Relative Prices and Sectoral Productivity

The relative price of services rises with development. A standard interpretation of this fact is that productivity differences across countries are larger in manufacturing than in services. The service sector comprises heterogeneous categories. We document the behavior of relative prices and expenditure shares across two broad classifications of services: traditional services, such as health and education, featuring a rising relative price with development, and non-traditional services, such as communication and transportation, featuring a falling relative price. We find a strong reallocation of real expenditures from traditional to non-traditional services with development. Using a standard multi-sector model extended to incorporate an input-output structure, we show that cross-country productivity differences are much larger in non-traditional services (a factor of 106.5-fold between rich and poor countries) than in manufacturing (only 24.5-fold). Moreover, the productivity difference between non-traditional services and manufacturing is reduced by half when abstracting from intermediate inputs. Development requires solving the productivity problem in non-traditional services in poor countries.