A model of diversification and growth in developing economies

Abstract

I build a growth model that resembles the situation of many emerging/developing countries: they are far from the world technological frontier and they have a comparative advantage in one (or a few) primary commodity. Their great challenge is to introduce into the economy goods that are produced elsewhere in the world economy but the technology of which is unknown in the domestic economy. Building new sectors from scratch is hampered by two market failures. In the first place, entrepreneurs must be willing to invest in discovering production technologies abroad and adapting them to local conditions. This process has information externalities: the pioneers have to undertake investments in information that cannot be patented and that can easily be copied by oth ers who haven’t made the investment (copycats). Second, there is a coordination problem. Success in establishing new industries is dependent on non-traded inputs that may serve a whole family of sectors (call them “infrastructure”, for short). In the absence of these inputs, no firms can emerge in any of the sectors composing a given family. This is a task that falls to an extra-market actor (call it the “government”). A simple model allows us to calibrate the conditions under which a government that balances its budget can succeed in maximizing growth. The solution involves subsidizing information investments of pioneers and taxing both the traditional sector and copycats in the modern sectors who may be induced to invest by the investment in information made by pioneers.