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Jobs in a changing American economy: there have been dramatic shifts in the share of manufacturing and service industry jobs since the end of World War II. Understanding past patterns of employment growth can help us understand employment patterns going forward.

ECONOMIES TRANSFORM OVER TIME. Our economy certainly has, and continues to do so. One recent transformation in the United States was the emergence of the so-called new economy during the late 1990s, when productivity accelerated. We hear about the new economy much less these days than before the high-tech bust and the recession. But is this because our economy has reverted back to its old form or because the new economy never happened? * One cannot help but be a skeptic about the new economy hypothesis. Productivity growth rates have hit impressive levels since November 2001, the official end of the last recession, yet job cuts continued through 2003 and, in some manufacturing industries, even through early 2004. * When employment finally increased in September 2003 for nonfarm businesses as a whole, it did so at a snail's pace. A much-anticipated resurgence in jobs finally showed up in the March payroll survey. Employment grew in March by 337,000 and then in April by 288,000--levels that are characteristic of a typical (and sustainable) recovery. We expect an increase of 200,000 to 300,000 jobs a month over the next several months as the economy firms up. * The monthly change in total employment, a widely used economic indicator, hides the dynamic nature of U.S. labor markets. The figure--net gain or loss in jobs--is a summary measure of hires, resignations and layoffs; of closings and starts; restructuring of operations; and in general, an adjustment or reallocation of labor resources within a firm, within an industry, across sectors and across geographical areas (i.e., local communities, states and international borders). All of these developments occur both in a given month and over time in ways that alter the structure of the economy. * Over time, the U.S. employment base has shifted from manufacturing to services. This transformation has provoked a slew of studies and debates tackling interrelated issues. They include the decline in manufacturing jobs, the rise of the service sector, the slowdown in productivity growth (in the 1970s, before talk of the new economy), the role of technology and the more muted business cycle.


We explore some of these issues in this article--the second of a three-part series on jobs. In particular, we discuss the underlying dynamics in the economy's structural transformation and the implications for American jobs and the economy as a whole.

The mortgage sector is an active player in this debate, as its members do things like adopting offshore outsourcing as a business strategy. The issues we present here serve as an introduction to the third article in this series, which will focus on changes in the financial services industry in general and mortgage lending industry in particular, and analyze employment from a microeconomic perspective.

A service economy

Currently, the vast majority of U.S. workers--more than 82 percent of the working population--is employed in the service sector. In contrast, more than 16 percent are employed in the industrial sector, and less than 2 percent in agriculture.



This was not always the case. One hundred years ago, in the early part of the 20th century, the structure of employment dramatically shifted from agriculture to industry. In the decades following World War II, the U.S. economy transformed again, this time from industry to services.

Since 1945, the total number of employees in the service sector has increased from 25 million to 109.3 million, according to the Bureau of Labor Statistics' (BLS') Current Establishment Survey (CES)--more commonly referred to as the payroll survey. Correspondingly, as a share of total nonfarm employment, the service sector has increased from 60 percent in 1945 to the current 83 percent.

Manufacturing, which is the largest component of the industrial or goods sector, employed 13.5 million in 1947 and peaked in 1979 with 19.5 million employees, but has since reduced employment to 14.5 million. Not surprisingly, the share of manufacturing in total nonfarm employment declined from 33 percent to 11 percent. Figure 1, which plots the levels of employment, and Figure 2, which plots the shares, show that the service sector has absorbed more and more of the working population.

The service sector is composed of the following BLS-defined supersectors: (a) trade, transportation and utilities; (b) information; (c) financial activities; (d) professional and business services; (e) education and health services; (f) leisure and hospitality; (g) other services; and (h) public administration. We plot the employment in seven services sectors in Figures 3 and 4. The upward trend across the post-war period is evident in all service sectors.



The goods sector is comprised of manufacturing, construction, and natural resources and mining. Employment in construction has trended upward over time, as in services, while manufacturing and mining jobs have both slowed since about the 1940s (see Figure 5).

Production, broken into the goods and services sector, also shows a similar rise in share of services and decline in share of goods sector in total production. Indeed, the United States now has a service-based economy.


