Development and Underdevelopment in the Globalizing Economy

A development and underdevelopment is presented using a Schumpeterian model for an open global economy with technology transfer and trade. When in the context of free commerce there exist strong enough mechanisms allowing technological asymmetries between countries to generate higher innovation incentives for the leaders, persistent inequality and divergence will result. Identical countries will reach different steady states. Such mechanisms include labor- and market- seeking foreign direct investment (FDI), which originated at the end of the 19th Century and has increased rapidly since the 1980’s. They also include the typical “colonial diktat” imposed by Great Britain in the 19th and early 20th Centuries. In the presence of labor-seeking FDI, the advantage a leading country’s innovators obtains by producing with the follower’s wages results in higher incentives to innovation for which FDI spillovers may not compensate the follower. It also crowds out the follower’s innovation. In the case of a small following country all of whose labor is demanded by leading country innovators, all innovation will be crowded out (the banana republic). Market-seeking FDI, providing goods that can only be sold where they are produced, also results in unequal incentives to innovation. Finally, when colonies’ markets and transportation options are limited by their colonial masters, or competitive industries are directly outruled, as in the typical colonial diktat of the 19th Century, persistent inequality and divergence arise. In contrast, in the case of autarchy, or in the case of free commerce without any asymmetric mechanisms, multiple steady states will only arise when country parameters differ. In all cases considered, marginal changes in the steady state determinants, such as population size, productivity fixed effects and institutions (represented by the degree of financial development and by the efficiency of a public input for producing innovated goods) result in growth effects for diverging countries and level effects for countries following the leader in parallel trajectories.