Chapter 8: Sector Development And Market Saturation

1. PRODUCTIVITY GROWTH AND SECTOR SHIFTS

After having dwelt on the subject of labour productivity and its growth rate, let us see how this has affected the distribution of the labour force, and look at the related sector shifts and market saturation. Today the service sector is the most important part of any modern economy, but the situation was totally different a thousand years ago. At that time agriculture dominated total output. Medieval history prefers to focus on the deeds of kings and noblemen and, to a lesser degree, on the work of philosophers, writers and artists, but the peasant was the mainstay of the economy as he had been for millennia. Farmers produced not only enough to nourish their own families but also the surplus needed to feed the landlord and the townspeople. While over 90 percent of the workforce was engaged in agriculture, maybe no more than 5 percent of the working population, mostly living in towns, were occupied in what one might call the equivalent of today’s secondary sector: in building, transport and manufacturing (the production of goods such as pots and pans, knives, footwear and clothes). The remainder of the population, the administrators and scribes, the soldiers and priests, made up the equivalent of today’s service sector (see Appendix A).

As labour productivity increased over the following centuries due to better agricultural practices, fewer farmers were needed to produce food for the whole population and employment had to shift to other sectors. This shift became more noticeable after 1500, but even in Britain around 1700, just before the Industrial Revolution, some 50 to 60 percent of the labour force was still needed in agriculture (as in many developing countries today). During the 18^th century, agricultural productivity got a boost from selective livestock breeding and new farming techniques and practices, leading to a significant fall in agricultural employment. This, in turn, supplied the workers for the Industrial Revolution.

The proportion of workers employed in agriculture continued to fall throughout the 19^th and 20^th centuries because of mechanisation and heavy chemical inputs. In the 1950s, agriculture still employed 10 percent of the workforce in the USA (and 20 percent in Western Europe) but by the end of the millennium this had fallen to no more than 2 percent (3 percent in Western Europe). Excluding imports of tropical produce, those who remain in agriculture in the West today produce not only all the plant food the population consumes, but also all the plant food fed to animals (which is by far the largest part) as well as all the food that is exported. Productivity increase in agriculture over the millennium is therefore much higher than the fall in the proportion of people working in the agricultural sector would indicate. A rough calculation indicates that the productivity of modern farmers is possibly 150 times higher than that of their counterparts of AD 1000.

As agricultural productivity increased, the secondary sector, which includes not only manufacturing but also transport and construction, absorbed a large part of the manpower freed by the greater efficiency achieved in the primary sector. Most of today’s advanced nations began to industrialise between 1830 and 1870 but this process started much earlier in Britain, the birthplace of the Industrial Revolution. As industrial employment grew in Britain some thought that it would end by absorbing most of the workforce. By the middle of the 19^th century, socialist and, in particular, communist ideologues saw the future as one huge factory and thinkers such as Karl Marx were convinced that salvation from exploitation by the factory owners could come only from the internationalisation of workers’ organisations and from the proletariat taking over. As we know, the future did not turn out that way for a number of reasons, the main one being the effect of rising productivity, which Marx failed to foresee.

The demand for manufactured products increased faster than industrial productivity in the advanced nations over the subsequent 100 years, leading to the growing importance of industrial employment. However, this situation changed after the Second World War when output began to outpace demand due to rapid gains in industrial productivity, and radically so after 1970-80 when demand for manufactured goods began to level off while industrial productivity kept rising steadily, specifically due to the introduction of robots.

The advantages of robots are manifold. They can execute dull repetitive work continuously and with much greater reliability and precision than humans. They reduce costs and working time and are, in fact, the ideal docile workers 19^th century factory owners could only dream of: indeed, they do not organise themselves in unions, nor do they protest against their working conditions, go on strike or press for higher wages. They work around the clock, rarely become ill and never pregnant. These are great advantages, but they have come at the price of falling industrial employment.

It would be interesting to compare productivity in the secondary sector to that of a thousand years ago. The labour productivity index cannot help us here because it measures the value of the average output of all types of production (food, goods and services), expressed in constant dollars, produced in one hour by a worker in the most advanced nation, compared with the value produced in one hour by a farmer practicing subsistence agriculture. However, trying to compare average productivity in the secondary sector over long periods of time does not really make sense because the composition of industrial production kept changing through the centuries. Most of the goods produced today (like the services we now pay for and include in the calculation of labour productivity) did not exist in the Middle Ages, nor even in 1900. If we limit ourselves to comparing productivity in such activities as the production of simple household goods that did exist a thousand years ago, today’s industrial production methods are possibly thousands of times more efficient than the manual production methods of a millennium ago.

Throughout history, then, labour has always had to shift from highly productive to less productive sectors. Over the past decades, automation in the manufacturing sector has forced people to seek employment in the less productive tertiary sector (comprising all services), which today employs some 75 percent of the workforce in the USA. As the computer revolution is spreading through the service sector this begs the question whether new sectors will be ready to absorb the workers shed by the service sector, or whether we are heading for permanently high unemployment. I shall come back to this important question later.

