Structural Change, Market Size and Sector Specific Endogenous Growth

In the course of growth, sectoral data features (i) changing relative expenditures of different sectors, (ii) non-constancy in the growth rates of relative prices and (iii) shifting relative TFP growth rates of sectors. This paper presents a simple model of directed technical change, which is able to reconcile these findings and in which structural change is driven by both a demand-side and a supply-side effect. Our theory and the input-output tables of the U.S. allow us to reconstruct how the structural change in terms of final consumption affected the market size of industry value added. Arguing that the structural change across broad categories of final consumption is exogenous from the perspective of an individual firm, this gives us an instrument for the industrial market size. We then empirically test for the market size effect of induced innovation. Our findings suggest that a 1 percent increase in market size leads to an increase of about 0:25 percentage points of the TFP growth rate.