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Deindustrialization has both positive and negative impacts. First, it could increase living standards, so consumers spend more dollars on services. Second, 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. Thus, there are several positive and negative impacts of deindustrialization. We will explore these impacts in detail throughout this article.
What is deindustrialization?
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 outset of economic development, a country’s economic sector typically transitions from primary activities like agriculture (primary sector) to secondary activities like manufacturing (secondary sector). This period was marked by the establishment of factories, which created numerous job opportunities. This process of industrialization is a key driver of economic growth for developing nations.
Rapid advancements in technology and production methods often lead to significant productivity gains within the manufacturing sector. This, in turn, can fuel the development of the service sector. As societies become wealthier, demand for services such as healthcare, education, and entertainment rises.
However, the rise of automation and technological innovation within the manufacturing sector can also have a significant downside. As manufacturers increasingly replace human labor with machines and robots, job creation in this sector naturally declines.
This phenomenon means that the manufacturing sector no longer dominates the economy. Two indicators show this: 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 manufacturing sector’s performance deteriorates. As a result, its productivity has decreased and has resulted in not competing with foreign manufacturers.
Positive impacts of deindustrialization
Industrialization can positively impact welfare and income. In addition, by shifting to the service sector, the economy produces fewer carbon emissions, reducing the negative impact on the environment.
Higher standard of living
One of the positive impacts of deindustrialization is a rise in living standards. As economies mature and reach the full potential of industrialization, productivity in the manufacturing sector often surpasses growth in the service sector. This translates to increased prosperity, observed in many developed countries. Consumers benefit from cheaper manufactured goods due to factors like automation and global competition.
An increase in income encourages the demand for services to increase. As a result, the service sector, such as financial services, tourism, and hotels, is growing rapidly. Additional dollar spending on manufactured products falls as a percentage of total GDP due to cheaper manufactured goods prices plus increased spending on services.
Long-term 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-labor ratio is already high, they can no longer rely on capital deepening by increasing the capital-labor ratio for growth.
They have to invest in technological advances. In the Solow growth model, technology—a contributor 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.
Job creation through offshoring
Some companies outsource their manufacturing overseas and focus on services because these provide more long-term benefits. They can also save costs by relocating factories to low-wage countries or close to raw materials sources.
Improvements in welfare also occur abroad. Increased offshoring brings more income and jobs to destination countries, not just profits for manufacturers. Factory relocation also brings capital inflows to the destination country.
For example, a US manufacturer shifting its production facilities to Indonesia demonstrates the positive impact on job creation, economic growth, and income in the destination country. However, it’s important to acknowledge the broader impacts of deindustrialization. While some countries benefit from offshoring, developed nations may experience job losses and require workforce retraining programs to address these challenges.
Diverse job opportunities
The positive impacts of deindustrialization involve a significant shift in the types of jobs available in an economy. Jobs in the service sector are also considered more creative, rely more on knowledge, and are less physically burdensome. In addition, it enables 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 highly variable work and skill levels. Therefore, 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. Due to job specialization, working conditions are also relatively monotonous.
Environmental benefits
Manufacturing activities contribute to high carbon emissions, which damage the environment. For example, in 2019, they accounted for about 23% of greenhouse gas emissions in the United States, some of which came from burning fossil fuels for energy.
Thus, reduced manufacturing activities reduce pollution and carbon emissions to the environment. However, this actually only happens in the home country. For example, suppose a manufacturing company moves its production facilities overseas. In that case, it means moving carbon emissions from the home country to the destination country.
Specialization and trade
Relocation is a common practice and reflects efforts to specialize. For example, 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, each country specializes in producing goods and services in which it has 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.
Negative impacts of deindustrialization
Shifts in economic structure, a hallmark of deindustrialization, also come with costs. Rising structural unemployment is an example. Another negative impact of deindustrialization is environmental degradation in manufacturing investment destination countries. A persistent current account deficit is another cost associated with deindustrialization.
Structural unemployment
Some jobs in certain manufacturers were lost. Indeed, other jobs, particularly in the service sector, are available. However, factors such as specialization hinder labor mobility.
When manufacturing workers are unemployed, they do not have alternative skills. Specialization makes them experts in their current job but not in skills in other occupations.
Thus, when employers move manufacturing locations overseas, it is difficult for manufacturing workers to find new jobs. As a result, 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 manufacturing 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 different from financial services.
In the end, the gap between the supply and demand for skills makes the service sector’s capacity to absorb workers relatively limited. As a result, 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.
Current account deficits
One potential impact of deindustrialization is the emergence of persistent current account deficits. These occur when a country relies heavily on imports due to a decline in its manufacturing sector output.
With fewer manufactured goods produced domestically, the country needs to import more to meet consumer demand. Simultaneously, a shrinking manufacturing base translates to fewer exports, further widening the gap between imports and exports.
This situation becomes even more pronounced when the service sector itself relies on imported supplies. For example, many service industries require technology and office equipment that may not be produced domestically. As these service businesses grow, their demand for imported goods also rises, further contributing to the current account deficit.
Reduced tax revenue
One significant impact of deindustrialization can be a decline in government tax revenue. Regions that have historically relied on a robust manufacturing sector for economic growth can face economic hardship if factories relocate to other countries.
Large-scale factory closures also have a ripple effect. Many businesses are connected to them in the supply chain. Thus, their closure prompts 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, which, in turn, could lead to cuts in public services in the region.
Environmental issues in developing countries
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. Second, 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.
Income inequality
Another potential impact of deindustrialization is an increase in income inequality. While the service sector offers a wider variety of jobs compared to manufacturing, it also tends to have a larger salary gap. For example, the salaries of retail and restaurant workers can differ vastly from those of lawyers or stockbrokers.
In contrast, the manufacturing sector generally features a more even distribution of wages across different positions. Workers in textile manufacturing typically receive salaries and benefits comparable to those in food and beverage manufacturing.
As a result, as economies transition from manufacturing to service-based economies, income inequality can widen due to the larger wage disparity within the service sector. This highlights the importance of considering policies that promote income equality alongside deindustrialization, such as investing in education and training programs to equip workers with the skills needed for higher-paying service sector jobs.
