Industrialisation
*
by
JOSHUA S. GANS
Melbourne Business School, University of Melbourne
Carlton, Victoria, 3053, Australia
EMail: J.Gans@mbs.unimelb.edu.au
First Draft: January 25, 1994
This Version: June 11, 1997
This paper presents a model that combines the increasing specialisation
and adoption of modern technologies views of industrialisation. Both of these
views have been used in the recent literature to demonstrate the possibility of
coordination failure. With simultaneous production across sectors, the model
generates the indeterminancy of equilibria common to the recent literature.
However, by positing quite natural time lags in production this
indeterminancy is eliminated. It is shown that, in such a framework, even with
optimistic expectations, firms prefer to delay industrialisation in the
development trap. This suggests that policies aimed at transition by using
indicative planning are unlikely to be successful. Journal of Economic
Literature Classification Numbers: O14 & O20.
Keywords: industrialisation, modernisation, specialisation, technology
adoption, complementarities, irreversible investment, indicative planning.
*
This paper draws on results from Chapter 4 of my Ph.D. dissertation from Stanford University (see Gans,
1994). I wish to thank Kenneth Arrow, Paul Milgrom, Scott Stern and two anonymous referees for helpful
discussions and comments. I also thank the Fulbright Commission for financial support. All errors remain
my responsibility.
2
I Introduction
It is generally acknowledged that the process of industrialisation involves the
application of “progressively modern” technologies in production. The concept of
“progressively modern” is, however, imprecise. Nonetheless, it is common to view
industrialisation as involving the use of production techniques that are more efficient at the
margin. Hence, in recent times, it has been argued that increasing returns are at the heart of
industrialisation processes. Moreover, it has been demonstrated that this implies that
coordination failure or a multiplicity of decentralised equilibria is an inherent possibility
giving rise to the notion that industrialisation or the lack of industrialisation can be
explained by expectations alone (Murphy, Shleifer and Vishny, 1989).
The idea that a lack of industrialisation can be the result of pessimistic selffulling
expectations suggests that indicative planning could be used fruitfully to push an economy
from a low industrialisation equilibrium. However, while a static model with multiple
equilibria can give rise to this possibility, it is only in an explicitly dynamic model where
transition processes and expectations formation are endogenised can such conclusions
readily be explored.
This point has been recognised by researchers. Krugman (1991) and Matsuyama
(1992) consider an explicit transition process associated with a static model of coordination
failure. By positing the existence of exogenous switching costs, they are able to
demonstrate under what parameters history rather than expectations determines whether the
economy reaches a good versus bad equilibrium. Specifically, when these exogenous
switching costs are high, the possibility of expectations driven transitions are limited and
hence, it is unlikely indicative planning will be an effective policy response to a lack of
industrialisation.
The purpose of this paper is to develop an explicit dynamic model where there are
no exogenous switching costs. Instead, I assume that production simply takes time. These
time lags have the effect of limiting the period by period growth of the state variable (i.e.,
the level of industrialisation). More significantly, this also means that the model exhibits
3
multiple steady states as opposed to multiple equilibria, with both states of persistent
industrialisation exhibiting increasing growth over time and a development trap. In the
development trap, even if firms are optimistic about the general level of demand in the
economy, each finds it optimal to wait rather than modernise or enter immediately. As
such, no rational expectations path exists from the development trap to a state of persistent
industrialisation suggesting that transition policies based on indicative planning are unlikely
to be successful.
While demonstrating the limitations of indicative planning is the primary purpose of
the paper, the model developed is interesting in its own right. This is because it unifies two
recent strands in the literature on industrialisation. Each strand takes a different perspective
on what the adoption of “progressively modern” technologies means. One strand posits a
direct linkage between technology adoption and greater marginal efficiency. Production
processes are potentially carried out by two processes: one with no fixed costs and constant
marginal costs and the other with some fixed cost but lower marginal costs than the first
process. Thus, “progressively modern” technologies involve producers incurring greater
fixed costs in order to improve the marginal efficiency of variable inputs.
1
Another strand of the recent literature has considered industrialisation as the use of
greater varieties of intermediate inputs in the production of final goods. Intermediate
inputs are imperfect substitutes for one another. Therefore, the employment of an
additional variety raises the efficiency of final good production at the margin.
2
Sometimes
this mechanism for industrialisation is interpreted as increasing returns due to
specialisation. The metaphor here is that additional varieties of intermediate inputs allow
each variety to perform a smaller range of tasks with greater efficiency.
This strand of the literature shares with the direct approach outlined above a
requirement that a fixed cost must be incurred before efficiency gains can be realised.
Here, the fixed costs are associated with the entry of new varieties into production. On the
1
This strand is best exemplified by the model of Murphy, Shleifer and Vishny (1989). An alternative
approach is developed by Baland and Francois (1995).
2
The industrialisation as greater product variety view has been analysed by Romer (1987), Rodriguez
Claire (1996), and Ciccone and Matsuyama (1996) among others.
4
other hand, in the direct strand, the fixed costs are associated with the modernisation of
production processes. Without the existence of such fixed costs, final goods producers
would demand a potentially infinite variety of intermediate inputs and would always adopt
the least cost technology. Industrialisation, whether it be from modernisation or entry,
becomes a problem because firms face a tradeoff between the action generating greater
efficiency and the fixed costs of adoption or entry.
