FS IV 90 - 9

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FS IV 90 - 9

Do Services Crowd out Manufacturing? The Case of West Germany

David B. Audretsch Hideki Yamawaki

May 1990

ISSN Nr. 0722 - 6748

Forschungsschwerpunkt Marktprozeß und Unter

nehmensentwicklung (IIMV) Research Unit

Market Processes and

Corporate Development ( U M )

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The extent to which services are complementary to or substi

tutes for the manufacturing of goods is examined using two different approaches. First, the West German input-output tables are used to identify the importance of services in

providing inputs for manufacturing goods. The calculated input coefficients reveal that certain types of services constitute a relatively large share of the inputs for manufactured goods while other types of services do not play an important role in providing inputs. Similarly, certain manufacturing industries rely heavily on service inputs, but other manufacturing indus

tries use relatively few services in producing goods. The em

pirical results also clearly show that services are becoming relatively more important and manufactured goods less important as inputs. The second approach incorporates services in a pro

duction function using a pooled cross-section and time series sample of West German industries. We find that the level of service output exerts a positive influence on output growth in manufacturing. The evidence from both the input-output analysis and the production function estimation suggest that, at least for the case of West Germany, services do not generally crowd out manufacturing activity. Instead, services tend to enhance manufacturing output in a complementary manner.

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Gewerbe? Das Beispiel der Bundesrepublik Deutschland

Anhand von zwei unterschiedlichen Forschungsansätzen wird in diesem Beitrag untersucht, in welchem Ausmaß das Angebot von Dienstleistungen und die Güterprodution komplementär oder sub

stitutiv zueinander stehen. Im ersten Ansatz werden Input- Output-Tabellen für die Bundesrepublik Deutschland verwendet, um die Bedeutung des Dienstleistungssektors als Input-Lieferant für die Güterproduktion zu analysieren. Die berechneten Input- Koeffizienten zeigen, daß bestimmte Arten von Dienstleistungen einen relativen großen Anteil der Inputs für die Güterproduk

tion ausmachen, während andere Arten von Dienstleistungen keine große Rolle als Inputs für die Güterherstellung spielen. Ähn

lich verhält es sich in bestimmten Bereichen des verarbeitenden Gewerbes, die in relativ großem Umfang Dienstleistungen als Inputs einsetzen, während andere Zweige des verarbeitenden Gewerbes in verhältnismäßig geringem Umfang Dienstleistungen für die Güterherstellung verwenden. Die empirischen Ergebnisse zeigen auch deutlich, daß Dienstleistungen immer wichtiger werden und daß Güter eine weniger wichtige Rolle als Inputs spielen. Der zweite Ansatz berücksichtigt Dienstleistungen in einer Produktionsfunktion, wobei eine Analyse von zusammenge

faßten Querschnitts- und Zeitreihendaten bundesdeutscher In

dustriezweige verwendet wird. Die statistische Analyse zeigt, daß das Niveau des Dienstleistungsoutputs einen positiven Ein

fluß auf das Produktionsergebnis des verarbeitenden Gewerbes hat. Sowohl die Ergebnisse der Input-Output-Analyse als auch die der Schätzung der Produktionsfunktion zeigen, daß zumindest für den Fall der Bundesrepublik Deutschland Dienstleistungen nicht generell den Produktionssektor verdrängen. Statt dessen verstärken Dienstleistungen tendenziell das Produktionsergebnis des verarbeitenden Gewerbes auf komplementäre Weise.

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I. Introduction: The Manufacturing-Service Interface

The purpose of this paper is to examine the linkage between the manufacturing and service sectors. In particular, we address the concern raised on both sides of the Atlantic that the rapid

growth of the service sector has somehow been crowding out the production of manufactured goods. However, despite the amount of public attention focused on this issue, virtually no systematic analysis has been undertaken to examine the extent to which

services are, in fact a substitute for manufacturing, or if they constitute a complementary activity that actually enhances the production of goods.

In the second section of the paper we provide an overview of the deindustrialization debate. At the heart of this debate is the claim that the opportunity cost of resources allocated

towards providing services is the output of manufactured goods.

Implicit in this view is the assumption that the value of

services is inherently less than that of manufactured products.

By contrast is the argument that services provide a key input into the production of goods and that the opportunity cost of resources shifted out of the service sector would also include foregone manufacturing output. In the third section we provide a conceptual analysis of services by decomposing services into four major groups, according to their relationship to

manufacturing.

A general method for analyzing the importance of services as an input for manufactured goods is introduced in the fourth

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section. This method is based on input-output analysis. Using the specific example of the. Federal Republic of Germany, we provide an example of how this method can be implemented is provided. The empirical evidence suggests that the relative importance for services as an input for manufactured goods varies considreably across both service and manufacturing

industries. Just as certain services are more widely used than others as an input in the manufacturing process, some types of manufactured goods are more dependent than others upon services as an input. However, the results clearly show that the relative importance of services as an input has been increasing over

time, while the share of services consumed in final demand has been decreasing. By contrast, the share of manufactured products that are subsequently used as intermediate inputs in producing goods has been clearly decreasing over time. There has been a sharp increase in the share of manufactured goods which are exported to other countries. Thus, the input-output analysis suggests that the relative importance of services as an input has been incrasing over time while that of manufactured goods has been decreasing.

In the fifth section services are included in a pooled cross-section production function for the Federal Republic of Germany. Based on the estimated output elasticities, it can be concluded that services are a complement to and not a substitute for manufactured goods. Finally, in the last section a summary and conclusions are provided. Both the input-output analysis and production-function estimation provide little support for the

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notion that services are a substitute activity for the

production of goods and therefore crowd out manufacturing.

Rather, the empirical evidence clearly suggests that, at least for the case of West Germany, services provide a complementary activity which enhances rather than displaces the production of goods.

II. The Deindustrialization Debate

A debate emerged in the 1980s regarding the relative virtues of manufactured goods versus services and whether service

industries were displacing manufacturing output.1 The origins of this debate seemed to emanate from two simultaneous shifts. The first and probably most important factor was the continued

transition of employment into services and out of the

manufacturing sector that left no developed nation unchanged.

For example, in the U.S. the share of employment in the service sector rose from 40 percent in 1959 to over three-quarters by the start of the 1990s. At the same time, employment in the American manufacturing sector fell from 40 percent of the total workforce in 1959 to under one-fifth by 1990.2 Similarly, while the share of economic output from services has substantially increased, the contribution from manufacturing has decreased.

1 Examples of this debate can be found in Abernathy et al.

(1983), Zysman and Tyson (1983), Wheelwright (1985), Cohen and Zysman (1987), Hayes and Wheelwright (1982), the Cuomo Commission on Trade and Competitiveness (1988), and

Dornbusch et al. (1988).

