Cross-country income differences in an open-economy two-sector growth model with specific factors

Abstract

This paper investigates how a country’s specific-factors endowment affects its path of economic development. We carry out the analyses within an open economy version of the two-sector neoclassical growth model in which we introduce fixed industry-specific inputs. Our main finding is that under factor price equalization differences in input intensity across sectors can explain why nations that seem to have similar factor endowments can show very different income levels. In particular larger amounts of factors that are specific to the more capital (labor) intensive activity lead the economy to enjoy larger (smaller) long-run capital stocks and income levels. The model can also account for overtaking episodes between countries along their development paths.