Services: Slowed but Still Strong

November's poor showing for job creation masks some key points: This sector has held up quite well and should grow sharply again soon

By Margaret Popper

For years the U.S. economy has been shifting from manufacturing to services. The way the government measures output, manufacturing still accounts for about half of gross domestic product, but when it comes to employment, 82% of Americans work at service-producing jobs. So the noticeable slowdown in service-job creation in November, according to the Labor Dept.'s Dec. 6 report, seemed more worrisome than a decline in manufacturing jobs. If employment in the services sector were to collapse, the U.S. would almost certainly fall into a double-dip recession.

Luckily, employment is a lagging indicator and is but one clue to how service businesses are holding up in a sluggish economy. By other measures, services came through the recent recession much better than manufacturing and are expected to rebound sharply when the recovery gains steam. Pricing for services has held up better than prices for tangible goods, and GDP growth from services has been more stable.


  Of course, services include everything from retailing to banking to health care to airlines, so some pockets are doing better than others. But overall, the economy's service side helped keep the recession shallow and is the foundation of the current -- albeit slow -- recovery. "The services sector has some crosscurrents going through it, but it's not where you see the big volatility in final demand like in auto and capital-goods manufacturing," says Richard Rippe, chief economist at Prudential Securities. "The general trend in services is upward."

One of the biggest differences between services and manufacturing in this recession was in pricing. During an economic slowdown, demand for goods and services drops. In reaction, sellers usually lower prices to maintain sales. The consumer price index (CPI), which measures monthly price changes for a variety of goods and services, reveals where slower demand has had the biggest effect on pricing.

In the 12 months ended Oct. 31, the cost of services outside of the energy sector rose by 3.7%. During the same period, durable-goods prices dropped 2.4%, the cost of clothes fell 2.1%, and the cost of personal computers and peripherals plunged 21.6%. Reading between the lines, service providers have been able to continue to raise prices despite the effects of the 2001 recession. "If you take the CPI and split it into goods and services, in the past couple of years the lines have diverged dramatically," says Rippe.


  The ability to raise prices helped maintain wage growth among services producers. The average weekly earnings of employees in the private-services sector rose by 3.8% in the 12 months through November, according to Labor Dept. data. By comparison, private-goods producers saw their average weekly wages rise only 2.2% during this period, almost a third less in percentage terms than the 3.2% average wage gain in the private sector overall.

Even where employment is concerned, hiring among service companies abated only recently. For the 12 months through November, the economy shed 710,000 jobs among goods producers, which include manufacturing, mining, and construction. Service producers added 498,000. Granted, November data were disappointing compared to October: Services added 11,000 jobs, vs. the 86,000 created in the previous month. In November, 51,000 goods-producing jobs were lost, following a loss of 80,000 jobs in October.

The slower hiring reflects some of the underlying seasonal factors that affect different service industries. The big loser was retailing. Payrolls in that sector shrank by 39,000 jobs. "Some of that may be the effect of seasonal adjustments," observes Ethan Harris, co-chief economist at Lehman Brothers. "Since Thanksgiving was late this year, retailers started hiring a week later than they did last year for the holiday season." Harris estimates that anomaly lowered the retail payroll tally by about 10,000 employees.


  Although retailers have taken a conservative approach to hiring this Christmas season, the first round of post-Thanksgiving sales was quite strong -- a trend that may continue to the surprise and delight of retailers. "Consumer spending is one of the stable elements of this economy," says Harris.

Consumers also helped prop up the financial-services sector, which has been able to hire and raise wages during the last two years. A big piece of that hiring came from the need to add mortgage lenders and processors. Mortgage rates have come down nearly 5 percentage points with the Federal Reserve's monetary easing that began in 2001. Consumers were able to refinance the debt on their homes and take out cash to pay for their purchases.

For the 12 months through November, 57,000 mortgage bankers started work. Banks, insurance companies, and real estate firms added 70,000 new jobs during that period. Even as the financial sector added jobs, its profits rose by 31% year-over-year through the third quarter, according to Commerce Dept. statistics.


  However, the upward swing for financial services may be petering out. For one thing, the refinancing boom is fizzling, so all those new mortgage lenders may find themselves looking for work again. At the same time the securities industry is likely to announce further layoffs after two years of dragging profits. "Securities and commodities brokers are gradually shrinking," says Lehman's Harris. Fortunately, financial services represent only about 7% of services employment, and securities brokers make up only about 9% of total financial services employment.

Unlike financial services, however, health-care services appear to be almost recession-proof. The sector has seen job creation and price increases continue unabated over the last two years. On average, medical-care services cost 5.4% more in October than they did a year earlier. In many areas, health-care professionals, particularly nurses, are in short supply. These shortages persist despite the addition of 278,000 jobs in health-care services in the 12 months through November.

While health-care growth is driven more by demographic trends, such as the aging population, and technological trends, such as new treatments for stubborn diseases, the recession has had some impact on the industry. With rising unemployment comes an increase in the number of people who aren't covered by medical insurance. The uninsured are more likely to postpone treatment in the current environment. But that pressure hasn't yet slowed demand for health care much.


  Transportation services have had a tougher road to travel than health care in 2002, but the drop in jobs has been balanced with some significant price increases. The sector, which includes railroads, trucking, air, water, and pipelines, lost 67,000 jobs in the 12 months through November. The airline industry's restructuring accounted for almost half of that. At the same time, tranportation-sector prices rose 3.7%, well above the national average of 2%.

One of the worst-faring services industries was communications, where prices fell by 1.5% in the 12 months ending October, 2002. Most of that was due to consolidation in an industry plagued by overcapacity. Communications service providers cut 109,000 jobs from November, 2001, to November, 2002. Small wonder the companies that make equipment for these providers are also floundering.

While services industries aren't completely impervious to recession, they tend to resist it better than manufacturing. And that should hold true as this economic recovery gains momentum. By the middle of 2003, Lehman's Harris expects services to be adding positions at a 100,000 to 200,000 a month clip, while manufacturers will show barely any job growth. Unlike those in the services sector, he says, "a lot of the job losses in manufacturing won't be recovered."

Popper is a finance writer in New York

Edited by Beth Belton

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