The paper provides a unified model of these two concepts of industrialisation. In so
doing, the common element of both strands is maintained, that is, that the size of the
market is a critical ingredient in determining the possibility of industrialisation. On
the technological side, however, producers in the intermediate input sector will face a multi
dimensional choice. They will face an entry decision of whether to enter into production or
not and a modernisation decision. The modernisation decision will involve a choice from a
menu of technologies rather than a simple binary choice between some constant returns and
increasing returns technology. Therefore, the level of fixed costs becomes a choice variable
of firms. By incurring greater levels of fixed costs, firms obtain progressively higher
levels of labour productivity. As such, an economy is considered to be more industrialised
the greater the level of fixed costs incurred by intermediate input producers and the more
varieties are available for final good production.
3
Section II presents a static model. However, here we follow the modelling
approach of Ciccone (1993) and consider the fixed costs associated with entry and
modernisation to be composed of final goods. Essentially this can be interpreted as an
assumption that the intensity of factor use in plant production are the same as for final good
production. An alternative assumption would be that plant production involved no
intermediate inputs at all and was solely composed of labour (as in Murphy, Shleifer and
Vishny, 1989). While this latter interpretation might be appropriate for models of growth
based on research and development, it is quite restrictive in the industrialisation context.
4
,
5
3
In the model to presented here, therefore, the fixed and marginal cost components of the increasing returns
technology are no longer parameters that determine the range of equilibrium. They are replaced by a meta
parameter describing the rate at which fixed costs are translated into lower marginal costs.
4
The use of labour versus final goods units as fixed costs can radically alter conclusions regarding the
multiplicity of equilibria (see Matsuyama, 1995). In Gans (1997a), we consider the choice of which factors
5
When fixed costs are in final good units rather than labour units, this model
generates the multiplicity of equilibria that is common to static models basing themselves on
one aspect of industrialisation (as noted by Ciccone, 1993). More importantly, the model
demonstrates that the same assumptions on parameters that allow the possibility of
multiplicity for one aspect also generate the possibility of multiplicity for the other. That is,
the same conditions that generate strategic complementarities between sectors in their entry
decisions, ensure that complementarities exist in their modernisation decisions. This is
because each action affects others though the same aggregate variables.
Section III then presents a dynamic version of the model in a discrete time setting.
This section contains the main results of the paper concerning indicative planning. It is
shown that conclusions regarding complementarities do not carry over into the dynamic
context. This creates the possibility of a development trap where expectations alone cannot
drive an escape. A final section concludes.
II Static Model
The model to be presented here is similar to the model of Gans (1995a) which itself
builds upon that of Ciccone (1993). The latter develops models of industrialisation in
which the fixed costs of entry and modernisation are in final good units while the former
develops a continuous technological choice space.
Sectoral Structure and Technology
The basic model to be considered here is of a closed economy consisting of two
production sectors  an upstream and a downstream sector. The downstream (or final
output) sector consists of a continuum of firms producing a homogenous final good
to use in plant production to be endogenous. It is shown there that the conclusions of models where fixed
costs are in final goods units are more robust to this change.
5
The model also shares with Ciccone (1993) that intermediate goods are the driving force of
industrialisation. This assumption need not have been made. For instance, Hansen (1995), considers a
model where industrialisation takes place at the level of final goods and entrepreneurial effort is the critical
fixed cost allowing for technology adoption.
6
denoted Y. Firms in this sector use a CobbDouglas technology, employing both labour,
L
Y
, and a composite of intermediate inputs, X,
Y X L
Y
· > ≥
− α α
α
1
1 0 , .
This production function exhibits constant returns to scale.
6
In addition, it is assumed that
the downstream sector is competitive with all firms being price takers. I assume the good
they produce is the numeraire.
Households consume final goods not used in production and supply one unit of
labour inelastically for which they receive a competitive wage, w. The total labour
endowment is L.
The intermediate input composite is assembled by final goods producers according
to the following technology,
X x dn
n
k
·

.
`
,
−
−
∫
σ
σ
σ
σ
σ
1
1
0
, >1
where x
n
denotes the amount of intermediate input of variety n that final good producers
employ. The elasticity of substitution between different varieties, σ, is constrained to be
greater than one implying that no single variety is necessary for production. It is assumed
that each variety, n, is produced by a single monopolist, regardless of their choice of
technology.
7
Thus, there is potentially a continuum of such firms lying on the [0,k]
interval of the real line.
8
Apart from the usual pricing decisions, potential producers in this
sector face two additional classes of decisions: (i) whether to enter production; and (ii) if
so, at what level of technology. The first class of decisions I term entry, while the second
is termed modernisation. Together these constitute industrialisation. I will deal with the
elements of each of these decisions in turn.
6
The CobbDouglas assumption is not critical here. The results below could also be presented using a
general constant returns to scale production function with the restrictions discussed by Ciccone and
Matsuyama (1996).
7
The fixed costs associated with entry make this a reasonable assumption as potential entrants find it
optimal to produce a new variety rather than compete with incumbent firms. Strictly speaking, however,
these firms are in monopolistic competition with each other as in Dixit and Stiglitz (1977).
8
The model is similar to the setup of Romer (1987), although it contains some additional generality for he
assumes that σ α · −
−
( ) 1
1
.
7
Entry Decisions
Entry into intermediate good production is costly. It is assumed here that a variety
cannot be produced without the firm incurring a unit charge in terms of the final good.
9
The level of this charge is independent of both the technological choice and the actual level
of production. Thus, it is a pure sunk cost of entry. As will be apparent below, firms will
find it optimal to enter production if and only if they face nonnegative profits upon entry
(given their optimal technological and pricing decisions).
