Saturday, November 20, 2010

At your service, our economy's a work in progress

THE structure of our economy is set to change over the 2010s, creating winners and losers and plenty of complaints. So it's worth remembering the economy's structure has been changing continuously since the gold rush.

An article by Ellis Connolly and Christine Lewis of the Reserve Bank reminds us that, over the past 80 years or so, the economy has been transformed from one centred on the production of primary products to an urbanised economy mainly producing services.

In the 19th century, agriculture accounted for about a third of our total output of goods and services (gross domestic product), but from about the 1930s its share started declining and today is down to a mere 3 per cent.

Why? Well, not because we're producing less agricultural stuff. We're producing more than ever. No, it's just because other parts of the economy have grown a lot faster than agriculture, thus reducing its share of the total.

While we've been producing more rural stuff we've been doing it using progressively more machinery, with fewer, bigger farms to capture the machines' potential economies of scale. So agriculture has become steadily more "capital intensive", releasing workers, who've moved to the city.

As agriculture's share started to decline, the manufacturing industry's started to increase. At the beginning of last century it accounted for roughly 15 per cent of total output, but by the 1960s it had reached a peak of 25 per cent.

From that point its share began to decline, halving to about 12 per cent today, even though it too is producing more than ever. And it, too, has become more capital intensive and less labour-intensive over the years.

This brings us to the sector that was growing much faster than agriculture and manufacturing and thus reducing their shares of the economy: services. Even in the 19th century, service industries accounted for about half the economy. By the 1960s the services sector accounted for 60 per cent of output and today it's up to 80 per cent.

I have to say that, particularly among older Australians, the growing share of the services sector - something that's happened in every country - is a bit of a worry. Agriculture and manufacturing produce physical goods - goods that can be exported or used to replace imports. Can Australians really make a living performing services for each other?

Yes we can - and we do. Quite a good living. "Services" may sound ephemeral, even servile, but they're not. Do you regard the work of doctors, nurses, carpenters, plumbers, journalists and TV stars, truck drivers, bank managers, firemen, teachers, professors and prime ministers as insubstantial or inconsequential?

A lot of people aren't quite sure what "services" includes, so let me give you the list (deep breath): construction; distribution services and utilities (electricity, gas and water, wholesale and retail trade, transport, postal and warehousing, information media and telecommunications); business services (financial and insurance, rental, hiring and real estate, professional, scientific and technical, administrative); social services (public administration and safety, education and training, health care and social assistance); and personal services (accommodation and food, arts and recreation).

By their nature, service industries are generally labour-intensive rather than capital-intensive, meaning they account for a larger share of total employment - 85 per cent -

than of output.

All these are old trends. The big news is the mining industry's growing share of output: it has gone from 2 per cent in the 1960s to 8 per cent today. And since mining's share of business investment spending has shot up to 19 per cent, we can be sure its output share will go higher.

Mining is the ultimate capital-intensive industry, so its share of total employment is just 1 per cent. But if it creates so few jobs, what's the point of it? It earns lots of income, and when that income is spent, jobs are created. Where? Mainly in service industries.

Another thing that has changed with the structure of industry is the composition of our exports. In the 1960s, agriculture accounted for 62 per cent of total exports of goods and services. Today it's 18 per cent.

Then, mining's share was 15 per cent; today it's 42 per cent - meaning primary commodities account for 60 per cent of our exports. We're a commodity-exporting economy and there's no getting round it. Always have been; probably always will be.

Manufacturing's share of total exports has increased by 8 percentage points to 17 per cent and services' share has gone from 14 per cent to 23 per cent. What services do we send abroad? We don't, really. Foreigners come here to buy tourism and education.

Why does the structure of the economy keep evolving? Connolly and Lewis identify four main drivers. First is the rising demand for services. As our real incomes grow over time there's a limit to how much more we can eat, wear, drive and watch - our demand for goods, in other words.

But there's no limit on the services we demand. We're spending ever more on health, education, recreation and financial services. Since 1960, the proportion of consumer spending going on services has increased from 40 per cent to more than 60 per cent.

Second is the industrialisation of east Asia. Over the past 50 years, Asia has exploited its low cost of labour to become a big global producer and exporter of manufactures (with the main location of that production slowly migrating from Japan to South Korea and Taiwan to China, as labour costs have risen with economic success).

The Asians have needed primary commodities as raw materials for their manufacturing, and we've been nearby. Their "comparative advantage" and ours have been a great fit.

Third is economic reform.

Reductions in trade protection of manufacturing contributed to its declining share, whereas deregulation has help to increase the share of various service industries, particularly banking and finance.

The final driver of structural change is technological advance. Computerisation has made primary and secondary industries more capital-intensive while increasing the size of computer-related service industries.

Improvements in business practices (including just-in-time production and out-sourcing) have contributed to the service industries' rising share of total output and employment.

The main thing to remember is that 200 years of efforts to increase productivity by means of "labour-saving" technology haven't led to ever-rising unemployment, as people always fear it will.

That's because higher productivity leads to increased real income and as that income is spent new jobs are created elsewhere in the (services) economy.