Our Dying Services sector... or why jobs growth stinks

RobertBrusca's picture

Our dying services sector
What it means

In sifting through more economic data and trying to pin down exactly what is going on in this recovery (yes, it is a never-ending task) I uncovered some very interesting trends. You might find them interesting, too…

Although we are in a global slump and US export markets are now under pressure in this economic recovery if we compare it to past cycles it turns out that the US manufacturing sector is doing much, much, better than the services sector. Not only are services jobs lagging much worse than what is normally the case but services spending is anemic, too. On the goods side of the economy industrial output is actually near normal despite the ‘weak recovery.’ It is astonishing. And while ‘demand’ or GDP has been weak in this recovery ‘public enemy number one’ might just be the composition of demand more than demand itself. There has been too little demand for services and therefore too little job growth.

Cyclical overview of industrial output
If we look at output from the start of the recession (instead of the end), of course it is weak. Moreover, it is weaker than in any other Post-War recession period for all categories of industrial output. But that is obvious. It’s for the same reason that you run the 50 yard dash faster than the 60-yard dash. This recession has been longer that past Post-War recessions, so the comparison is not fair - and then there is that ‘weak’ part. To put comparisons on a ‘fair footing’ we look as the rise in output in this cycle compared to past cycles counting from the end of the recession. To do this we group past cycles into two divisions: the expansions from the 2001 and 1990 recessions, and their weak recoveries; and, the recessions of 1982 and 1982 which had strong recoveries.

It turns out that this recovery in industrial output is pretty much a middle case; it is nearly uniform across the sectors I have compared. It is faster than the slow ones and slower than the fast ones. Looking at the headline for industrial production and several major divisions (MFG, durables, non-durables, consumer goods, consumer non-durables, consumer durables and business equipment) the average of the fast-slow cycles was faster than this cycle in only three out of eight categories. And in this recovery overall durable goods output and business equipment output is actually faster than it was at this point –even in the two strong recoveries. If we make the comparisons for services nothing is stronger in this cycle.

Goods and services in GDP- the structural shift
I have a longer research piece with exhibits on my blog (robertbrusca.blogspot.com) that shows charts on goods and services spending in the aggregate. Since 1985 the trend for GDP spending on goods economy-wide is dead flat at about 4% per year. The same calculation for overall services spending shows a considerable down shifting and a clear shrinking trend. This is for overall economic services spending not just the more familiar spending on services in PCE.

For both of these broad sectors employment trends are also on the decline.

While there is a lot of focus on this recession, and special problems have emerged since the financial crisis, it seems that this recession has simply peeled back a view of the economy that has been hidden. Some suggest that the boom in construction hid the structural changes in the economy because it allowed some very under-skilled workers to obtain and hold relatively high paying jobs.

Elsewhere I have written on the long term shifting trends in labor force participation rates (see http://seekingalpha.com/article/355341-a-closer-look-at-labor-participat...). While there is a focus on the current economic situation is seems that our circumstances are the result of a number of irons that have been warming in the fire for some time, rather than effects that have sprung full formed out of the financial crisis itself..

One of the intriguing things to me is why the services sector is so weak. Is it linked to other problems and imbalances? While there is a reason to be concerned about the large US current account deficit and the damage being done by other countries that pursue export led growth strategies displacing US-sourced production that does not seem to be the front and center problem in services. Still, the loss of output in the US regardless of the firmness of goods growth in GDP implies that there have been fewer domestic multiplier effects than there might have been. That means outsourcing goods output has contributed to some of the weakness in services. By having slower MFG output growth we have churned out fewer positive externalities in the domestic economy that might have stimulated services.

More to the point is that our MFG sector has been kept at a world class pitch by the competition from abroad. And that competition has been painful. Meanwhile, domestically there has been much less competition in the non-traded goods sector and now those chickens are coming home to roost…

We can see this very clearly in the way the services sector encompassing government has raised pay, added benefits and promised pensions that have created a string of liabilities that is crippling government today. State and local government have added to the bulk without adding contribution to GDP an amount that is commensurate. Many localities are now being crushed under the burden of retirement benefits they can’t afford to pay and for which they have not properly reserved.

In this cycle some of that is being addressed. It is the pullback in state and in local hiring that is the unprecedented factor in this cycle. But over the longer run it has been a reduction of services demand and jobs in the private services sector that has suddenly emerged as an issue even though it has been ‘in train’ for some time as the trends clearly show. Why has this happened?

