Full text of Chicago Fed Letter : Services Also Slow Down, No. 36

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ESSAYS O N ISSUES

THE FEDERAL RESERVE BANK
OF CHICAGO

A U G U S T 1990
N U M B E R 36

Chicago Fed Letter
Services also slow down
The issue of inflation dogs economic
policy. Pro-growth policies generate
inflation and that damages the econ­
omy in the long run; but anti-infla­
tion policies are anti-growth. Thus,
policymakers face an unforgiving
Catch-22, recently made worse, some
say, by a new “ m enace,” an inexo­
rable economic juggernaut called
services.

1.

Manufacturing prices com e dov jr»

c fp n K v c tp n

percent change from previous year
30

Crude

I Intermediate ^
10

1
0

Finished

------- % m — ---------------

-10

Services are immune to the normal
logic of economics, the story goes.
They continue to grow no m atter
what happens, and have an insatiable
appetite for labor. Worst of all, serv­
ices prices continually increase in
good times and bad, creating an
unstoppable wellspring of inflation.
O f such things are policymakers’
nightmares made.
It is easy to see the origins of this
story. Inflation began to heat up a
bit in the late 1980s, and monetary
policy was adjusted to push it back
down. The goods side of the econ­
omy responded right on cue. Figure
1 shows the year-over-year growth in
the Producer Price Index, less food
and energy, by stage of production.
With a clarity rare in economics, this
graph shows the slowdown’s steady
progress through the goods sector
pipeline. Crude goods inflation—
the most sensitive—began to move
downward in early 1988 and is now
actually in deflation. Intermediate
goods inflation followed suit in late
1988 and is now essentially zero.
Final goods inflation is now in the
process of slowing.
But, the service sector just keeps
marching on. W hether you look at
services inflation or services wages,
there is no sign that the current slow­

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down is having any effect at all, as
Figure 2 shows. The wage picture
seems especially worrisome. Services
have a miserable record of productiv­
ity growth so that there is little imme­
diate hope that these wage pressures
can be offset by productivity en­
hancement. Thus, the escalating
services wages may imply even worse
things to come in services inflation.
With trends such as these, it is easy to
see why some analysts wonder if any­
thing can be done to reverse the
current trends in services inflation,
short of a dramatic wrenching of the
economy.

1 987

1988

1987

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1990

But reality is less clear

This big picture, however, misses
much of the reality of the current
situation. Services and other related
categories are not as independent of
macroeconomic forces as the aggre­
gate numbers would indicate. Two
factors have obscured this in the
1980s. First, timing, as was once said
of a famous basketball player, “ It
wasn’t so much that he disobeyed
the law of gravity, he was just a bit
slow in obeying it.” Services simply
tend to respond slowly. Second,
rapid growth in some specific indus-

1989

19 9 0

tries have distorted the aggregate
numbers.
Figure 3 shows a breakdown of re­
cent trends in employment in spe­
cific services industries and related
areas. The signs of slowdown are
unmistakable. Finance, insurance,
and real estate are clearly showing
the strains of a slower economy. Res­
taurants and departm ent stores have
been cutting back their growth for
some time. The cutbacks in the
banking and brokerage industries—
not to mention S&Ls—have been
widely reported. Even taken as a

continued pressures on the wage and
price side? Part of the answer, once
again, is that changes take time to
work their way though the economy.
And wages, especially, adjust very
slowly to new circumstances. This
resistance to change was part of the
reason that the adjustments in m anu­
facturing in the early 1980s were so
wrenching. And while manufactur­
ing firms and their employees
learned greater flexibility during
those hard years, the service industry
was spared much of the hardship—
and the learning.

sures have been easing recently, even
though health services wages con­
tinue to skyrocket. If health service
workers, who are included in the
private sector service numbers, were
excluded, private service wages
would show an even greater fall in
growth. The benefits side is still
clearly a problem, but this added
pressure is a combination of social
security taxes and medical insurance
costs. The social security tax trend
will probably not continue to rise.
And the medical insurance costs are
just the problem of escalating health
care costs in another guise.
The state and local government sec­
tor is the other force pushing up
services wages. This sector is heavily
dom inated by health care and educa­
tion workers. As Figure 5 points out,
wages for these workers have been
rapidly escalating. Part of this repre­
sents, of course, health service work­
ers, but another part is caused by the
deliberate public policy in many
areas of raising teacher salaries to
attract better teachers. If you pay
higher wages, labor costs go up.

whole, services growth has slowed
noticeably in the last year.
Services do feel the pinch of recent
events. In the go-go days of financial
services and real estate, services
seemed untouchable. For not only
did these industries grow rapidly,
they fed on each other and pulled
other services such as legal services
and restaurants along. But junk
bond problems, the thrift debacle,
problems in real estate in the North­
east, and the market crash have all
combined to bring services back to
reality.
Services wages head skyward?

But if services are slowing, then the
question remains: Why are there

But, in fact, services wage pressures
have fallen. It is just that two sub­
sectors are pushing the average up—
health services and state and local
government. Careful analysis of the
Employment Cost Survey indicates
that if health care and education
could be separated from the rest of
services, the wage story would be
much better. Unfortunately the
numbers are not collected in a way
that allow this. Nevertheless, insight
can be gained by looking at some of
the detailed statistical series.
Figure 4 shows wages and total com­
pensations for private service work­
ers, thus excluding state and local
government employees, and for pri­
vate health service workers. As can
be seen, private service wage pres­

Thus, in the services sectors where
economic factors have reasonable
play, wage pressures have declined.
However in those sectors where the
normal forces of supply and demand
have at best indirect effects, such as
in our current health care system and
in the government sector, they have
not.
There are good reasons for some of
the resistance to the usual economic
laws. Well-qualified teachers are
necessary to maintain the United
States’ long-run competitiveness on
the international scene. This is a
goal worthy of non-trivial sacrifice.
Furthermore, these wage pressures
will not in all likelihood be a con­
tinuing problem; once wages for
teachers are adjusted to the desired
relative level, education wage in­
creases may be expected to slow.
And given the current fiscal situation
of most state and local governments,
those governments will likely be
forced to hold the line on wages
sooner rather than later.

