Introducing Capital in a Three-Sector Model of Structural Transformation: A Cross-Country Analysis

Advisor: Tiago Couto Berriel

Co-advisor: Carlos Viana de Carvalho

Recent literature has highlighted the importance of sectoral productivity growth in explaining reallocation of employment across sector through time--what is usually called structural transformation. In this paper, we develop a three-sector model of structural transformation with capital, allowing for multiple-sector investment shares. This framework enables us to investigate different causes of sectoral labor reallocation, such as sector-specific productivity growth, changes in sectoral investment shares, and growth in capital stock. We do benchmark and counterfactual exercises to assess the effects of each of these factors in explaining structural transformation and aggregate productivity. We find that sectoral productivity growth in agriculture was important in explaining sectoral labor reallocation, while the same does not apply to manufacturing and services. This last result contrasts with what was recently explored in the literature using a framework without capital. Capital accumulation actually plays an important role in explaining sectoral shifts in employment, while productivity growth in manufacturing is important in our model in explaining an increase aggregate productivity. We argue that considering a simple framework without capital can bring to misleading conclusions about what are the main drivers of structural transformation and aggregate productivity across countries.