of the decline in share of manufacturing in gross domestic product (GDP).

The erosion in manufacturing’s base, argued Krugman and Lawrence, had happened due to a shift of consumer expenditure away from manufacturing towards services. This, they said, was a result of the decline in prices of manufactured products, which had happened due to a large improvement in productivity.

That paper provided another piece of evidence to argue against the notion that international trade was the reason behind the predicament of blue-collar workers in the US. Krugman and Lawrence argued that evidence from the US economy belied the predictions of the factor price equalization theory of trade.

Factor price equalization theory suggests that if a country abundant in skilled labour (e.g., the US) trades with a country abundant in unskilled labour (any developing country), then the former would specialize in the export of skill-intensive products.

This would lead to an increase in demand for skilled labour and hence a rise in their relative wages. The rise in wages in turn would lead to a decline in the relative share of skilled labour in other sectors, thereby leading to a situation where the ratio of skilled to unskilled labour declines in all industries.

The authors argued that data for the US economy between 1979 and 1989 did not conform to this trend. Despite there being a rise in the relative wages of skilled labour, all industries were employing more of it. The paper concluded that it was incorrect to blame international trade for the difficulties being faced by US manufacturing and the US economy, and the reasons were rooted in the domestic economy itself.

In a 1999 International Monetary Fund (IMF) Staff Paper, Cambridge University economist Robert Rowthorn and the IMF’s Ramana Ramaswamy argued on more or less similar lines.

The authors looked at data from 18 industrial countries over 1963-1994 and concluded that deindustrialization there since the 1970s had primarily been due to domestic issues, even though globalization played a role in accentuating the process.

According to their findings, between half to two-thirds of the relative decline in manufacturing employment was to be explained by changing preference patterns, differential productivity growth and associated price changes.

A falling investment-to-GDP ratio was another important cause for fall in demand for manufactured goods in these economies, which according to the authors accounted for one-sixth of the deindustrialization in these economies. This, the paper argued was almost equal to the effect of north-south trade on the manufacturing sector of these countries.

A 2009 American Sociological Review paper by Christopher Kollmeyer of the University of Aberdeen, which examined deindustrialization in 18 OECD countries during 1970-2003 also arrived at similar conclusions. Kollmeyer, however, accorded greater weight to the role of north-south trade in driving deindustrialization than Rawthorn and Ramaswamy did.

He also pointed out that some of the apparent loss in manufacturing employment might simply reflect a change in nomenclature as factory services (such as design or cleaning) began to be outsourced and “factory workers" were no longer being employed to perform them.

A recent NBER paper examined the patterns of manufacturing employment in Denmark to find that a significant portion of the “decline" in manufacturing employment between 1993 and 2007 can be explained by switching from manufacturing to services.

The authors argue that a non-negligible portion of what is construed as a decline in manufacturing employment and number of firms has been happening because of erstwhile manufacturing firms switching over to non-manufacturing activities. These activities could constitute assuming the role of a wholesaler given the existing knowledge of producers and consumers in the given sector, or moving to activities such as design or research and development.

The paper gives an example of an 18th century firm, Iver C. Weilbach & Co., which sold magnetic compasses to sailors in its first hundred years, then moved to providing on-board checks and now offers both printed (outsourced from others) and electronic (produced in-house) navigation maps and support on a 24x7 basis.

The authors use these findings to argue that the traditional focus on reviving manufacturing in advanced countries might have missed this phenomenon and hence runs the risk of preserving less efficient manufacturing activity against the modern switchers which are more research oriented and display much higher levels of productivity.

The paper argues that it is in these activities that advanced economies still enjoy a comparative advantage, unlike in assembly and production activities, where the advantage may have shifted to developing countries.

Such research, however, is of little consolation to the distressed workforce in advanced economies that have been facing deflationary economic conditions and joblessness since the onset of the Great Recession.

The political economy implications of these conditions are already visible. The US, the biggest capitalist country in the world, is aggressively pursuing mega-regional trade agreements it claims will bring back jobs to the domestic economy by promoting exports.

Donald Trump, who has sharply polarized the country in the run-up to the next presidential elections, has threatened to impose duties on imports coming into the US from China if elected to power. The situation is not very different in developing countries as well, most of which are experiencing headwinds to growth given tepid global demand.

Where does the solution lie? A return to mercantilism? Or should we go back to nationalization of industries, which is purportedly being considered in Britain right now? Answers to such questions are inextricably linked to issues of what should be an appropriate industrial policy as well as overall growth strategy.

Just as many other forms of government intervention, once considered beyond the pale, are gaining currency, it is likely that the coming months and years will witness growing calls for governments to step in and frame industrial policies.

Maybe the 21st century will require a new kind of industrial policy, as Harvard University economist Dani Rodrik outlined in a 2004 research paper. Rodrik argued that industrial policy should be seen as a part of the process of economic self-discovery, in which the state and private firms work jointly to identify and address bottlenecks to productivity and growth.

“A central argument of this paper is that the task of industrial policy is as much about eliciting information from the private sector on significant externalities and their remedies as it is about implementing appropriate policies," wrote Rodrik. “The right model for industrial policy is not that of an autonomous government applying Pigovian taxes or subsidies, but of strategic collaboration between the private sector and the government with the aim of uncovering where the most significant obstacles to restructuring lie and what types of intervention are most likely to remove them."

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