GLOBAL INCOME DIVERGENCE, TRADE AND INDUSTRIALIZATION: Modelling Strategy

GLOBAL INCOME DIVERGENCE, TRADE AND INDUSTRIALIZATION: THE GEOGRAPHY OF GROWTH TAKE-OFFS

GLOBAL INCOME DIVERGENCE, TRADE AND INDUSTRIALIZATION: Modelling StrategyIn this paper, we posit a model in which these four aspects (northern industrialization and growth take-off, income divergence, and trade expansion) are jointly endogenous. To this end, we combine aspects of the ‘economic geography’ literature (Krugman 1991) with aspects of the endogenous growth literature (Romer 1986, 1990; Lucas 1988: Grossman and Helpman 1991; Aghion and How’itts 1991). Before presenting our model’s logic, we review the relevant lessons of these theoretical literatures.

Consider first the economic geography literature introduced, inter alia, by Krugman (1991a, b), Venables, and Krugman and Venables. This literature (see Fujita, Krugman and Venables 1997 for a synthesis) focuses on the location effects of international integration between identical regions. One remarkable feature of these models is the possibility that a gradual lowering of interregional trade costs can result in the catastrophic agglomeration of industry. In this context, the adjective catastrophic indicates that trade cost reduction has no location effect until a critical level is crossed, and below this level, a discrete jump in agglomeration of industry occurs (often involving total agglomeration). Within each region this sort of ‘punctuated equilibrium’ time path would appear as a sweeping inter-sector resource shift not unlike the Industrial Revolution.
Consider next the lessons of the trade and endogenous growth literature, such as Romer and Rivera-Batiz, and Grossman and Helpman. Virtually all of these models posit technological externalities – knowledge spillovers or production externalities -as the essential feature that prevents capital’s return from falling as the human, physical, and/or knowledge capital stocks rise. A number of empirical studies (Jaffe et al. 1993, Eaton and Kortum 1996; Cabellero and Jaffe 1993) show that these growth-sustaining externalities have an important local component in the sense that international borders seem to dampen the externalities.*
Combining these two sets of lessons can produce a two-region model in which the gradual, exogenous lowering of trade costs – driven by lower transportation and communication costs as well as by market opening initiatives – can produce three stages of growth.