Brian Motley

English

Research Papers in Economics

FRBSF WEEKLY LETTER
January 16, 1987
The Shift to Services
When manufacturing industries, such as steel,
textiles, and farm machinery c:ontract, a nation
loses some of its capacity to produce goods and
its workers lose jobs. Between 1980 and 1985,
total civilian employment in the United States
increased by 71f2 million persons, but manufac-
turing industries lost 800,000 jobs. This loss has
led to concerns that our industrial base is shrink-
ing, and that this apparent trend may reduce the
potential growth rate of our economy in the long
run.
The rapid growth of employment in service
industries has more than offset the loss of man-
ufacturing jobs, but the shift to services seems to
have reinforced fears of a shrinking industrial
base. Some argue that productivity growth is
slower in the service industries than in those
producing goods, and therefore that the long-run
growth rate of the economy as a whole will be
impaired as the economy shifts from producing
goods toward producing services.
In this Letter, I argue that a secular shift toward
the production of services does not necessarily
imply lower productivity growth for the econ-
omy as a whole. Indeed, it may be a hallmark of
healthy economic growth rather than a har-
binger of economic retreat.
Trends
Contrary to popular perceptions, the shift in our
economy from goods-production toward ser-
vices is not new. It has been going on
throughout the postwar era and even before.
Charts 1 and 2 show the shares of service and
manufacturing production, measured in terms of
both output and employment, in the domestic
economy since 1950. Among services, I include
retail and wholesale trade, transportation and
communications, finance, insurance and real
estate, and miscellaneous services such as busi-
ness and personal services, health care, and
education.
Chart 1 gives no obvious sign that the trend
toward services has accelerated in the last five
years, although the recent trend does appear to
hav~ been somewhat more rapid than in the
1950s. Data extending further back in history
indicate that the trend toward services has been
going on since at least the nineteenth century. In
contrast, Chart 2 shows two distinctly different
trends in the manufacturing sector: the share of
manufacturing in total output has remained
roughly the same, while manufacturing's share
of employment has fallen.
The data in these two charts imply differences in
the behavior of productivity (output per worker)
between the two sectors. The stable share of
manufacturing in total U.s. production despite
its declining share ofthe labor force reflects the
rapid growth in the productivity of labor
employed in that sector. In the service sector, in
contrast, output and employment have grown at
similar rates, which suggests, on the surface, a
much poorer productivity record.
Interpretation
There are several reasons to be cautious in con-
cluding from these data that the shift to services
will damage the potential of our economy to
grow in the long run. First, in several service
industries, output per worker has grown much
more rapidly than productivity in manufacturing.
One example is the communications industry,
where output per full-time worker has grown at
an annual rate of 5.0 percent since 1950, com-
pared to 2.6 percent growth in manufacturing
and 1.2 percent for the domestic economy as a
whole.
Second, our measures of output, and hence pro-
ductivity growth, in services may be biased
downward because it is more difficult to mea-
sure improvements in the quality of services
than in the quality of goods. Measures of output
in services are constructed by deflating the dol-FRBSF
lar values of expenditures on services byesti-
mates of the change in the prices of services.
Often, however, service prices rise because of
improvements in the quality of services. But
these improvements are difficult to measure
because there is no physical unit of "standard
quality" toserve as a benchmark. For example,
hotel room prices may increase in partial reflec-
tion of greater comfort, but it is difficult to quan-
tify improvements in "comfort." This difficulty
in measuring quality improvements in services
may mean that our measures ofthe prices of ser-
vices are biased upward, and hence that our
measures of the growth of output in service
industries are biased downward.
Measuring quality improvements is especially
difficult for those industries in which technologi-
cal advance has taken the form of entirely new
products rather than improvements to existing
products. Airline transportation, telecommunica-
tions, fast food chains, and financial services
such as automatic teller machines and credit
cards are prominent examples. The resulting
increase in output may not be adequately cap-
tured in existing data for those industries. For
example, airline transportation has largely
replaced railroads for inter-city passenger travel
in the last thirty years. Because this development
is not treated as an improvement in quality
within the overall category of inter-city transit,
but rather as a whole new product, the dramatic
increase in output that took place when planes
replaced trains may be missed.
Finally, to a considerable extent, the decrease in
the share of manufacturing in total employment
has been the indirect result of the sector's tech-
nological dynamism. As productivity in goods