Technological Choice in the Upstream Sector
Upstream producers are able to choose, to some extent, their technology of
production. After entry, a typical technology has them using labour, l
n
, and producing
output, x
n
, according to,
x
l
F
n
n
n
·
Ψ( )
.
The choice of F
n
, itself, is assumed to be endogenous  it represents a fixed cost (in final
good units) to the firm as well as a technological choice. Higher choices of F
n
mean a
lower labour requirement, that is, ′ < Ψ ( ) F
n
0 with a choice of zero fixed costs resulting in a
constant returns to scale technology with Ψ( ) 0 1 · .
10
Upstream firms are able to choose
their technology from a menu  assumed here to be any positive real number.
11
The actual technology adopted will depend upon demand conditions. As final
goods producers earn zero profits, the inverse demand for a given intermediate input
depends on the marginal cost of producing a unit of the composite, X. This is also the price
of X and it is denoted by P. Thus,
9
Many models of industrialisation assume that the fixed costs of industrialisation are in labour units (e.g.,
Murphy, Shleifer and Vishny, 1989; RodriguezClare, 1996; and Ciccone and Matsuyama, 1996). This
assumption makes it more difficult to generate strategic complementarities. The substantive results of the
model to be presented below could be generated under the labour units assumptions but only at the expense
of additional restrictions of the kind explored by Ciccone and Matsuyama (1996).
10
Every result to come only requires that the marginal labour requirement when F
n
= 0 be some positive
constant.
11
Dasgupta and Stiglitz (1980) and Vassilikas (1989) analyse continuous mechanisms for technological
choice but in very different contexts to that here.
8
P p x dn x dn p dn
x
n n
k
n
k
n
k
n n
k
· ·
¹
'
¹
¹
¹
¹
'
¹
¹
¹
·

.
`
,
·
−
∫ ∫ ∫
−
−
min
{ }
0
1
0 0
1
0
1
1
1
σ
σ
σ
σ
.
12
Profit maximisation by final goods producers yields their demand for an individual variety,
x
n
,
x X
P
p
n
n
·

.
`
,
σ
,
where use is made of the assumption of constant returns to scale in final good production.
13
Since intermediate input producers face demand curves with a constant elasticity, 
σ, their optimal pricing scheme if they undertake positive production in period t is,
P w F dn w
n
k
· ( )

.
`
,
· ℑ
−
−
−
−
∫
− σ
σ
σ
σ
σ
σ
σ
1
1
0
1
1
1
1
1
Ψ( ) ,
the standard constant markup over marginal costs.
Using the optimal pricing rule, some simple substitutions show that, P w · ℑ
−
− σ
σ
σ
1
1
1
and x F X
n n
· ℑ
−
−
Ψ( )
σ
σ
σ 1
, where,
ℑ· · ℑ
{ ¦ ( )
[ ]
−
≤ ∫
Ψ( ) , F dn k F
n
k
n
n k
1
0
σ
.
The aggregate, ℑ, is a measure of the overall level of industrialisation. It is increasing in
both the variety of intermediate inputs produced and the level of technology chosen by
upstream firms.
Now consider the labour market. To satisfy demand, the labour requirement for an
intermediate input producer is simply, l F X
n n
· ℑ
−
−
Ψ( )
1
1
σ
σ
σ
. As such, total labour demand
in the upstream sectors is,
L l dn X
X n
k
· · ℑ
∫
−
0
1
1 σ
.
12
There is a formal difficulty here when k = 0. One could with additional notation assume that there is
always an arbitrarily small subset of upstream that always chooses to produce. However, here it is more
convenient to adopt the convention that when k = 0, P · ∞.
13
In deriving this demand function, the infinite product space is approximated as the limit of a sequence of
finite economies. See Romer (1987, 1990) and Pascoa (1993) for a more complete discussion of this issue.
9
For the final goods sector, note that the CobbDouglas production implies that,
L
PX
w
X
Y
· ( ) · ( )( )ℑ
− −
−
− 1 1
1
1
1 α
α
α
α
σ
σ
σ
.
It is assumed that the labour market clears in every period. As such, L L L
Y X
· + and,
therefore, X L ·
( )
ℑ
−
−
−
α σ
σ α
σ
( ) 1
1
1
. Finally, it remains to find the wage level each period. This
can be found by looking at the marginal product of labour in the production of final goods
and using the solution for X: w · − ( ) − ( ) ℑ
−
− 1
1
1 1
1
σ
α α
α σ α σ
α
σ
( ) ( ) .
Substituting the relevant aggregate variables into this equation gives a convenient
reduced form for the payoffs of an intermediate input producer entering into production.
To examine the structure of these payoffs, consider upstream profits (of an entrant) when
wages are held constant,
π
σ α
σ α n n n n n n n
p w F x F F wL F · − ( ) − − · ( )ℑ − −
−
−
−
Ψ Ψ ( ) ( ) 1 1
1 1
.
