The “Services” Based Economy Delusion——More Wall Street/Keynesian Agit-Prop

There no longer is any doubt about the state of industry and manufacturing in the US as well as the rest of the world. The most diehard, stubbornly optimistic economists have now completely given up on the “goods economy.” Instead, they have been forced to try to explain why such a slump would show up exactly when it shouldn’t, and further why its sudden appearance does not matter. For the most part, economists have been taken with the service sector as the means of comfort despite the fact that, in GDP anyway, a great deal of the “service economy” doesn’t actually exist.

The largest single component of services GDP (or total GDP, for that matter) is imputed in the form of phantom rental income since the BEA treats owner-occupations as if they were all an economic enterprise. From the BEA:

The rental value of tenant-occupied housing and the imputed rental value of owner-occupied housing are both part of PCE housing services, reflecting the amount of money tenants spend for the service of shelter and the amount of money owner occupants would have spent had they been renting. Owner-occupied housing is included in PCE because the NIPAs treat the owner-occupant as if it were a rental business, or in other words, a landlord renting to him or herself. [emphasis added]

The highlighted portion is relevant as it is not particularly obvious that it is true, nor why we should suspect that it might ever be (unless the Picketty’s of the world gain enough political hold to outlaw private ownership of shelter). It’s an odd basis for economic interpretations where we are forced to think about the economy where private individual housing doesn’t exist for the sake of personal shelter. For 2014, that amount was$1.37 trillion! That is up from $1.228 trillion in 2010, or a compounded growth rate of 2.7% per year. The growth rate has been accelerating in the past few, with imputed owner’s rent jumping 3.6% 2013 to 2014. Since these estimates are included in PCE, the fact that the “services” component is rising doesn’t, unlike goods, immediately suggest actual growth.

Further, a rise in shelter costs, both imputed and real, might instead be a serious economic drag given necessary trade-offs – made more so without a steady increase in wages. This point is also transferred upon the “service economy” that might appear to be growing based on any number of regulatory burdens that count in practice as a tax rather than actual growth (Obamacare being the biggest).

It stands to reason, then, that if the goods economy were inarguably in distress and getting worse, there is little reason to suggest that the “service economy” will instead pick up the slack since we can’t tell what is real and what is phantom, nor can we separate services as a positive economic catalyst within a lackluster overall environment (at best). Yet, that is the position of economists not just here but suddenly now applying the same wishful thinking to China, of all places.

Traders pay close attention to China’s industrial sector because that’s where the data is. Reports on industrial output come out monthly and include detailed numbers on many different sectors. That’s in line with China’s modern history as “the world’s factory” — a nation that rose to prominence by building stuff mostly exported to other nations.


But China has been evolving into a consumer economy, more like the United States, that depends increasingly on consumer spending by its own citizens who are growing wealthier.


As consumers become more affluent, they spend more on services like tourism, entertainment and education, which is what has been happening in China. The service sector now accounts for about half of Chinese GDP, while industrial activity accounts for just one-third. Yet China’s service sector is relatively new and still gets less attention than manufacturing.

That was quoted from an article under the headline Investors Are Worrying Too Much About China. It’s an interesting take given that Chinese GDP, managed or not, has slumped to a low that used to be associated with recession equivalence – and not all that long ago. If 7% growth (or likely worse) is now the standard for a “services” or “consumer” economy, the Chinese might want to get back in the business of industry; if only they could, which is the entire point. The Chinese consumer has always been somewhat of an afterthought, not given any sort of prominence until it became increasingly clear the industrial side wasn’t going to revisit its pre-2008 growth rates any time soon (or ever). Thus, like the US economy, services are being treated as a consolation, and only a potential one.

The fact that services make up a greater or even majority portion of GDP isn’t as meaningful as its proponents make it out to be. Even if we set aside all objections about the relative importance of goods vs. services, it still doesn’t add up to a healthy economy where goods, production and industry are in recession. That point is made more relevant by the fact that a significant portion of services are dedicated to the other parts of the supply chain, namely transporting, managing and selling goods.

It is from that point that even the most optimistic views on the US economy have suddenly softened just recently.

Deutsche Bank economists on Tuesday reduced their forecast on U.S. economic growth in the fourth quarter of 2015 and first quarter of 2016 due to recent disappointing data on trade, construction spending and manufacturing activity.


They said in a research note they pared their view on domestic gross product in the last three months of last year by 1 percentage point to 0.5 percent, which they added “still might be too high in light of what could be much larger inventory liquidation than what we have assumed.”


The year-end weakness would spread into the first quarter of this year. The economists scaled back their first-quarter GDP forecast by half a point, to 1.5 percent, they said.

If that is correct, we have yet another looming weak period lasting a significant amount of time; at the very least continuing still further, more than eight years since the Great Recession was “officially” declared, the instability in GDP that can only mean continued economic weakness where there really should not be any (the FOMC just declared overheating, after all). If services spending does what is proclaimed from it, economically speaking, GDP estimates more than anything should be shooting upward to suggest all this overheated activity and predicates.

It isn’t just Deutsche Bank’s highly orthodox and nearly-perpetually optimistic economists, however, that are moving in the “wrong” direction:

The Federal Reserve Bank of Atlanta said Monday it now believes fourth-quarter GDP grew at just a 0.7% pace, down from a prior estimate of 1.3% growth. J.P. Morgan Chase cut its estimate in half to 1% growth from 2%. Forecasting firm Macroeconomic Advisers lowered its estimate by three-tenths of a percentage point to 1.1%.


If those estimates pan out, it would mean the economy ended 2015 in roughly the same precarious state in which it began the year. GDP grew 0.6% in the first quarter of 2015 before rebounding in the spring and summer.

The problem now is that there is no “residual seasonality” with which to try and maintain the fairy tale for a little while longer. It again suggests what has been the pattern all along, namely that that “rebound in the spring and summer” was the anomaly. The bigger picture is much worse, given the risks of such an unstable economic state and the appearance of manufacturing recession, financial turmoil, commodity crash, etc., concurrent to it. In short, no matter how hard economists try to suggest services, services, services, the economic risks here and China (and everywhere in between; though in those places the risks are already alarming reality) are and continue to be toward the downside.

The financial portion of those risks paint increasingly dire scenarios where the downside is something more than just manufacturing recession or even mild full-scale recession. Junk bonds, in particular, and the extrapolations from them into a credit cycle picture are exceedingly bleak already, and there will be no amount of service growth to bolster against it. In short, the service economy may well be doing fine, though I doubt it, but in the end it won’t be nearly enough to save anyone. It isn’t so much chicken and egg as it is factoring how economic factors inter-relate and how an economy actually works. GDP isn’t it, and I haven’t even touched trend-cycle yet.