Why We Can’t Shun Manufacturing for the Service Sector

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 early in the 19th century. Compare that with the production of almost anything manufactured — the number of workers now required to produce 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 let’s put a little data behind this. The following table lists the 2010 national sales and employment numbers for 2-digit NAICS industry sectors, ranked in terms of total sales.

When considering what industry sectors to prioritize for workforce and economic development efforts it is important to look beyond basic employment numbers. This is because, while a sector might have a lot of jobs, it might not actually be producing a lot of income for the region, which is also very important for overall economic health and vitality.

Sectors that generate more income per worker tend to have much bigger ripple effects, which means that a lot more people are impacted as a result of direct and indirect spending. The following table is organized by sales per worker, derived by dividing the total sales for an industry by total employment for a particular year.

Here’s our take on manufacturing and a few other basic observations that help to illustrate the difference between production and service sectors.

When it Comes to Income Manufacturing is Still King

At $4.4 trillion in total sales, manufacturing is by far the biggest income generator in our nation, despite a fairly rapid decline in employment (manufacturing has slipped to fourth in overall employment). Despite these trends, manufacturing still manages to far outperform all other industries in terms of pure income creation. Each individual that works in manufacturing generates roughly $370,000 per year. This is a very important fact to consider in a day and age when many folks advocate for improving the service sectors. 

Again, here’s the thing to note: sectors like manufacturing that generate more income per worker have much bigger ripple effects, creating much more impact in a region while helping to raise wages in lower-productivity service sectors. 

Government Services: High on Employment but Low on Productivity

The government sector is twice the size of the manufacturing sector (in terms of employment) but only produces $3 trillion in earnings or $130K in income per worker. Government is a bit trickier to analyze using the sales per worker criteria because the government is essentially capturing tax dollars and spending them on various services (education, military, infrastructure). Government can provide a lot of stability to regional economies, but it’s not really a growth industry (unless you’re in DC!).

Utilities and Finance – Low Employment but High Sales/Job Ratios

The utility and finance sectors have lower employment (ranked 8th and 21st, respectively) but rather large sales to job ratios (250K per worker and 650K per worker, respectively). Keep in mind, the utility sector has a lot of overhead and equipment that factor into the equation. There is a huge amount of capital in play in this sector that requires a relatively small workforce. Finance and insurance can generate very large amounts of capital, and they have much less overhead.

Health Care is Not a ‘Growth Industry’

Health care, the ultimate service sector, has become the second-largest employment sector in the country, yet it produces only $90K in sales per worker, which is pretty low compared to manufacturing, information, or finance. Basically, the health care sector is important for obvious reasons and it can be a source of good jobs for a local region, but it’s not really an “economic driver” that is going to propel our nation into greater prosperity.

Retail Trade vs. Information

The retail trade and information industry sectors have similar income generation ($1.19 trillion and $1.13 trillion, respectively), however, retail trade is five times the size of information in terms of employment. This is why every economic developer is looking for “the next Facebook” and not “the next Napa Auto Parts.” Retail trade only generates $70K per worker while information generates $350K per worker.

So what’s wrong with a service-based economy? It shrinks manufacturing employment as well as the manufacturing sector’s 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 or other production sectors in favor of service sectors.

Dr. Robison is EMSI’s co-founder and senior economist with 30 years of international and domestic experience. He is recognized for theoretical work blending regional input-output and spatial trade theory and for development of community-level input-output modeling. Dr. Robison specializes in economic impact analysis, regional data development, and custom crafted community and broader area input-output models. Contact Rob Sentz with questions about this analysis.

Illustration by Mark Beauchamp