2 Quoted from Audretsch and Claudon (1989, p. 2).

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Ray (1986) reports that in Great Britain between 1973 and 1983 there was a decrease in manufacturing output of 15 percent, while the output of services increased by 80 percent.

The second factor was the globalization of markets during the previous two decades. As McCulloch (1988) notes, at the heart of the battle for global markets are the manufacturing industries. Thus, when Thurow (1985, p. 23) concludes that

America is "losing the economic race",3 he attributes the cause to a weak performance in the manufacturing markets, "Today it's very hard to find an industrial corporation in America that isn't in really serious trouble beasically because of trade problems...The systematic erosion of our competitiveness comes from having lower rates of growth of manufacturing productivity year after year, as compared with the rest of the world."

Public policy has not remained unaffected by this debate.

For example, a host of regional policies have been implemented in West Germany to impede the process of "deindustrialization"

(Grabher, 1988 and 1989). Similarly, in the U.S. there were

numerous congressional bills passed in the late 1980s to promote manufacturing productivity in the hopes of fostering

international competitiveness.4

3 Lester Thurow, "Losing the Economic Race," New York Review of Books, September 1984, pp. 29-31.

4 For example, although Senator Bill Bradley had already labelled it a "mush word", within the first month of 1987 there were already eighteen reports undertaken by the U.S.

government to identify public measures that could be undertaken to enhance manufacturing productivity and

therefore international competitiveness. This is described in The Economist, 31 January 1987, p. 32.

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On the one side of this debate is the argument that the rapid emergence of the service sector has crowded out the

production of manufactured goods (Kutscher and Mark, 1983). At the heart of this argument is the assumption that manufactured goods are inherently more valuable than services. Thus, to the extent that services are a substitute economic activity for the production of goods, a society suffers by shifting resources away from manufacturing and towards services. This view is

expressed by Lee Iacocca, Chairman of the Chrysler Corporation, who attributes high import penetration and plant closures to the displacement of jobs in the manufacturing sector by jobs in the service sector: "We can't afford to become a nation of video arcades, drive-in banks and McDonalds hamburger stands."5 And the columnist Robert Kuttner asks, "Must we lose the industrial world series?" and warns against the "splendid illusion of the service economy vainly attempting to make up for the

deficiencies of the manufacturing economy."6

The view that services somehow displace manufacturing is a continuing theme in the recently published report of the MIT Commission on Industrial Productivity (Dertouzos et al., 1989).

In particular, the Commission argues that services are

inherently inferior to the production of manufactured goods for five reasons (Dertouzos et al., 1989, Chapter.two). The first argument is that manufactured goods account for the vast bulk of imports for every developed country, while services account for 5 "U.S. Deindustrialization: The Case Against it," Wall Street

Journal, 12 November 1986, p. 1.

Robert Kuttner, "Must we Lose the Industrial World Series?"

Business Week, 17 November 1986, p. 20.

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only a small share of the total exports. Thus, in order to obtain the foreign currency needed to pay for imports,

manufactured goods must be sold to other countries. As a nation shifts its economic activity from the production of goods

towards services, the resulting balance of payments deficits will serve to impede overall economic growth.

The second argument is that manufacturing enjoys an

inherently greater rate of growth in productivity. Reallocating resources out of manufacturing and into services will therefore lower the national productivity growth. The third and related point is that wages are higher in manufacturing industries than in services. According to the MIT Commission on Industrial

Productivity, "There is also reason to believe that if large sections of American manufacturing industry were ceded to other countries, high-wage nonmanufacturing industries would follow them" (Dertouzos et al., 1989, p. 40). The Industrial Union Department of the AFL-CIO completed an analysis of recent job creation in the United States, and concluded that service

occupations "experiencing the largest net growth in the number of jobs demand little skill, are only weakly organized into unions, and usually offer little pay — ranging from building custodians to fast food workers... prospects for upward mobility out of these lower rung jobs are slight" (AFL-CIO, 1984, pp. 11- 12) .7

The fourth argument is that manufacturing firms are the engines of technological change. Not only does the vast bulk of

By contrast, recent studies by Lawrence (1984) and Urquhart (1984) reach the opposite conclusions.

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R&D expenditures emanate from the manufacturing sector, but most of the innovative activity is contributed by manufacturing

firms.8 Thus, Dertouzos et al. (1989, pp. 40-41) attribute long

term economic growth to "depend on the presence of a healthy, technologically dynamic manufacturing sector."

The last point may be more relevant for the United States than for Europe — the need for national security.lt is argued that dependence upon other countries for key manufacturing

inputs into defense goods could jeopardize national security and render the country untenably vulnerable.

Another school of thought questions the view that services are inherently less valuable than the production of goods.9 This view points out that services can frequently contribute more value added than does manufacturing. Using the PIMS (Profit Impact of Market Strategy) data base of the Strategic Planning Institute in Cambridge, Massachusetts, Quinn et al. (1988) found that the value added per employee was virtually identical

between the manufacturing and service sectors. On average, each employee contributes about $25,000 of value added in

manufacturing as well as in services. While the mean value added per employee was about $27,000 in retailing, it was somewhat lower, $23,000, in non-retailing services.

Consistent with this is the finding that capital intensity, measured by the gross book value of assets per employee, is also

8 American high technology industries account for nearly 75 percent of all R&D expenditures, and the remaining

manufacturing industries account for virtually all of the rest (National Science Foundation, 1987).

See for example Quinn (1988), Roach (1988), and Quinn et al.

(1987).

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roughly equivalent between the manufacturing and service sectors (Quinn and Pacquette, 1989). For both manufacturing and services the gross book value of assets averaged $83,000 per employee. In fact, in non-retailing services gross book value averaged about

$140,000 per employee, while in retailing it was around $40,000 per employee. Thus, while small-scale retail, domestic services, restaurant and entertainment services are certainly not

particularly capital intesnive, other service industries such as communications, transportation, pipelines, and electric

utilities rank among the most capital intensive industries in the economy (Kutscher and Mark, 1983).

This is consistent with the findings of Acs and Audretsch (1990, chapter one) that over three-quarters of the employment growth in U.S. manufacturing between 1976 and 1986 was in firms with fewer than 100 employees, while employment growth actually decreased in manufacturing firms with at least 500 employees by more than ten percent. By contrast in the service and financial sectors, nearly half of the employment growth was in firms with at least 500 employees.

Finally, Reissert et al. (1989) argue that services are inherently valuable because they provide jobs for workers that would otherwise not be employed. They suggest that, at least in the case of West Germany, the opportunity cost of many workers in the service sector is essentially zero. That is, these

workers would not have the opportunity to work in the

manufacturing or agricultural sector because of the structural shift that has occurred in the Federal Republic of Germany

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limiting employment opportunities in manufacturing. Employment in services, therefore, not only has a low opportunity cost, but contributes by providing employment to workers who would

otherwise have been unemployed.

