In the first work package, following a survey of the literature, a baseline structural change model that incorporates Roy's selection mechanism is developed. Roy’s selection mechanism operates on a simple comparative advantage idea: A worker chooses to be employed in manufactures as long as her wage in this sector exceeds her labor income in services. In other words, she chooses employment on the basis of her comparative advantage. This mechanism enables us to model worker allocation across sectors more realistically than the standard multi-sector models with wage equalization across sectors.
In the second work package, we collected data for the US economy from 1968 to today in order to determine the changes in the overall income distribution, and labor allocations and wage distributions across sectors. We used this data to realistically calibrate the baseline model and see what percentage of the changes in relocation of activity and resources across sectors and the changes in income distribution can be explained by structural change. We show that our model can reproduce 60 percent of the actual change in the employment shares and 38 percent of the worsening in inequality. Although these are significant amounts, the results suggest a big role for factors that are not directly related to structural change, such as demographics, market power, migration, and politics.
Our computations show that the worsening of inequality during structural change is mainly due to the reversal of the roles of the two sectors in high-wage versus low-wage sector status. While the manufacturing sector was the low-wage sector initially, its average wage level became much higher by the end of the structural change period. During the same period, service sector wages move in the opposite direction; average wage level becomes lower as a result of the structural change that brings in many workers that are shed from the manufacturing sector. The bigger size of the now low-wage sector, services, leads to a worsening in the overall income distribution.
In the third work package, we extended the model to make it more realistic in terms of capital income distribution. This meant endogenizing the savings decisions of households in order to account for the pattern of saving rates across the income distribution. Since the literature so far has used the solution to a series of static models to capture the dynamic behaviour of the economies during the structural change period, having a fully dynamic model will advance the state-of-the-art. For this purpose, we set up and solve a three-period OLG model with bequests and Roy’s selection mechanism.
Both the baseline model and the extended version can be simulated not only for US, but also for European countries. As such, the project creates a tool to guide policy makers. One can use it to discuss the trade-offs in creating more inclusive societies during the structural changes any EU-member country is expected to go through.
Dissemination of the project results will be through academic publications and conferences. Aside from the international conferences the researchers will present their results at, there will be a special workshop to disseminate the results of the project and collect feedback from the eminent researchers of the field.