The effect of rising industrialisation in this case is to depress profits and the marginal return
to modernisation. This is because increased entry and modernisation by others provides
more competition for any given upstream firm, reducing their total revenue. However,
when wages are varied profits become,
π
σ
α σ
σ
n n n
L F F · ℑ − −
−
− −
−
Λ Ψ( )
( )
1
1
1
1.
where Λ · − ( ) − ( )
−
−
α σ α σ
α α
α
σ σ α
( ) ( )
( )
1 1
1
. The flows of income and goods leading to this
equation are depicted in Figure One. The wage effect
14
exerts a positive feedback on both
entry and industrialisation decisions  they reflect higher demand for final goods and
greater efficiency in its production, raising demand for intermediate inputs. As explored by
Ciccone (1993), if the socalled increasing returns due to specialisation ( ( ) σ −
−
1
1
)
outweigh the decreasing returns to additional use of the intermediate input composite (α),
the game between intermediate input producers exhibits strategic complementarities (with
the wage effect outweighing the competition effect). The greater the level of
14
Ciccone (1993) refers to this as a “(fixed) cost effect.” This interpretation simply reflects the choice of
numeraire. Basically, the wage effect is how industrialisation generates a rise in wages relative to the price
of final goods, further raising individual returns to entry and modernisation.
10
industrialisation, the greater the marginal return to both entry and modernisation.
Therefore, for the rest of this paper it is assumed that σ α − ≤ 1 .
To emphasise, the pathways through which entry and modernisation decisions
affect industrialisation and, in turn, how industrialisation effects those decisions are
essentially the same. Both entry and modernisation decisions reduce the revenues of others
through the competition effect and raise them through the wage effect. Moreover,
industrialisation impacts upon these decisions through a single variable in the profit
function  raising the gross profits (and marginal profits) net of modernisation and entry
costs. Thus, it impacts upon these decisions in a very similar manner.
15
Both aspects of
industrialisation, therefore, have the same economic interpretation.
Equilibria
In order to simplify the exposition of what follows, I will adopt the following
functional form for Ψ( ) F
n
,
Ψ( ) ( ) , F F
n n
· + >
−
1 0
θ
θ .
This functional form captures the notion that greater sunk costs reduce the marginal labour
requirement and also imposes diminishing returns to this process. To ensure π is concave
in F
n
, it is assumed that θ
σ
<
−
1
1
.
Since the reduced form profit function already takes into account labour and good market
clearing, only equilibria in the game between intermediate input producers need be
considered. Suppose that m k ≤ upstream firms are active. Let
B F
n F n n
n
( ) argmax ( ; ) ℑ ≡ ℑ π be the best response set for their modernisation decisions.
16
15
Slight differences do occur because the entry decision depends on gross profits, while the modernisation
decision depends on marginal profits. Their qualitative aspects are, however, the same.
16
This involves an implicit assumption that firms producing low ordered varieties will enter first in any
equilibrium. This is a reasonable assumption given the symmetry among upstream producers producing
modern varieties and the fact that basic input producers do not face an entry charge.
11
The pair ( ,{
ˆ
} ) m F
n n m ≤
constitutes a pure strategy Nash equilibrium if:
(i)
ˆ
(
ˆ
) F B
n n
∈ ℑ for all n m ≤ ;
(ii)
ˆ
(
ˆ
)
( )
ℑ· +
−
∫
F dn
n
m
1
1
0
θ σ
; and
(iii) max ( ,
ˆ
) ,
F n n
n
F n m π ℑ < ∀ > 0 .
Thus, in equilibrium, all firms choose the technology that maximises profits and these
decisions generate a consistent level of industrialisation. In addition, in equilibrium, if they
choose to enter, nonactive firms earn negative profits.
The following proposition summarises the possible equilibria arising in this model.
The proof is in Appendix A.
Proposition 1 (Static Equilibria). Suppose that the initial level of
industrialisation is ℑ
0
. The following characterise, completely, the set of pure
strategy Nash equilibria:
(i) If
L < ℑ
−
− −
− 1
0
1
1
Λ
α σ
σ
( )
, then for all parameters, there exists a “development trap”
with no further entry (or modernisation) by intermediate input producers;
(ii) If
1
1
1
1
1
1
1
θ σ
α σ
σ
α σ
σ
( )
( ) ( )
−
− −
− −
−
− −
−
≥ >
Λ Λ
k L k and L < ℑ
−
−
− −
− 1
1 0
1
1
Λθ σ
α σ
σ
( )
( )
, there exists an “entry
equilibrium” with no modernisation (i.e., k firms enter into production but
F
n
· 0 for all n);
(iii) If L k >
−
−
− −
− 1
1
1
1
θ σ
α σ
σ
( )
( )
Λ
and
1
α
θ > , there exists an “industrialisation equilibrium”
(i.e., k firms enter into production and F
n
> 0 for all n).
Several remarks on this proposition are in order. First, the presence of the entry cost
means that a development trap is somewhat generic to the model (i.e., we can always find
an initial level of industrialisation that makes this an equilibrium). If the labour endowment
is large enough or if k is large enough, there exist multiple equilibria in this model. Both
the entry and industrialisation equilibria Pareto dominate the development trap since positive
output (and hence, consumption) occurs in these cases. The additional condition for the
existence of an industrialisation equilibrium (that 1 >θα) is a sufficient condition for global
concavity of aggregate consumption in the level of modernisation. As such, it does not
appear to be excessively restrictive here. Note too that (along with the condition for
strategic complementarity) this condition implies that firm profit functions are concave in
technology choice.
12
III A Dynamic Model of Industrialisation
The above model shares with other static models of the “big push” the idea that
temporary government intervention can potentially facilitate a change from the development
trap to persistent industrialisation. It also shares with those models the possibility that
generating optimistic expectations or some form of indicative planning could achieve this
task without the need for direct government intervention.
As has been noted elsewhere (e.g., Krugman, 1991), in order to properly analyse
this latter possibility one needs to move from a static model to consider dynamics
explicitly.