In contrast to the view that services crowd out

manufacturing activities is the argument that services are, at least in certain cases, complementary to the manufacturing of goods. According to this school of thought, services not only provide an infrastructure enhancing manufacturing activities, but they can also serve as inputs into the manufacturing

process.

At the heart of the complementarity argument is the

observation that services, regardless of the source, constitute a substantial share of the total inputs in manufacturing. Quinn et al. (1988) estimate that 75 percent of manufacturing inputs are actually services, alhtough many are provided by the

manufacturing firm itself.10 These types of services are often referred to as "business services" and incorporate seven major industries — advertising; consumer credit reporting and

collection; mailing; reproduction and stenographic services;

services to buildings such as cleaning, maintenance, and exterminating services; personnel supply services, including both temporary-help suppliers and employment agencies; computer and data processing services; and miscellaneous business

services, which include R&D, management and consulting, and 10 It should be noted that the MIT Commission on Industrial

Productivity (Dertouzos, 1989) estimate that services

purchased outside of the manufacturing firm constitute only 17 percent of manufacturing inputs.

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protective services (McCulloch, 1988). Howe (1986) documents how these business services were the most rapidly growing sector in the U.S. in the 1980s.11

Ray (1986) notes that a similar phenomenon has occurred in the United Kingdom. He attributes this to three major factors.

First, a type of vertical disintegration has taken place,

whereby services previously performed by the manufacturing firm itself are increasingly purchased from a speciality service company. Second, services previously purchased from other manufacturing companies are increasingly obtained from

independent service firms. And third, new types of services have emerged, which are generally obtainable from service companies.

Ray (1986) points out that the purchase of services from other manufacturers decreased from 5.5 percent of gross output in 1973 to 2.8 percent in 1983. Over this same period the purchases of services from non-manufacturing firms rose by almost 3.5

percentage points, from 4.5 percent of gross output to 8

percent. Thus, there was a distinct shift in purchasing services away from other manufacturing firms and towards independent

service companies. While these service inputs used to be supplied either by the manufacturing firm itself or else by another manufacturing firm, they are increasingly supplied by service firms.

Quinn (1988) also argues that services enhance the

production of goods by enabling manufacturing firms to respond 11 In 1982 business services accounted for $90,7 billion of GNP

and employed 3.4 million people in the U.S.; by 1986 business services provided $162.8 billion of GNP and 4.9 million jobs (Tschetter, 1987).

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more quickly to market changes and by promoting flexibility in production. For example, Carlsson (1989) illustrates how the

implementation of flexible manufacturing systems and computer- integrated systems tend to lower variable costs but raise the share of total costs accounted for by certain services, such as training, cost accounting, communication, and control systems.

All three of these schools of thought regarding the

relationship between manufacturing and services suffer from a lack of systematic empirical support. Thus, in the fourth

section of this paper we employ the Input-Output table for the Federal Republic of Germany to provide an empirical test of the question, "Do services crowd out manufacturing?", and in the fifth section an estimate of the contribution of services to productivity and output growth is derived from a pooled cross- section time series production function model.

III. Complementarity versus Substitutability

To what extent does the allocation of resources into services displace the output of manufactured goods, or serve as a

substitute for manufacturing, and to what extent does it enhance the production of goods, or serve as a complement? While

services are commonly grouped together for statistical purposes, or perhaps to refer to economic activity not engaged in

manufacturing or agriculture, it should be emphasized that this broad classification includes a wide spectrum of economic

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activities, ranging from restaurants and mom and pop retail

stores, to multinational transportation, financial, and business services. Thus, it is not unreasonable to expect that different types of services may have varying relationships to

manufacturing industries. Similarly, given the diversity of manufacturing activities in every EC nation, it would not be surprising to find that the relationship between any given type of service and any specific manufacturing industry may also depend on the nature of the manufactured product. That is, the

issue of complementarity versus substitutability is most likely to vary considerably with the specific service and manufacturing industry considered.

In fact, several analytical classifications have been made for services and the manner in which they relate to

manufacturing (see Bhagwati, 1987; Deardorff, 1985; and Sampson and Sampe, 1985). Service industries can, in this respect, be broadly divided into two groups — services which are related to the production of goods, and services which have no relationship to manufacturing. Within production-related services exist two distinct categories of service industries. The first type

provides auxiliary services for manufacturing activities. In this sense, services play a key role in contributing to the infrastructure that most efficiently enhances the viability of manufacturing firms. For example, Yamawaki (1989) and Williamson and Yamawaki (1989) find that the establishment of an effective distribution system has played a key role in facilitating

Japanese exports in the United States. The distribution network

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provides the mechanism by which the manufacturing firms are able to market their products. Other examples of auxiliary services which are complementary to production activities include

financial services and maintenance. While these services are not essential to manufacture the product, they enhance the viability o the manufacturing firm.

A second category of production-related services are

indirect services. In contrast to auxiliary services, indirect services are actually used as inputs into the production

process. For example, knowledge is among the most crucial inputs in producing high technology products. The generation of this knowledge typically is the product of a service — scientists and engineers employed in R&D laboratories. Without the service of R&D, there would be considerably less generation of knowledge and therefore less innovative activity. A similar example of an indirect production-related service is education and training of workers. To the extent that high-skilled workers are an

important factor in the production process, the greater will be the role which training and employee education plays (Sorge,

1985).

Of course, many types of services are not related at all to the production of goods. Still, there are important distinctions to be made between two major groups of non-production related services. The first category consists of those non-production related services which are exportable to different countries. An example of such an exportable non-production related service is entertainment. While entertainment does not generally provide an

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auxiliary or indirect service in that it is used as an input into the production process, it can be, under certain

circumstances, exported across national boundaries. Even fast food chains have demonstrated that restaurants, although they are not related to the manufacturing of goods, are exportable.

By contrast is the category of services which is non

exportable. These are services which are not sold across

national boundaries. Examples include services provided by local governments, which are generally restricted to the domestic

sphere.

These four sub-categories, which are summarized in Figure 1, reflect different relationships for the interface between

services and manufacturing. Both of the categories of production related services — auxiliary services and indirect services — can be considered to be complementary to and not substitutes for manufacturing activity. In the case of auxiliary services, a contribution is made to the infrastructure that is required by manufacturing firms. Without the existence of such auxiliary services, manufacturing firms would be handicapped. In global markets, this would tend to impede the international

competitiveness of domestic firms vis-a-vis foreign rivals which have access to such auxiliary services. For example, Williamson and Yamawaki (1989) conclude that while the success of Japnaese firms in penetrating U.S. manufacturing markets can be

attributed to some extent to the establishment of a

distributional network, the failure of American firms to engage in reciprocal activities in Japanese manufacturing markets is at

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Figure 1

Classification of Service Industries

According to Interface with Manufacturing

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least partially the result of their hesitancy in establishing such distributional networks in Japan. Thus, in this case the distributional service serves as a complement to manufacturing firms.

