CHAPTER 6

Shifting Sands: Consumers Prefer Services

Now that we’ve toured the realm of GDP, let’s take note of the elephant in the castle. Americans are champion spenders. Overall, personal consumption totals about 70 percent of our domestic economy.

According to a March 2019 GOBankingRates study, Americans spend an average $103 a day per person. Much of that goes to housing payments—then there’s getting the kids ready for school and driving to work and making dinner. But we also spend a startling sum on beer and pizza.

Gallup’s final study of consumer spending—the pollster stopped tracking U.S. consumer spending in July 2017—revealed how we dispose of a considerable amount of our disposable income:

Yes, we’re at a high end of the consuming range for modern-day industrial economies—United Kingdom residents averaged $65 a day; Chinese citizens were consuming at a rate of less than $16 daily. But those inequities are seldom trumpeted and haven’t sounded many alarms. In a functional sense, we work to be able to consume, and in the relatively advanced, wealthy economy we enjoy, it is reasonable to expect a higher share of output to be devoted to our own wants and needs over physical capital and infrastructure.

The state of the labor market plays a crucial role in determining spending behavior. When people consume, they make their decisions based on their expectations for future income: confident, spend away; not so confident, cut back. A tight labor market breeds confidence. If you’re in a job you might not have for long, or might not want for long, and you look around to find plentiful opportunities, you’re more likely to spend and possibly take on debt.

One of the more interesting aspects of the recovery from the Great Recession of 2008 and 2009 was our caution. Consumer spending did not surge the way it had in previous U.S. recoveries. It has been the case that recoveries in the United States have been proportional to the recessions themselves—that is, the steeper the recession the more aggressive the recovery. It’s that “pent-up demand.” During a recession consumption gets postponed or delayed because of concerns about personal income, and when the recession is over and people are confident again about their future employment and income, they make up for lost consuming. This didn’t happen in the recovery from the Great Recession. Consumers were wary of taking on debt after working it down during the recession and increased their spending only about as much as their incomes increased. This lack of a spending burst at the end of the recession earned the recovery its characterization, and criticism, as a “slow” recovery.

If consumers disappointed critics by their post-recession hesitancy, consumer balance sheets in 2019, in aggregate, were in relatively good shape. Americans were financially healthy. Of course, there were caveats. Many Americans were dealing with considerable debt. But aggregate personal debt was relatively low compared to income, and in combination with historically low interest rates, provided for historically low debt service to income ratios—that is, payments due on outstanding debt compared to income—as explained in Figure 6.1.

What We Buy and Why

You can divide what consumers buy into three classes: nondurable goods, durable goods, and services.

Figure 6.1 Low aggregate personal debt combined with low interest rates to reduce debt service to income ratios to historic lows by 2020

Source: Board of Governors of the Federal Reserve System (US)

Release: Household Debt Service and Financial Obligations Ratios

Units: Percent, Seasonally Adjusted

Frequency: Quarterly

For further information please visit the Board of Governors.

Board of Governors of the Federal Reserve System (US),

Household Debt Service Payments as a Percent of Disposable Personal Income [TDSP],

Retrieved from FRED,

Federal Reserve Bank of St. Louis;

https://fred.stlouisfed.org/series/TDSP,

November 19, 2020.

Nondurable goods are things like food, energy, and clothing (despite seeing Uncle Walter in the same sweater every Christmas for the last ten years). These items are basic to human existence, but they also represent a decreasing share of our overall consumption bundle. When our income goes up, we move on to other things: dining out, vacations, a nicer house, or just a new washing machine.

Tracking nondurable goods consumption isn’t particularly interesting from a macroeconomic perspective. There’s a fair amount of variation in spending on things like energy, where prices are volatile; but as an advanced economy, most of us consume all the nondurable goods we want. Our problem isn’t that we’re starving but that we have enough money to make bad food choices. The most meaningful feature of nondurable goods consumption is the seasonal variation in our patterns of consumption, particularly at year-end, around the holidays.

Durable goods are things that last. Think major appliances or autos. Here too, their share of our larger consumption bundle is declining. Still, sales of durable goods are important to watch for two reasons.

