Services Sector Powering Up, Pointing To Sustained Recovery

The services sector—long the engine of the U.S. economic growth but an unusual drag in the recovery this time around—is finally showing signs of sustained strength, from job creation to overall output.

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“The service sector has been slower to come around,” says Robert Brusca, chief economist at FAO Economics, who has been tracking the dynamic closely for some time. “This pickup in job growth may actually be authentic. Statistically, we are kind of on the same path we’re seen before. The kind of growth we’re now getting in this sector is relatively strong compared to the numbers we’ve seen since 2000.”

The trend has been underscored in nonfarm payroll data over the past few months, including the better-than-forecast December data released Friday, which showed healthy gains again in retail trade and leisure and hospitality.

“We are seeing growth in service sector jobs and that looks good,” former White House chief economist and Stanford University professor Ed Lazear told CNBC.

The jobs recovery in that area—long overdue and anxiously expected—is most pronounced over the past six months, during which time private sector service employment rose some 850,000 to almost 92 million. Over the past 12 months, payrolls are up more 1.5 million.

“The numbers we’re looking at are ones with some substance,” said Brusca of FAO. “You look for the demand for services to rise, after that happens, the demand for jobs rises.”

The pickup is in stark contrast to the first year of the recovery, when services payrolls were essentially flat, following a deep decline during the 2007-2009 recession.

In the four recessions prior to the recent one, the number of services jobs held steady or rose slightly. In the Great Recession, some 3.4 million were lost.

“When you have a recession as significant as this one has been, it better be that the service sector jobs are picking, and good service sector jobs are picking up, if that doesn’t happen the economy isn’t recovery,” said Lazear of Stanford.

Such an interpretation is well founded in labor market trends of the past two decades.

During the 1990-2000 period—the longest peacetime expansion in U.S. history—services counted for some 80 percent of net private sector payroll growth. In the previous US expansion, the economy added more than 6 million service jobs in the 2003-2007 period, but lost 2.5 million manufacturing ones during that time.

The broader trend is matched by a key sub-category of the services economy—professional and business services. Some five million jobs in that area were created during the 90s economic boom. In the past ten months, business and professional services has averaged 42,000 a month.

A high percentage of those businesses tend to be smaller ones. And growth of that area was key to the surge in the ADP private payrolls report Thursday.

“Eighty percent were in the small business sector,” Diane Swonk, chief economist at Mesirow Financial, told CNBC. “They tend to be newer small businesses, startups. That could an interesting trend going forwards—new biz startups. That was the vast [portion] of job creation in the 90s.”

Equally important to the labor market is that the acceleration service sector job creation coincides with the peak of an unexpected surge in manufacturing jobs during the early stage of the expansion; though they rose in December, payrolls were relatively flat in the preceding five months.

The service recent strength is evident in broader economic trends, as well.

Services were one of just two areas to contribute positively to overall GDP growth in the past three quarters. Sequential quarterly growth averaged 2.1 percent, outpacing other areas, and closely mirrors overall GDP growth on that basis (2.5 percent).

Once again, bright spots of the earlier phase of the recovery ( exports, durable goods) posted declines or slower growth rates Based on those metrics.

Brusca of FAO says it could be part of the new structure of the economy. “What may come back first is demand for goods, then later as the recovery gets more mature, services come back and that gives you the broad job creation.”