Relative Prices and Sectoral Productivity

Lack of comprehensive sectoral productivity data across a large set of countries has turned researchers to structural analysis using detailed international price data to infer cross country productivity at the sector level. Because the relative price of services is higher in rich than in poor countries (and rises with development), a standard interpretation of this observation in the literature is that cross-country productivity differences in the service sector are much smaller than in other sectors of the economy, in particular industry and tradable sectors. Using disaggregate price data from the International Comparison Program we show that the behaviour of the relative price of aggregate services is driven mainly by traditional services such as government, health, and education, but that for richer countries non-traditional services such as communication and transport and insurance and financial services gain in importance. We also show that the price of non-traditional services decreases with income and is much higher than that of traditional services, especially for poor countries. This pattern together with the reallocation across services account for the higher price of services in rich relative to poor countries. We study the importance of disaggregating the service sector for productivity implications at the sector level. Using both a simple development accounting framework and a model of the structural transformation in services, we find that cross-country productivity differences are very large in non-traditional services and at least as large as those in manufacturing. We argue with these results that development requires also an emphasis on solving the productivity problem in non-traditional services in poor countries.