Service Sector Inflation Remains Mild

by: Mark J. Perry

According to BEA data, the U.S. economy has increasingly become more and more of a service economy (see top chart above). In the early 1950s, less than half of the national output took place in the private services-producing sector of the economy, and more than 40% in the private goods-producing sector. Now more than 2 out every three dollars of GDP is produced by private service industries in the U.S. (legal, financial, management, administrative, technical, scientific, publishing, information technology, etc.), and the share of value added by private goods-producing industries has fallen to 17.7%, or less than half its share fifty years ago.

CNBC reported last week:

The annual change in prices for data processing, recreation, lodging, medical services and tuition are all showing a downward trend, according to David Rosenberg’s analysis of the government’s CPI data.

With all the hubbub about $100 oil, surging food prices, along with the comparisons to the 1970s, Rosenberg, who is chief economist and strategist at Gluskin Sheff, is trying to make the point that the U.S. is now primarily a service economy, with these industries accounting for much of our employment and two-thirds of our spending (see top chart above).

“Service sector inflation is now running at historical lows of little more than one percent, and here we are about to enter the third year of a statistical economic recovery,” said Rosenberg, formerly the economist at Merrill Lynch where he made his name by going against the perma-bullish Wall Street crowd (see bottom chart above). “Service sector inflation used to be sticky, because this area of the economy years ago was dominated by unions, was protected by entry barriers, and did not face much in the way of competitive pressures. The times have changed,” wrote Rosenberg in a note to clients Tuesday.

Commodity-based economies have a serious inflation problem because food and energy are so crucial to that smokestack, low-income model,” said Steve Cortes of Veracruz LLC. “But in a services-based economy like the U.S., many areas are outright deflating, like technology — and many more key areas churning sideways: professional services, brokerage of all kinds, hotels. Inflationary periods like the 1970s start with wage inflation, which is sorely missing from this recovery.

Indeed, Rosenberg found there is an 88 percent correlation between wages and inflation —and wages today, adjusted for productivity gains, are declining on an annual basis. Don’t look for that to change any time soon with unemployment still above 8 percent. Maybe that’s why the Federal Reserve says it has a dual mandate of stable prices and full employment.

I've made some of these same points before. In the inflationary 1970s, almost every measure of prices was increasing: food, energy, core inflation, wages, services, interest rates, etc. We now have a wide mix of inflationary, deflationary and flat inflationary forces, along with decelerating wage increases and low interest rates, and that's not a formula that results in overall inflationary pressures. At least not yet. And since inflation for services has been below 2% for almost two years now, there's not inflationary pressure there.

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