2. PER CAPITA GROSS DOMESTIC PRODUCT AND DOMINANT SECTORS

Production is a dynamic process. Production patterns change as countries move from underdevelopment and primitive agriculture to industrialisation, to mass-consumption, and finally to the service era. It is worth illustrating this progress in the light of the history of the economic development of Western Europe and the USA described in Chapters 1 and 2. This shows that different economic activities rose to the fore and then declined as the per capita GDP grew (as always, the pcGDP is expressed in constant 2000 U.S. dollars). The dominant sectors were, from the year:

1000-1450 (corresponding pcGDP of Western Europe maybe $300-$515): Primitive agriculture, hand-made goods.
1450-1650 (corresponding pcGDP of Western Europe maybe $515-$900): Foodstuffs, minerals, basic commodities.
1650-1850 (corresponding pcGDP of Britain: $900-$3,000): Early mining of coal, leather, footwear, wood and furniture, ceramics, glassware, paper, textiles, simple chemicals, early iron and railway production.
1850-1929 (corresponding pcGDP of Britain and then the USA: $3,000-$9,300): Shipbuilding, steel and other metals, heavy industry, mechanical engineering, electrical engineering, basic chemicals, early motor vehicles, early oil production, early consumer goods.
1929-1980 (corresponding pcGDP of the USA: $9,300-$22,700): Oil, consumer goods, automation, electronics, organic chemicals, plastics, synthetic fibres, pharmaceutical products, aviation industry, service sector, early mainframe computers, early space industry, entertainment industry.
1980-2000 (corresponding pcGDP of the USA: $22,700-$34,260): Computer-controlled processes, robotics, telecommunication, PCs, space industry, advertising, mass tourism, entertainment industry, the Internet, banking and financial services, consultancy services, medical services, biogenetics.

This sequence shows that in the course of the economic development of the West, each sector started at a particular level of pcGDP, reached full development, then aged and declined as new sectors began to take over.

Although globalisation, foreign direct investment, exports, outsourcing and tourism are modifying this pattern in the developing world, in particular for smaller economies, by and large the pcGDP remains a good indicator of what the leading sectors will be. As their pcGDP rises, countries move up the production ladder according to a clear sequence. Below a pcGDP level of $1,000 their economies are dominated by agriculture, raw materials and hand-made goods; from about $1,000 to $3,500 by textiles and light industry; from about $3,500 to $7,500 by heavy industry; from about $7,500 to $15,000 by mass consumer goods; and above $15,000 by services.

3. FROM NEW PRODUCT TO MARKET SATURATION

As they grew from low to high pcGDP, the production patterns of the western economies changed, as outlined above. New sectors opened up one after the other, penetrated the economy and then dominated it. This is very much in line with the observations of Schumpeter who remarked upon the process of market penetration. A typical sequence of such penetration is shown in Figure 8.1, which gives a general picture of the process of market penetration.

Figure 8.1:

Market Penetration of a New Product

When a new major innovation, capable of driving the economy forward, enters the market, growth is initially extremely high. Examples mentioned by Schumpeter as ‘bursts of creative destruction’ in the USA, are the production of railway tracks in the 1830s; steel in the 1860s and 1870s; and electricity and motor vehicles after 1900. They all grew at over 20 percent per annum¹ in the first decade. This initial phase of penetration of major innovations lasted about 15 years in the 19^th and early 20^th centuries. It is indicated by a Roman I in Figure 8.1.

This is followed by a phase of rapid growth (indicated by a Roman II), lasting maybe 20 to 25 years, during which growth percentages are still substantial, but tailing off towards the end. Afterwards production moves into a phase of maturity (III), which lasts another 20 to 30 years, at the end of which the market is saturated. Schumpeter noted that these three phases together lasted about 60 years in the 19^th and early 20^th centuries.

The market penetration of high-tech products such as VCRs, PCs, mobile phones or digital cameras, follows a pattern similar to the one shown in Figure 8.1. However, as such products are more affordable than, say, cars, the time-span between the moments those new products were put on the market, and the end of Phase III, will be much shorter than 60 years.

During Phase I profit margins are high but so are prices: if a new product is very expensive, only the wealthier sections of the population or those who absolutely need it will buy it. As production moves into the rapid-growth phase (Phase II), production methods are perfected, more producers enter the highly profitable market, and competition increases. This leads to falling prices with the result that more people will acquire the product. This trend is usually accentuated by the fact that incomes have been rising with economic growth during the intervening years. Profit margins are still substantial but falling. It is towards the end of this phase of widespread penetration that new technologies contribute most to the growth in labour productivity.

In Phase III mass production techniques have been fully developed, competition becomes severe and in the end, from being more profitable than average, profitability begins to trail the average. By now market penetration is almost complete; most households in the richest nations will have acquired the product and domestic markets become saturated.

