The structural transformation between manufacturing and services and the deline in the U.S. GDP volatility

Abstract

For a single firm with a given volatility of total factor productivity at the gross output level (GTFP), the volatility of total factor productivity at the value added level (YTFP) increases with the share of intermediate goods in gross output. For a Cobb-Douglas production function in capital, labor and intermediate goods, YTFP volatility is equal to GTFP volatility divided by one minus the share of intermediate goods in gross output. In the U.S., this share is steadily around 0.6 for manufacturing and 0.38 for services during the 1960-2005 period. Thus, the same level of GTFP volatility in the two sectors implies a 55% larger YTFP volatility in manufacturing. This fact contributes to the higher measured YTFP volatility in manufacturing with respect to services. It follows that, as the services share in GDP increases from 0.53 in 1960 to 0.71 in 2005 in the U.S., GDP volatility is reduced. I construct a two-sector dynamic general equilibrium input-output model to quantify the role of the structural transformation between manufacturing and services in reducing the U.S. GDP volatility. Numerical results for the calibrated model economy suggest that the structural transformation can account for 32% of the GDP volatility reduction between the 1960-1983 and the 1984-2005 periods.Volatility decline, Structural change, Real business cycle, Total factor productivity