DP12458 Structural Change with Long-run Income and Price Effects

Author(s): Diego Comin, Danial Lashkari, Martí Mestieri
Publication Date: November 2017
Date Revised: May 2018
Keyword(s): Implicitly Additively Separable Preferences, Nonhomothetic CES preferences, structural transformation
JEL(s): E2, O1, O4, O5
Programme Areas: Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12458

We present a new multi-sector growth model that features nonhomothetic, constantelasticity-of-substitution preferences, and accommodates long-run demand and supply drivers of structural change. The model generates a log-linear relationship between relative sectoral demand and real income, implying non-vanishing nonhomotheticities for all income levels. The model is consistent with the decline in agriculture, the hump-shaped evolution of manufacturing, and the rise of services over time. We estimate the demand system derived from the model using household-level data from the U.S. and India, as well as historical aggregate-level panel data for 39 countries during the postwar period. The estimated model parsimoniously accounts for the broad patterns of sectoral reallocation observed among rich, miracle and developing economies. Our estimates support the presence of strong nonhomotheticity that is stable across time, income levels, and countries. We find that income effects account for over 80% of the observed patterns of structural change.