Industrialization and the role of government

We construct a two-sector endogenous growth model to examine the role of government in industrialization. Three main features of this model are (a) household preference is non-homothetic; (b) government’s sector-specific spending is introduced as a production factor and (c) technological progress occurs only in the manufacturing sector through learning-by-doing. By using the model with these features, we derive the optimal policy for government resource allocation, optimal tax rate and share of government spending for each sector, to maximize the household’s utility. In addition, we examine the dynamics of the model. The model reveals that (a) increments in both agricultural productivity and manufacturing productivity cause labour to move from the agricultural sector to the manufacturing sector; (b) depending on the relative elasticity of production with respect to government’s spending between the two sectors, the optimal tax rate will shrink or expand with the passage of time and will stay at a level of balanced growth path in the long run and (c) as the industrialization progresses, the optimal share of government spending for the agricultural sector will decline.