By David Born and Christian Krys

De-industrialization is the talk of the town these days, but this discussion is nothing new. Jean Fourastié's three-sector hypothesis, developed in the 1950s, already described the decline of the industrial sector and the rise of the service sector as a natural evolution on the path to greater prosperity for all. In the 1970s, economists wondered whether we might even be witnessing a transition to post-industrial societies. So much for theory. But what does the empirical evidence say today?

To assess this question, we first need a working definition of de-industrialization: De-industrialization can be described as a process of economic and social transformation characterized by a decline in the importance of industrial sectors, particularly manufacturing and heavy industry. Their level of importance is regularly measured as the share in value added. Where the level of economic development is high, industrial production loses importance relative to services, which doesn’t necessarily mean that the total gross value added (GVA) in manufacturing declines.

Indeed, many of today's leading economies have gone through such a process. The most prominent example may be the United States of America: In the 1970s, many US companies began closing their factories in the USA, relocating them to newly industrialized, low-wage countries, such as South Korea, Hong Kong, Taiwan, and Singapore.

In Europe, too, a fall in industry's share of GVA can be observed since 1995: Overall, manufacturing's share of GVA in the European Union declined from 20% in 1995 to 16.5% in 2021. However, although the share of manufacturing in total value added in Europe has shrunk from the level it was at in the mid-1990s, it has remained roughly stable since 2010 (see figure 1).

Around one-sixth of the EU’s gross value added was generated in the manufacturing sector in 2021. Some 31.5 million people (16% of the entire population) still work in manufacturing companies in the European Union. In Europe, therefore, it remains difficult to generalize about a post-industrial society and the disappearance of industrial production.

De-industrialization would endanger prosperity

Manufacturing was once considered an outdated sector with no role to play in the knowledge and service society, but the facts tell a different story. De-industrialization would endanger European prosperity: not only is European industry today responsible for almost three-fifths of all exports from the EU but also for more than half of all private sector research and development spending.

Furthermore, industry is strongly interconnected with other sectors through its value creation networks. Thus, European industrial companies are also one of the most important demand-side consumers for other industrial goods as well as for services from the tertiary sector in Europe.

Alongside other sectors of the European economy, its people also particularly benefit from a strong industrial sector. The industrial workforce benefits from above-average wages paid by the sector compared to other sectors. Moreover, as mentioned, demand from industry for goods and services from other sectors also means that the industrial sector indirectly creates jobs in other sectors of the economy. Lastly, manufacturing industries generate high profits; taxes paid on such profits contribute to a strong welfare state.

Seen in the round, de-industrialization would put all of that at risk. If Europe loses (a significant part of) its industry, thousands of jobs will be lost, ultimately threatening Europe’s prosperity. Europe's prosperity can only be secured by three key components: innovation, competitiveness , and strong exports.

Significant variation within Europe in terms of industry’s share in GVA

Yet there are striking differences concerning levels of industrialization across Europe: With Germany's share of GVA originating in industry at around 21% and, for example, the Czech Republic's at as much as 25%, the industrial GVA in France is significantly lower, at around 11%.

The share of industrial GVA in Europe’s largest industrialized nations has shrunk in recent years, significantly in some cases. In France, the share of industrial GVA was around 16 percent in 2000, whereas by 2021 it was some 6 percentage points lower. In Italy, too, industry’s share in gross value added fell by about 3.5 percentage points over the same period. While Germany’s industrial GVA remained stable at around 22 percent of the total for a long time, the figure has been falling slowly but steadily since 2016, the decline is far less pronounced - even now it still stands at around 20.8 percent.

So much for the empirical evidence regarding de-industrialization in Europe. However, the current energy crisis has again raised fears of de-industrialization. How justified are such fears? Does the current energy crisis have the potential to act as a strategic gamechanger, i.e., act as a stimulus for a significant re-location of European manufacturing industry?

The current energy crisis: Is it a strategic gamechanger?

One thing is clear: the current energy crisis is hitting industry particularly hard, given that this sector of the economy, alongside transportation, is among the biggest consumers of energy. Especially German manufacturing, which accounts for around one-third of all the value added by manufacturing in Europe, has been hit extremely hard by the current energy crisis, since natural gas, notably from Russia, was particularly important in Germany's energy mix as a bridging technology for the transition to a more climate-neutral economy.

The current rise in gas and energy prices could therefore turn out to be a strategic gamechanger as companies are now considering other locations for their manufacturing operations . Many businesses, especially those in the energy-intensive sectors, have already exhausted all other short-term options to cut the use of gas - apart from curbing production.

CEOs might now ask themselves: why not seize the opportunity and make investments in places where energy is already much cheaper? Or re-locate to where renewable energy inputs will soon be available in large quantities? To a large extent, answers to these questions probably depend on how long the instability on the European gas and electricity markets is likely to continue, or when and indeed whether prices return to pre-crisis levels, and ultimately on the availability of energy in general.

A full-scale exodus of industry from Europe is not to be expected

In response to these questions and during a complex analysis (for further details download the attached pdf), we find that a full-scale exodus of European industry from Europe appears unlikely. Instead, we see a more likely shift in where value is created within the EU. Due to their energy mix, various countries, including Spain and Sweden, are significantly less affected by the current energy crisis than places like Germany, whose higher dependency on Russian gas is an additional, aggravating factor not evidenced in other countries.

Further reasons support our thinking: motivated by recent supply chain disruptions during the COVID-19 pandemic, many European companies have indicated that, in the future, they would undertake more of their manufacturing locally again. This implies that companies are bringing important manufacturing stages back closer to the final production location to ensure more resilient and shorter routes of transportation.

Europe also offers many advantages as a business location, such as the dense network of companies that has developed into a veritable industrial cluster, bringing together specialized suppliers with OEMs, a highly trained workforce and qualified employees, or the European single market, which offers easy access and great sales opportunities for companies.

European industrial policy is currently already aiming to support the new nearshoring trend. There are various programs to bring future key industries to Europe, e.g., chip or battery manufacturing. While the EU's subsidy programs compete with other countries offering similarly generous support, several big-name companies have recently been convinced to relocate their manufacturing to Europe.

In terms of achieving climate targets, it is also in the European Union's interests to encourage industry to remain on the continent through favorable industrial policy. The development of climate technologies is considered one of the most important areas of technology for the future. To remain a leader in this field, the EU requires the expertise of engineers working in European companies. That will enable the EU to use the existing technology base to find new ways to cut carbon emissions with innovative ideas while at the same time enabling growth. Experience shows that it is possible to decouple emission levels from economic growth. A step back is the relocation of production facilities to countries with less stringent environmental regulations.

In summary, Europe is likely to remain a strong industrial hub despite all the crises it faces. Many industrial companies will not simply turn their backs on the continent, meaning that industrial production is very likely continue to take place in Europe in the foreseeable future.