Production next enters a phase of ageing and decline (Phase IV). Growth percentages shrink because there is no longer a boost from first time buying, but only replacement. Furthermore, the fall in domestic production is much steeper than the fall in domestic consumption because of foreign competition. Countries with low labour costs have by now have set up their own production units and are exporting rather than importing. As competition increases sharply, profit margins become wafer-thin and many domestic producers begin to sustain losses. In Phase V a balance is finally reached between domestic production and imports, and domestic per capita production stabilises.

All major products, be they washing machines, cars, steel or computers, and even services, tend to follow growth curves similar to Figure 8.1. Annual growth rates of consumption per inhabitant soar at the beginning, level off over many years, and eventually fall to near zero.

The onset of consumption of a product is largely dependent on the per capita GDP a country has attained, and on the price of the product. In a country where the pcGDP is $3,000 to $5,000, only those in the top quintile (the 20 percent of the population with the highest income) can afford, for example, a car. With rising pcGDP, those in medium income quintiles will start buying cars, and at a pcGDP of about $20,000 even people in the lowest quintiles will have the money to buy (second hand) cars and consumption begins to approach saturation.

The capacity to produce goods or services, too, depends on the pcGDP. As a country moves from underdevelopment to development or, in quantitative terms, from low pcGDP to high pcGDP, average educational levels increase. Its inhabitants first become semi-educated, low-paid workers, taking up labour-intensive jobs in the textile and electronic assembly industries instead of obtaining their livelihood from simple agriculture. As infrastructure improves and productive capacity builds up, workers next move on to car and consumer goods industries, and finally to services. By that time educational levels are high and so are salaries. Other, less-developed countries will by then have taken over sectors that are labour-intensive or that can function with lowly qualified workers.

A country’s capacity to enter certain lines of production therefore depends on its average educational level, on the investment it can attract, and on the accompanying transfer of technological know-how. As educational levels increase, and countries gradually enter new sectors, average wage levels rise. The higher the wage level, the more difficult it is to remain competitive in older sectors, for example in heavy industry. Steel, for instance, whilst it has become a leading sector in Brazil and is still profitable in South Korea, is in difficulty in the USA and Western Europe where it has entered Phase IV of its sector development.

National economies therefore conceal a variety of conditions, ranging from sectors that are healthy and growing to sectors that are loss-making and declining. Generally speaking, whether a certain sector is in difficulty or not in a particular country depends roughly on that country’s pcGDP.

In an ideally integrated world market with free trade and no barriers of any kind, domestic production would keep falling in the older industries during Phase IV, and one would think that it might cease altogether in the long term as new foreign competitors, producing more cheaply due to lower wages, keep penetrating the market. However, older production processes too undergo technological change and, by permitting higher productivity, allow a large part of local production to remain competitive with imported products.

Labour costs nowadays account for just 11 percent of overall manufacturing costs in the USA² and cheaper foreign labour is no longer able to compensate in many cases for shipping costs, and political and security risks. Moreover, domestic plants have the advantage of being closer to the customers, which leads to speedier distribution. Workers therefore do remain active in older-type sectors, although the number of people active in these sectors as a percentage of the total labour force will diminish as demand saturates, while productivity keeps growing.

Furthermore, barriers of one sort or another exist or are erected in many sectors, permitting domestic producers to survive in the face of cheaper foreign competition. A larger part of consumption will therefore be supplied by domestic industries than justified solely by economic considerations because the world economy is not an open system. Indeed, governments yield to pressure to protect employment for electoral motives, or to keep alive sectors that are deemed vital for the national economy. This allows ageing sectors to survive in leading nations, thereby leaving many workers in less productive industries. As a consequence, over-all labour productivity will remain lower and the economy less dynamic than it would otherwise. Protectionism has other negative side effects. For instance, by putting obstacles in the path of free trade, it forces domestic consumers to pay prices above those they would pay in an open market. It is nevertheless unrealistic to expect protectionism to disappear as long as political motivation and nationalist factors influence decision-making.

4. THE BUILD-UP OF CRISIS CONDITIONS DURING SECTOR SATURATION

Sector development explains how, one after the other, industries rise to grow into leaders, then to produce profits below average, and finally to become one of the many mature or declining industries that make up the economy. It also shows why industries at the cutting edge become problem cases within a matter of decades as their sector passes from Phases I and II, to III and IV in Figure 8.1, and market saturation sets in. The latter is a painful occurrence, and one may ask whether it is possible at all to avert the extreme competition due to oversupply as sectors age. Let us therefore look at the developments during Phases II and III that contribute to this. Three factors stand out clearly:

i) The creation of domestic excess capacity. Demand increases rapidly in new sectors during Phases I and II, and domestic production capacity expands to satisfy it. The problem is that demand for a new product (or a new service) is higher when people are still first-time buyers than at the moment when most have already acquired the product. More important is that, during Phases I and II, part of the total production is exported whilst by the time Phase III is reached, some of the countries behind in development, to which the exports went, will have set up their own production units. Demand for domestic production will therefore fall when countries reach Phase IV. The creation of domestic surplus capacity is consequently a natural process that occurs during Phases II and III of the production curve.

ii) The appearance of aggressive foreign producers who want to jump onto the bandwagon by developing export-oriented production capacity. By producing at lower cost because of longer working hours, lower wages and lower social security costs, these foreign producers sell at prices below those of domestic producers, and so manage to penetrate the markets of the advanced economies.

