Economics Seminar -"Divergent Transformation Paths: An Anatomy of the Baumol Cost Disease"

We propose a novel explanation for secular stagnation that is linked to the process of structural
transformation in post-industrial economies. We merge several data sources on sectoral production
and innovation activities to document that while production workers move out of manufacturing
and into non-research-intensive services, researchers move out of manufacturing and into research-
intensive services, exhibiting divergent paths. We build a general equilibrium model of structural
transformation and directed technical change where the sectoral allocation of productive and innova-
tive resources is determined endogenously. We enrich this framework by allowing for heterogeneous,
time-varying markups across sectors. The model mimics key features of structural change in em-
ployment, expenditure and innovation activity, including the divergent paths in production and
innovation. We find that in the absence of structural change and the prevailing demographic trends,
TFP would have grown by 62% between 1947 and 2010 in the US, as opposed to the observed TFP
growth of 30%, with 87% of the slowdown due to structural change in production and innovation
and the remaining 13% due to demographic forces.