Why have these structural transformations occurred? The principal force influencing the labor reallocation across industries has been innovation.

Technological advances have had a tremendous impact on the goods-producing industries (agriculture and manufacturing), as erstwhile labor-intensive processes now use proportionally more capital (machinery, equipment and structures). The nature of the product in the service sector--that is, service--made it less prone or even impossible to adapt new technology to improve efficiencies and production. Services need the human touch, so innovation in the form of rapid rates of specialization is the driving force in the rapid growth in jobs in services.

Technological change can lead to the introduction of new products, new production techniques and reductions in the cost of capital. As industries transform--for example, a new industry produces a product (computers) that substitutes for an older one (typewriters)--labor will tend to reallocate across sectors, moving toward new industries. Automation results in a different kind of substitution--that of capital for labor.

When demand for labor falls in industries from labor-saving techniques and capital, redundant labor is released and becomes free to move into expanding industries.

Profound push-and-pull factors have had to work together for the two waves of transformation in the employment structure of the United States.

Prior to the 1910s, the United States was predominantly agrarian. The first round of technical advances moved labor out of agriculture and into nonagricultural activities. Machinery was substituted for animals as a power source, for example. Both the goods sector and service sector benefited from the released workers.

(To paint a compelling picture of this first wave, following is a story from the childhood of one of the authors of this article: Doug Duncan, currently employed in the service sector. It dramatically illustrates the tractor saving the day.)

I often tell people that on the farm on which I grew up in rural Minnesota we burned wood for heat, and when I was very young we hauled that wood with a pair of Clydesdale draft horses. When I was 10 we got a tractor to do the work of the Clydesdales--a significant change of technology. For me it was particularly significant in that I was in charge of emissions control on the Clydesdales.

Other discoveries and developments such as chemical fertilizers, weed control, irrigation methods and other automation, and seed genetics have resulted in better and larger yields while requiring less and less labor inputs.

While innovations were being implemented in agriculture, the industrial sector--composed of manufacturing, mining and construction--developed. Initially, the industrial sector was labor-intensive. It required huge labor resources to manufacture new consumer products such as automobiles and new raw materials and machinery to build roads, factories and utilities.

Back then, the industrial sector absorbed labor released from farms faster than the service sector. And from the 1910s through the 1930s, as America industrialized, it was the industrial sector that was the employment base of the economy.

The second wave of labor reallocation involved workers moving from manufacturing into services. Again, as innovations created new goods for capital and improved production processes, manufacturing had to shed jobs, and the expanding service sector was more than willing to take them in.

Rapid rates of productivity were realized reducing labor demand and boosting production in the manufacturing industries.

To be sure, the service sector is older than the manufacturing sector. Even though there were doctors, teachers, shopkeepers and lenders well before the industrial revolution, those service activities were not organized in such a way that they constituted an industry. According to Webster's Third New International Dictionary, an industry is "a group of productive or profit-making enterprises or organizations that have a similar technological structure of production and that produce or supply technically substitutable goods, services or sources of income."

It is no wonder, then, that among service-oriented activities, the first ones to be recognized--and be counted--were transportation, communication and utilities. Service industries that provided supporting services to the manufacturing sector benefited from technology and had become capital-intensive themselves.

After World War II, the movement toward specialization transformed traditional services into industries as we know them today. Rapid growth of the U.S. population put demand pressures on all sectors, but it was more striking in the service sector. Services required more and more labor resources, even highly skilled workers.

Retail and wholesale trade developed as separate industries from manufacturing. Tasks such as accounting, previously performed in-house, moved out of manufacturing companies and into business service industries.

Specialization transformed jobs in industries such as education and health-care services. Professional (or white-collar) activities multiplied. As an example, in health care, new occupational titles were created as physicians and specialists necessitated a larger support base of medical technologists, physician assistants, nurse practitioners, medical transcriptionists and the like.

Credit markets (and financial markets as a whole) matured as industries themselves as well as in support of other sectors that required funding for capital investment projects. Expanding corporations as well as startups in manufacturing, mining and transportation needed new machinery, equipment and buildings. Financial innovation created more and more complex financial systems that necessitated sophisticated, knowledge-based professions in banking, investment companies and other business-oriented services.

