The effects of sectoral TFP on China’s structural transformation and growth

Since the 21st century, China has followed the Kuznets patterns of structural transformation across broad sectors while simultaneously witnessing the transformation and upgrading of industries within them. Intra-sectoral analysis reveals that high-technology manufacturing and nontraditional services exhibit distinct patterns of total factor productivity (TFP) growth, capital deepening, and employment dynamics compared to their traditional counterparts, with these internal disparities often exceeding inter-sectoral differences. While sectoral TFP is a recognized driver of structural change, its dual role in shaping both inter- and intra-sectoral transformation remains under-explored. To isolate these effects, we develop a multi-sector dynamic general equilibrium model. Our quantitative analysis shows that between 2003 and 2020, TFP growth in high-technology manufacturing and traditional services was a critical engine of China’s structural transformation and economic growth. Specifically, TFP gains in high-technology manufacturing increased its value added and employment shares within the secondary sector by 7.90 and 8.29 percentage points, respectively, boosting annualized aggregate labor productivity growth by 1.97 percentage points. In comparison, TFP growth in traditional services lifted the value added and employment shares of nontraditional services by 10.85 and 8.51 percentage points while contributing 1.59 percentage points to labor productivity growth. Although capital deepening has been a marginally stronger driver of past development, its role is diminishing with declining investment rates. Therefore, China’s future economic trajectory will depend more critically on TFP improvement. Prioritizing TFP improvements in high-technology manufacturing and harnessing untapped TFP potential in nontraditional services are crucial for sustaining high-quality development.