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The Growth of Service Industries

The Paradox of Exploding Costs and Persistent Demand

Edited by Thijs ten Raa and Ronald Schettkat

Problems arise if budgets for services are held constant whilst prices rise. Education, cultural activities and health services are under constant budgetary pressure. The authors argue that the price of commodities is linked to demand and price increases would therefore seem to threaten the very existence of these services. The paradox of these services is that in spite of their exploding costs, demand persists.
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Chapter 10: Light on the mystery of service sector growth: some stylized facts

Thijs ten Raa and Ronald Schettkat

Extract

Thijs ten Raa and Ronald Schettkat The work in this volume illuminates the mystery of the service sector, which attracts a rising share of nominal output even though relative prices of services are rising. This is a fundamental puzzle for economics, which pays so much attention to the impact of relative prices. Even more surprising – although a less well-established fact – is the rising service share in real output over recent decades. Why doesn’t demand shift away from products that continually rise in price? The development process of industrial economies has been described in classic contributions such as Salter (1960) as following the law of negative correlation between price and quantity demanded. Industries with a higher rate of productivity growth and thus declining relative prices (technologically progressive industries) will attract demand and should therefore also expand in employment terms. Yet, we observe that the contrary occurs in the industrialized world. High productivity growth manufacturing industries decline everywhere in employment while service industries suffering from ‘Baumol’s cost disease’ expand. This is a mystery, which is clearly present in contradictory ‘facts’ and rival explanations in the literature. One of the most fundamental contradictory ‘facts’ is whether the share of service industries in real output actually expands, remains constant, or shrinks. The works presented in this volume investigate the various hypotheses and mysteries ranked around the development of the service sector. Complex theoretical issues and measurement problems are involved in evaluations of the development of the service sector and, not surprisingly, the views on...

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