R & D and the high-tech sector--the next wave?

Because innovation has been key to the transformation of the employment structure of the U.S. economy, it's reasonable to expect that the next wave will be in sectors where innovations are more likely to originate.

Research and development (R & D) activities play an important role in product development. Businesses experiment with different ways of doing things. Because of the relentless competition they face, they are constantly trying to find ways to generate more output from the same amount of input or the same level of output with less input.

Although research centers have already emerged as independent industries, in-house departments in corporations (both goods-oriented and service-oriented) still exist. But there are tremendous pressures for the R & D departments to increase value-added. We will likely see more R & D activities contracted out.

We are also witnessing the transformation of technology industries into an important, distinct sector. High-technology industries, including computers, Internet and telecommunications, are found in the goods sector as well as the service sector. The American Electronics Association (AeA), a high-tech trade association headquartered in Washington, D.C., and in Silicon Valley, California, defines the high-tech industry as a "maker/creator of technology, whether it be in the form of products, communications or services."

AeA has identified 49 North American Industry Classification System-based (NAICS-based) industries to comprise the high-tech sector: 30 in manufacturing, seven in communications services and 12 software and tech services.

It is in the knowledge sector--which encompasses industries in high-tech, R & D and research centers--where we are beginning to see rapid changes in employment and production.

Furthermore, the products in this knowledge sector are transforming services into goods and goods into services. Digitization has essentially transformed information, entertainment and training into goods, as they are packaged into CDs, DVDs and Web servers--essentially the mass production of services. Technology has also enabled manufacturers to customize their goods, fashioned much like in the service sector. Mass customization is making waves in the apparel industry. For example, in 1999 Levi Strauss & Co. introduced its "Personal Pair" custom-fit jeans using body-scanning technology. And Lands' End has begun offering custom-fit shirts and pants through its Web site.

The next wave of transformation in the employment structure of the economy will therefore pit this knowledge sector against the rest of the economy, as the knowledge sector develops and its products evolve. But for these future changes to become more apparent, it is necessary to abandon the goods-versus-services frame of thinking.

International labor reallocation

Labor-intensive activities such as in the apparel and leather goods industries have lagged behind the rest of the manufacturing industry during the second wave of transformation from industrial to services.

But as international markets opened up, a new type of reallocation of labor occurred, an international one. U.S. manufacturing firms have moved or contracted out some of their labor-intensive operations abroad. Increasingly, operations in service-oriented industries are also moving abroad.

Changes in trade policies have permitted some U.S. companies to become multinational companies (MNCs), and foreign companies to come to the United States. The MNCs have provided jobs where they have set up shop. Likewise, Japanese and German automakers, for example, in the United States provide thousands of jobs to Americans. Manufacturing industries in different nations have expanded their markets abroad.

Business innovations and trade policy are key movers of the changes that are taking place in the world market. Cost pressures and other factors in the United States have induced companies to tap abundant resources abroad. These resources include labor as well as capital and raw materials.

Input costs help drive the process. If a firm finds the price of one of the inputs in its production process is increasing in an environment where it can't change the price it charges for its final product, it will start searching for a substitute input or alter the production process to use less of the higher-cost input. Thus, price disciplines the company to conserve resources through substitution or efficiency gains.

Moving operations offshore or contracting out to foreign companies can make good business sense. However, the recent loss of jobs (including programmer jobs) by Americans to their foreign counterparts has increased the clamor for trade policy reform. Economists, backed by the law of comparative advantage, will tell everyone that it would be a big mistake for the United States to impose new trade barriers. Constructing trade laws is certainly not an easy task for policy-makers, because the (net) gains from freer trade are easier to understand in a theoretical sense but hard to measure in the real world.

A more stable economy

The transformation to a service-based economy is believed to be a factor in the stabilization of business cycles. Generally, service industries are less volatile than goods industries. Thus the economy has shifted its employment base toward the more stable services sector, which implies more stable jobs.

