Decreases in Manufacturing's Share of GDP and Employment Are a Result of Increasing Productivity
From Paul Krugman's book "Pop Internationalism" (updated, original source):
"Between 1970 and 1990 manufacturing declined from 25.0 to 18.4 percent of GDP. International trade explains only a small part of the decline in the relative importance of manufacturing to the economy. Why then has the share of manufacturing declined?
The immediate reason is that the composition of domestic spending has shifted away from manufactured goods. In 1970, U.S. residents spent 46 percent of their outlays on goods (manufactured, grown, or mined) and 54 percent on services and construction. By 1991, the shares were 40.7 percent and 59.3 percent respectively, as people began spending comparatively more on, for example, health care, travel, entertainment, legal services, fast food and so on. It is hardly surprising, given this shift, that manufacturing has become a less important part of the economy.
In particular, U.S. residents are spending a smaller fraction of their incomes on goods than they did 20 years ago for a simple reason: goods have become relatively cheaper. Between 1970 and 1990 the price of goods relative to services fell 22.9% percent. Goods have become cheaper primarily because productivity in manufacturing has grown much faster than in services. The growth has been passed on in lower consumer prices.
Ironically, the conventional wisdom here has things almost exactly backward. Policymakers often ascribe the declining share of industrial employment to a lack of manufacturing competitiveness brought on by inadequate productivity growth. In fact, the shrinkage is largely the result of high productivity growth, at least as compared with the service sector. The concern that industrial workers would lose their jobs because of automation is closer to the truth than the preoccupation with a presumed loss of manufacturing because of foreign competition."
MP: The chart above shows the incredible increases in U.S. manufacturing productivity, which has made American manufacturing increasingly more efficient and more competitive, leading to lower prices for manufactured goods. Because the productivity gains for manufacturing have exceeded productivity gains for services-producing industries, the prices for manufactured goods have fallen relative to prices for services, which had led to decreases (increases) in manufacturing's (service's) share of GDP and employment.
HT: James E. Miller's post "The Good Krugman"
Update: Log scale graph appears below: