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2. A Simple Theory of Economic Development at the Extensive Industry Margin
- Author:
- Dario Diodato, Ricardo Hausmann, and Ulrich Schetter
- Publication Date:
- 09-2022
- Content Type:
- Working Paper
- Institution:
- The John F. Kennedy School of Government at Harvard University
- Abstract:
- We revisit the well-known fact that richer countries tend to produce a larger variety of goods and analyze economic development through (export) diversifcation. We show that countries are more likely to enter ‘nearby’ industries, i.e., industries that require fewer new occupations. To rationalize this fnding, we develop a small open economy (SOE) model of economic development at the extensive industry margin. In our model, industries difer in their input requirements of non-tradeable occupations or tasks. The SOE grows if proft maximizing frms decide to enter new, more advanced industries, which requires training workers in all occupations that are new to the economy. As a consequence, the SOE is more likely to enter nearby industries in line with our motivating fact. We provide indirect evidence in support of our main mechanism and then discuss implications: We show that there may be multiple equilibria along the development path, with some equilibria leading on a pathway to prosperity while others resulting in an income trap, and discuss implications for industrial policy. We fnally show that the rise of China has a non-monotonic efect on the growth prospects of other developing countries, and provide suggestive evidence for this theoretical prediction.
- Topic:
- Industrial Policy, Poverty, Reform, Economy, Diversification, Exports, and Convergence
- Political Geography:
- Global Focus