Baumol, Engel, and Beyond: Accounting for a century of structural transformation in Japan, 1885-1985

by Kyoji Fukao (Hitotsubashi University) and Saumik Paul (Newcastle University and IZA)

The full article from this blog post was published on The Economic History Review, and it is now available on Early View at this link

Bank of Japan, silver convertible yen. Available on Wiki Commons

Over the past two centuries, many industrialized countries have experienced dramatic changes in the sectoral composition of output and employment. The pattern of structural transformation, depicted for most of the developed countries, entails a steady fall in the primary sector, a steady increase in the tertiary sector, and a hump shape in the secondary sector. In the literature, the process of structural transformation is explained through two broad channels: the income effect, driven by the generalization of Engel’s law, and the substitution effect, following the differences in the rate of productivity across sectors, also known as “Baumol’s cost disease effect”.

At the same time, an input-output (I-O) model provides a comprehensive way to study the process of structural transformation. The input-output analysis accounts for intermediate input production by a sector, as many sectors predominantly produce intermediate inputs, and their outputs rarely enter directly into consumer preferences. Moreover, an input-output analysis relies on observed data and a national income identity to handle imports and exports. The input-output analysis has considerable advantages in the context of Japanese structural transformation first from agriculture to manufactured final consumption goods, and then to services, alongside transformations in Japanese exports and imports that have radically changed over time.

We examine the drivers of the long-run structural transformation in Japan over a period of 100 years, from 1885 to 1985. During this period, the value-added share of the primary sector dropped from 60 per cent  to less than 1 per cent, whereas that of the tertiary sector rose from 27 to nearly 60 per cent in Japan (Figure 1). We apply the Chenery, Shishido, and Watanabe framework to examine changes in the composition of sectoral output shares. Chenery, Shishido, and Watanabe used an inter-industry model to explain deviations from proportional growth in output in each sector and decomposed the deviation in sectoral output into two factors: the demand side effect, a combination of the Engel and Baumol effects (discussed above), and  the supply side effect, a change in the technique of production. However, the current input-output framework is unable to uniquely separate the demand side effect into forces labelled under the Engel and Baumol effects.

Figure 1. Structural transformation in Japan, 1874-2008. Source: Fukao and Paul (2017). 
Note: Sectoral shares in GDP are calculated using real GDP in constant 1934-36 prices for 1874-1940 and constant 2000 prices for 1955-2008. In the current study, the pre-WWII era is from 1885 to1935, and the post-WWII era is from 1955 to 1985. 

To conduct the decomposition analysis, we use seven I-O tables (every 10 years) in the prewar era from 1885 to 1935 and six I-O tables (every 5 years) in the postwar era from 1955 to 1985. These seven sectors include: agriculture, forestry, and fishery; commerce and services; construction;  food;  mining and manufacturing (excluding food and textiles); textiles, and  transport, communication, and utilities.

The results show that the annual growth rate of GDP more than doubled in the post-WWII era compared to the pre-WWII era. The real output growth was the highest in the commerce and services sector throughout the period under study, but there was also rapid growth of output in mining and manufacturing, especially in the second half of the 20th century. Sectoral output growth in mining and manufacturing (textile, food, and the other manufacturing), commerce and services, and transport, communications, and utilities outgrew the pace of growth in GDP in most of the periods. Detailed decomposition results show that in most of the sectors (agriculture, commerce and services, food, textiles, and transport, communication, and utilities), changes in private consumption were the dominant force behind the demand-side explanations. The demand-side effect was strongest in the commerce and services sector.

Overall, demand-side factors — a combination of the Baumol and Engel effects, were the main explanatory factors in the pre-WWII period, whereas  supply-side factors were the key driver of structural transformation in the post-WWII period.

To contact the authors:

Kyoji Fukao, k.fukao@r.hit-u.ac.jp

Saumik Paul, paulsaumik@gmail.com, @saumik78267353

Notes

Baumol, William J., “Macroeconomics of unbalanced growth: the anatomy of urban crisis”. American Economic Review 57, (1967) 415–426.

Chenery, Hollis B., Shuntaro Shishido and Tsunehiko Watanabe. “The pattern of Japanese growth, 1914−1954”, Econometrica30 (1962), 1, 98−139.

Fukao, Kyoji and Saumik Paul “The Role of Structural Transformation in Regional Convergence in Japan: 1874-2008.” Institute of Economic Research Discussion Paper No. 665. Tokyo: Institute of Economic Research (2017).

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