May 8, 2013    Volume 20, No. 6

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Without A Strong Manufacturing Sector, The U.S. Struggles To Break Out Of Recession

By Richard A. McCormack

The United States is having a more difficult time recovering from recessions because of the shift to a service-based economy. Without a strong manufacturing sector, the country is not generating the jobs and growth that accompanied recoveries of the past half century, according to researchers at UC Berkeley and Siena College.

The rise of services and the slower pace of recovery from economic downturns "are not simply coincidental but are connected," say Martha Olney, professor of economics at Berkeley, and Aaron Pacitti, assistant professor of economics at Siena College of Loudonville, N.Y. Analyzing data from recessions since World War II, "the results confirm our hypothesis," write the two economists. "The higher is the share of services, the slower is the economic recovery. The increased share of services in the economy over the last half-century added about one year to the current economic recovery."

The reason for this is "quite simple," Olney and Pacitti found. A company that manufactures goods can produce ahead of anticipated demand and place its output into inventory. Service providers can't do this.

"The more services an economy produces, the smaller is the role for anticipation in spurting an economic recovery," they argue. "In a service-based economy, it will therefore be harder for a recovery to take hold. Recoveries will be slower in service-heavy economies than in goods-heavy economies."

Companies that make products start producing them in anticipation of increased demand from consumers who do not want to see empty shelves. "Whether buying boxes of cereal or a new pair of slacks, customers expect goods to be available when they are ready to shop," according to the research. "The resulting inventory cycle is a long-known characteristic of recessions and recoveries."

But this cycle has been broken because service providers "can't produce ahead of demand. A restaurant can't produce a meal ahead of demand; you have to be in the booth. Your dentist can't produce an inventory of teeth cleaning; you have to be in the dentist's chair. . . Only then can they produce a final service. The greater the share of services in an economy, the greater the share of businesses that must wait for demand to actually pick up before they can increase production."

What to do to solve this problem? "Industrial policy aimed at restoring the manufacturing sector could be beneficial," write the researchers. "Tax policy that provides large re-shoring tax credits for goods-producing firms and levies large tax penalties on firms that offshore goods production could increase the share of goods in total output. Additionally, targeted investment in public goods and infrastructure would accomplish the same end."

The researchers believe that "any policy that reduces the share of services will increase the speed of recovery." This includes government spending, and increasing government's share of the GDP. Without additional government spending, Americans must get used to having longer and slower economic recoveries, which "place a greater strain on state and federal budgets while decreasing tax revenue and increasing expenditures on automatic stabilizers" like jobless payments and food stamps. Increasing government spending "requires that politicians find the will to use expansionary fiscal policy during a downturn," they argue. "In the current political environment, we are not optimistic, but if expansionary powers of fiscal policy are ignored, recoveries will continue to lengthen, exacting a severe toll on workers, firms and the macro economy as a whole."

The paper, "Goods, Services and the Pace of Economic Recovery" (Behl Working Paper Series WP 2013-04), published by the Berkeley Economic History Laboratory, is located at

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