In theory there is nothing wrong with such an approach. In order to be profitable, production must aim for economies of scale and the production of fully operative new units in newly industrializing countries usually surpasses the absorption capacity of local markets. Many of the new industries in developing economies therefore produce largely for export, since this is often the only path to rapid development. The incomes of people in the newly industrializing countries will gradually increase and the moment will come when local customers become sufficiently affluent to be able to absorb domestic production. Export-led development is in fact a natural process that has happened throughout economic history. It should not cause any problem as long as newly industrializing countries, in turn, import other goods and services from the advanced nations in order to keep trade balanced.

The problem is that some countries practice a form of mercantilism. They make the conquest of foreign markets their main objective while trying to keep imports out, thereby seriously aggravating the plight of industrial producers in the nations to which they export. This was, for instance, the case of the USA before 1930, or of Japan in the second half of the 20^th century. In recent years China (and other East Asian exporters) have bought up massive amounts of dollar assets in order to keep their exchange rates down. This makes Chinese goods artificially cheap in western markets while reducing the competitiveness of foreign goods in China. It distorts trade and is, in practice, again a form of mercantilism.

iii) The unwillingness of owners to close down loss-making businesses; and also the resistance of the workforce to job losses. The creation of excess capacity in leading sectors has long-term consequences. Once a factory has been built it will have to function for several decades to justify investment. When problems arise at the end of Phase III of sector development, the managers and owners of a firm that produces domestic appliances cannot shift production to, say, pharmaceutical products. All they can do to remain competitive with cheaper foreign imports is to rationalize production by installing more efficient production methods, slim down and lay off workers. The workers, in turn, will resist this and defend their jobs through industrial action and political pressure, and governments tend to oblige by granting subsidies or protection. This opposition to adaptation complicates and delays the shrinking process imposed by saturation, and exacerbates problems. The reorganization of older sectors, often undertaken with the help of government subsidies, is usually insufficient to allow all producers to survive, and the death of a sector is therefore a painful, drawn-out process of protection and subsidies, making the losses that much greater when the end comes.

It is quite understandable that owners, managers, workers and governments do not want to let sectors be taken over by foreign competitors. A large amount of capital has been ploughed into the industries of these sectors. One must not only count the accumulated equipment, buildings and infrastructure but also the investment in training and specialised knowledge that has been built up in that particular field.

When industries are in Phases I or II of their sector development, demand exceeds supply, enabling substantial profits to be made. This sets in motion a correcting phenomenon: more businesses start up in these promising sectors, thereby creating a rising demand for specialists.

A lack of specialists in a given field always leads to a corrective movement. The short-term answer is the importation of people with the necessary qualifications from developing countries. During the last few decades, for instance, the rich nations have been trying to attract computer specialists or medical doctors to make up for the shortage in the domestic market. More significant for the long term is that high demand influences the studies young people choose when they finish college.

Only a few decades ago, for example, thousands of young people trained for technical, scientific and engineering jobs for which demand in industry was high. However, with the manufacturing sector melting away since 1970-80, this demand has been shrinking ever since. During the 1980s many of those with scientific capabilities turned instead to computer science, as the computer industry was in full expansion, and computer programmers were snapped up the moment they finished their studies.

In the 1990s it was management, economics, finance and the law that attracted students with their good prospects. The many start-ups in the bubble economy of the 1990s caused an insufficiency of qualified people, and induced companies to offer high salaries to financial specialists, consultants and specialised lawyers. As students queued up dreaming of the manna they were going to collect, business schools, economic faculties and law schools flourished. Today genetic engineering is the new promising sector, whilst demand for medical care and pharmaceutical products is also intensifying; the latest rages are therefore biogenetics and medical studies.

The problem is that the reaction to high demand ends by creating oversupply. This is inevitable. Young people select a field of study on the basis of job prospects existing when they are about to begin their studies, and not on the basis of the as yet unknown job market that will be in existence when they are 40 or 50.

When yesteryear’s promising sectors turn into tomorrow’s problem sectors, many will discover that they specialised in fields for which demand did not live up to their expectations of permanent good jobs and high salaries. This is already beginning to happen to those students who were lured by the high demand and the prospect of good salaries existing in the computer industry in the 1980s. Similarly there will inevitably be an oversupply of economists, and financial and management specialists within a decade or two. When they lose their jobs at the age of 40-50, many highly qualified and well-paid workers will to have to search for employment in sectors for which they will have no particular qualifications. Over-specialisation will then be a handicap, and the most successful workers will be those with the ability to adapt to the ever-changing job market.

It is therefore not only firms but also the people working for them, who are hit by saturation. Having invested heavily in expensive studies and in building up experience, they will do what they can to fend off competition because the alternative will be accepting a job well below their qualifications and a much lower salary, or long-term unemployment.

