Erstwhile Urban Wanderer

December 21, 2008 – In the 1980s, the United States embarked on a dubious experiment to transform itself from a “quaint” agrarian and manufacturing economy into a “service economy.” So how is that working out for us?

By Dave Eriqat

The very first time I heard the term “service economy,” way back in the 1980s, I scoffed. Even as economically illiterate as I was back then, the very notion of an economy not fundamentally based on manufacturing and agriculture seemed viscerally repugnant and intellectually dishonest. It just sounded unnatural, like men having babies. Over the intervening years, as I studied the economy, my revulsion to the notion of a service economy has only intensified.

I believe that many of the economic problems we’re seeing today – excessive debt, declining standard of living, homelessness, insolvency of everything and imminent depression – are the result of our embracing the fallacious service economy model during the past few decades.

Trends

Since peaking around the year 1950, the percentage of jobs in the U.S. devoted to producing goods has steadily declined, while wealth-consuming “service” jobs have picked up nearly all the slack. To my surprise, the share of jobs in government has increased only slightly, from 13.5% in 1950 to 16.1% in 2007. (Frankly, government seems a lot more obtrusive than that statistic suggests, probably because a lot of service jobs are quasi-government jobs, thanks to the privatization of many government functions.)

As shown in the chart below, “goods producing” jobs, about two-thirds of which are “manufacturing” jobs, have plummeted from 38.3% in 1950 to 16.1% in 2007. I find it an interesting coincidence that the shares of goods producing and government jobs are equal, at 16.1% each. In other words, exactly the same percentage of people are employed in government, consuming wealth, as are employed producing goods, generating wealth. Furthermore, 16.1% is another way of saying that one in six workers works for the government! Each of the other five workers are thus supporting one-fifth of a government worker, plus one-third of a social security recipient, for a total of about one-half of another person. I won’t discuss agricultural jobs here, except to assert that there has been a similar decline in the number of agricultural jobs, especially as family farms have vanished in favor of giant agricultural corporations.

U.S. job distribution as a percentage of all jobs (source: BLS)

The chart below depicts the “personal saving rate” in the U.S., which is basically income minus expenditures. The Bureau of Economic Analysis, the source for this data, presents two sets of figures, based on NIPA and FFA. I honestly don’t understand the difference between the two, but they both indicate more or less the same thing, which is a noticeable decline in the personal saving rate of Americans since about 1980.

U.S. personal saving rate (source: BEA)

Notice in the above chart, which spans roughly the same time interval as the jobs distribution chart above it, that there is a slight correlation between the saving rate and the number of goods producing jobs. There’s certainly a better correlation between those two figures than between anything else in the two charts. Of course, this makes intuitive sense to me. Goods producing jobs create real wealth, which can then fund savings. If the number of goods producing jobs declines, then so does our ability to save.

U.S. consumer credit as percentage of income (source: Federal Reserve)

As shown in the chart above, by the late 1970s consumer debt was leveling off. Yet we then observe a pronounced resumption of debt growth following the inception of the service economy in the 1980s. Either people developed an increased appetite for spending which could only be financed with debt, or their incomes failed to keep up with their expenses, or a little of both. In any case, the three charts above appear to show a close correlation between the decline of goods producing jobs, the decline of savings, and the growth of debt.

I’ve long harbored the nostalgic opinion that the year 1975 represented the peak of everything good in the United States: egalitarianism, civil liberties, individual affluence and industrial development. The saving rates shown in the chart above do suggest that the period between 1970 and 1980 was the final peak in the personal saving rate, suggesting the peak of individual affluence. And 1979 was the peak year for the number of goods producing jobs, a total of 24,997,000, of which 19,426,000 were manufacturing jobs, suggesting the peak of industrial development; it’s been downhill in both job categories ever since.

