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 researchintensive services, exhibiting divergent paths. We build a general equilibrium model of structural transformation and directed technical change where the sectoral allocation of productive and innovative 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 employment, 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.