Manufacturing and the Externalization of Services: A Theoretical Model

The growth of the U.S. service sector over the past several decades is both unprecedented and puzzling. Regional scientists are accustomed to thinking of services as nonbasic activity subservient to manufacturing and the extractive industries. Yet between 1976 and 1986, the U.S. service sector grew at an average annual rate of 5.39 percent, nearly double the growth rate of total employment in the economy. The externalization hypothesis suggests that at least part of the growth in service employment can be traced to the spin-off of service activities from within the manufacturing sector. This paper presents a theoretical model of service externalization that may be used for empirical tests of the externalization hypothesis.