During the same period, from 1975 to the present, “inflation” has soared and everything from houses, to cars, to utilities and food has become steadily less affordable. But isn’t that just another way of saying that wages have not kept up with inflation? In other words, might it not be the case that our drift away from a goods producing economy toward a service economy has caused a decline in real wages? In addition, I believe that moral values and social harmony are partially linked to economic conditions. Clearly, crime is correlated with economic conditions, and I think other social values are as well, values like honesty, integrity, violence, and fairness. As our economy’s ability to generate real wealth has diminished, so too, it seems, has our devotion to these measures of civility.

In addition, whereas a large percentage of families in the 1970s could subsist on the wages of a single worker, today most families need two workers to support the family. In part that’s due to higher expectations: of bigger houses, fancier cars, more gadgets. But I think part of the reason two incomes are needed is that we’re simply not earning as much in real terms as we used to because we’ve exported much of our wealth-producing manufacturing infrastructure. I also believe that two-income households have exacerbated the decline in civility, for obvious reasons. I just read an article today titled, U.S. Teens Portrayed as Violent, Unethical. I can’t help but wonder if this would be the case if kids today were supervised by a stay-at-home parent, as kids were when I was a kid.

Economic Pyramid

My idea of a healthy, sustainable structure for an economy is best depicted by the diagram below. Although I did not depict government in this diagram (what subconscious thoughts does that reveal?), I think government ought to occupy no more than a small segment at or near the very top of the pyramid.

Ideal economic pyramid

Since the inception of the service economy, the U.S. has sought to export much of the base (the bottom three tiers shown above) of the pyramid to other countries in a shortsighted quest to increase profits by reducing labor costs. However, wealth flows from the base of the pyramid upward. Without the base, there is no wealth creation to support the top. In the early days of the service economy, culminating in the frothy dot-com bubble era of the late 1990s, the U.S. continued to receive the wealth generated by the “outsourced” bottom of the pyramid because it retained the expertise and intellectual property embodied by the top of the pyramid. Over time, however, as countries developed their own expertise and intellectual property, a new top of the pyramid has begun to form in those countries that earlier received its base.

Today the U.S. economy isn’t structured anything like my diagram above. The top three tiers of the U.S. economic pyramid are grotesquely bloated and the bottom three are emaciated. Consider, for example, that the U.S. has about one-twentieth of the world’s population but about one-half of the world’s lawyers!

For many years I’ve been preaching about the vital need to make manufacturing and agriculture the foundation of the economy, because the free wealth from the earth and the sun is the only true source of wealth. All other economic activities are paid for from this free wealth. I’ve always felt like an oddball because I’ve never been able to make people understand what I’m saying, nor have I ever encountered anyone else who shared these views of mine. So I was extraordinarily delighted the other day when I ran across an outstanding essay (perhaps his best ever) by Karl Denninger, titled, We’re All Madoff. For the first time ever I read someone else write the very words I’ve been mumbling to myself for years:

Money is in fact production; you gain it only three ways – by growing something, mining something or making something. That is, by producing a thing (whether it be a car, apples, a barrel of oil or software) that did not exist before. In the most-basic of terms, all money ultimately comes from the energy imparted upon the earth by the Sun. [My emphasis.]

The Physics Of Economics

Modern economic theory seems more akin to voodoo than science. Between the half-baked theories of insular academics and the obscene manipulation of the “official” economic statistics, it’s a wonder that we can make any sense of the economy at all.

This confusion is both unfortunate and unnecessary, however, because economics is fundamentally based on physics, particularly the first law of thermodynamics. One cannot get more energy out of a system than one puts into the system. In fact, given that no system is 100% efficient, one will surely get less energy out than one puts in. Consider an automobile engine. We put gasoline into it. That gasoline contains a certain amount of potential energy. But not all that potential energy finds its way to the tires of the automobile. The engine itself is not 100% efficient. Tremendous amounts of energy are lost as heat (that’s why engines need a cooling system). Additional energy is lost between the engine and the road. Now consider the human body as an engine. Its energy source is food. Food contains a certain amount of potential energy too, just like gasoline. And just like the automobile engine, the human body “loses” a certain amount of that potential energy in the form of heat (which is why we have a cooling system as well). The laws of physics make it impossible to get more “work” out of a human being than the amount of energy put in.