17
Taken literally, the economy could easily move back and forth between the two
[equilibria]. The problem is that, in a completely static framework, one cannot capture
the difficulty of the transition in the process of industrialization, which may be
responsible for stagnation. In order to understand the selfperpetuating nature of
underdevelopment and the inability of the private enterprise system to break away from
the circularity, it is necessary to model explicitly the difficulty of coordination.
(Matsuyama, 1992a, p.348)
Matsuyama extends the Murphy, Shleifer and Vishny (1989) model to a dynamic setting.
In his model, firms face adjustment costs in adopting the modern technology or switching
back to the traditional one. As such, they need to anticipate not only the current movements
of others but their future movements as well. In this setup, Matsuyama finds that
indicative planning will not be sufficient to generate an escape from a development trap if
adjustment costs are large or the discount rate is high.
Ciccone and Matsuyama (1996) also offer an explicitly dynamic model of the big
push.
18
Their model has the same structure as the static model above although they do not
consider a modernisation choice and entry costs are in labour (rather than final good) units 
 this being the substantive difference between their model and that described above. The
only other significant difference between their model and the one in the previous section is
that:
X t x t dn
n
( ) ( ) ·

.
`
,
−
−
∞
∫
σ
σ
σ
σ
σ
1
1
0
, >1.
17
The former possibility is discussed in Gans (1997b).
18
Murphy, Shleifer and Vishny (1989) also offer a simple dynamic model of industrialisation. It is,
however, only a two period model whereas the alternatives here and elsewhere have a long time horizon.
13
There is potentially an infinite number of entrants in any period t. Using this framework
they analyse several models in a continuous time setting. They provide several examples of
models that exhibit multiple dynamic equilibria and thus, allow the possibility of indicative
planning. In those models, however, growth in the industrialisation equilibrium involves
constant per capita consumption. They do present one model with rising per capita
consumption and multiple steady states without the possibility of indicative planning.
However, that involves constant growth in the industrialisation steady state. Allowing the
possibility of increasing growth may be more consistent with the empirical reality of
industrialisation (see Romer, 1986).
In this section, I wish to consider an alternative approach to dynamics using the
model of section II. In so doing, I will use the form of X(t) above but, for reasons that will
soon become apparent, use a discrete rather than continuous time setting.
19
Households
and firms in this model solve intertemporal maximisation problems. For upstream firms,
incurring entry costs in period t allows them to start production in period t and successive
periods. Their technological choices involve sunk costs as well, although these can be
spread over time. By accumulating quantities of the final good over time, upstream
producers can increase their labour productivity. Thus, suppose that, at time t, the
cumulative amount of the final good purchased by firm n is,
F t f s
n n
s
t
( ) ( ), ·
·
∑
0
where f s
n
( ) is the amount of the final good purchased in period s. Then in t, and in
subsequent periods, the firm is able to produce x t
n
( ) without additional investment
according to: l t F t x t
n n n
( ) ( ( )) ( ) · Ψ . Thus, by incurring sunk costs, intermediate input
producers require only Ψ( ) F
n
units of labour to produce a unit of intermediate input in
subsequent periods. To make the choice space of upstream firms continuous, I suppose
that their choice of f t
n
( ) is endogenous in each period and can take any positive real value.
19
All dynamic recent models of industrialisation and endogenous growth that I am aware of use a
continuous time setting.
14
As before, higher accumulations of F t
n
( ) mean a lower labour requirement, that is,
′ < Ψ ( ( )) F t
n
0.
20
Households now solve an intertemporal maximisation problem. In each period,
they choose their level of consumption of the final good to solve:
max ( ( ))
( ) C t
t
t
t
U C t
{ ¦
+
·
∞
·
∞ ( )
∑
0
1
1
1
δ
subject to
1
1
1
1
1
1
0
+
·
∞
+
·
∞
( )
≤
( )
+
∑ ∑ r t
t
t
r t
t
t
C t L w t v
( ) ( )
( ) ( ) ( )
where v(0) is the value of share holdings in upstream firms, U(.) is a continuously
differentiable, nondecreasing, strictly concave function, δ > 0 is the subjective discount
rate and r(t) is the interest rate. The solution to this optimisation problem is characterised
by the familiar Euler condition and the binding budget constraint:
′
′ +
·
+ +
+
U C t
U C t
r t ( ( ))
( ( ))
( )
1
1 1
1 δ
for all t,
1
1
1
0
+
·
∞
( )
−
( )
·
∑ r t
t
t
C t Lw t v
( )
( ) ( ) ( ).
That is, to justify any rising growth in consumption, the interest rate must rise over time.
As discussed in depth by Romer (1986), a problem arises in contexts such as these:
with net profits increasing in the level of industrialisation, ℑ( ) t , utility could become
unbounded. Indeed, in this framework, from any positive level of industrialisation, all
intermediate input producers choose to enter and modernise in a single period, leading to
nonsensical infinite production. To avoid this difficulty, here I exploit the structure of the
positive and negative feedbacks in the model in section II by introducing time lags into
production.
For final good production, it is now assumed that:
Y t X t L t
Y
( ) ( ) ( ) + ·
−
1
1 α α
.
20
Some depreciation could be included in this specification, although it would not alter the results to come
in any substantive manner.
15
That is, production of final goods takes one period. This is the reason why I have used a
discrete time setting. Allowing for this possibility means that the positive feedback (i.e.,
wage effect) from industrialisation will be delayed one period. As will be shown, this leads
to a mixture of substitution and complementarity in cash flows that results in smoothed
industrialisation across time.
