International Finance Discussion Papers (IFDP)
November 2026
Who Built the Service Economy?
Immo Schott and Vladimir Smirnyagin
Abstract:
We show empirically that the reallocation of employment from manufacturing to services in the U.S. was driven by large incumbent service firms, which expanded by opening additional establishments. Guided by these facts, we develop a two-sector general equilibrium model of firm dynamics in which incumbent firms can scale by operating multiple establishments. Quantitatively, a relative increase in manufacturing productivity and a decline in replication costs—the cost of opening and managing additional establishments—jointly account for more than half of the observed sectoral reallocation. The productivity channel shifts employment toward services but leaves the firm-size distribution unchanged. Lower replication costs, by contrast, generate the disproportionate expansion of large, multi-establishment service firms and, on their own, account for roughly one third of the reallocation generated by the two forces jointly. Our results identify firm dynamics—specifically, incumbent expansion through new establishments—as a quantitatively important force behind structural transformation.
Keywords: Firm dynamics; structural transformation; multi-establishment firms; entry
DOI: https://doi.org/10.17016/IFDP.2026.1450
PDF: Full Paper
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