Wednesday, 20 July 2022

Local Multipliers and the Growth of Services: Evidence from late 19th Century USA, Great Britain, and Sweden

by Vinzent Ostermeyer, Lund University, Department of Economic History. 

Read more about Vinzent's reserach here.
Read the full paper (open access) here

A common periodization of economic development is that first labor shifts out of agriculture into industry and only then the service sector grows. However, such views disregard that already during the late 19th century — a period commonly associated with rapid industrialization — services were an important part of the economy growing at rates comparable to or even faster than industry (Weiss, 1967, 1971; Hartwell, 1973; Gemmell and Wardley, 1990; Broadberry et al., 2010, 2018; Rosés and Wolf, 2019). Why did such a service economy evolve earlier than conventionally thought?

While economic historians traditionally focus on explaining the emergence of industry, less work has been devoted to studying the emergence of services (Broadberry et al., 2018). Given that the historic origins of the service sector are largely unclear, it can be useful to look at contemporary periods for possible explanations. The employment multiplier framework formulated by Moretti (2010) predicts that industrial growth should have been a key contributor to the growth of services as each new industrial jobs stimulates through increased demand the local service sector. Moretti (2010) shows that in the contemporary USA 1.6 service jobs are created for each new industrial job. This number increases to 2.5 for the creation of skilled industrial employment. The multiplier is larger for skilled industrial jobs because they require higher levels of human capital, which translates into higher productivity and wages. Additionally, relatively wealthier households tend to spend more of their income on services.

I contribute to the literature on the historical emergence of services by testing whether and if so by how much multiplier effects can explain the emergence of the service sector. Specifically, I use full-count census data across a set of countries to estimate employment multipliers in a consistent way for the late 19th century. Using data from the IPUMS project published by the Minnesota Population Center (2019) and Ruggles et al. (2021), I build a detailed panel measuring the size of the industrial and service sectors at the regional level in the USA, Great Britain, and Sweden. In my approach, I classify the occupation, sector, and skill levels of individuals according to HISCO and HISCLASS codes.

I then follow the regression approach by Moretti (2010). For each country, I regress the change in the number of jobs (E) in the non-tradable (NT) – i.e., service – sector on the change in log total employment in the tradable (T) – i.e., industrial – sector for region r between two census years t. This approach controls for the potential bias of time-invariant factors and common shocks across regions in a given year. I use cluster-robust standard errors at the regional level in all regressions to account for serial correlation and possible heteroscedasticity in the standard errors.

β1 measures the employment multiplier as an elasticity. To give it a more intuitive interpretation, I multiply it with the ratio of non-tradable to tradable jobs. The employment multiplier then measures the number of jobs created in the non-tradable sector given an additional job in the tradable sector. To also isolate arguably exogenous variation in the demand for labor in the tradable sector, I follow Moretti (2010) by using a Bartik shift-share instrumental variables approach where I instrument the change in tradable employment with a region-specific weighted average of the national growth in tradable employment. Intuitively, the instrument relies on the notion that cities with a higher initial share of tradable employment in industry i should experience a larger positive shock if this industry grows at the national level.

My main finding is that across countries, the addition of one tradable job in a local labor market led to the creation of 0.5 to 1 additional non-tradable job(s). Next, I divide tradable employment into a skilled and non-skilled part and use both as outcome variable. As predicted, I find that the multiplier effect is entirely driven by the creation of skilled tradable employment. The effect was largest in the USA where adding one skilled tradable job increased local service employment by about 2.5 jobs. In Great Britain and Sweden a little less than one service job was created.

One concern against utilizing multiplier effects for public policy is that they could mainly lead to the expansion of unskilled service employment. I argue that such concerns are unwarranted for the late 19th century. By splitting the service sector into a skilled and non-skilled part and estimating separate multiplier effects for both, I show that multiplier effects contributed to the growth of both types of services.  I also show that employment multiplier effects increased employment across a range of different services and most notably personal and business services. Especially the multiplier effect for business services is noteworthy as they were key for industrialization and required relatively more skills.

This paper has several contributions to and implications for the literature. In a comparison to a step-wise understanding of economic development where industrialization occurs first and only afterwards there is an emergence of services, I show that both sectors are intimately related as a substantial part in the growth of services is due to simultaneous industrial growth. Because the industrialization during the late 19th century created growth in other sectors as well, its role for economic development is arguably broader than often recognized.

My paper also contributes to the current literature on employment multipliers. While this literature focuses on single countries in contemporary settings (Moretti, 2010; Moretti and Thulin, 2013), I employ a unified methodology and use for the first time data harmonized across a set of countries. This enables a plethora of comparisons. Given that I follow Moretti (2010), I can compare the historic multiplier effects in the USA to the contemporary ones. Overall, both multipliers are of very similar size. Second, I can compare the employment multiplier effects across countries historically. Consistent with the theoretical framework, I find larger multiplier effects in countries that are less technologically advanced and have a higher geographic internal mobility, e.g., Sweden compared to Great Britain.



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