Structural Change: Implications of Policy and other Barriers

Christopher A Pissarides

Centre for Economic Performance

London School of Economics

Presentation at Oxonia

10 May 2005

Oxonia 10May05 2

Contents

This presentation is based on a joint project with Rachel Ngai of the London School of Economics, financed by the ESRC

Motivation for the study

Structural change and economic growth

Barriers to structural change

Policy implications

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Motivation

• Growth takes place at uneven rates across industrial sectors

• This usually gives rise to “structural change”

• Defined as the movement of labour and capital across industrial sectors

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• What are the implications of uneven growth for structural change when there are no frictions?

• What are the implications of mobility barriers and frictions?

• Is there evidence that policy or other barriers matter?

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Our Modelling Approach

• Economy consists of many distinct sectors

• Some produce final consumption goods (e.g. clothes and food)

• Some produce both consumption goods and capital or intermediate goods (e.g. manufacturing)

• And some production takes place at home (e.g., cleaning and ironing)

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• TFP growth is “unbalanced”: new technology is not uniformly spread across industrial sectors

• We claim that unbalanced TFP growth is the cause of structural change

• When does structural change take place and how?

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Nature of structural change

• Structural change requires non-unitary income or price elasticities

• Otherwise differences in TFP growth rates are absorbed by prices

• Our model implies unit income elasticities, so structural change is due to non-unitary price elasticities

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• Formally, we have

– constant elasticity of substitution utility functions defined over consumption goods (and leisure)

– Cobb-Douglas production functions in all sectors

– one aggregate capital good allocated to all sectors

– fixed labour force allocated to all sectors

– or, fixed total annual hours allocated to market work, home work and leisure

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Implications

• If consumption goods are not close substitutes (elasticity of substitution less than 1)

labour moves to sectors with low TFP growth

prices of goods with low TFP growth rise

real consumption shares are approximately constant

There is a limiting state with only two sectors, the slowest growing consumption sector and the capital-producing sector

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• These are more of less the implications of Baumol’s 1967 classic “Unbalanced Growth” model:

labour moves to stagnant sectors

stagnant sectors suffer from “Baumol’s cost disease”

economy’s growth path is on a declining trend

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• But crucially, we show that without mobility barriers economy is on a steady-state growth path

• Growth rate equal to the rate of growth of the capital-producing sector

• If there are mobility barriers structural change is slower and aggregate growth rate not strictly constant

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Parameter restrictions

• Elasticity of substitution across broad sectors, e.g., two-digit industries, less than 1 (their products are poor substitutes), e.g.,

– Food, clothes, TV sets

• But elasticity of substitution within commodity groups is 1 or bigger, e.g.,

– whether you use electronic means to store information or paper means

– whether you eat at home or go to restaurant

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Implications

• At the two-digit level or broader

– labour share of slow-growing consumption sectors is expanding

– labour share of fast-growing consumption sectors is contracting

– labour share of capital goods production converging to investment share of output

– real consumption shares approximately constant

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• Within narrower groups,

– Labour share of fast TFP-growth sectors

expanding, e.g., ICT, types of cloth sold

– Home production time declining if market

technology grows faster than home

technology

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Employment flows during structural change

Total Consumption

Manufacturing(high TFP growth)

Services(low TFP growth)

Agriculture(high TFP growth)

Market(higher TFP growth)

Home(lower TFP growth)

Higher TFP growthSub-sector

(e.g., emailing)

Lower TFP growthSub-sector

(letter delivery) Labour flow

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International trade

• Tradable goods have good substitutes across nations

• Hence, fast TFP-growth sectors producing tradable goods may retain or attract labour share

• Provided they grow faster than international competitors

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Barriers to economic activity

• Two types, mobility barriers and taxation-regulation of activities

• Effect of mobility barriers temporary but because structural change is ongoing, they last for a very long time

• Effects of regulation-taxation may persist indefinitely

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Taxation-regulation

• Taxation-regulation of market activity drives

work hours to the home

• It affects mainly market sectors that are close

substitutes to home production (e.g., services)

• May explain some of the gap across nations in

employment rates, especially in services

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Taxation-regulation and TFP

• Think of taxation-regulation as having opposite

effect of TFP

• Prescott and Rogerson ask, can it explain the

difference between US and EU employment

rates?

• Main differences should be in women’s

employment and in services

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• “Reverse engineering” exercises: difference in employment rates can be explained by a 40% effective shortfall in European TFP.

• Given the much smaller measured shortfall, rest is attributed to taxation-regulation

• But this concerns level of TFP and substitutions between home/market

• Does not need dynamics

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• Except that over time, if TFP growth in market is higher than in home, effect of taxation-regulation should be getting smaller as home hours fall

• So eventually negative implications of taxation should be diminishing

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Mobility barriers

• For capital: the cost of closing down businesses in contracting sectors and setting up businesses in new sectors

• For labour: policies that inhibit mobility, e.g., social security, housing, etc.

