Structural Change: Implications of Policy and other Barriers

1. 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

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 Oxonia 10May05

3. 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 Oxonia 10May05

4. 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? Oxonia 10May05

5. 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) Oxonia 10May05

6. 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? Oxonia 10May05

7. 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 Oxonia 10May05

8. 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 Oxonia 10May05

9. 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 Oxonia 10May05

10. 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 Oxonia 10May05

11. 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 Oxonia 10May05

12. 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 Oxonia 10May05

13. 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 Oxonia 10May05

14. 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 Oxonia 10May05

15. Employment flows during structural change Labour flow Oxonia 10May05

16. 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 Oxonia 10May05

17. 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 Oxonia 10May05

18. 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 Oxonia 10May05

19. 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 Oxonia 10May05

20. “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 Oxonia 10May05

21. 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 Oxonia 10May05

22. 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” Oxonia 10May05

23. 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 Oxonia 10May05

24. 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 Oxonia 10May05

25. 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 Oxonia 10May05

26. Ranking of countries:Admin burden on start-ups

27. More on data • Data on 2-digit sectors but for the next set of graphs aggregated into five sectors • Agriculture and mining • Manufacturing • Other production industries • Business services • Personal services (including government) Oxonia 10May05

28. 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 Oxonia 10May05

29. Oxonia 10May05

30. Oxonia 10May05

31. Oxonia 10May05

32. Oxonia 10May05

33. Oxonia 10May05

34. Oxonia 10May05

35. Model implications II TFP growth in the market higher than in the home • Female employment should be rising Oxonia 10May05

36. Oxonia 10May05

37. Model implications III 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 Oxonia 10May05

38. Manufacturing employment share of WAP Oxonia 10May05

39. Service share of WAP Oxonia 10May05

40. US UK FR GE IT Oxonia 10May05

41. 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 Oxonia 10May05

42. Services share of WAP vs. barriers, 17 countries Oxonia 10May05

43. Manufacturing share of WAP vs. barriers Oxonia 10May05

44. Service share vs rank of barriers, 17 countries Oxonia 10May05

45. Gender employment gap vs. barriers rank Oxonia 10May05

46. 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 Oxonia 10May05

47. Service employment share and women’s employment 1970-2000 Oxonia 10May05

48. 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 Oxonia 10May05

49. 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 Oxonia 10May05