Similarly, indirect services, which provide inputs into the production process, are clearly complementary to manufacturing.

The extent to which resources are allocated towards R&D activities in high technology industries will subsequently enhance the manufacturing capability. In fact, the failure to invest in such complementary R&D services in high technology industries may result in a loss of international competitiveness

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in global markets.

By contrast, resources allocated towards non-production related services can be considered to be substitutes for manufacturing, in that they do not enhance the production of goods. However, in the case of exportable non-production related services there is no reason to assume that such economic

activity is in any way inherently inferior to manufactured products. The argument discussed in the previous section that services are incapable of providing foreign currency in a manner analogous to the sale of physical goods in the international market does not hold up here. As long as global demand exists for an exportable service, and a nation maintains its

comparative advantage in providing that service, there is no 12 Recent evidence provided by Audretsch and Yamawaki (1988)

and Yamawaki and Audretsch (1988) suggests that strategic R&D expenditures constitute a key determinant of the U.S.- Japanese trade advantage.

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analytical distinction between selling a physical good or service in the international market.

However, to the extent that resources shift out of

manufacturing and into non-production related services which are not exported, the argument that services crowd out manufacturing is valid. A country engaged only in this type of activity will not be able to import goods from other nations in the long run.

IV. Measurement Issues and Input-Output Analysis

Comparing aggregate measures for manufacturing and service output over time indicates the relative importance of these sectors in the economy but sheds little light on the issue of complementarity versus substitutability. For example, Table 1 employs data from the Statistisches Bundesamt Wiesbaden13 to decompose the growth in the value of total output in the Federal Republic of Germany (FRG) between 1970 and 1984 into growth

emanating from the manufacturing and service sectors. While the value of total output in the FRG rose by 173.7 percent between 1970 and 1984, the manufacturing sector grew by 140.5 percent and the service sector by 239.8 percent. Thus, the share of output accounted for by manufacturing decreased from 51.46 percent in 1970 to 45.22 percent in 1984. Over the same period

13 These data are from Statistisches Bundesamt Wiesbaden,

Volkswirtschaftliche Gesamtrechnungen, Reihe 2: Input-Output Tabellen, various years.

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Table 1: Total Output of Services and Manufacturing in the Federal Republic of Germany (millions of DM) 1970-19843

1970 1975 1980 1982 1984

Total 1437248 2198660 3269270 3574580 3933640

Manuf acturing 739632 1019923 15349051613647 1778802 (51.46) (46.39) (46.95) (45.15) (45.22)

Services 479961 8647011259446 1457568 1631352

(33.39) (39.33) (38.52) (40.78) (41.47) Wholesale

Retail

Railroad Transportation Water-Way Transportation Communications

Other Transportation Banking & Finance Insurance

Real Estate Restaurants Research Health

117933 (3.61)

139614 (3.91)

159276 (4.05) - 101522

(3.11)

113373 (3.17)

121222 (3.08)

- 14829

(0.45)

14973 (0.42)

15003 (0.38)

- 15791

(0.48)

18455 (0.52)

17900 (0.46)

- 35525

(1.09)

41700 (1.17)

45367 (1.15)

- 69627

(2.13)

77665 (2.17)

92195 (2.34)

- 65149

(1.99)

84391 (2.36)

96855 (2.46)

- 28245

(0.86)

32854 (0.92)

38510 (0.98) - 125879

(3.85)

162537 (4.55)

188103 (4.78)

- 53892

(1.65)

57922 (1.62)

61989 (1.58)

- 34793

(1.06)

41105 (1.15)

49692 (1.26)

- 46817

(1.43)

50549 (1.41)

55788 (1-42)

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Table 1 (cont.)

1970 1975 1980 1982 1984

Miscellaneous Social Services

- - 172144

(5.27)

202461 (5.66)

235701 (5.99)

Local Government - — 246730

(7.55)

275569 (7.71)

293681 (7.47)

Social Security - - 92160

(2.82)

100770 (2.82)

111580 (2.84)

Non-Profit — — 38410

(1.17)

43630 (1.22)

48490 (1.23) a The percentage of total output is listed in parentheses. Due to

the omission of agriculture and mining the shares of total output accounted for by services and manufacturing do not sum to 100.

Source: Statistisches Bundesamt Wiesbaden, Volkswirtschaftliche

Gesamtrechnungen: Input-Output-Tabellen, Fachserie 18, Reihe 2, various years.

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the share of output accounted for by services rose from 33.39 percent to 41.47 percent.14

Table 1 also shows that certain service industries, such as wholesale trade, banking and finance, real estate, and

miscellaneous social services accounted for a substantially greater share of total output in 1984 than in 1980.15 However, not all service industries experienced such rapid growth during this period. For example, the share of output fell for railroad transportation and local government services.

While these aggregate measures suggest that the relative importance of services has been increasing in the FRG, and that manufacturing is accounting for a smaller share of economic

activity, it would be inaccurate to conclude prematurely that the shift towards services represents a crowding out of

manufacturing. As suggested in the previous section, services may provide a vital input into the manufacturing of goods. To gain some insight into the extent to which services are used as an input to produce manufactured goods, the West German Input- Output Table can be used to identify the disbursement of output goods and services among three major categories: (1) inputs into the production process of a good or service, (2) consumption as part of final domestic demand, and (3) exports.16 This enables 14 The shares of total output accounted for by manufacturing

and services do not sum to one because of the existence of the agricultural sector.

15 Due to a change in the classification system in 1978, no comparable data exist at the disaggregated industry level prior to 1980.

16 Further explanations are provided in Chapter One of Statistisches Bundesamt Wiesbaden (1984).

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the degree that each service and manufacturing industry is subsequently used as an intermediate input into the production process to be identified.

The disbursement of the output for 22 manufacturing industries and 16 service industries among these three

categories for 1980, 1982, and 1984 is indicated in Appendices A, B and C. For example, in Appendix A the first column shows that in 1980 DM 100,251 million of output from the chemical industry was subsequently used as an intermediate input in the production of a good or service. The number in the parentheses indicates that chemical products accounted for 6.66 percent of all direct inputs in 1980.17 The second column shows that the DM 15,435 million of chemical products directly consumed

represented 2.05 percent of final domestic demand. Similarly, the third column reveals that the DM 44,706 million of chemical exports comprised 11.87 percent of total exports. Finally, the last column shows that the DM 161,286 million of chemical

products produced accounted for 4.93 percent of the value of West German output in 1980.18

A comparison of industry disbursement among these three categories between 1980, 1982, and 1984 reveals that the

relative importance of specific industries in contributing to total inputs, final domestic demand, and exports can shift over time. For example, the share of inputs accounted for by the chemical, shipbuilding, printing and publishing, and food 17 Direct inputs exclude labor inputs and indirect taxes.