• Education, training, “lifelong learning” facilities, “adaptability”

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Implications

• Barriers to closing down jobs and businesses likely to slow down structural change

• But are likely to be less important than barriers to expansion in new sectors, because the normal turnover of labour eventually allows decline

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• Therefore mobility barriers are likely to have bigger impact on expanding sectors than on contracting sectors

• There should be more unemployment in growth equilibrium

• Less job creation in services and other expanding sectors

• For example, less fast uptake of ICT production

• More home production

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Data

• In the process of compiling summary institutional data on barriers

• I give the ranking of countries on the basis of barriers to entrepreneurship, very similar to ranking on the basis of employment protection legislation

26

Ranking of countries:Admin burden on start-ups

1 Denmark 11 Finland2 US 12 Portugal

3 UK 13 Japan

4 New Zealand 14 Greece

5 Ireland 15 Austria

6 Australia 16 Germany

7 Sweden 17 Belgium

8 Canada 18 Spain

9 Netherlands 19 France

10 Norway 20 Italy

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More on data

• Data on 2-digit sectors but for the next set of graphs aggregated into five sectors

1. Agriculture and mining

2. Manufacturing

3. Other production industries

4. Business services

5. Personal services (including government)

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Model implications I

TFP growth in agriculture and manufacturing higher than in services

Employment share of agriculture falls towards 0

Share of manufacturing falls towards investment rate without trade

With trade it may rise or remain above investment rate

Share of services rises towards consumption rate

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United States

0%5%

10%15%20%25%30%35%40%45%50%

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

empl

oym

ent s

hare

s

AGR PRO MAN BUS SER PER SER

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Great Britain

0%

10%

20%

30%

40%

50%

60%19

71

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

1993

1995

1997

1999

2001

empl

oym

ent s

hare

s

AGR PRO MAN BUS SER PER SER

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Germany

0%

5%

10%15%

20%

25%

30%35%

40%

45%

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

empl

oym

ent s

hare

s

AGR PROD MAN BUS SER PER SER

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France

0%5%

10%15%20%25%30%35%40%45%

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

empl

oym

ent s

hare

AGR PROD MAN BUS SER PER SER

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Italy

0%5%

10%15%20%25%30%35%40%45%

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

empl

oym

ent s

hare

s

AGR PRO MAN BUS SER PER SER

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Japan

0%5%

10%15%20%25%30%35%40%

empl

oym

ent s

hare

s

AGR PRO MAN BUS SER PER SER

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TFP growth in the market higher than in the home

Female employment should be rising

Model implications II

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Gender employment gaps

0%

10%

20%

30%

40%

50%

60%

IT Ggap US Ggap UK Ggap FR Ggap GE Ggap

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More mobility barriers

Share of services lower

Share of manufacturing out of working age population falling but share of services not rising fast enough to compensate

Unemployment rate higher

Employment-to-population rate lower

Model implications III

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Manufacturing employment share of WAP

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

US

UK

FR

IT

JA

GE

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Service share of WAP

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

US

UK

FR

IT

JA

GE

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Employment share of services

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

US

UK

FRGE

IT

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Implications of last three charts

• Manufacturing share in working age population converging

• Service share not converging

• Therefore, net transfer of working time from manufacturing share to out of the labour force

• Barriers affect job creation in services adversely, which translates to lower overall employment

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Services share of WAP vs. barriers, 17 countries

R2 = 0.7027

0.2

0.25

0.3

0.35

0.4

0.45

0.5

0.55

0.6

0 5 10 15 20

barriers rank

serv

ice/w

ap

sh

are

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Manufacturing share of WAP vs. barriers

R2 = 0.0004

0.1

0.12

0.14

0.16

0.18

0.2

0.22

0.24

0 5 10 15 20

barriers rank

man

/wap

sh

are

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Service share vs rank of barriers, 17 countries

R2 = 0.3211

50

55

60

65

70

75

80

0 5 10 15 20

barriers rank

serv

ice

emp

loym

ent

shar

e

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Gender employment gap vs. barriers rank

R2 = 0.3293

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0 5 10 15 20barriers rank

ge

nd

er

ga

p

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Is service share the only problem for women?

• Very preliminary – US service expansion seems to be creating more jobs for women than expansion of service share in Europe

• Justified by our claim that barriers, in addition to slowing down convergence, drive production to the home

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Service employment share and women’s employment 1970-2000

20%

30%

40%

50%

60%

70%

80%

40% 50% 60% 70% 80%service employment share

fem

ale

em

plo

ym

en

t ra

te

US

GE

FR

UK

IT

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Conclusions I

• Normal process of economic development requires structural change because of unbalanced TFP growth

• Delaying the process (sometimes called “deindustrialisation”) harmful

• May temporarily hold average TFP growth up but eventually structural change will dominate

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Conclusions II

• Low female employment in countries like Italy and Spain seem to be associated with high barriers to change

• Low service employment share also symptom of barriers

• Barriers have bigger impact on expanding service share than on contracting manufacturing share