Endogenous phase switch in Baumol's service paradox model

This paper develops a two-sector model that considers Baumol's service paradox. The paper simultaneously incorporates two ideas about technological progress in the model: (1) the consumption of services contributes to human capital accumulation and (2) the production of manufacturing leads to technological progress due to learning-by-doing. Accordingly, productivity growth in both services and manufacturing is endogenously determined. We show that initially, a shift in the employment share toward the services sector decreases the per capita real GDP growth rate, but at some point in time, the shift begins to increase the growth rate. Therefore, we observe an endogenous phase switch from a phase where the employment shift toward services depresses the economy to another where the employment shift promotes the economy.

► A two-sector model that considers Baumol's service paradox is presented. ► Both service productivity and manufacturing productivity are endogenously determined. ► A U-shaped relationship between service employment and economic growth is obtained.