18 Due to depreciation and inventory adjustments, the sum of inputs, final domestic demand and exports does not equal the value of total output.

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industries increased substantially between 1980 and 1984, as it did for the wholesale trade, banking and finance, and

miscellaneous social service industries. By contrast, the role of petroleum products, plastic products, iron and steel, and textiles as an input became less important. A similar decrease in the relative role of service inputs occurred for

transportation (other), restaurants, and health services.

However, a markedly different trend in the relative importance of services as inputs emerges than that for manufacturing. While the share of total inputs generally rose for most of the service industries over this period, it tended to fall for most

manufacturing industries.

The trend over time in the relative importance of specific manufacturing and service industries in final domestic demand also varies considerably. Although the share of several

services, such as insurance and real state, of final domestic demand rose between 1980 and 1984, the relative importance of most service industries remained remarkably stable over this period. By contrast, the extent to which specific manufacturing industries provide goods directly consumed is markedly more

variable. While the share of final domestic demand accounted for by certain manufacturing industries, such as electrical

equipment and tobacco rose substantially between 1980 and 1984, other industries, including petroleum products, wood products, textiles, and beverages became relatively less important.

As the low export shares of the services indicate, service industries do not generally constitute a large part of exports.

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By contrast, the export shares of a number of manufactured industries are relatively large. In certain manufacturing

industries, such as chemicals, office machinery, motor vehicles, electrical equipment, and paper mill products, the export share rose substantially between 1980 and 1984.

The relative roles of manufacturing and services in providing inputs into the subsequent production of goods and services is examined in further detail in Table 2. While the total value of direct inputs used increased by 172.8 percent between 1970 and 1984, inputs provided by the manufacturing sector grew only by 118.3 percent, and inputs provided by the service sector grew by 273.39 percent. Thus, the growth of

inputs from the service sector was about two and one-third times as great as that of inputs from the manufacturing sector.

Consequently, the share of total inputs emanating from services rose from 27.55 percent in 1970 to 37.83 percent in 1984. By contrast, the share of total inputs provided by manufacturing industries fell from 58.08 percent to 46.47 percent over the same period.

Table 2 also shows that services play a particularly large role as an input in wholesale trade and in transportation

(other), as well as in miscellaneous social services. The share of total inputs rose considerably in the wholesale trade, real estate, miscellaneous social services, and local government service industries, between 1980 and 1984, while it fell somewhat in the restaurtant and health industries.

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Table 2: Service and Manufacturing Inputs in the Federal Republic of Germany (millions of DM), 1970 - 1984a

1970 1975 1980 1982 1984

Total Inputs 668544 1017976 1504890 1664550 1823920 Manuf acturing 388285 544222 760376 818341 847510 (58.08) (53.40) (50.53) (49.16) (46.47)

Services 184774 332078 493526 602704 689926

(27.55) (32.58) (32.79) (36.21) (37.83)

Wholesale - - 57677

(3.43)

78978 (4.74)

89800 (4.92)

Retail - - 6795

(0.45)

10396 (0.62)

11530 (0.63)

Railroad Transportation - - 9157

(0.61)

8501 (0.51)

8127 (0.45)

Water-Way Transportation - - 6487

(0.43)

7318 (0.44)

7282 (0.40)

Communications - - 20621

(1.37)

23841 (1.43)

25724 (1-41)

Other Transportation - - 48689

(3.24)

46589 (2.80)

57826 (3.17)

Banking & Finance - - 60236

(4.00)

78901 (4.74)

90418 (4.96)

Insurance - - 11270

(0.75)

12721 (0.76)

14254 (0.78)

Real Estate - - 20118

(1-34)

31163 (1.87)

35961 (1.97)

Restaurants - - 23078

(1.53)

21350 (1.28)

22559 (1.24)

Research - - 18001

(1.20)

17182 (1.03)

22024 (1-21)

Health - - 38336

(2.55)

40057 (2.41)

43586 (2.39)

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Table 2 (cont.)

1970 1975 1980 1982 1984

- - 127886

(8.50)

157976 (9.49)

186736 (10.24)

Local Government - - 28924

(1.92)

41741 (2.51)

45419 (2.49)

Social Security - - 30

(0.00)

90 (0.01)

80 (0.00)

Non-Profit - — 22227

(1.48)

25900 (1.56)

28600 (1.57) a The percentage of total inputs is listed in parentheses . Due to

the omission of agriculture and mining the shares of total inputs accounted for by services and manufacturing do not sum to 100.

Gesamtrechnvngen: Inpvt-Ovtpvt-Tabellen, Fachserie 18, Reihe 2, various years.

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The direct consumption of manufactured goods and services in final domestic demand is compared in Table 3. While final

domestic demand increased by 170.1 percent between 1970 and 1984, manufactured goods which were directly consumed increased by 130.8 percent. Over this same period the direct consumption of services increased by 190.7 percent. The 45.8 percent higher growth in the direct consumption of services than manufactured goods resulted in an increase in the realtive share of final domestic demand accounted for by services from 48.13 percent in 1970 to 51.81 percent in 1984 and a decrease in that accounted for by manufacturing from 46.79 percent to 39.97 percent over the same period.

The two largest contributors in the service sector to direct consumption are the retail trade and the real estate industries.

Several service industries, such as real estate and restaurants, experienced considerable growth in direct consumption. By

contrast, other service industries, including wholesale trade, retail trade, and miscellaneous social services played a

noticeably smaller role in 1984 than in 1980.

