UK: Smith on Economics - The new, weightless way to grow.

UK: Smith on Economics - The new, weightless way to grow. - The weightless and footloose nature of service activity creates problems for economists and tax collectors. But such 'creative destruction', says David Smith is vital to sustain economic growth

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Last Updated: 31 Aug 2010

The weightless and footloose nature of service activity creates problems for economists and tax collectors. But such 'creative destruction', says David Smith is vital to sustain economic growth.

Old economies, like old soldiers, don't grow old, they just fade away. Well not quite, but you might think so from listening to a new way of describing and analysing economies that is becoming increasingly fashionable. Britain's economy, in this new language, is becoming increasingly 'weightless'.

What does this mean? Economists will never use an easy expression when a difficult one is available. The idea of weightlessness, in fact, is very straightforward. Traditional economic activities, starting with agriculture, and then moving on to mining and manufacturing, had a tangible product. As economies mature, however, an increasing proportion of their gross domestic product becomes devoted to service-sector activities.

Thus, economic activity becomes progressively weightless - with no material products to show for the endeavour.

In the case of Britain, about 22% of the economy is accounted for by manufacturing. Of the rest, the major part, about 64%, is services. Services growth is responsible for the bulk of economic growth in Britain over the past two and a half decades. A similar pattern has been evident in the US, where the share of services in total output has grown from 63% in the mid-1970s to 70% now.

When a haircut is weightless

It does not, however, yet apply to the Asian tiger economies.

In Singapore, for example, the services component of GDP has slipped from 64% in the mid-1970s to about 61% today, while manufacturing has grown from 24% to 28%.

According to Professor Danny Quah of the Centre for Economic Performance at the LSE, weightlessness includes not only what he describes as low-level activities such as hairdressing, gardening and stocking supermarket shelves, but also financial services, telecoms and most information technology, notably computer software. Some of you might argue that many of these things are not weightless at all. A haircut does have a physical manifestation - or at least mine do - and I would hope that a gardener would make a garden look different.

Second-rank services

The theory that economies become increasingly service-dominated as they mature is well-established. There is one familiar argument about this shift - it is that manufacturing represents 'proper' economic activity and services are somehow second-rank. In the mid-1980s, leading industrialists such as Lord Weinstock and Sir John Harvey-Jones queued up to give evidence to a House of Lords' committee expounding precisely this view. Manufacturing has always been disproportionately important to the UK economy because of its key role in exports. Most manufacturing can supply both home and export markets, while many service industries are domestically-based, the industrialists argued. Put more simply, you can export a machine tool but you cannot, easily, export a haircut. There is something in this argument, although there are clearly services that you can export - on-line information, for example - and manufactures that you cannot, British electrical plugs, perhaps.

The second general point about weightlessness, particularly when applied to sectors such as financial services, is that it is much more footloose than traditional industries. If a leading bank wanted to shift its foreign exchange dealing operation from London to Frankfurt, it could do so by shipping a few of its dealers out to Germany. This is not like shutting down a factory and moving its plant and equipment overseas.

This is even more the case with information technology. If we take something as straightforward as e-mail, the beauty of it is that no one knows where in the world you are sending it from, or where you are reading it. IT activity is not only weightless, it is also essentially stateless. According to Quah, 'Weightless economies show no respect for transportation costs or slow adjustments.

Relocating value from one place to another involves only bits and bytes, not atoms and molecules. Thus, some have described a new international trade as the seamless shifting of electronic bits across national boundaries replacing the traditional piling up in seaports of bales of textiles and bottles of wine.'

All the predictions are that weightlessness will increase over the next few years. And as it increases, it puts certain pressure on governments.

Because this new activity can shift between states, and because much of it thus occurs on no country's land, there is a problem of capturing the tax revenues that go with it. The footloose nature of such activity means, more than ever, that governments will need to engage in tax competition, with the economic spoils going to those countries with the lowest tax rates. Microsoft's software developers can be based, as now, near Seattle, but they could just as easily operate from some offshore tax haven.

Problems of measurement

The other problem, mainly for economists, is one of measurement. How do you measure exports and imports in this new, weightless world? And how, even more problematically, do you measure productivity growth? The US has already revised its GDP data to try to take account of the greater contribution of computers to GDP but few pretend that it has got the right answer. Other countries are struggling too.

These are the problems, but let us look on the bright side.

It was the economist Joseph Schumpeter who, in the 1930s, identified the particular role of technological progress in economic growth. Such progress created waves of 'creative destruction' in which the old industries were swept away and replaced with new ones, lifting economic growth in the process. We are, almost certainly, in the middle of such a wave at present. Even if we find it difficult to measure, weightlessness is surely good for us.

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