First, they tend to be expensive, and consequently have a bigger impact on GDP. When you buy a durable good, the entire purchase price shows up in the national income accounts even though the useful life of that good stretches over a long period of time.

Durable goods can create shadowy volatility in the quarterly GDP numbers simply due to timing. For example, when the cash-for-clunkers program was initiated under the Obama administration to get aging gas guzzlers off the road and encourage the consumption of more fuel-efficient new cars, we saw a considerable spike in auto sales, which consequently led to a transitory increase, that is, a temporary spike, in GDP. When you take delivery of a new car it has thousands of dollars of impact on GDP. If it happens on the last day of the third quarter, GDP jumps that amount for that period, if it happens on the first day of the fourth quarter, GDP jumps for that quarter. If it happens on a large enough scale, it reveals why we see volatility in quarterly GDP reports and why those reports can be misleading in the short run. Volatility tends to smooth itself out over a long enough period of time.

The second reason we keep a close watch on durable goods sales is because the products are expensive and long-lived. The decision to buy a new durable good or fix an old one tells us something about another popular—if of limited value because it is dominated by recent, shortterm developments—economic measuring stick, consumer confidence. If consumers are feeling good about the economy, they’ll commit and upgrade their existing durable goods; if they’re concerned about their future income streams, they’ll repair rather than replace.

Services: The Biggest Share and Growing

The largest share of our consumption spending is for services. The spending share of services grew from 46 percent in 1959 to 67 percent in 2019, while the share of nondurable goods dropped from 40 percent to 25 percent. As our income rises, we tend to want others to do things for us that we can’t or don’t want to do. When we get a raise we‘ll use some of that money to enjoy a dinner out instead of buying more carrots. We have all the carrots we want, so an increase in our income isn’t going to change our carrot consumption (unless we’re talking diamonds).

The demand for some services can be explained by natural forces like demographics. The U.S. population is aging; the aging population needs medical care. It’s necessary that we consume more medical services—and with rising income levels, we can shift our consumption bundle in that direction. It’s not that we’re decreasing our consumption of durable and nondurable goods, but the additional consumption is in services. And again, in aggregate—not all Americans are so fortunate—we are wealthy enough to afford it.

Measuring real economic output in the service sector is problematic. It’s easy to track the nominal spending on services, but that nominal spending reflects a combination of spending on an actual service and the change in its price. Disentangling price movement from a real change in output is the challenge.

Again, medical services illustrate the point. They’re going up in price but they’re also going up in quality. How do we distinguish between the two? Serious trauma accidents are health events that were once fatal but now, frequently, treatable. The price of treatment has increased, but we’re getting improved outcomes. You’re spending more but you’re buying a better product. Clearly, the real output of healthcare services is increasing, but by how much?

The question applies to many services. Most of us enjoy a wider and better choice of restaurants where we live. But how much of our spending on food outside the household represents an increase in the quality of the food and restaurant experience, and how much is simply our willingness to pay a nominally higher price because we don’t want to cook?

One of the most difficult services to measure for changes in output is security. We spend a lot on security, but it doesn’t produce any real output. If it works, nothing happens. What’s the value of that nothing? Immense. Consider the growing need and skyrocketing costs for cybersecurity. If customers of a local construction business have their financial data stolen from that company’s computers, it could, and frequently has, put the company out of business. But implementing a cybersecurity program is costly, and if no data thief attacks, what’s it worth? So, we continue to increase our spending on security, but measuring the value of that output is extremely difficult.

More and more frequently, services involve paying people to do something we otherwise would have done ourselves. If you’re a do-it-yourselfer, you don’t pay yourself, and consequently the output associated with your effort isn’t captured in GDP. But it does show up when you pay a service provider to do it.

Takeaways

Equilibrium

Our tastes and preferences for the things we spend our money on can change over time based on new innovations in products and services, and based on what we have already consumed. A large segment of consumers are secure in their food, clothing, shelter, and electronic gizmos, and we are seeing an increasing share of consumption devoted to services, to employing other people to do things for us. But not all the shift toward services is about already having enough goods. An aging population requires more services. This is particularly evident in health care, where the shift to more service-intense consumption is reflected in our need for more medical services.