The build-up of the preconditions for the crisis through which all industries sooner or later pass is therefore a phenomenon that takes place over many decades. The root of the problem is over-investment during Phases II and III. All is well as long as demand keeps pace, but towards the end of Phase III sectors that held out promising prospects a few decades earlier begin to saturate, and demand falls. This produces a glut, not just in productive capacity but also in the number of specialists who trained to work in these sectors, as mentioned above. Hence, overproduction during Phase IV is the consequence of the way producers, investors, and students reacted to prevailing circumstances decades before that time.

The creation of oversupply in boom times is a phenomenon typical of human economic behaviour. Business cycles find their origin in the same kind of behaviour. However, these are short-term cycles, whilst the cycle from rapid expansion to over-investment and sector saturation is a much longer process, lasting maybe 60 years or more around 1900, and less today. Market saturation is therefore a phenomenon which will be extremely difficult to avert.

5. THE AGRICULTURAL SECTOR

The sequence described above would imply that, in an open global market, countries at pcGDP levels of $20,000 or more abandon the production of more labour-intensive goods and, instead, import them from countries at pcGDP levels below $10,000. It would seem that this applies in particular to food production and, according to this sequence, one would expect the advanced nations to have moved out of a large part of agriculture by now, and to be importing agricultural produce from developing nations. Yet, this is not the case for a number of reasons.

Unlike manufacturing, agriculture cannot be moved to any country. It is more like sectors of the economy such as forestry and mining, or coal, oil and natural gas production. These cannot be considered normal sectors of the economy that can be taken over by less advanced countries producing at lower cost, but are sectors where natural endowment plays a major role. A country is either endowed with rich oil or copper deposits or it is not; it has large tracts of forests left or it has not. So, mining, energy production and forestry are not like car production or financial services that can be set up anywhere in the world, once the level of education and the state of the infrastructure permit competitive production.

Agriculture is therefore a special sector. Food production is highly dependent on the average climatic conditions, geography and soils of the producing region. Certain areas are particularly suited to grow food because of their ideal geographic position, easily accessible and workable rich soils, and abundant rainfall. These factors confer a definite advantage to certain nations in spite of their high pcGDP.

The American Midwest is a case in point. Its rich plains, where the prairie grasses have created a deep, fertile topsoil in a process that has taken millions of years, are the breadbasket of America. Mechanised agriculture is easy in these flat lands. Driving through these plains, sown uniformly with corn for mile upon mile, one realises the advantage of size, easy access and good soils. Amongst high pcGDP producers, production costs necessarily favour the vast and rich American farmland. American agriculture is furthermore extremely efficient.

The new rural Europe that grew up after the Second World War in fact followed the American model. The grouping of smaller plots into larger units, mechanisation, chemical fertilisation and the application of ever-larger quantities of pesticides and herbicides led to the doubling of agricultural yields in Western Europe over the last half century.

This is typical of agriculture in the advanced nations, which no longer has anything in common with the primitive agriculture that is still practiced in many poor countries. The 2-3 percent of the workforce remaining in agriculture in America and Western Europe today have become very productive people. Modern farming practices now require a technological input and a corresponding high level of education not found in countries with low pcGDP.

Food production remains barely sufficient to satisfy domestic needs in many developing countries, as has been the case throughout history, because of poor agricultural technology, lack of money and bad planning, but also because of low-quality farmland. The poorest countries therefore rely on food imports from the rich countries to make up for shortcomings in years of bad harvests, rather than exporting to them.

The large technological gap in food production between the rich world and the rest (which is not easy to bridge) is not the only problem. As the population of the developing countries is expected to grow rapidly until possibly 2050, and meat will constitute a growing part of consumption as people become more affluent, most developing countries will have to make huge advances in agricultural productivity just to keep up with rising domestic demand, and will find it almost impossible to become large food exporters.

The rich world no longer faces such constraints. As the chemical agricultural revolution spread through North America, Western Europe, Japan, Australia and New Zealand, people in the rich world were able to eat more every year while spending less of their budgets on food. Furthermore, their diets changed as the demand for protein-rich food soared. As a result, most of the plant food grown by American and Western European farmers is now fed to animals, and about 35 percent of the caloric intake in the rich world comes from animal sources.

Agriculture has long been a protected sector in the most advanced economies. Subsidies encouraged farmers to grow more food in the post-war years. None of the major producers seemed to object, as the ever-rising food output produced by the chemical revolution was fed to animals. However, demand for food began to level off in the 1980s, when the rich nations entered Phase IV of their food consumption. Domestic markets were nearing saturation while farmers in the rich nations continued to be more productive. There was a food shortage in the developing world, but as developing countries were in no position to pay, a worldwide surplus was created, causing world food prices to decline by about one third in real terms throughout the 1980s.³ This was the turning point in the agricultural policies of the rich nations. Instead of cutting subsidies to farmers, the European Community began to dump its surplus onto the world market. The USA countered with its own export subsidies and thus began the battle for the food markets that has polarised multilateral trade talks ever since.