As Table 4 indicates, there was a substantial increase in exports of 274.1 percent between 1970 and 1984. Since

manufacturing exports grew by 271.3 percent and service exports by 322.6 percent, the relative importance of manufacturing and services in contributing to exports remained remarkably stable over the fifteen year period. Exports continued to be dominated by manufactured goods rather than services throughout the

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Table 3: Service and Manufacturing Final Domestic Demand in the Federal Republic of Germany (millions of.DM), 1970 - 1984

1970 1975 1980 1982 1984

Total 339023 576057 751770 836880 915810

Manufacturing 158624 210982 320147 339379 366081 (46.79) (40.88) (42.59) (40.55) (39.97)

Services 163178 279554 391452 444500 474439

(48.13) (54.17) (52.07) (53.11) (51.81)

Wholesale 29275

(3.89)

31113 (3.72)

34773 (3.80)

Retail - - 94727

(12.60)

102165 (12.21)

106703 (11.65)

(0.53)

4038 (0.48)

4026 (0.44)

(0.04)

307 (0.04)

304 (0.03)

(1.94)

16250 (1.94)

17820 (1.95)

(1.89)

16573 (1.98)

17373 (1-90)

(0.62)

5370 (0.64)

6346 (0.69)

Insurance - - 16790

(2.23)

19410 (2.32)

24034 (2.62)

Real Estate - - 104874

(13.95)

130315 (15.57)

150840 (16.47)

(3.78)

34777 (4.16)

37366 (4.08)

Research - - 15567

(2.07)

20985 (2.51)

24414 (2.67)

Health - - 8487

(1.13)

10492 (1.25)

12202 (1.33)

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Table 3 (cont.)

1970 1975 1980 1982 1984

- - 27800

(3.70)

27222 (3.25)

29383 (3.21)

(1.53)

7753 (0.93)

8855 (0.97)

Social Security - - - - -

Non-Profit - - 16189

(2.15)

17730 (2.12)

19890 (2.17) a The percentage of final domestic demand is listed in parentheses.

Due to the omission of agriculture and mining the shares of final domestic demand accounted for by services and mnufacturing do not sum to 100.

Gesamtrechnungen: Input-Output-Tabeilen, Fachserie 18, Reihe 2, various years.

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Table 4: Total Exports of Services and Manufacturing in the Federal Republic of Germany (millions of DM) , 19-70 - 1984a

1970 1975 1980 1982 1984

Total 134393 240001 376630 448660 502750

Manufacturing 114335

(85.22)

193453 (80.61)

305810 (81.20)

376755 (83.97)

424552 (84.45)

Services 15170

(11.29)

36532 (15.22)

51649 (13.71)

59253 (13.21)

64105 (12.75)

Wholesale - - 24620

(6.54)

17360 (3.87)

18577 (3.70)

Retail - - - -

(0.36)

2368 (0.53)

2664 (0.53)

(2.36)

10872 (2.42)

10314 (2.05)

(0.08)

1609 (0.36)

1823 (0.36)

(1.36)

14024 (3.13)

16338 (3.25)

(0.06)

120 (0.03)

91 (0.02)

Insurance - - 185

(0.05)

223 (0.05)

222 (0.04)

Real Estate - - 887

(0.24)

1059 (0.24)

1302 (0.26)

(0.63)

1795 (0.40)

2064 (0.41)

Research - - 1237

(0.33)

2938 (0.65)

3254 (0.65) Health

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Table 4 (cont.)

1970 1975 1980 1982 1984

- - 5872

(1.56)

6320 (1.41)

6779 (1.35)

(0.14)

565 (0.13)

677 (0.13)

Social Security - - - - -

Non-Profit - = - -

a The percentage of total exports is listed in parentheses . Due to the omission of agriculture and mining the shares of total

exports accounted for by services and manufacturing do not sum to 100.

Gesamtrechnungen: Input-Output-Tabeilen, Fachserie 18, Reihe 2, various years.

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period, as reflected by the 1984 export share of 84.45 percent for manufactured goods and 12.75 percent for services.

Other than in the wholesale trade industry, services play only a minor role in contributing to exports. However, the export share has noticably increased in the communications,

transportation (other), and research industries. By contrast, in the restaurant and miscellaneous social service industries,

services are becoming less important over time.

One of the conclusions from Tables 2-4 is that the relative role of manufactured goods in providing inputs for subsequent production is greater than that of the service industries in providing inputs. However, the trend appears to be that the role of services in providing inputs is becoming relatively more

important while that of manufactured goods is becoming less important. As Table 5 shows, the share of services used as inputs rose by about four percentage points between 1970 and 1984, while the proportion directly consumed fell by nearly five percentage points. By contrast, Table 6 indicates that the share of manufactured goods subsequently used as inputs fell by about five percentage points between 1970 and 1984, the proportion directly consumed remained virtually constant, while the share going towards exports rose by more than eight percentage points.

Although both manufacturing and services experienced substantial increases in output between 1970 and 1984, the disbursement of this output was strikingly different and reflected an increasing tendency for services to be used as inputs and manufactured goods to be exported. Table 7 shows that

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Table 5: Disbursement of Services among Inputs> Final Domestic Demand, and Exports in the Federal Republic of Germany (millions of DM), 1970 - 1984a

1970 1975 1980 1982 1984

Input 184174 332018 493526 602704 689926

(38.37) (38.40) (39.16) (41.35) (42.29) Final Domestic Demand 163178 279554 391452 444500 474439 (34.00) (32.33) (31.08) (30.50) (29.08)

Exports 15170 36532 51649 59253 64105

(3.16) (4.22) (4.10) (4.07) (3.93)

Total 479961 864701 1259446 1457568 1631352

a The share of total services is listed in parentheses. Due to the omission of indirect taxes the shares do not sum to 100.

Gesamtrechnungen: Input-Output-Tabellen, Fachserie 18, Reihe 2, various years.

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Table 6: Disbursement of Manufactured Goods among Inputs, Final Domestic Demand, and Exports in the Federal Republic of Germany (millions of DM), 1970 - 1984a

1970 1975 1980 1982 1984

Input 388285 544222 760376 818341 847510

(52.50) (53.36) (49.54) (50.71) (47.64) Final Domestic Demand 158624 210982 320147 339379 366081

(21.45) (20.69) (20.86) (21.03) (20.58)

Exports 114535 193453 305800 376755 424552

(15.49) (18.97) (19.92) (23.35) (23.87)

Total 739632 1019923 1534905 1613647 1778802

a The share of total manufacturing output is listed in parentheses.

Due to the omission of indirect taxes the shares do not sum to 100.

Gesamtrechnungen: Input-Output-Tabellen, Fachserie 18, Reihe 2, various years.

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Table 7: Disbursement of Change in Output among Inputs, Final Domestic Demand, and Exports in the Federal Republic of Germany

(millions of DM), 1970 - 1984a

Services Manuf acturing

Inputs 505752

(57.50)

459225 (47.02) Final Domestic Demand 311261

(35.39)

207457 (21.24)

Exports 62535

(7.11)

310017 (31.74)

Total 879548

(100.00)

976699 (100.00)

a The share of the changes in service and manufacturing output is listed in parentheses.

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of the DM 879,548 million increase in service output dispersed among these three main categories during this fourteen-year period, 57.50 percent was subsequently used as an input. By contrast, only 47.02 percent of the increase in manufactured goods was used as an input. Thus, as reflected in Tables 5 and 6, the share of services going towards inputs rose between 1970 and 1984, while it fell for manufactured goods over the same period. Because manufactured goods increasingly were shipped overseas, the share of manufacturing output going towards exports increased dramatically over this fourteen-year period.

