By Martha L. Olney and Aaron Pacitti
Recovery from recessions takes longer than it has in the past.
The current crisis aside, this change has not happened because recessions themselves are longer. Nor has it occurred because recessions are deeper than in the past. Instead this change is the result of slower economic growth following the end of a recession. And slower growth means longer recoveries.
As shown below, the four longest recoveries in recent history, as measured by the number of months it took until the economy recovered all of the jobs lost during the recession, also have been the four most recent recoveries—those that followed the recessions of 1981, 1990, 2001, and 2007.
Why is it taking longer and longer for the U.S. economy to recover from recessions?
We argue that the shift from being a goods-producing, manufacturing-based economy to a service economy — what some have termed “deindustrialization” — is causing the pace of economic recoveries to slow. As is typical of economies recovering from the bursting of an asset bubble and a financial crisis, the recovery from the 2007 recession would be longer than usual. But our research suggests that the rise of the service sector has made it even longer than in the past. For example, the recovery from the 2007 recession will last about one year longer than it would have half a century ago.
The U.S. economy is much more service-dependent today than it was back then. Since 1950, services have risen from 40 percent to 65 percent of output and from 48 percent to 70 percent of jobs. Yet the rise of the service sector is not necessarily a bad thing. Although there are many “bad” service jobs that pay low wages and are insecure, there are also many “good” service jobs. The service sector runs the gamut from serving fast food to conducting brain surgery.
Also, the rise of services can be partially attributed to faster productivity growth in manufacturing and rising incomes. These are trends to cheer. Nevertheless, we find that there are large negative macroeconomic externalities from having a service-based economy—slower growth and longer recoveries—that portend a gloomy future.
We can think of two complementary reasons why a service-dependent economy might experience slower recoveries: goods can be produced in anticipation of demand, and goods can be exported. At this stage, our research doesn’t distinguish between these two possibilities. But both possibilities share one idea: Because services can’t be inventoried nor, for the most part, exported, services are only produced when domestic demand exists.
Goods-producing businesses are not dependent on domestic demand to increase production as the economy comes out of a recession. They can produce in anticipation of increasing demand or in response to increased external demand. Either way, domestic demand need not increase before goods production increases. Service producers are not so lucky.
A restaurant won’t produce a meal before you are in the booth. And your dentist can’t produce and inventory a teeth cleaning. You have to be in the dentist’s chair.
So service producers must wait until the customer or patient is present, for only then can they produce. The greater the share of services in the economy, the greater the share of businesses that must wait for domestic demand to actually pick up before they can increase production. And thus, the more services an economy produces, the longer it will take for a recovery to take hold.
But we need not simply tolerate longer recoveries as a consequence of the rise of the service sector. We could look to public policy to step in and counterbalance the negative aspects of our current economic climate, as we have in the past. One set of policies could counter the rise of services directly by promoting exports or encouraging domestic manufacturing. Another set of policies could address the effect of the rise of services by strengthening the safety net for those workers who will invariably experience longer spells of unemployment.
Whether or not we choose to enact public policies, the new bottom line appears clear: with the economy more dependent on services, recoveries now take longer, exacting a severe toll on workers, firms, and the macroeconomy as a whole.
Martha L. Olney is an adjunct professor of economics at UCBerkeley and a member of the Berkeley Economic History Lab. Aaron Pacitti is an assistant professor of economics at Siena College.
Cross-posted from the blog of the Institute for New Economic Thinking, INET Blog.