Wednesday, May 2, 2012

The biggest thing no one is talking about…

The biggest thing no one is talking about…
Or why is the US services sector so darn weak?

Job growth is about having demand and fulfilling it by having someone work in the US to fulfill that demand. Spurring demand alone does not do it. You need demand coupled with sector level economic efficiency. Right now we have two trends that working against job growth in the US. One is well-known in the goods sector and the other is never talked about; it is the service sector and it is the bigger problem for job growth right now.

There are two telling charts about why US jobs growth is struggling. The first one is below and is the most familiar. It shows that since the mid- 1980s the US purchases of goods for the economy as whole (not just consumer sector) have been volatile, but steady. The growth rate of real spending on goods is just under 4% per year even in this weak climate after a severe economic contraction and its weak recovery.  And with that stability we have had a tendency for job growth to decline year in and year out. The chart itself shows very few episodes of Yr/Yr job growth. We have one now mostly because we are recovering from the severe loss of jobs in the recession. Goods sector jobs are still some 12% lower than they were just before the recession began…. so much for thinking that the recent MFG job growth is really good news.

The reason for this steady jobs erosion is several-fold: It is because of productivity. We can make a given amount output with fewer workers. It is because of imports. When we demand or buy goods, we can purchase those goods from overseas. So we do not need as many US-based workers to buy the same quantity of goods.

The second ‘telling chart’ about jobs and the economy may be unexpected to you. It is the services sector. Services jobs and spending have both been transitioning to lower rates of growth. The chart is actually a bit stunning. For this chart I have used the comprehensive data on services, goods and structures in the economy. I have manipulated the growth rates to construct long term indices of real sector activity for goods and for services. From 1990 through 2007 it was rare indeed that service sector goods purchases did not grow at 2% per year or more. There are only a few isolated examples of spending that was so weak. Spending was usually so much stronger.

Since the recession the best growth we have gotten from services in this cycle is 1.4% Yr/Yr. And this is from the jobs-producing sector of the economy. As the chart below shows job growth does tend to follow services purchases. And services jobs have been getting even more volatile than output in recent cycles. Job growth is not just about demand weakness in the US, it is about the composition of demand itself. Based on the relationship between spending and jobs a growth shift in demand of one percentage point from Goods to Services would create an additional 112,000 jobs. Yet spending on goods is being maintained at a historically normal pace and spending on services is wallowing at never-before-seen lows. Why?   

The goods sector is small as a jobs source. Goods jobs are only 11% of the total of services jobs. The GDP shares of output are skewed to services too at around 61% of GDP. 

The weakness in the services sector is harder to chronicle. Some of it is because of productivity but while that can explain job weakness it does not explain demand weakness as easily. Service sector demand weakness has been in train for a long time as the chart below demonstrates.  In past recoveries the pickup in demand and in jobs occurred usually right at the recession end, in the last two cycles demand picked up but was delayed as the pickup in jobs actually preceded the pickup in demand and exceeded it. In this cycle demand is still quite weak and in the not averaged data in the chart above we see that job growth in services is exceeding the growth in the demand for services. This has happened before, but it is rare (1987, 1993).

We do not have any clear link as to why services spending has gotten so much weaker. It is curious that it has happened with goods spending continuing on its historic firm path. What has changed that has hit services demand harder than goods demand?    

One thing is relative prices. Since 1990 the ratio of core goods to core services prices (taking energy out of the picture, entirely) has fallen by nearly 25%. Thus goods have become are much less expensive relative to services. Since the recession there has been a slow and partial reversal of this process. (see the chart that is below)

What we do know is that some of the components in services have among the fastest rising prices in our various price measures, like the cost of health care and the cost of education. Health care is, of course, in the news and the problems with having employer-paid healthcare insurance and overconsumption as well known; other issues are well known if not easily able to be solved.  Education costs keep rising and yet we complain that Americans’ quantitative skills are on the decline. Are we overpaying for what we are consuming in education or will these expenditures pay off for students?

In this recession the steady rise of the ratio of core services prices to core goods prices (negative values on a year-over-year basis in the chart above) has been stopped. We can see that goods prices are now starting to rise relative to services prices persistently since late 2009 (see chart above). And with this there is some growth in services spending and jobs once again –although it is still very limited. . 