The relative importance of service inputs into manufacturing industries is shown in Table 8, which lists the soures of

service inputs into manufacturing industries. By dividing the contribution of each service industry by the total amount of direct inputs used in the industry, which is indicated in the last column, the input coefficients are obtained and listed in Table 9.19 It is clear that the importance of services as inputs into producing manufactured goods varies considerably across industries. For example, services account for 44.92 percent of the direct inputs in the tobacco industry and 36.11 percent of the direct inputs in the office machinery industry. Similarly, the input coefficient is particularly high in fine ceramics, musical instruments and sporting goods, stone and clay,

beverages, and instruments. In all of these industries services account for at least one-third of all direct inputs.

19 It should be noted that the input coefficients are defined here as the percentage of direct inputs, and not all inputs, accounted for by the service input.

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Wholesale

& Retail

Transportation Communi

cations

Finance

& Banking

Other Total Direct Inputs'

Chemicals 6258 3976 1236 312 14873 121781

Petroleum Products 1811 1390 34 9 603 58758

Plastic Products 1282 618 248 88 3167 24 2 48

Rubber 492 172 56 23 838 6045

Stone & Clay 1332 1863 108 104 4153 22530

Fine Ceramics 87 149 14 9 291 1605

Glass 580 252 42 19 731 5774

Iron & Steel 3406 2322 167 43 2513 85792

Non-Ferrous Metal 2613 331 27 28 806 22662

Foundary Products 908 285 43 29 1090 7646

Cold Finishing (Steel

Pipes & Tubes) 1273 794 252 57 1829 20566

Steel Products 1130 487 164 57 2155 13792

Machinery (non-electrical) 3784 2134 1078 352 11964 79337

Office Machinery 942 147 70 19 3074 11774

Motor Vehicles 9429 2136 599 126 11073 101263

Shipbuilding 274 82 30 13 498 4443

Aircraft & Space Vehicles 359 57 2 26 863 5104

Electrical Equipment 4342 1468 578 226 9408 56310

Instruments 738 232 191 38 1526 8355

Fabricated Metal Products 1680 787 226 75 3011 22433

Musical Instruments &

Sporting Goods 451 125 53 26 671 3943

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& Retail cations & Banking Direct Inputsa

Lumber Products 525 426 45 39 407 6667

Wood Products 2043 898 290 112 2332 18918

Paper Mills 1317 810 35 36 626 13042

Paper Products 462 623 119 37 1352 13558

Printing & Publishing 637 626 176 50 2283 14287

Leather 488 135 120 22 512 5213

Textiles 1563 463 190 91 1889 21183

Apparel 1111 319 199 260 2751 15592

Food 7375 5207 410 161 5768 127569

Beverages 1202 910 140 31 2689 15144

Tobacco 194 137 4 8 1365 3802

a Does not include indirect inputs such as labor.

Source: Statistisches Bundesamt Wiesbaden, Volkswirtschaftliche Gesamtrechnungen: Input-Output- Tabellen , Fachserie 18, Reihe 2, 1984.

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Wholesale

& Retail

Transportation Communi

cations

Finance

& Banking

Other Total.

Chemicals 5.14 3.26 1.01 0.26 12.21 21.89

Petroleum Products 3.08 2.37 0.06 0.02 1.03 6.55

Plastic Products 5.29 2.55 1.02 0.36 13.06 22.28

Rubber 8.14 2.85 0.93 0.38 13.86 26.15

Stone & Clay 5.91 8.27 0.48 0.46 18.43 33.56

Fine Ceramics 5.42 9.28 0.87 0.56 18.13 34.27

Glass 10.05 4.36 0.73 0.33 12.66 28.13

Iron & Steel 3.97 2.71 0.91 0.05 2.93 9.85

Non-Ferrous Metal 11.53 1.46 0.12 0.12 3.56 16.79

Foundary Products 11.88 3.73 0.56 0.38 14.26 30.80

Cold Finishing (Steel Pipes

& Tubes) 6.19 3.86 1.23 0.28 8.89 20.45

Steel Products 8.19 3.53 1.19 0.41 15.63 28.95

Machinery (non-electrical) 4.77 2.69 1.36 0.44 15.08 24.34

Office Machinery 8.00 1.25 0.59 0.16 26.11 36.11

Motor Vehicles 9.31 2.11 0.59 0.12 10.93 23.07

Shipbuilding 6.17 1.85 0.68 0.29 11.21 20.19

Aircraft & Space Vehicles 7.03 1.12 0.04 0.51 16.91 25.61

Electrical Equipment 7.71 2.61 1.03 0.40 16.71 28.45

Instruments 8.83 2.78 2.29 0.45 18.26 32.62

Fabricated Metal Products 7.49 3.51 1.01 0.33 13.42 25.76

Musical Instruments &

Sporting Goods 11.44 3.17 1.34 0.66 17.02 33.63

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& Retail cations & Banking

Lumber Products 7.87 6.39 0.67 0.58 6.10 21.63

Wood Products 10.80 4.75 1.53 0.59 12.33 30.00

Paper Mills 10.10 6.21 0.27 0.28 4.80 21.65

Paper Products 3.41 4.60 0.88 0.27 9.97 19.13

Printing & Publishing 4.46 4.38 1.23 0.35 15.98 26.40

Leather 9.36 2.59 2.30 0.42 9.82 24.50

Textiles 7.38 2.19 0.90 0.43 8.92 19.81

Apparel 7.13 2.05 1.28 1.67 17.64 29.76

Food 5.78 4.08 0.32 0.13 4.52 14.83

Beverages 7.94 6.01 0.92 0.20 17.76 32.83

Tobacco 5.10 3.60 0.11 0.21 35.90 44.92

a The input coefficient is measured as the share of direct inputs (last column, Table 8) accounted for by each service industry.

Source: Statistisches Bundesamt Wiesbaden, Volkswirtschaftliche Gesamtrechnungen: Input-Output- Tabellen, Fachserie 18, Reihe 2, 1984.

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By contrast, the input coefficient is relatively low in the iron and steel, non-ferrous metal, and food industries. In none of these industries do services account for more than one-fifth of total direct inputs.

Table 9 also indicates that the relative importance of specific service industries in providing inputs also varies considerably across manufacturing. For example, the input coefficient for wholesale and retail trade is relatively high for the foundary products, non-ferrous metals, musical

instruments and sporting goods, wood products, and paper mills industries. At least one-tenth of total direct inputs emanate from wholesale and retail services for these industries.