Appendix B derives the relevant aggregate variables as a periodbyperiod general
equilibrium of the model. Substituting these into the cash flow equation gives a convenient
reduced form for the cash flow of an intermediate input producer producing a positive
output in period t,
π
σ
α
σ
n n n
t L F t t t f t ( ) ( ( )) ( ) ( ) ( ) · ℑ − ℑ −
− −
−
Λ Ψ
1 1
1
1
.
where Λ is as before. Observe that if σ α − ≤ 1 , then, from a systemwide point of view,
there exists a positive feedback between the past technological choices of intermediate
input producers and the firm’s current choice. To see this more clearly, suppose that there
is no further increase in overall industrialisation in period t. Then the mixed partial
derivative of the profit function with respect to f t
n
( ) and ℑ − ( ) t 1 is nonnegative if and only
if ℑ − ℑ
−
−
( ) ( ) t t 1
1
1
α
σ
is nondecreasing in ℑ − ( ) t 1 for all f t
n
( ) . Observe that holding the
current increment to industrialisation, ∆ℑ ≡ ℑ − ℑ − ( ) ( ) ( ) t t t 1 , constant, this is equivalent
to,
∂
∂
α
σ
ℑ −
ℑ −
ℑ − + ℑ
≥
−
( )
( )
( ) ( )
t
t
t t
1
1
1
0
1
∆
,
which is true if and only if σ α − ≤ 1 . Then, ceteris paribus, the greater the past level of
industrialisation, the greater is the marginal return to both entry and modernisation.
It is worth noting, however, that the firm’s current technological choice is a
strategic substitute with the current choices of other intermediate input producers. So while
a greater level of past industrialisation raises the marginal returns to entry and technological
decisions today, greater current industrialisation dampens those incentives. The former
(complementary) effect emerges because greater past industrialisation pushes up current
wages which in turn raises demand for intermediate inputs through higher aggregate
16
demand. On the other hand, the latter (substitution) effect occurs because of the reduction
in current intermediate input prices caused by lower marginal costs of production and the
competition of entrants.
Equilibrium Defined
Given the dynamic context, the definition of what constitutes an equilibrium in the
game between intermediate input producers needs to be restated. Let
B f
n t
t f
r
t
n n
t n
t
,
( )
( )
( ), ( ) argmax ( ); ( ), ( ) ℑ ℑ − { ¦ ( )
≡
( )
ℑ ℑ − ( )
≥ { ¦
+
−
≥
≥
∑
τ τ π τ τ τ
τ τ
τ
τ
τ
τ
1 1
1
1
be the best response set for an active firm n k t ≤ ( ). A strategy pair, ( ( ),{
ˆ
( )} )
( )
k t f
n n k t
t
τ
τ
≤
≥
{ ¦
constitutes a pure strategy Nash equilibrium if, for all t:
(i) {
ˆ
( )} {
ˆ
( ),
ˆ
( )}
,
f B
n t n t t
τ τ τ
τ τ ≥ ≥
∈ ℑ ℑ −
( )
1 for all active n;
(ii)
ˆ
( )
ˆ
( )
( )
( )
ℑ · +
( )
·
−
∑
∫
t f dn
n
s
t
k t
τ
θ σ
1
0
1
0
;
(iii) max ( ) , ( )
( )
( )
f
r
t
n
t n
t
n k t
τ
τ
τ
τ
τ
π τ
{ ¦
+
−
≥
≥
( )
< ∀ >
∑
1
1
1 ;
(iv) r(t) satisfies the household Euler condition.
Thus, in equilibrium, all firms choose the technology that maximises discounted cash flows
and these decisions generate a consistent level of industrialisation. In addition, in
equilibrium, if they chose to enter, nonactive firms would earn negative profits. Finally,
the rate of interest satisfies the intertemporal optimisation condition for households.
Linear Utility
As will be discussed further below, the time structure of production makes the
specification of industrialising equilibria very difficult. However, one can show that
persistent industrialisation is possible.
21
In order to make clear the forces driving this
result, I will start with the case of linear utility (i.e., U(C(t)) = C(t) for all t) and generalise
this in Proposition 2’ below. In this simple case, the interest rate, r, is constant and equal
to the subjective discount rate, δ.
21
This result is related to the Momentum Theorem, initially stated in Milgrom, Qian and Roberts (1991)
for contracting problems, and extended in Gans (1994, Chapter 3) to game theoretic contexts.
17
Proposition 2 (Persistent Industrialisation). Let utility be linear. Suppose that
at some time t, ℑ > ℑ ( )
*
t , where ℑ ·
( )
+
−
− − * 1
1
1
δ
δ
σ
σ α
ΛL . Then
ℑ − ℑ ≤ ℑ + − ℑ ≤ ( ) ( ) ( ) ( ) ... τ τ τ t 1 for τ > t.
Once again the proof is in Appendix A. This proposition says that once industrialisation
reaches a critical level, the process will persist and continue of its own accord. Note too
that, under persistent industrialisation, the state variable of industrialisation evolves
according to,
ℑ · ℑ −
+
−
( ) ( )
( )
t L t Λ
1
1
1
δ
δ
α
σ
,
a unique path. Thus, in the spirit of “big push” theories of industrialisation, the economy
can be stuck in a development trap from which an escape could be made provided sufficient
coordination of the decisions of intermediate input producers is achieved.
