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The Structural Transformation Between Manufacturing and Services and the Decline in the U.S. GDP Volatility
Alessio Moroy First Version: September 2008 — This Version: October 2009

Abstract In this paper I construct a two-sector, input-output growth model to quantify the role of the structural transformation between manufacturing and services in reducing the U.S. GDP volatility. For a sectorwith a given gross output TFP volatility, value added TFP volatility is an increasing function of the share of intermediate goods in gross output. In the U.S. this share has been around 0.6 in manufacturing and 0.38 in services during the 1960-2005 period. Thus, the same level of gross output TFP volatility in the two sectors implies a 55% larger value added TFP volatility in manufacturing. In themodel, this implies that when the services share in GDP increases, the volatility of TFP in the implied aggregate production function is reduced and GDP volatility declines. Numerical results for the calibrated model economy suggest that the increase in the share of services in GDP can account for 32% of the U.S. GDP volatility reduction between the 1960-1983 and the 1984-2005 periods. JELClassi…cation: C67, C68, E25, E32. Keywords: Volatility Decline, Structural Change, Real Business Cycle, Total Factor Productivity.

I would like to thank Michele Boldrin, Javier Díaz Giménez and Nezih Guner for their guidance and Vasco Carvalho, Antonia Diaz, Huberto Ennis, Esteban Jaimovich, Matthias Kredler, Paolo Mattana, Vincenzo Merella and seminar participants at Carlos III, Cagliari, Uppsala,the SMYE 2009 in Istanbul, the XIV Workshop on Dynamic Macroeconomics in Vigo, and the EEA-ESEM Meeting 2009 in Barcelona for the useful comments. The Region of Sardinia is kindly acknowledged for …nancial support. The usual disclaimers apply. y Department of Economics, Universidad Carlos III de Madrid, amoro@eco.uc3m.es.

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Introduction

There is a large literature documenting thedecline over time in the U.S. GDP volatility. Among the various explanations advocated to explain this process are: improved inventory management techniques (Davis and Kahn, 2008), better monetary policy (Leduc and Sill, 2007), better …nancial instruments (Jermann and Quadrini, 2006), a decline in aggregate total factor productivity (TFP) volatility (Arias et al., 2007), and the structuraltransformation between manufacturing and services.1 This last explanation is based on the observation that services represents the least volatile component of GDP and that the share of services in GDP increased in the U.S. between the 1960-1983 and the 1984-2005 periods. Table 1 reports the volatility of real value added in manufacturing and services during the 1960-2005 period and the average shares ofmanufacturing and services in GDP in the 1960-1983 and the 1984-2005 periods.2 Table 1 Volatility and Relative Size of Manufacturing and Services in the US SD% 60-05 GDP share 60-83 GDP share 84-05 Manufacturing 4.26% 0.45 0.33 Services 1.68% 0.55 0.67 In the literature, the structural transformation hypothesis has been mainly tested through …xed weights counterfactual experiments. These experiments…x the shares in GDP of broad categories of goods to those of a given period. Next, a counterfactual GDP series is constructed using these shares together with the actual series of the broad categories real value added. The volatility of the counterfactual GDP series is then compared with the volatility of the actual GDP series. With this procedure, Davis and Kahn (2008) …nd that the structural
SeeMcConnell and Perez-Quiros (2000), Blanchard and Simon (2001), Stock and Watson (2002) and Dalsgaard et al. (2002), among others. In this paper, the term "structural transformation" refers to the transformation of the aggregate production function of the economy that occurs when the share of services in GDP increases relative to that of manufacturing. 2 Figures are computed using Jorgenson...