A new development in the last decade has been the emergence of several medium-pcGDP exporters such as Brazil, Chile and Mexico who have, in turn, become efficient food producers, thereby adding to the world’s surplus. Consequently, the 2003 trade talks of the World Trade Organisation in Cancún (Mexico) saw the emergence of a new alliance of food exporters from the developing world. They put free farm trade high on the agenda and made a co-ordinated attack on European, Japanese and American agricultural policies, condemning their protectionism and subsidies.

Lately the world has swung from overproduction to a shortage of food as many people in developing countries have become rich enough to want more high-protein food, and as some of the agricultural land has been converted to the production of biofuels. Food prices are now rising rapidly and we may be heading for a future of food shortages. From a long-term point of view those governments that subsidised agriculture therefore did well not to let farmers go out of business in lean years.

Food production will always remain a special sector. While from the economist’s point of view it makes more sense for each country to produce what it is best at given its particular climate, soils and pcGDP, this is not what happens. The economy has to deal not with ideal, but with real people and nations, with their fears and egocentric interests.

Food it not just a simple commodity that people are willing to buy from the cheapest producer. Food and cuisine are strongly associated with local culture in many countries. Food is also health: people are what they eat and there have been too many health scares for them to listen to ‘reasonable’ economic arguments. People want to have a say in the way their food is produced.

Food also elicits deep emotional reactions for other reasons. Nationalistic feelings and identification are a reality, and throughout history people have shown an aversion to losing control over their destiny. They do not like depending on overseas suppliers for anything they consider essential to their national security, because dependence on other nations will subject them to the policy dictates of those nations. They would rather pay more to domestic producers than lose control.

Certain sectors in particular are considered vital for national security, and the most prominent amongst these are food production, energy, and especially anything to do with arms production, including even steel, satellites and the high-tech sector. Governments are therefore willing to support such sectors by subsidising them; this leads to market distortions and wholly indefensible mechanisms (from the economic point of view) such as export subsidies.

National striving for energy independence is a case in point. The rich nations dislike having to depend on Middle Eastern oil producers. On one occasion these producers shut the oil tap (1973), holding the West to ransom and both in 1973 and 1979 the OPEC cartel squeezed much more out of the rich world than economic conditions warranted. So there is an active effort to develop home-grown alternatives even if these are more expensive, and a continued foreign policy drive to attempt to control Middle Eastern oil production.

In the same way, people do not want to depend on other nations for their food, not even on friendly ones if they can help it. There are too many historical examples of nations turning against former allies. If bossy nations controlled the food supply of others, they would have them at their mercy.

Control over food resources can mean the difference between having a secure supply, and scarcity. Nations that can afford it therefore will try to grow their own food. This can take ridiculously uneconomic forms. Saudi Arabia, for instance, desalinises seawater at tremendous cost to irrigate the desert and grow wheat at wholly uncompetitive prices.⁴ Yet, unless there is a radical evolution away from the concept of nation-identification and the antagonism between different nations, it is to be expected that arguments that are sensible from the economic point of view will be unable to overcome the nationalistic mistrust that lies at the core of protectionism in agriculture, as in other sectors.

6. THE FLIGHT FROM THE MANUFACTURING SECTOR

Agriculture is not the only sector to have suffered from overproduction. Production in the industrial sector, too, has been growing vigorously in developing countries with pcGDPs in the $3,000-10,000 bracket, leading to heightened worldwide competition.

Newly industrialising countries are now beginning the kind of sector development that started around 1870 in today’s advanced nations and even earlier in Britain. Whilst their industrial employment is growing rapidly, this will not continue forever, as these newly industrialising countries can be expected to follow the sector development of their forerunners.

By the mid-1950s the share of the workforce employed in the secondary sector peaked at 36 percent in the USA, when it attained a pcGDP of $15,000 (in 2000 dollars). A decade later it peaked also in Western Europe.⁵ Ever since, employment in the industrial sector has been shrinking as a percentage of the total in the most advanced nations. This reduction accelerated as the automation of manufacturing processes increased industrial productivity. People had to look for employment in the service sector and today the secondary sector (manufacturing, construction and transport) employs just over 20 percent of the workforce in the USA and about 30 percent in Western Europe.

The fundamental cause is automation combined with the irreversible saturation of the market for manufactured goods. This saturation is already leading to severe international competition between rival industries. Natural growth is no longer sufficient to bring high returns and manufacturers are therefore vigorously trying to buy up competitors or to push them out of the market in order to capture their customers.

A striking example is the car industry. Demand, which can be measured by the number of new cars bought annually, had been increasing for many years. American and European car production grew, even though imports from Japan grew more rapidly. This is no longer the case today, when the car markets of all the advanced nations are practically saturated. Car producers are now aiming for a faster turnover by introducing new gadgets or new, fashionable colours or models, or by trying to convince customers to go upmarket and buy a flashier car to impress friends and neighbours. There is nevertheless a limit to the production customers are able and willing to absorb, and it is unrealistic to expect substantial further growth in the car market of the most advanced nations.