When we look at services what do we see? We see some of our least competitive and most controversial sectors. We see education where public sector quality has slipped and private sector costs have soared. We see healthcare where much the same has been in train with costs rising faster than the CPI by a large margin and persistently; in medicine innovation and technologies are keys drivers of costs making it unique. These sectors along with government make up about 36% of services employment. When we compare core services prices to core goods prices we find that services prices have been advancing faster than goods for some time. Since 1990 the ratio of core goods to core services prices (taking energy out of the picture, entirely) has fallen by nearly 25%. Services have becoming very expensive relative to goods; is it any surprise that we are buying fewer of them? Cable TV has become increasing expensive, for example, despite technology and competitiveness from the internet. Here we have a business that has in many communities monopoly status.

I think what we are seeing in the US is less the impact of some sudden shift than an ongoing adjustment to technology and sorting out competitive forces. With more pressure on budgets consumers are going to look more closely at some of the services they were used to purchasing rather than providing them themselves. Much services expenditure is associated with homeownership. The stress on that sector has undoubtedly cut back on that spending. But that is only the new aspect. Being unemployed focuses your attention on things you can do for yourself when time is more plentiful and money is scarce. That helps to explain why some of this contraction has been expedited in this downturn.

Still I think the point for services is that the down trends go back to 1985.

Cyclical comparisons by sector
When we compare some aspects of this recovery to past the past seven recoveries services spending emerges as exceptionally weak. Household and utilities spending, health care spending and recreation spending as well as spending for financial services are the absolute worse at this point in the cycle compared to past cycles. Transportation services are better in this recovery than in only one other. Food bests two other recoveries. Meanwhile goods in GDP are faring better, generally but not for all categories. Recreational goods purchases are the weakest in this recovery but spending on vehicles is in the 54th percentile of the high-low range making more it or less average Spending on other durables including household items like furniture and electronics is in the 30th percentile - weak but not as bad as for services. These calculations are from GDP accounts and track demand trends.

So why is the goods sector doing better? It certainly is true than multinational corporations have the option it to go ahead and do things abroad that are either taxed the most here, regulated the most here or are just plain cheaper abroad. It should make you wonder. Has this migration abroad been just for cheap labor or to evade regulation? The NFIB (National Federation of Independent Businesses) has a survey that assesses what its memberships’ biggest problem is. ‘Government requirements’ has just jumped up to its second highest reading at this point in the expansion and is very near the all-time cyclical high. Manufacturing firms can outsource to avoid the worst of the requirements in the US but services firms are stuck. Another reason is prices. As we saw in the previous discussion, goods are simply relatively cheaper than services.

Right now health care is a big issue. The Supreme Court is deciding the constitutionality of the Obamacare program. Some firms are said to be wary of hiring with this large obligation hanging in the balance even though its start date is in the future and the law’s status is unclear.

Goods Vs Services
Very few economists have formed the problem of the economy in this way as a goods Vs services issue. But there is a very clear dichotomy between how well the goods sector is doing and how well the services sector is doing. The issue is that we are getting our weakest growth in our most important job-producing sector. Shouldn’t we be paying attention to that?

When I compare spending in recoveries it turns out that in this recovery spending on goods especially durable goods and on business equipment and software have pretty much kept pace with recoveries in the past. At one point business equipment and software spending was faster in this cycle than in any previous recovery. The problem, as I like to re-cast it HAS NOT BEEN WHOLLY WEAK DEMAND. It has been the composition of demand. IF we had bought more services and fewer goods there would have been much more jobs growth in this expansion. With that, income growth would have been higher and corporate profits would have been lower. And the recovery would have been more balanced. We need to look more closely into this area to try to understand what has happened to our services sector.

Some figures for perspective
In this recovery consumer services bought/supplied have grown by 3.2 percent from their level at the end of recession as of the 33rd month of the expansion. It is the weakest performance we have seen by a long shot in the last eight recoveries that lasted this long. The previous low point at this point in the cycle was in the 2001 recovery at 6.5% before that it was the 9.2% rise in the 1990 recovery. Again, in those comparisons you get the sense of structural change as it is in the most recent recoveries that growth has become progressively weaker. The average for this point of the expansion cycle would be an 11.4% gain in services output if we had normal service sector growth. IF we had that, we would have had 5.5 million MORE jobs even after discounting for productivity growth in the sector and the loss of goods sector jobs from that demand shift to services. That means about 165K more jobs per month than what we have had all recovery long. This not a trivial problem it is a huge problem. And no one seems to be thinking about it.

It is something to think about.