Till recently, a slump in industrial production meant an economic recession and great social pain. Not any more, though. Industrial growth in India declined to just 0.6 per cent in February and 1.3 per cent in March, among the lowest monthly rates for a decade. Yet most people expect the economy to grow 6 per cent.
You might think that an industrial slump causes more pain in rich, industrialised countries. Not so. Industrial output in the US fell by 4.7 per cent in the January-March quarter, yet GDP grew 2 per cent. In Japan, industrial production fell 2.9 per cent, but GDP grew 3.2 per cent in the last three months for which data is available. Industrial output has fallen while GDP has risen in a string of countries–Britain, Spain, Mexico, the Philippines, Poland.
An industrial slowdown still drags down profits and employment, but much less so than earlier. Indeed, even in developing countries hit by various external shocks rather the business cycle, crises no longer seem as deep or hurtful as in the past. Consider how quickly Mexico recovered from the tequila crisis of 1995, East Asia from the financial crisis of 1997-99, Russia from the 1998 debacle and Brazil from the one in 1999. Crises were much nastier and longer in the 1980s.
What has changed? Three things. First, the strident growth of services. Second, growing computerisation and inventory management. Third, growing mechanisation of industry.
Much has been written about the rise of services (led by computer software) in India, from 36 per cent of GDP in 1980 to 46 per cent in 1999. But not many people know that, in this respect, India lags behind Bangladesh (50 per cent) and Pakistan (49 per cent), and even behind African countries like Senegal (56 per cent) and Zimbabwe (55 per cent). Globally, the share of services in GDP has risen from 55 per cent in 1980 to 63 per cent in 1999.
Meanwhile the share of industry in global GDP has dropped from 38 per cent to 31 per cent. The share of agriculture has also fallen a bit. The world is increasingly dominated by services. And, according to economists, services are more recession-proof than industry.
Why? Consider the classic business cycle of past decades. An industrial boom leads over-confident businessmen to over-invest in industrial capacity. Excess production causes a pile- up of unsold inventories. New orders fall, industries cut production and sometimes go bust. Lay-offs and closures reduce employment, and less employment means less money in the pockets of workers to spend, further reducing the total demand for goods. Production and demand chase each other in a downward spiral. Eventually bankruptcies and closures remove excess supply from the system, and demand revives because of deficit financing and easy money from the government. The economy recovers, and a new business cycle begins. The strength and frequency of the business cycle seems to have diminished as services supplant industry. But why? Why should services not experience the same boom and bust cycle as industry?
The conventional answer is that people may reduce consumption of goods in a recession, but will not pull children out of school, or stop seeing doctors. I do not find this a convincing explanation. Spending on basic services remains high in recessions, but that is true of basic goods too, like food. In difficult times, people cut down on many services like entertainment, tourism, eating out. During a recession, less production of goods means correspondingly less financing, moving and selling of such goods, and this hits three major service industries– banking, transport and trade. We all know how the computer software industry is being hammered by the global downswing in technology. So, why should we think that services are inherently more recession-proof than industry?
The main reason lies in inventories. In a recession, unsold goods pile up in shops and factories. It takes industry a while to realise that it is producing too much, that the business cycle has risen too high. Then orders for goods fall very sharply, exacerbated by the fact that demand may be virtually zero for many firms till excess inventories are liquidated. Thus, inventories exacerbate the business cycle in both the upswing and downswing.
However, while industrial goods can be stockpiled, services cannot (with a few exceptions). You cannot stockpile haircuts, trips to Kashmir, or visits to restaurants. Any fall in demand translates immediately into less supply of services–there is no lag caused by inventory accumulation. Service providers may create excess capacity as over-optimistically as manufacturers, but excess capacity hits services faster, stops over-investment more quickly, and lays the ground for a quicker recovery. So, while services are not recession-proof, they tend to produce shallower, shorter recessions.
This is borne out by recent global experience. The US, for instance, has suffered only one recession since 1982, in 1990-91, and that lasted barely two quarters. The business cycle has not disappeared, but has become much more muted.
The rise of services is only one of three reasons for this. The second is the rise of computerisation and other techniques to manage production with less inventories. This has enabled manufacturers to control inventories far more stringently, and arrange just- in-time delivery. The less the inventories, the faster the industry will adjust to changes in demand. Cycles of over-optimism and over-pessimism get less deep and frequent.
Finally, this effect is reinforced by increasing mechanisation, which has greatly reduced the labour content of industry. Some decades ago, cars and steel were two of the biggest employers globally. But today, thanks to highly mechanised technology, the labour constitutes only 2.4 per cent of the value of a Maruti car, and less than 2 per cent of the value of steel from Essar. So, when demand falls, there is much less labour to retrench. Bankruptcy puts fewer people out of work. This further diminishes the pain and depth of the business cycle.
The happy conclusion: The world is becoming a safer place. This means countries can proceed to globalise with fewer fears. Not only are the advantages today greater, the risks are lower too.