investment viewpoints

Lower service productivity, higher inflation?

Lower service productivity, higher inflation?
Natalia Bucci - Co-head of Convertible Bonds

Natalia Bucci

Co-head of Convertible Bonds
Florian Ielpo, PhD - Head of Macro, Multi Asset

Florian Ielpo, PhD

Head of Macro, Multi Asset

If there is one word that our media has been able to relay in recent months, it is inflation. Price growth was the market's problem in 2021 and it has become the public's problem in no time. Whereas in previous periods of rising inflation, the arrival of the topic in the mainstream media more or less marked the end of the problem – let's remember the worrying inflation of the summer of 2008 or the first quarter of 2011– this time, it is quite different. Inflation is not only higher than usual but also more persistent than ever. In the latest instalment of Simply put, where we make macro calls from a multi-asset perspective, we assess the role of the service sector in today’s high inflation.


Need to know


  • The service sector is clearly the anomaly in this post-Covid cycle, as it has been hiring new staff at an unprecedented rate
  • This pace of hiring reflects an industry with an abnormally low productivity growth rate: to produce more, you need to bring on more hands
  • The hiring blitz has probably increased the multiplier effects of the fiscal plans by generating excess demand in turn– and in so doing, boosting inflation


Services demand shock and inflation

What factor or combination of factors could explain the unusual nature of the situation? One avenue of enquiry is the service industry has been significantly boosted by the stimulus of 2020 and 2021, leading services to expand both in terms of output and employment. Not only did this services demand shock create inflation, but it occurred in a context of abnormally low productivity: to produce more, more people had to be hired. Historically, low productivity and demand shocks do not go well together, and this is the avenue we explore here.


A buoyant service industry

One of the elements on the macro level that clearly distinguishes the current situation from the previous decade is the state of the service industry. As discussed in previous editions of this column, not only have services experienced a strong economic boom once the post-Covid reopening of our economies was over, but the sector has been able to respond quickly to this rapidly expanding demand by hiring at an unprecedented rate.

Figure 1 shows the long-term evolution of the workforce employed by the goods and services sectors. On the goods side, it would be appropriate to adjust for the trend in industrial job losses that has not been recovered since the 2008 crisis. However, even with this adjustment, the goods industry would still be licking its wounds from 2020 to the present.

The services industry is doing better: in the space of a few quarters, it experienced its worst contraction and has almost fully recovered from this collapse in two years. The pace of this recovery is commensurate with the depth of the contraction, and it is essential to understand its origin.


Figure 1: Number of workers by industry and trend


Source: Bloomberg, LOIM


We are hiring

The sector faced a demand shock and to deal with it, it had to face another problem: the sector saw its productivity over the previous decade collapse. Services is not a sector in which productivity gains are particularly strong, let alone elastic. Our estimates show a productivity growth in services of about 0.9% over the very long term (1960-2023). This productivity growth has collapsed over the last decade to 0.3%, three times lower than its long-term trend. This is a structural problem that cannot be solved by fiscal spending or interest rate cuts: the 2021-2022 recovery had to adjust to it.

The solution when productivity gains are not possible is to increase the quantity of the factor that enables demand to be met: labour. Unsurprisingly, a period such as the one we currently find ourselves in is naturally accompanied by a large number of hirings, since in order to produce more one can only employ more people. This is not the case for the goods industry: its productivity in the previous decade was lower, but since the recovery it has recovered rapidly. All this is relatively clear from figure 2.


Figure 2. Goods and services productivity vs inflation in the US

Multi-Asset-simply-put-US prod v inflation-01.svg 

Source: LOIM, Bloomberg.


What happens when services productivity falls?

Hiring in the services sector is therefore strong, and part of the explanation for this is the sector's slow productivity growth. The problem with this situation is, of course, the snowballing effects associated with it: the fiscal stimulus of 2020-2021 led to an explosion of employment in services, and this hiring in turn created a surge in demand that extended the effect of the demand shock. The low productivity of services thus acted as a catalyst in terms of how our economies responded to the pandemic measures.

To put it very economically, low productivity seems to have fed the Keynesian multiplier, and the synchronisation of plans in the northern hemisphere limited the leakage of multiplier effects abroad. Figure 1 compares productivity growth in the goods and services sectors with inflation. While the relationship in 2010-2020 for services seemed like ancient history, 2022-2023 has returned to the long-term trend, and is now close to the series of points belonging to the late 1970s. Low productivity equals higher inflation, as we are now bitterly aware. Our central bankers were probably right in raising rates so sharply and so quickly: it took them much longer to react in 1970, with the consequences that we know. More than ever, let's look at the service industry, as it seems to hold the key to the current inflation puzzle.



Simply put, low productivity in services has forced the sector to hire more people on an unprecedented scale, and this has lit a fire under demand and inflation.


Macro/nowcasting corner

Our proprietary nowcasting indicators for global growth, global inflation surprises, and global monetary policy surprises are designed to track the recent progression of macroeconomic factors driving the markets.

They currently show:

  • Our nowcasting growth indicator remains low at the moment. Only China still shows signs of improvement
  • Our inflation nowcasting indicator declined marginally over the week, as Eurozone data keep on suggesting that inflation should decline now
  • Our monetary policy nowcasting indicator oscillate between 45% and 55%, edging higher this week with the better Chinese data


World growth nowcaster: long-term (left) and recent evolution (right)

Multi-Asset-simply-put-Growth nowcaster-17 Apr-01.svg

World inflation nowcaster: long-term (left) and recent evolution (right)

Multi-Asset-simply-put-Inflation nowcaster-17 Apr-01.svg

World monetary policy nowcaster: long-term (left) and recent evolution (right)

Multi-Asset-simply-put-Monetary Policy nowcaster-17 Apr-01.svg

Reading note: LOIM’s nowcasting indicator gather economic indicators in a point-in-time manner in order to measure the likelihood of a given macro risk – growth, inflation surprises and monetary policy surprises. The Nowcaster varies between 0% (low growth, low inflation surprises and dovish monetary policy) and 100% (the high growth, high inflation surprises and hawkish monetary policy).


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