Income Differences and Input-Output Structure

We consider a multi-sector general equilibrium model with input-output (IO) linkages and sector-specific productivities to investigate how the IO structure interacts with sectoral productivities in determining cross-country differences in aggregate income per worker. Using tools from network theory, we show that aggregate income can be approximated as a simple function of the first and second moments of the joint distribution of the IO multipliers and sectoral productivities. We then estimate the parameters of the model to fit their joint empirical distribution. Poor countries have few high-multiplier sectors, while most sectors have very low multipliers; by contrast, rich countries have more sectors with intermediate multipliers. Moreover, the correlations of sectoral IO multipliers with productivities are positive in poor countries, while being negative in rich ones. The estimated model predicts cross-country income differences extremely well and significantly better than a multi-sector model without IO linkages. Finally, we perform a number of counterfactuals and compute optimal tax rates.