General Utility Functions
With more general utility functions, the result here becomes more complicated as the
interest rate, r(t), changes over time. Suppose that in period t, ℑ > ℑ ( )
*
t , and ∆k t ( ) +1
firms choose to enter in t+1 with firms modernising to a level, f. In this case, the relevant
Euler condition for intermediate input producers becomes (with ∆ℑ + ≡ ℑ + − ℑ ( ) ( ) ( ) t t t 1 1 ),
g t t L f t t t
r t
r t
( ( ), ( )) ( ) ( ) ( ) ( )
( )
( )
( )
∆ Λ ∆ ℑ + ℑ ≡ + ℑ − ℑ − ℑ + ·
+ +
+
− −
−
1 1 1 0
1 1
1
1 1
1
θ σ
α
σ
.
When utility is linear, the g(.) (i) is positive at ∆ℑ + · ( ) t 1 0 since ℑ > ℑ ( )
*
t ; (ii) becomes
negative as ∆ℑ + ( ) t 1 grows large; (iii) is strictly decreasing in ∆ℑ + ( ) t 1 ; and (iv) is strictly
increasing in ℑ( ) t , once again, since ℑ > ℑ ( )
*
t . The first three properties guarantee that
∆ℑ + ( ) t 1 is positive and finite (as depicted in Figure 2(a)), while the last guarantees that
∆ ∆ ℑ + > ℑ + ( ) ( ) t t 2 1 and that industrialisation is increasing over time.
These four properties are potentially violated when utility takes a more general form
and the interest rate varies over time. Observe that the interest rate depends both on
∆ℑ + ( ) t 1 and ℑ( ) t . From the household Euler condition,
1 1 1
1
1
1
1
+ + · +
′ ℑ − −
( )
′ ℑ − + −
( )
−
−
r t
U L t k t
U L t k t F
( ) ( )
( ) ( )
( ) ( )
δ
α
σ
α
σ
α
σ
α
σ
Λ ∆
Λ ∆
.
18
With strictly concave utility, one can see that r(t+1) is decreasing in ∆ℑ + ( ) t 1 and
increasing in ℑ( ) t . This means that any of the above properties could be violated.
Therefore, we need additional conditions to assure that any solution, ∆ℑ + ( ) t 1 , to the
general firm Euler condition is positive, finite and increasing in ℑ( ) t . Let
ℑ ≡ ℑ ℑ ·
{ ¦
*
( ) ( , ( )) t g t 0 0 . The sufficient conditions are:
(i) Marginal utility is bounded from below, lim ( ( ))
( ) C t
U C t
→
′ · < ∞
0
µ ;
(ii) There exists no ∆ℑ + > ( ) t 1 0 with the property that g t t t ( ( ), ( )) , ( )
*
∆ℑ + ℑ > ∀ℑ < ℑ 1 0 ;
(iii) g t t ( ( ), ( )) ∆ℑ + ℑ 1 ( g t ( , ( )) 0 ℑ ) is nondecreasing (increasing) in ℑ( ) t , for all ∆ℑ + ( ) t 1
and ℑ > ℑ ( )
*
t .
Of these conditions, only (ii) appears to differ significantly from the properties listed for the
linear case. It does not require that g be nonincreasing in ∆ℑ + ( ) t 1 , although this is
sufficient for (ii) to hold. All that is required is that the highest value of g occurs at
∆ℑ + · ( ) t 1 0 when ℑ < ℑ ( )
*
t .
22
This guarantees that entry and modernisation can only
possibly occur if past industrialisation reaches a critical value. Figures 2(b) and 2(c), give
two examples of g satisfying these conditions. Note that in each ∆ℑ + > ( ) t 1 0 and
∆ ∆ ℑ + ≥ ℑ + ( ) ( ) t t 2 1 guaranteeing the conclusion of Proposition 2.
Assuming conditions (i) to (iii) it becomes possible to generalise Proposition 2 to
more general utility functions.
Proposition 2’ (Persistent Industrialisation). Assume the conditions (i) to (iii)
hold and suppose that at some time t, ℑ > ℑ ( )
*
t , where ℑ ≡ ℑ ℑ ·
{ ¦
*
( ) ( , ( )) t g t 0 0 . Then
ℑ − ℑ ≤ ℑ + − ℑ ≤ ( ) ( ) ( ) ( ) ... τ τ τ t 1 for τ > t.
It is worth emphasising here that these propositions guarantee that only ℑ + − ℑ ( ) ( ) t t 1 and
hence, C t C t ( ) ( ) + − 1 is increasing over time. They do not guarantee that the growth rate
in consumption is rising (in contrast to endogenous growth theory  Romer, 1986),
although that is possible. In Appendix C it is shown that, by dropping condition (iii) and
replacing it with an alternative bound on g t ( , ( )) 0 ℑ , the growth rate in consumption is
bounded away from zero, for all time after ℑ > ℑ ( )
*
t . Thus, in contrast to neoclassical
growth theory, positive per capita growth persists over time. Proposition 2’ also ensures
22
It is not sufficient for this condition to hold only for ℑ · ℑ ( )
*
t .
19
that industrialisation ensues so long as industrialisation exceeds a critical value. This
property has an interesting implication (as will be shown below). It also holds for all utility
functions with a sufficiently high intertemporal elasticity of substitution.
23
Nonetheless, it
is shown in the appendix that without (ii), if it is ever the case that growth become positive
(not just at a critical level of industrialisation), then positive growth would persist
thereafter.
