INDUSTRIAL DYNAMICS AND THE NEOCLASSICAL GROWTH MODEL

I. INTRODUCTION Economists have long pondered the impact of a changing industrial composition on the overall economy. Questions such as whether the decline in the manufacturing sector is a worrisome trend are only a recent variant of this question. Not long ago the discussion was more focused on particular parts of the manufacturing sector such as the textile industry. (l) Similarly, the prominence of recent advances in computing and information technologies has cast these industries as possible catalysts of improved economy-wide performance. However, despite the urgency to some of these inquiries, the foundation for these questions is quite old and is often traced to Schumpeter (1942) who described the evolution of the industrial sector as exhibiting a process of creative destruction through the introduction of new goods and technologies. With all the changes occurring at the industry level, one might think that the overall economy would also show signs of this churning. However, the aggregate goods market data trends have remained very stable over time. In fact, these aggregate trends are so well recognized and so consistent over just about any subinterval of time that they have become the cornerstone for the idea of balanced growth and the neoclassical growth model. (3) Recent work has taken steps toward reconciling changes in the sectoral composition of output with this remarkable aggregate stability. Collectively, this work explores the modeling restrictions required for this reconciliation. Kongsamut, Rebelo, and Xie (200l) consider balanced growth in the face of a persistent reallocation of labor from agriculture to manufacturing and services. The key to aggregate stability in their model is a knife-edge relationship between a productivity parameter and a preference parameter. This relationship is employed also in Meckl (2002). Foellmi and Zweimuller (2002) build an endogenous growth model, which also accommodates structural change in employment along a balanced growth path. In their model, dynamic differences in income elasticities across sectors give rise to sectoral dynamics where expanding and declining industries coexist. Balanced growth is achieved by assuming a particular willingness to substitute across goods in a hierarchical preferences structure. Most recently, Ngai and Pissarides (2007) build a model where structural change results from different rates of technological progress across industries and balanced growth arises because of a unit elastic intertemporal elasticity of substitution. This paper also considers trends in industrial composition in a structure that allows balanced growth. However, we focus not only on trends in sectoral employment but also in the skill composition of this employment. We begin by documenting labor and output trends in the 13 major industrial classifications used by the U.S. Commerce Department. Labor trends are documented using U.S. Current Population Survey data from 1968 to 2004, while output trends are derived from U.S. national income account data from 1968 to 1999. For each industry classification, we disaggregate employment to reveal the trends in unskilled and skilled labor employment. This disaggregation allows us to dichotomize industries as initially relatively high skilled or low skilled. We find that the ratio of skilled workers to unskilled workers has grown in each industry. The absolute increase in the ratio was largest in the initially skilled industries and the ratio has grown faster in the unskilled industries. Furthermore, industries with a relatively high use of skilled workers have accounted for an increasing share of output over time. With these empirical facts in hand, we build a neoclassical growth model consistent with these trends. The model shares some features with the one in Ngai and Pissarides (2007). In particular, good-specific technological changes yield sectoral dynamics, while unit intertemporal elasticity of substitution yields balanced growth. …