Nevertheless, our economy is predicated upon the confused notion that human productivity can increase without bound. But what is “productivity”? It is output. Obviously, output cannot increase without bound, thanks to the laws of physics. So how is it that human productivity appears to increase? By overlooking all the other inputs, including energy, natural resources and machines, which themselves are made from resource inputs and human labor. The true equation for calculating human productivity is,

human output = human labor + energy + resources.

Obviously, the labor potential of a single human being is a constant, so the only way human output (productivity) can increase is by increasing the other inputs, that is, energy and resources. Even if productivity-enhancing machines are used to augment human labor, output can only be increased by increasing the energy and resource inputs.

But where do the energy and resource inputs come from? The earth and the sun! In other words, human labor alone does not generate wealth. Remove energy and resources from the equation above and we end up with this equation,

human output = human labor.

In other words, without the free wealth from the earth and the sun, human output will equal human labor. No wealth is created from human activity alone. To put it another way, if we’re all laboring to wash each others laundry, are we producing any wealth? No, that’s a zero-sum transfer of work; our labor alone is insufficient to create wealth.

Yet, this is precisely what is implied by the so-called service economy, which revolves around human labor and brain power alone. Clearly, such an economy cannot generate real wealth because it omits the only sources of wealth, which are energy and resources from the earth and sun. While we humans may arrogantly claim credit for creating wealth, the truth is that all we are doing is extracting wealth from the earth and sun and channeling it to serve us. We aren’t creating anything, nor can we. We are net consumers of wealth by virtue of the thermodynamic fact that we consume more energy than we output as work.

Lifecycle Of Wealth

It is, nevertheless, an observable fact that workers produce more “wealth” than they consume, otherwise companies could not stay in business. For instance, using dollars as a means to quantify wealth and productivity, a typical worker might produce $100,000 of output but be paid a salary of $40,000. Now, I hope I’ve made a good case above that the extra $60,000 of “wealth” produced by the worker didn’t come from the worker himself, but from the extra inputs of energy and natural resources. But where did the extra “wealth” go? To the owners of the means of production, and the government through taxation. In other words, workers are basically machines that process and channel free wealth from the earth and sun to the owners of the means of production and the government. Our entire economy revolves around this transfer mechanism, whether we’re talking about a simple mineral mine or a complex, globalized enterprise making iWidgets.

Free wealth is extracted from the earth and sun, a portion goes to the workers, the lion’s share goes to the owners of the means of production, and a share of both the workers’ and owners’ wealth goes to the government in the form of taxes. This is our economic system in a nutshell. Without the first step, the free wealth from the earth and sun, there can be no economy.

Conclusion

In my opinion the “service economy” has been an unmitigated economic disaster for the United States. It has impoverished our country, a fact that has been masked by the accumulation of unprecedented amounts of debt, which now threatens our standard of living, if not our economic survival. At the very least, a country that idolizes consumption ought to place as much emphasis on producing goods as it does on consuming them.

Instead we thought we could shift the burden of producing goods onto other countries and continue to enjoy the benefits of consuming them, while failing to understand that we were relinquishing our wealth-generating means in the process. As I said in my essay, Economic Warfare?, I don’t think it’s happenstance that China has sought to acquire the U.S.’s manufacturing base, even at the expense of subsidizing its exports to the U.S. through the purchase of U.S. debt. An astute observer cannot help but conclude that since manufacturing generates wealth, those who wish to be wealthy ought to acquire a manufacturing capability.

As we ruminate on how we’re going to dig ourselves out of the coming depression, we might want to consider restoring our productive capacity. But this time around, due to the limitations imposed by peak oil, we need to restore a productive capacity that is smaller in scale and more localized in scope.