Price Index inflation, less food and
energy, in the 12 months ending in
May 1990 was 4.7% compared to
4.6% in the 12 months ending in
May 1989 and 4.3% in the 12 months
ending in May 1988. Services infla­
tion was 5.2%, 5.0%, and 4.4% for
the same periods. Certainly a some­
what greater increase, but not that
much different. Taking health care
services out only reduces services
inflation to 4.9%, 4.8%, and 4.2%.
Inflation simply has not moved very
much in any direction since 1983,
except for the 1986 oil price col­
lapse.

4. Service wages are f BSi“ » »—
percent change from previous year

Service-producing private industries
C o m p en sa tion

C o m p en sa tion

Health industries

The bottom line

The health care system has some
special problems. AIDS and the drug
crisis have put large and fast growing
burdens on the health care system.
New technologies that have saved
lives and improved the quality of life
for many people are enormously
expensive and require highly trained
workers. These factors create real
costs that society must bear either
though taxation or higher medical
prices.

are higher, in part, because insur­
ance now covers a broader, more
expensive set of medical treatments.
Beyond that, the growing needs of
individuals without insurance raise
prices. Hospitals must cover their
costs. If the government does not
directly reimburse the hospitals, the
added cost goes into hospital over­
head. This higher overhead, in turn,
becomes part of the cost of medical
insurance.

Simply put, as new demands are put
on the health care system, prices
climb. Medical insurance premiums

But, the basic problem should not be
overstated. Services have not caused
a major problem. The Consumer

The services sector is slowing. Those
who are depending on services to
forestall recession should not rest
easy. On the other hand, those who
feel that a recession will be necessary
to bring services inflation under
control should practice patience.
Net of health care costs, wage pres­
sures are falling and the services
sector is responding to monetary
policy. Like the basketball player
who seems to defy gravity, the serv­
ices sector will come down to earth.
—Steven Strongin

M&M

WW*

___ _

K a rl A . S c h e l d , S e n i o r V ic e P r e s i d e n t a n d

1

5. Government wages are still headed up

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E d w a rd G . N a s h , E d ito r.
p ercen t change from previous year
7

C hicago F ed L e tte r is p u b l i s h e d m o n t h l y b y t h e
C o m p en sa tion

R e s e a rc h D e p a r tm e n t o f th e F e d e ra l R eserv e
B a n k o f C h i c a g o . T h e v ie w s e x p r e s s e d a r e t h e
a u t h o r s ’ a n d a r e n o t n e c e s s a rily th o s e o f th e

6

W a g es and
salaries

F e d e ra l R e s e rv e B a n k o f C h ic a g o o r th e
F e d e r a l R e s e rv e S y ste m .

A rtic le s m a y b e

r e p r i n t e d i f t h e s o u r c e is c r e d i t e d a n d t h e

5

R e s e a r c h D e p a r t m e n t is p r o v i d e d w i t h c o p i e s
o f th e re p rin ts .
4

C hicago F ed L e tte r is a v a i l a b l e w i t h o u t c h a r g e
fro m th e P u b lic I n f o r m a tio n C e n te r , F e d e ra l
R e serv e

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B a n k o f C h ic a g o , P .O . B o x 8 3 4 ,

C h ic a g o , Illin o is ,
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ISSN 0895-0164

6 0 6 9 0 , (3 1 2 ) 3 2 2 -5 1 1 1 .

Manufacturing activity in the Midwest rebounded sharply in May from its
April slump. After gaining steadily from its most recent low in December, the
MMI dropped 1.5% in April. The May spurt in the MMI, up 2.6% from April,
in large part represents a return to pre-April activity levels. Gains were con­
centrated in durable-goods industries, led by transportation and metals.
Over the first four months of this year, the MMI had been lagging the expan­
sion in national manufacturing activity. The growth in May’s MMI put the
Midwest slightly ahead of the nation, growing 3.7% regionally since Decem­
ber compared to 3.5% nationally. Once again, gains in auto-related industries
provided the margin of difference.

Chicago Fed Letter
F E D E R A L R E S E R V E B A N K O F C H IC A G O
P u b lic I n f o r m a tio n C e n te r
P .O . B o x 8 3 4
C h ic a g o , Illin o is

(312) 322-5111

60690

N O T E : T h e M M I a n d th e U S M I a r e c o m p o s ite
in d e x e s o f 17 m a n u f a c tu r in g in d u s tr ie s a n d a re
d e riv e d fro m e c o n o m e tr ic m o d e ls th a t
e s tim a te o u tp u t fro m m o n th ly h o u r s w o rk e d
a n d k ilo w a tt h o u r s d a ta .

F o r a d is c u s s io n o f

t h e m e t h o d o l o g y , s e e “R e c o n s i d e r i n g t h e
R e g i o n a l M a n u f a c t u r i n g I n d e x e s , ” E c o n o m ic
Perspectives, F e d e r a l R e s e r v e B a n k o f C h i c a g o ,
V o l. X I I I , N o . 4 , J u l y / A u g u s t 1 9 8 9 .