De-industrialization of the Riches and the Rise of China

Abstract

This paper tries to understand the structural transformation in a global world. While employment and output have shifted out of the industrial sector and into services in the G7 countries, the majority of world manufacturing employment is now located in the developing countries of Asia, especially in China. China’s manufacturing industry is the largest in the world in terms of employment, employing more manufacturing workers than do all of the G7 countries combined. In addition, the merchandise exports of China account for more than 10 percent of the world merchandise exports. First, I analyze the relationship between productivity change and industrial employment in a closed economy general economy model for each of the G7 economies. The model has non-homothetic preferences incorporating Engel’s law to capture the declining role of agriculture in all of the G7 nations. On the other hand, the central feature of the model is uneven technological progress between industry and services to create the movement of labor from industry to services. I find that an explanation of de-industrialization due to increased productivity in industry relative to services in a closed economy setting is not compelling. After showing the failure of a closed economy model I investigate the effect of openness to understand the de-industrialization of the G7 economies in the context of the recent emergence of China in the world economy following the idea of Coleman (2007), who argues that the emergence of giant economies sets in motion a structural transformation in other countries around the world. I ask, To what extent is de-industrialization in the world’s richest nations the result of the emergence of China in world product markets, and to what extent would this de-industrialization have occurred anyway as the result of secular shifts in sectoral productivity in the G7 countries? I present a simple open economy framework to illustrate the effects of China on the de-industrialization of the G7 nations studying a two-country, three-sector model with no international labor mobility, in which countries trade industrial goods due to the (Armington) assumption that production of different goods is country specific. This feature of the model, and the degree of substitutability in preferences between home and foreign produced units of each good, endogenously determine each country’s equilibrium pattern of employment, production, and trade. I compare the de-industrialization predictions of the closed economy and open economy models between 1978 and 2006. I calibrate to sectoral data from China and the G7, and conduct numerical experiments to quantify the effect of the emergence of China on the de-industrialization of the economic activities in the G7 countries. I find that the sectoral labor productivity differences in the industrial sector in China and the rest of the world affect the sectoral distribution of employment in the G7. I argue that the results are promising for the future research.

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