Competition is becoming more severe every decade and American car manufacturers have been losing market share to overseas producers for many years. As new East European, Latin American and Asian producers are about to enter the car market, this will seriously aggravate the already precarious condition of the American car industry and also that of the remaining Western European car manufacturers. The latter will find themselves in difficulty in the coming decades and take-overs and mergers can be expected to follow.

By 2020-30 the markets for durable goods, household appliances and electronic equipment are also likely to be saturated in the advanced nations, considering that they began their rapid development (Phase I) in the 1950s and 60s. Saturation will also begin in today’s high-tech industries, such as the mobile phone and computer industries. Being labour-intensive, most electronic goods will furthermore not be produced in the USA or Western Europe but in Asia. It is therefore unlikely that there will be much scope left for the expansion of industrial production in the advanced nations after 2020, not even in the chemical industry.

Another part of the secondary sector, the building sector, has been expanding for half a century now and there seems to be no end to this long boom. A property is the most expensive item most households will ever acquire, and the pcGDP had to grow considerably for the purchasing power of households in the middle to lower quintiles to become sufficient to buy a property. The cause of soaring demand-and rising property prices-in the last decades has been the growth of the segment of the population aged 45 to 65: as the baby-boomers moved upwards through the population pyramid and their incomes rose rapidly, they had the means to enter the property market. Furthermore, families have been disintegrating into units of one, two or three persons, thereby accentuating the need for more housing units. However, all this is about to change. The population of Western Europe and Japan will begin to fall within a matter of a decade or two, and even the American and Canadian populations will probably begin to stagnate by the middle of the century, despite their present higher birth rates and immigration. One should consequently expect the building boom of the last half-century in the rich countries to subside during the following decades.

Most secondary sector activities are thus set to stagnate or even decline in the advanced nations. Industry will remain competitive solely by slimming its workforce and by becoming more efficient through the increasing introduction of automated machines to replace human labour. Extrapolations of trends since 1960 indicate that employment in the secondary sector (as a percent of total workforce) could well fall to about 20 percent in Western Europe and to maybe 16-17 percent in the USA by 2030. This would imply the disappearance of a large number of jobs in the secondary sector during the next quarter century.

There is nothing enriching for human beings in doing heavy, unhealthy, or dull repetitive work and one should therefore not consider the disappearance of jobs in the secondary sector a disaster in the absolute sense. It is, however, an unsettling prospect for many, and one must expect strong opposition, first of all from the trade unions because their power base will disappear as industrial employment shrinks. Many also fear that, if they lose their job in industry, they may never find another. Governments, too, may well want to protect jobs in industry because unemployment has remained high, notably in the European Union (where it is about 7 percent of the workforce) and because certain sectors are considered to be of strategic importance. Yet, employment in the secondary sector will continue to shrink whether it is opposed or not. Economic history shows that adaptation is a necessary and continuous process and that shrinkage, which hit the primary sector first, has been hitting the secondary sector for several decades now. The question is: Will this shrinking stop here or will it, sooner or later, also hit the tertiary sector?

7. THE SATURATION OF THE SERVICES SECTOR

Industrial production creates large employment in services related to industry. Once it rolls off the assembly line a car, for instance, gives work to salesmen, to banks for arranging loans, to insurance companies, petrol distributors, garages, spare-part retailers, towing companies, car-rental companies, traffic police, technical inspection services, government employees issuing license plates, road-tax collectors and so on. However, as the volume of consumed industrial goods reaches saturation, the growth of the services related to it will end too.

The great expansion of the range and volume of services in the leading economies since 1970 should not blind us to the fact that the consumption of services tends to follow a curve similar to the one drawn in Figure 8.1. Around 1970-80 most of the service sector was in Phase I of its development, and an increasing number of businesses were entering the market, making large profits and absorbing the labour the industrial sector was unable to employ. This is no longer the case today: many service businesses have already entered, or are about to enter, Phase III and in line with the usual pattern, growth and profit margins can be expected to slow down.

This situation will worsen within the next 20-30 years, as a large number of businesses, which are still expanding and healthy at present, will enter Phase IV of Figure 8.1. At that time, there will be too many businesses offering identical services for a demand that will stagnate or may even begin to decline. Even the promising sectors of the 1980s and 1990s, including advertising, medical services, insurance, management consultants, and firms offering financial services may be heading for Phase III and saturation by 2030.

This is likely to be the case in the banking sector as well, and it is interesting to draw a parallel between the development of the latter and the history of the car industry. As demand for cars exploded when the car industry was in Phase I, more producers entered the race, supplying local markets, and the number of American car producers peaked at 274 in 1909.⁶ The car industry gradually underwent a process of concentration, to the point where today there are only three independent car manufacturers in the USA, half a dozen in Europe and maybe as many in Asia. Furthermore, foreign producers have cornered a large slice of the American car market.

