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To Be or Not to Be at the BOP: A One-North-Many-Souths Model with Subsistence and Luxury Goods

Author

Listed:
  • Zon, Adriaan van

    (UNU-MERIT)

  • Schmidt, Tobias

    (Centre for European Economic Research (ZEW))

Abstract

In this paper we seek to explain the causes and consequences of Northern penetration in Southern subsistence markets in order to reach the countless masses at the Bottom of the (Income) Pyramid. To this end we formulate a One-North-Many-Souths model, inspired by the Krugman (1979) North-South model. In our model, Southern countries are differentiated with respect to population size, but also the degree of internal connectedness as a proxy for the cost involved in reaching the local subsistence market. Northern subsistence goods production in Southern countries takes place under increasing returns to scale, why local production of subsistence goods takes place under constant returns to scale. Using this set-up, we show what kind of Southern countries would be penetrated first, and under which conditions this would happen. From the point of view of Northern producers, Southern countries can be divided into three classes: the broad class of partner- and non partner countries, and within the class of partner countries, the sub-classes of small and large partners. In this context, small partners are so small, that all of local subsistence production is taken over by the North, while in large countries part of subsistence consumption must still be met out of local subsistence production. The main insights coming from numerical simulations with the model are that Northern penetration on Southern markets releases (labor) resources that can then be used for producing tradable luxury goods. This has a negative terms of trade effect for the South, but a positive income effect, while, moreover, the latter effect tends to outweigh the former. In addition, small partner countries generally stand to gain more from Northern penetration than large countries, as in small partner countries relatively more resources would be released when shifting production of subsistence goods from local to Northern technologies. Using numerical simulations in which we increase the rate of imitation, we show that this leads to higher terms of trade for the South, and consequently, a higher penetration of the North in Southern countries with respect to subsistence production. The reason is that the opportunity cost of using Northern labor in Northern luxury goods production falls, and consequently more Northern labor is allocated to its alternative use of managing subsistence goods production in Southern countries. Thus we are able to "explain" the recent penetration of Northern firms in subsistence goods production in countries like India and China (which have become increasingly important as manufacturing trading partners), as the latter countries are both large in population terms as well as relatively well connected.

Suggested Citation

  • Zon, Adriaan van & Schmidt, Tobias, 2008. "To Be or Not to Be at the BOP: A One-North-Many-Souths Model with Subsistence and Luxury Goods," MERIT Working Papers 2008-046, United Nations University - Maastricht Economic and Social Research Institute on Innovation and Technology (MERIT).
  • Handle: RePEc:unm:unumer:2008046
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    References listed on IDEAS

    as
    1. Gene M. Grossman & Elhanan Helpman, 1991. "Quality Ladders and Product Cycles," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 106(2), pages 557-586.
    2. Helpman, Elhanan, 1993. "Innovation, Imitation, and Intellectual Property Rights," Econometrica, Econometric Society, vol. 61(6), pages 1247-1280, November.
    3. Kiminori Matsuyama, 2000. "A Ricardian Model with a Continuum of Goods under Nonhomothetic Preferences: Demand Complementarities, Income Distribution, and North-South Trade," Journal of Political Economy, University of Chicago Press, vol. 108(6), pages 1093-1120, December.
    4. Krugman, Paul, 1979. "A Model of Innovation, Technology Transfer, and the World Distribution of Income," Journal of Political Economy, University of Chicago Press, vol. 87(2), pages 253-266, April.
    5. Romer, Paul M, 1990. "Endogenous Technological Change," Journal of Political Economy, University of Chicago Press, vol. 98(5), pages 71-102, October.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Bottom of the Pyramid; North-South model; luxury goods; subsistence goods;
    All these keywords.

    JEL classification:

    • D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models
    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • F16 - International Economics - - Trade - - - Trade and Labor Market Interactions
    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
    • O33 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Technological Change: Choices and Consequences; Diffusion Processes

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