Federal Reserve Bank of Cleveland June 15, 1986 ISSN 042H-1276 The Emerging Service Economy by Patricia E. Beeson and Michael F. Bryan "I wish you wouldn't squeeze so, " said the Dormouse, who was sitting next to Chart 1 Real Output by Sector Chart 2 Employment by Sector her. "I can hardly breathe. " Billionsof 1982 dollars Millions "I can't help it, "said Alice very meekly, 2400 66~--------------------~ "I'm growing. " "You've no right to grow here, " said-the Dormouse. "Don't talk nonsense, r s said Alice more boldly, "you know you're growing too." "Yes, but I grow at a reasonable pace, " said the Dormouse, "not in that ridicu- lous fashion. " -Alice's Adventures in Wonderland Alice and the Dormouse in Lewis Carroll's classic story offer a lesson about human nature that can be ap- 1955 1960 1965 1970 1975 1980 plied to our economy. 800r------------ ••...••• Change often produces uncertainty 600 1955 1960 1965 1970 1975 1980 and anxiety. When the economic envir- onment changes, our anxieties are fre- quently reflected in political and legis- 18~ lative action. 1955 1960 1965 1970 1975 1980 ~ So it is with the emerging service 13 1955 1960 1965 1970 1975 1980 economy. Over a long period of time, ;o~man,ufact~red ~ood~ the U.S. economy has become increas- l ingly oriented towards the production 1955 1960 1965 1970 1975 1980 4 1955 1960 1965 1970 1975 1980 and employment of services, while SOURCE: U.S. Department ofCommerce, SOURCE: U.S. Department ofLabor, moving away from more traditional Bureau ofEconomic Analysis. Bureau ofLabor Statistics. goods-producing industries. As the transition continues, legislative policies designed to protect goods producers I Wish You Wouldn't Squeeze So In 1950, total employment in the U.S. have become more popular. Since 1945, our economy has undergone was 48.5 million workers. By 1984, it This Economic Commentary exam- some dramatic changes; total employ- had almost doubled to 91.1 million. Vir- ines the expanding service economy ment has nearly doubled and real out- tually all of the increase (90 percent) and suggests that its emergence is not put has increased almost threefold. was in the service-producing indus- something to be feared. Rather, service While there have been increases in both tries. The majority of the remaining sector growth reflects a natural-and output and employment in all three employment gains occurred in manu- inevitable-response to rising wealth. major sectors of the economy (manufac- facturing, with only slight gains in turing, non manufacturing goods, and nonmanufactured goods employment services), the largest gains occurred in (agriculture, mining, and construction). the service sector (charts 1-2). Patricia E. Beeson, a visiting economist at the The views stated herein are those 0/ the authors Federal Reserve Bank 0/ Cleveland, is on leave and not necessarily those 0/ the Federal Reserve from the University 0/ Pittsburgh, where she is Bank 0/ Cleveland or 0/ the Board 0/ Governors 0/ assistant professor, department 0/ economics. the Federal Reserve System. Michael F. Bryan is an economist at the Federal Reserve Bank 0/ Cleveland. The authors would like to thank Katherine Barnum lor her research assistance. industries showing above-average real Changes in the types of goods the since they represent a higher-order of consumption than food, which is a Chart 3 Shares of Gross National output growth rates include utilities, economy produces have also increased Table 1 Output and Employment Growth by Service Industry Product wholesale trade, and other services the demand for intermediate services. Average Annual Percentage Change, 1950-1985 basic, low-order consumption item. Percent (primarily health care and business Increased incomes and expanding However, productivity gains were services). Employment growth in servi- markets have resulted in more product Industry Output (1982 dollars) Employment most prominent in the farming sector, ces has been paced by the health care differentiation that, in turn, has All services 3.7 2.5 rising at an average annual rate of 4.8 and business service fields, and has increased the importance of services in percent over the same 38-year period. been above average for the finance, the design, production, advertising, and Communications 6.7 (1) 1.8 (6) Nonfarm productivity rose at a lesser insurance, and real estate industries. distribution of these goods. Because of Utilities 5.5 (2) 1.4 (7) 1.9 percent per year. As a result, the :~I55 1955 1960 1965 1970 1975 1980 the gains from specialization and econ- Other services 4.4 (3) 3.3 (1) substitution effect probably encouraged Wholesale trade 4.3 (4) 2.1 (4) the growth of farming relative to non- 30 omies of scale in the provision of these I Can't Help It, I'm Growing services, proportionately more of these FIRE* 3.7 (5) 3.2 (2) farm businesses. Retail Trade 3.0 (6) 2.3 (3) Overall, the income and substitution We can identify a number of likely services are being provided by special- Government 2.3 (7) 2.1 (5) sources of service-sector growth: the ized firms in the service sector rather Transportation 1.7 (8) 0.4 (8) effects in the farming sector tended to growth in the demand for services in the than being provided in-house by firms *Finance, insurance and real estate. offset each other. Nonetheless, the sub- production of goods, increases in U.S. in the goods-producing sector. SOURCE: U.S. Department of Labor, Bureau of Labor Statistics. stitution effect in this case was likely wealth, relative price adjustments be- While increases in the demand for to be weaker than the income effect, tween goods and service industries, and intermediate services have contributed since it is commonly believed that the changes in labor force demographics. to the increased service-sector activity, simply, consumption of most goods and Consumers are thus encouraged by influence of relative prices on food con- Many service industries produce so- exact figures concerning their contri- services increases in response to a pro- lower prices to consume proportion- sumption is very small." called intermediate services. These are bution to the overall growth of the ser- ductivity improvement, but there is ately more goods and services produced The evidence from farm output is services used for the prod uction of vice sector are not available. Based on also a shift in this consumption toward by industries that have the largest pro- consistent with the story outlined goods, such as computer, engineering, an examination of input-output tables an increasing proportion of luxury ductivity gains and to consume propor- above. Generally, since 1947, real U.S. SOURCE: U.S. Department of Commerce, legal, accounting, and advertising ser- of the U.S. for 1947-1977, however, we goods and services. tionately less goods produced by indus- farm output has risen, in an absolute Bureau of Economic Analysis. vices. Over time, the value of interme- estimate that only about 15 to 20 per- The distribution of necessities and tries with low productivity growth. sense, by about 1.1 percent per year. diate services as a percent of the value cent of the overall growth of the service luxuries is probably not even between Economists call this the "substitution But real output by nonfarm businesses of goods has been increasing, rising sector during this period can be attrib- goods-producing and service-producing effect" of a productivity change. rose, on average, at a 3.4 percent Similarly, almost 70 percent of our from 29 percent in 1947 to 37 percent in uted to an increase in intermediate ser- industries. For example, the goods pro- The effect that productivity annual pace. As a result, the share of increased production since 1950 has 1977.2 In much the same way, the rela- vices. While this represents a signifi- duced in agriculture, construction, and advancements have on the distribution farming to total U.S. business output occurred in service industries. The tive growth of the manufacturing sec- cant increase, other factors, namely mining can probably be categorized as of national output by industry depends was reduced by more than 50 percent goods-producing sector, far from stag- tor during the industrial revolution changes in U.S. productivity, are prob- those that satisfy basic, lower-order upon the combined influence of the in the postwar period, dropping from nant, however, nearly doubled its out- was partially the result of shifting the ably more powerful explanations for needs. Manufacturing industries, how- income effect and the substitution about 5.6 percent in 1947 to only 2.4 put, primarily in U.S. manufacturing. provision of farming inputs from the growth of the service sector. ever, are typically thought to produce effect. If the production of higher-order percent last year. As a result of this growth, our econ- farmers to manufacturers." As a nation's average productivity goods that satisfy a somewhat higher goods occurs in industries that are Income and substitution effects may omy has been transforming-from one When the market for specialized busi- rises, it becomes wealthier in the sense order of needs; consequently, we expect experiencing the greatest productivity also explain the changes in the distri- where two of every five workers were ness services was small, these services that it can now enjoy more goods and these industries to develop after the gains, this industry will unambigu- bution of national output between ser- employed in the goods-producing sector, were either provided in-house by firms, services for the same amount of nonmanufactured goods industries. On ously increase its share of a nation's vices, manufactured goods, and non- to one where only about one of every or they were not produced at all.