However, in industries such as petroleum products, iron and

steel, and paper products the input coefficient is substantially less. Less than four percent of the total direct inputs in thse industries come from wholesaling and retailing.

Similarly, the input coefficient for transportation services is relatively high in the fine ceramics, paper mills, beverages, and lumber products industries. By contrast, transportation

services play no important role as an input in industries such as non-ferrous metal, office machinery, and aircraft and space vehicles.

From the detailed input-output analysis in this section it can be concluded that the role of services as an input into West German manufcturing varies considerably across industries.

Further, while the propensity to be subsequently used as an

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intermediate input is typically greater for a manufactured good than for a service, services play an important role in providing inputs and are apparently becoming more and not less important over time. The reasons for this increased role in services as inputs are only speculative but can be reduced to two

hypotheses. First, technology and factor prices may have evolved in such a way as to promote a more extensive use of services in the production process. Second, the composition of output in the Federal Republic of Germany may have shifted away from those goods where services do not play an important role as inputs and towards those goods which are more service-intensive in the

production function. While these two hypotheses are not

necessarily mutually exclusive, we recommend that they become the explicit subjects for detailed future research. In any case, whatever the cause, the empirical evidence based on an input- output analysis for West Germany suggests that the recent increase in the relative share of economic activity accounted for by services has not at all been a perfect substitute for manufacturing activity. Because services provide a key

contribution, and one which is apparently growing over time, as an input in the production process, to some extent the increase in services has served as a complement to enhance the production of manufactured goods.

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V. Econometric Evidence on the Relationship between Manufacturing and Service Activities

In the preceding section, we have used input-output tables of the West German economy to provide an overview of the markets in which the manufacturing and service sectors sell and buy. An input-output table provides important information about the relative importance of the service sector as inputs into other sectors of the economy, and its input coefficients describe the technology of production.

While this approach is quite useful, another approach to tackle the question of complementarity between manufacturing and services is to estimate their relations directly by using an econometric model. In this section, we first review the previous work that uses this approach to examine complementarity/

substitutability between exports and affiliate service

activities. Then, we propose an econometric model to assess whether a significant relationship exists between service and manufacturing activities. In particular, we estimate the

contribution of service activities at the aggregate level to productivity and output growth in manufacturing industries at the more disaggregated level, by using pooled cross-section and time-series data for West Germany.

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1. The Relationship between Merchandise Trade and Services

While the question of whether services are complementary to manufacturing has not been scrutinized to a great extent in the previous literature, there exists some evidence in the field of international economics that indicates the complementarity

between service and manufacturing activities. In particular, the previous literature on foreign direct invetment has addressed the question of whether service activities of local affiliates promote exports of goods produced by their parents. Pennie

(1956), Bergsten, Horst, and Moran (1978), and McCulloch (1988), among others, have pointed out that a manufacturer's success in a market abroad hinges critically on its non-manufacturing

activities in the local market. In particular, Bergsten, Horst, and Moran argued that direct investments in ancillary and

service activities promote exports since they enable the

manufacturer to develop a goodwill asset in the local market and to circumbent the inefficiency associated with arm's-length

transactions. Service activities that the manufacturer's affiliates undertake in local markets include marketing,

distribution, technical assistance and after-sales services to customers, warranty, financing, and repair and parts services.

While the general complementarity between exports and net sales of foreign affiliates has been identified by Bergsten, Horst, and Moran (1978), Lipsey and Weiss (1981 and 1984), and Blomström, Lipsey, and Kulchycky (1988), empirical evidence supporting the specific hypothesis that service activities of

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affiliates abroad promote exports of parents is scarce. The only existing study that has tested this hypothesis systematically is by Yamawaki's (1989).

To test the hypothesis that service activities of Japanese affiliates in the United States promote sales in the United States of goods produced by Japanese parents, Yamawaki used the following simultaneous-equation model:

log DIST = aQ

log EXP = bo

m

+ a-]_ log EXP + zi + e m

+ b-L log DIST + [ b j+i Xj + u

(1)

(2)

Where DIST is a proxy for service activities of U.S. affiliates, EXP is Japanese exports to the U.S. markets, Z and X are the vectors of exogenous variables, and e and u are the disturbance terms. Based on the result of the Hausman test that was applied to a sample of 44 industries for 1986, he rejected the null hypothesis that log EXP is statistically independent of the disturbance term of the log DIST equation, but he could not reject the null hypothesis that log DIST is statistically independent of the disturbance term of the log EXP equation.

Furthermore, the estimated coefficient for log DIST, bx , in equation (2) was highly significant and had a positive sign, while the 2SLS estimate of the coefficient for log EXP, a-j_, was only marginally significant. Thus, Yamawaki's estimation results suggested that service activities promote exports strongly, at least in the case of Japanese firms in the United States. This

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result supports the hypothesis that affiliate service activities are complementary to exports of goods produced in the home

country.

2. Contribution of Services to Productivity Growth in Manufacturing

2.1 Hypothesis

Since the studies summarized above are not originally designed to examine the complementary relationship between services and manufacturing, their evidence on this relationship is at best

indirect. More direct evidence on the relationship between services and manufacturing could be obtained by estimating a production function for manufacturing and assessing the

contribution of services to output and productivity growth.

As our analysis of the input-output structure for West Germany indicates, services are often used as inputs into

manufacturing sectors. Thus, for a given production technology, manufacturing outputs depend on service inputs. While this

input-output relationship between services and manufacturing is most prominent for their complementarity, it is quite

conceivable that service activities at the aggregate level

produce some external effects on manufacturing activities. Thus, the contribution of services to output growth in any

manufacturing industry will be internal as well as external to the industry.

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The development of services would enhance the efficiency of production by broadening the menu of available technologies.

First, the availability of more efficient transportation systems and reduced transportation costs may expand the geographic size of markets and thus make it feasible for the manufacturer to adopt a more efficient size of production (Scherer et al., 1975) and new technologies. Second, the existence of sophisticated distribution systems, along with efficient transportation

systems, may augment coordination of complex flows of goods in the production system. In particular, procurement and supply of materials and parts that are well coordinated to the production processes are essential to achieve higher production efficiency.

The role of Sogo Shosha (general trading company) in Japan as coordinator is a typical example where service activities in trade contribute to enhancing efficiency in production (Yoshino and Lifson, 1986). Third, the availability of well-developed financial markets and, in particular, the presence of financial intermediaries that support the formation of new businesses with innovative production technologies may improve the efficiency of manufacturing industries. Entry of such innovative new firms

into the industry would eventually contribute to its productivity growth. Finally, as a consequence of the development of communications, data processing services,

information services, and management consulting, knowledge and information have been disseminated widely and promptly within the economy. Thus, the knowledge and information that increase output for similar amounts of inputs and for similar production