production has increased, the relative prices of
goods have fallen and indirectly increased the
real incomes of workers in both goods- and ser-
vice-producing industries. Since households
have chosen to enjoy their rising real incomes
by buying more services, the rapid productivity
advance in goods production has been reflected
in more of the national income being spent on
services. The greater demand for services gener-
ates more jobs in businesses that produc:eser-
vices, while, over time, productivity growth in
goods production frees workers from the goods-
producing industries to move into service jobs.
The movement of workers out of agriculture
throughout United States history reflects the
same sort of process at work.
The rising share of services in total output may
dampen the swings in the economy associated
with the business cycle. Because goods are dur-
able and can be stored, producers tend to add to
their inventories when business is strong and to
draw them down when business is weak. Sim-
ilarly, households tend to accelerate or delay
purchases of durable goods in response to
changes in current economic conditions. These
are important reasons cyclical movements in the
economy tend to be cumulative. When services
make up a larger share of national output, these
cumulative processes maybe less pronounced.
Thus a beneficial side-effect of a more service-
oriented economy may be less severe cyclical
swings in production and employment.
Conclusions
The secular shifting ofresources among indus-
tries is a hallmark of economic growth. As
income levels in our economy increase, and rel-
ative prices change, consumer demands change
and, in response, the composition of output also
changes. At the same time, above-average pro-
ductivity growth in some sectors makes it possi-
ble over time for some industries to release
workers for employment elsewhere.Percent
Contrary to popular opinion, there has not been
any noticeable acceleration recently in the grad-
ual shift ofthe economy away from producing
goods toward producing services. The trend over
the last five years appears consistent with trends
established as far back as the nineteenth cen-
tUrY.MOreover, the datasUggest that the rate of
productivity growth in some service-producing
industries is at least as high as the rate in tradi-
tional goods~producing industries, especially
after taking account of a probable downward
bias in measures of productivity growth in
services.
Thus, the secular trend toward service produc-
tion may be a sign ofthe strength of the U.S.
economy rather than a cause for concern. The
trend does not necessarily imply a slower rate of
advance in overall productivity, but instead
reflects the ability of sectors with rapid produc-
tivity growth to release workers to take jobs
elsewhere.
1985 1980 1975 1970 1965 1960
Output
Chart 2
Share of Manufacturing in
National Output and Employment
1955
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1950
40
44
46
48
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54
Chart 1
Share of Service Industries in
National Output and Employment
52
50
Percent
34
32 Brian Motley
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1955 1960 1965 1970 1975 1980 1985
Opinionsexpressed in this newsletterdo not necessarily reflect theviews ofthe managementofthe Federal Reserve Bank ofSan
Francisco,orofthe Board of Governorsofthe Federal Reserve System.
Editorial commentsmaybeaddressedtotheeditor(GregoryTong) ortotheauthor....FreecopiesofFederal Reserve publications
can beobtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco
94120. Phone(415) 974-2246.uo~6U!4S0m 4o~n U060JO OpOA0U
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BANKING DATA-TWELFTH FEDERAL RESERVE DISTRICT
(Dollaramounts in millions)
Selected Assets and Liabilities
Large Commercial Banks
Amount
Outstanding
12/24/86
Change
from
12/17/86
Change from 12/25/85
Dollar PercenF
Loans, Leases and Investments1 2 207,957 2,878 7,129 3.5
Loans and Leases' 6 187,334 2,481 4,964 2.7
Commercial and Industrial 53,755 1,932 1,545 2.9
Real estate 67,458 - 2 1,291 1.9
Loans to Individuals 39,958 - 64 1,427 3.7
Leases 5,586 - 3 86 1.5
U.S. Treasury and Agency Securities2 13,081 329 2,485 23.4
OtherSecurities2 7,542 68 - 320 - 4.0
Total Deposits 212,335 3,439 8,603 4.2
Demand Deposits 59,413 2,996 7,528 14.5
Demand Deposits Adjusted3- 39,977 406 5,778 16.8
OtherTransaction Balances4 18,972 179 4,249 28.8
Total Non-Transaction Balances6 133,950 265 - 3,173 - 2.3
MoneyMarket Deposit
Accounts-Total 46,682 - 87 860 1.8
Time Deposits in Amounts of
$100,000 or more 32,004 164 - 5,780 - 15.2
Other Liabilities for Borrowed MoneyS 25,227 - 1,959 - 485 - 1.8
Two Week Averages
of Daily Figures
Reserve Position, All Reporting Banks
Excess Reserves (+)/Deficiency(-)
Borrowings
Netfree reserves (+)/Net borrowed(-)
Period ended
12/15/86
10,054
4
10,050
Period ended
12/1/86
93
23
70
1 Includes loss reserves, unearned income, excludes interbank loans
2 Excludes trading account securities
3 Excludes u.S. governmentand depository institution deposits and cash items
4 ATS, NOW, Super NOW and savings accounts with telephone transfers
S Includes borrowingvia FRB, TT&L notes, Fed Funds, RPs and other sources
6 Includes items not shown separately
7 Annualized percent change

The shift to services

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The shift to services

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