Looking back at the charts of employment, we see how there have been pronounced fluctuations in manufacturing and in construction jobs (see Figure 5) that are not evident in services (see Figure 1).

Take a look at employment growth from some other angles (see Figures 6, 7, 8 and 9). First, we compare year-over-year changes in employment between the goods sector and the service sector (see Figure 6). This shows that during economic recessions, employment in the goods sector declines, as firms cut jobs. Employment growth in services does not indicate widespread slashing of jobs; instead we see a slowing in the growth of the services work forces (the graph barely crosses the axis into negative territory).

But there are differences across services. Employment in education and health services seems to be resistant to economic downturns (the graph still shows an upward trend--see Figure 7). In contrast, employment in information services mimics employment fluctuations in the goods sector (line repeatedly moves into negative territory--see Figure 8).

This isn't surprising, as industries that are closely integrated with manufacturing (trade, transportation and utilities) or have products that feature similar characteristics as manufactured products (information services) seem to respond to business downturns as manufacturing industries do (see Figure 9).



While analysis of business cycles is not the focus of this article, we learn something relevant from this exercise. The insight is that the volatility in manufacturing industries--and those that are integrated with them or have similar production methods--has important implications for the study of the business cycle. Moreover, the stability in services seems to point out that income elasticity of demand for services seem to be smaller than commonly thought. Some services have become less of a luxury and are perceived as more of an everyday necessity. Thus, consumers purchase them regardless of how well the economy is doing.

Productivity prospects

The driving force behind labor migration and the disappearance of jobs is productivity gains. Labor moves from a sector that is experiencing gains in productivity to a sector with low productivity. The most recent wave was from manufacturing to services. But the emigration of jobs from manufacturing is not over. We can expect the share of our labor force employed in manufacturing to continue to decline, but real manufacturing output will most likely continue to increase (see Figure 10).

Overall labor productivity growth rates have averaged about 1.6 percent annually from the 1970s through the mid-1990s, compared with the average growth rate of 2.8 percent a year for the two decades prior (see Figure 11). So the argument goes: If annual labor productivity growth in manufacturing has averaged 2.5 percent from 1950 through the mid-1990s, then the growing service sector must be responsible for the deterioration in overall productivity from the 1970s through the mid-1990s.



First, the surge in overall productivity in the latter half of the 1990s--which signaled to many the transformation into the so-called new economy--occurred despite the full-blown service sector.

Second, labor productivity growth in some--but not all--service industries is slow. Improvements in productivity cannot be achieved in services as readily as in those industries that use machinery and equipment on a large scale, because services are labor-intensive by nature. Labor cost-cutting measures have been difficult to apply in service industries to date. There is not much room for productivity enhancement there.

That is not to say that efficiencies are nonexistent in services or will not increase over time. Improvements in the quality of services are better measured in ways other than output per hour worked. However, alternative methods are unique to each product and cannot be generalized across all service industries. Therefore, little insight has been obtained from them for the economy as a whole.

Third, the argument that the United States would have been growing at double-digit rates had it maintained a manufacturing-based economy may be true mathematically. But why would one try to control the movement of labor out of manufacturing into the expanding service sector? Especially since those jobs were made redundant through automation and the resulting boost in productivity has been beneficial to the economy.




Final thoughts

The dramatic shift in employment toward services-providing industries and away from manufacturing has been driven by innovation. The United States became the first service economy, but other advanced economies followed suit. They experienced the same benefits from technology and modernization of processes and financial systems.

Our economy's transformation did not cause it to lose its superpower role just because it ceased to have a dominant industrial or goods sector. Instead, we have transformed previously unorganized activities into efficient and mature service industries, and created new jobs as specialization spread. Having a service-based economy means more stable jobs and more muted business cycles.

Veronica Cacdac Warnock is senior economist and Douglas G. Duncan is senior vice president and chief economist for the Mortgage Bankers Association (MBA).
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Title Annotation:Economic Analysis
Author:Warnock, Veronica Cacdac; Duncan, Douglas G.
Publication:Mortgage Banking
Geographic Code:1USA
Date:Jun 1, 2004
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