There are some very specific things in the economy’s troubles that are contributing to this as well. Banking is a service and that sector –once a high flyer- has been hit hard and is now in low gear. Housing weakness for example has probably cut the demand for services. A lot of services expenditures surround the purchase and maintenance of a house: lawn and garden services, pool maintenance, painting and upkeep. When someone is unemployed or under employed these are jobs that can be done by the homeowner. Other services like eating out or vacationing can be set aside if money is tight. Certainly goods purchases can be and are put off as well, at least for durable goods.  But for services the list of postponable items is longer. In many cases buying services is a leisure-work trade off or a lifestyle choice. When you have lots of time on your hands your leisure is not worth as much to you especially if your income is lower.  

On balance we should be aware that the dynamic between labor force participation rates and services consumption are probably related. If the choice is between having some of the services you like to buy or foregoing them and foregoing a lesser job some may choose to remain idle and to wait for the good job to reappear. It may never re-appear.

I think there is a lot to consider when it comes to the evaporation of services spending. We have never seen it as weak as it is. The goods side of the economy is all but back to normal. Of course, I speak of the consumption side: the output side isn’t back either. But competitiveness is something we are still working on. And that involves the much bigger question of the global economy and the allocation of investment between foreign and domestic sources by US firm..

As a policy matter The US is caught with the issue of cheaper foreign labor and putting more demands on firms that located in the US like providing healthcare.

To me the lesson of the housing crisis was that Barney Frank failed in trying to get everyone involved in the housing boom that was in train. But he didn’t just fail. He ruined it for everyone. This is the real lesson. By setting up 120% mortgages and urging (mandating) Fannie and Freddie to underwrite more and more subprime loans, by setting the desired down payment in some cases to zero, by taking away the income test from home buyers, we did let ‘anybody’ into the exclusive homeownership club. And then it became that old Groucho Marx Joke- ‘Don’t want to belong to a club that would have you as a member?’

Housings hurdles were not discriminatory by ‘mistake.’ Discrimination is not a bad word. It is just used with the modifier ‘race’ too often. Firms need to and do discriminate, by income, by credit quality, and when you take that away you ruin economics. And that is what the housing bubble did. Let’s not apply that same stupid idea to our businesses when we set policy. If we force them to take on more and more responsibilities that are really social welfare responsibilities, we will kill even more job growth.

 We need to encouraging hiring real long terms hiring. We do not need gimmick hiring. Hiring comes from spending. It emanates from spending coupled with the provision that the desired goods or services can be effectively produced and delivered in the US. The slide in the US competitiveness position is clear. What is going on in services is less clear. Let’s not make it worse because we want to adhere to some social agenda.

Computers have facilitated call centers and few other remote job sucking possibilities. But so many services are simply needed to be provided on the spot. We need to consider what is happening to reduce our demand for these things as well as what we can do to bring the spending on services back to life and jobs along with it.

The table below should help in this assessment…

This table looks at the rise in spending from the end of the recession in the recovery period for key consumer goods and services categories. It compares the rise this cycle with average of the past seven cycles back to 1960 ( the 1980 recovery did not last this long, so it is not part of these comparisons) and places this cycle in the percentile range between the best and worst among these.

We see immediately see that service sector is worse off than the goods sector. The service sector averages a rank of 6.6 out of a possible seven ranked cycles. Durable goods sectors average 5.3 out of seven, and non-durables sectors average a near normal 4.3 out of seven. The average recovery would post a 3.5 average rank.

Of the seven sectors in services this cycle is the worst recovery in five on them. While the non durables rebound is 80% to 90% of normal the durables rebound is 90% of normal for vehicles and closer to 50% for other categories, the service sector averages a rebound that has been 43.6% of average. It is nearly 60% below normal on average.

Clearly the sector we understand the least is services and for all the coverage about manufacturing and our large trade deficit and US competiveness our worst problems are right here at home in a sector where there is virtually no international competition.

It’s the biggest tissue in the economy right now and NO ONE is talking about it.