The Biggest Threat to Service-Sector Wages: The Service Sector

By Hank Robison, EMSI Senior Economist

There’s been a lot of talk lately about the shift in the US economy away from production and increasingly into services. Consider the employment data from the US: In 1950, 30% of all US jobs were in manufacturing while 63% were in services. In 2011, 9% of total employment remains in manufacturing, 86% in services.

So does this signify a shift in consumers’ tastes from manufactured goods to services? The short answer is no; if anything, we consume more “things.” The difference is that things are manufactured with far less labor, and they are increasingly made somewhere else: the manufacturing industries still remaining in the US have seen tremendous improvements in productivity. Less-skilled work continues to flow out of the US, but the work that remains is higher-skilled, and more productive. Accordingly, the manufacturing jobs that remain in the US pay well.

Some look to the loss of US manufacturing jobs without concern: the future (they argue) is in service industries. As jobs disappear in manufacturing, others open in services like health care and retail. The problem is that as more manufacturing jobs leave, more productivity leaves as well.

Consider this: Classical economists saw productivity as the key in determining relative wages — the more productive the laborer, the higher his/her wages. Unlike manufacturing, service-sector jobs have strict limits in terms of productivity. For example, a live performance of Beethoven’s 5th requires the same amount of performers/employees as when it was performed in the 19th century. Compare that with the production of almost anything manufactured — a bolt of fabric, for example.

So how is it that workers in service sectors, where productivity has relatively little growth, maintain wages competitive with workers in manufacturing, where productivity has done nothing but increase?

At least part of the answer lies in what modern economists have dubbed the “Baumol Effect,” after influential economist William Baumol. The Baumol Effect states that lower productivity notwithstanding, service industries have to pay wages comparable to manufacturing in order to get the workers it needs: it’s a simple matter of labor market competition.

So what’s wrong with a service-based economy? It shrinks manufacturing employment as well as its ability to prop up wages. A labor market that loses wage pressures of high-productivity manufacturing industries will settle at wage rates lower than markets where this wage-boosting effect is present. Economic development policy makers should be careful about shunning manufacturing.

See more on this topic here: Industry Employment and Income Comparison.

Illustration by Mark Beauchamp

One Response to “The Biggest Threat to Service-Sector Wages: The Service Sector”

  1. Daniel P.G.

    I realize that this is an older post, but I have some questions. Although we’ve watched wages remain stagnant in comparison to other factors since the late ’70s, productivity has increased. Although, I believe that their is a general belief that productivity remains constant in the service sector (the analogy for instance of music production), isn’t it possible that the means of service production shift, and as a result productivity as well. If the economy has shifted to service industries, and wages–in comparison to productivity–have remained stagnant while capital and CEO profits have increased than is it not possible that some of this productivity is shared in the service sector? For instance, distribution is a service, and improved highways benefit the productivity of that service? The work a restaurant employee provides is a service. Technologies that improve the efficiency and monitoring of profits that server provide benefits productivity? I personally believe that the biggest threat to service sector wages is the belief that service sector employees are throw away commodities. Even service employees believe this, and when they move into management positions, they tend to treat their co-workers as throw away commodities because you can train a ‘new employee’ to do the job they were doing. This of course doesn’t account for role a service employee has as a memory of service preference for individual accounts. These are thoughts I’m having, and I suppose the question is, is data being tracked that accounts for real productivity gains in the service sector. E.G. your symphony account is real, however, in the entertainment service sector the kinds of entertainment have become more efficient with new technologies e.g. a single DJ preforming a mash-up of Beethoven’s 5th to an audience ten times the size of a concert hall symphony on a computer.