We can expect an analogous development to take place in the banking sector. Local banks are swallowed up by rivals, as the banking sector is well into Phase II of its development. The penetration of American banks into Western Europe is already under way, and this is analogous to the penetration of big American car producers such as General Motors and Ford into Western Europe after the Second World War, when they were at the cutting edge of development. The European banking sector is now consolidating as a result of American penetration and European political integration. Competition between banks has increased spectacularly. Until recently depositors remained with their bank for life but today foreign and domestic banks try to attract each other’s customers by aggressive advertising campaigns.

The banking sector has undergone a radical change under pressure of competition and this can be expected to continue. Since the sector is only in Phase II of its development, profit margins are still fat but they will shrink, as increased competition will force banks to offer better conditions in order to retain or attract customers. Only those banks that are prepared to slim down, and radically improve the efficiency of their working practices in a bid to reduce costs, stand a chance of surviving. International take-overs have become commonplace and we must expect a large number of local banks to disappear from the market between today and 2030, and to be absorbed by the larger banks. Within decades, a few international giants will dominate the banking sector and international penetration will take on proportions that we can barely imagine today. While the ownership of banks still elicits strong nationalistic feelings, these are beside the point. Even if foreign banks or service companies take over domestic ones, real ownership will belong to the shareholders, and American shareholders will be as likely to own large slices of foreign companies, as foreign shareholders to own parts of American companies.

Whoever owns service companies and wherever they are based, the physical contact with customers still has to take place, with few exceptions, at the domestic level. Some services can be located anywhere, and a typical example is the outsourcing of certain labour-intensive services to cheap labour countries such as India. The Internet, too, allows some services to be provided by foreign-based companies, but by and large, the service sector is not like the secondary sector where manufactured goods can be bought from any producer, whether domestic or foreign. Furthermore, many services are provided by government or by medium and small-scale businesses (see the example of services related to the car industry, given above), and it is therefore difficult to see how the vast majority of services not related to IT could ever be supplied from abroad.

Even so, as competition increases and productivity grows, the services existing today will be supplied by an ever-decreasing proportion of the population. In the normal course of events, society would then be moving towards the final stage of its development: it should be ready to start completing the transition from the post-industrial era towards the leisure era.

If working time were to decrease further and holidays to lengthen, an entire range of new jobs would be created in the part of the service sector one could call the leisure sector. The latter comprises hotels and restaurants, entertainment, sports and fitness centres, and shops providing equipment for do-it-yourself activities. Many other activities would flourish if free time increased, in particular art and craft schools, spiritual groups, the organisation of conferences, and permanent education centres; one might call this the ‘self-improvement sector’. Longer holidays would also stimulate the tourist sector, whether local or exotic. Productivity is extremely low in the leisure sector and it is the ideal candidate for absorbing semi-skilled workers.

The continued reduction in the number of working hours is the cornerstone upon which the growth of employment in the leisure sector rests. However, given the present relatively open state of the world economy and the international trade and competition that accompanies it, workers in the advanced economies will find it very difficult to obtain a further reduction of their working hours. In most advanced nations the unofficial practice of overtime is already reversing the long-term historical trend of falling working hours (see Appendix C), and governments may even be forced to increase the statutory workweek. This could well leave the advanced nations with a serious problem, as they would then be unable to make the transition to the leisure society, and to absorb the workers with the lowest qualifications, who are the ones most likely to be ejected from the service sector.

There is another development that will have a major impact on employment in the most advanced nations: the ageing of their populations. As an ever-larger proportion of the population retires in the coming decades, some fear that there will not be enough workers left to fill all the jobs and that, instead of being stuck with permanently high unemployment, the advanced nations are, on the contrary, heading for an acute labour shortage. The labour productivity growth forecasts made for the USA (see Appendix C) do not support this view. Further growth in labour productivity will probably more than compensate for the falling activity rate, implying that new types of services will have to be created as the service sector reorganises and becomes leaner. As always, the ones most likely to suffer from this reorganisation will be lowly qualified people, and also those with the kind of qualifications for which demand will be shrinking.

The per capita GDP is set to rise further, not only in the USA but also in all the advanced nations (see Chapter 11). The problem will therefore not be insufficient income for the average inhabitant, but the specific lack of buying power of the retired. If the retired had sufficient income, a host of new services would be created, from increased medical aid to the personal care sector (help for the aged), which could absorb workers insufficiently qualified to compete for highly productive jobs in the rest of the economy. Their employment will thus depend on whether or not a sufficient part of the growing national income can be redirected towards the retired.

Future employment of lowly qualified workers therefore requires the expansion of the leisure sector through the shortening of working hours, as well as the payment of decent pensions. The advanced nations will find it extremely difficult to move in that direction because both a further shortening of working hours and the high financial burden of transferring more money to the retired would make the advanced economies even less competitive than they already are. As long as newly industrializing countries remain in their catching-up phase and continue their assault on the markets of the rich world, this will impede any further social development there. As social problems mount, such a situation could well lead to a wave of protectionist measures and a retreat from globalisation in the coming decades.

Written by globaleconomyfuture

April 25, 2008 at 11:10 am

The Global Economy and its Long-Term Future