Developed economies have witnessed substantial growth in the share of labour employed in services in the post-war period. In the BaumolInman model, this results from preference shifts, a high income elasticity of demand for services, limited substitution between services and manufactures, and high exogenous productivity growth in manufacturing. This closed-economy model neglects the fact that typically goods are tradables and services are non-tradables, and it assumes competitive product and labour markets.

In Discussion Paper No. 811, Research Associate Giorgio Brunello develops a two-sector framework that allows for productivity differentials and non-competitive behaviour in product and labour markets. Prices and wages are mark-ups on marginal costs and reservation wages respectively. The relative sizes of the mark-ups depend on the substitutability between domestic and foreign goods and services and the parties' relative bargaining power. He uses this model to examine employment growth by sector in Italy during 1951-90 and finds that average product market mark-ups declined in manufacturing but rose in services after the first oil shock, while labour market mark-ups rose in manufacturing but declined in services.

His simulations show that the share of employment in services would have fallen from the actual 60% to about 52% if product and labour market mark-ups had remained at their average 1959-73 levels. This is equivalent to some 750,000 additional employees in industry and about a million fewer in services. Increased exposure to international competition need not raise sectoral (or aggregate) employment growth, however, if labour market mark-ups also rise, as appears to have happened in Italian manufacturing after the first oil shock. The rise in unions' relative bargaining power then apparently more than offset the effects of a small average rise in foreign competition in product markets.

Markups in the Labour and Product Markets and the Relative Performance of Industry and Services: Italy 1951-90
Giorgio Brunello

Discussion Paper No. 811, July 1993 (HR)