The Impossibility of Indicative Planning
The model under conditions (i) to (iii) has a very interesting implication. As a
model of dynamic coordination failure this one differs from analogous static models (like
that of section II) in that optimistic expectations would not generate an escape from the
development trap. In many models of coordination failure, there exist rational expectations
paths from the development trap to industrialisation. Here, however, there exists no
rational expectations or perfect foresight paths from nonindustrialisation to
industrialisation.
To see this, suppose that, the economy is at some low level of economic activity,
k
0
< ℑ
*
. Also, for this demonstration, suppose that utility is linear (this will not be
necessary for Proposition 3 below). Now suppose that, beginning in the development trap,
all potential intermediate input producers expect k k −
0
others to enter and adopt some
modern technology in the current period. Let the expected level of technology be some
constant, f > 0, and the new number of intermediate input producers be high enough such
that the resulting expected level of industrialisation would make these decisions profitable
when considered overtime (i.e., k f ( )
( ) *
+ > ℑ
−
1
1 θ σ
). The question must be asked: is it
profitable for a given modern input producer to enter and modernise their technology this
period? A producer could, after all, wait one period before taking either of these actions.
To consider the optimal decision, all that is relevant are the cash flows of firms in the
current and next period. The two period cash flow from entering and modernising today is,
23
The easiest way to see this is to examine utility of the form, U C t C t ( ( )) ( ) , · ≤ <
−
−
1
1
1
0 1
γ
γ
γ . All of
the conditions (i) to (iv) hold for γ close enough to 0.
20
Λ
Λ
L f k k k f k
L f k k f k f
n
n n
( ) ( )( )
( ) ( )( )
( ) ( )
( ) ( )
+ − + +
( )
+
( )
+ − + +
( )
− −
− −
−
+
− −
−
+ −
−
1 1
1 1 1
1
0 0
1
0
1
1
1
1
0
1
0
1
1
1
θ σ θ σ
δ
θ σ θ σ
α
σ
α σ
σ
.
And the two period cash flow from waiting until tomorrow to enter and modernise is,
1
1
1
0
1
0
1
1
1 1 1
1
1
+
− −
+
( )
+ − + +
( )
−
( )
+
+ −
−
δ
θ σ θ σ
δ
α σ
σ
ΛL f k k f k f
n n
( ) ( )( ) ( )
( ) ( )
.
Thus, there is a tradeoff between the earnings from production and higher productivity
today and deferring the sunk costs of entry and modernisation. An intermediate input
producer will choose to wait rather than produce if the following inequality is satisfied,
δ
δ
θ σ θ σ
α
σ
1
1
0 0
1
0
1
1 1 1
1
+
− −
−
( )
+ ≥ + − + +
( )
−
( ) ( ) ( )( )
( ) ( )
f L f k k k f k
n n
Λ .
When f
n
· 0, this inequality holds, strictly, by the condition for the development trap (i.e.,
that k
0
< ℑ
*
). Moreover, it is easy to show that, from low levels of industrialisation, the
left hand side increases with f
n
faster than the right hand side. This means that it is always
optimal to wait.
This argument leads to the following proposition for general utility functions.
Proposition 3. Assume conditions (i) to (iii) hold. Given any initial level of
industrialisation, ℑ( ) 0 , if ℑ < ℑ ( )
*
0 then the economy is in a development trap for all
t. Otherwise, it is in a state of persistent industrialisation.
The optimality of waiting means that no rational expectations/perfect foresight path exists
from the development trap to persistent industrialisation. The reason for this is that if it is
always optimal for one intermediate input producer to wait, by symmetry, it is optimal for
all firms to do so.
24
As a consequence no industrialisation occurs and hence, any
expectations to the contrary would not be fulfilled. Observe that this result holds for any
positive discount rate. Thus, the nonindustrialisation equilibrium is absorbing in the sense
of Matsuyama (1991, 1992).
25
Note, however, this fact is a direct result of the assumed
time lag in production of the final good. This assumption makes modernisation and entry
24
This result is similar in flavour to the example of Rauch (1993) although in a very different context to
the one presented here.
25
Matsuyama (1991) states that one state is accessible from another if there exists a rational
expectations/perfect foresight equilibrium path from one that state that reaches or converges to the other. A
state is absorbing if, within a neighbourhood of it, no other state is accessible.
21
today strategic substitutes with similar decisions on the part of other producers. It is also
important to note that there does not exist a rational expectations path from industrialisation
to the development trap. This latter feature is a direct consequences of the irreversibility of
entry and technology adoption.
When a development trap is purely the result of coordination failure, it is often
argued that the role for the government is to coordinate the expectations of individual
agents, making them consistent with those for persistent industrialisation. This is also the
stated goal of indicative planning. If possible, such a policy would be costless (save,
perhaps, the costs of communication), and firms would modernise on the basis of
optimistic expectations.
The above proposition shows that this solution will not work. This is essentially
because the problem, while one of a failure to coordinate investment, is not one of a failure
to coordinate expectations. If a government were to announce that firms should modernise
to a certain degree, even if this were believed perfectly by firms, each individual firm
would still have an incentive to wait one period before modernising. And, in that case, the
optimistic expectations created by the government would not be realised and the policy
would be ineffective.
Irreversibility and the time lag of production mean that history rather than
expectations matter for the selection of persistent industrialisation as opposed to a
development trap.
26
The previous level of industrialisation determines whether the
economy will continue to industrialise in the future. However, it does not specify the
precise path this could take and there could be a multiplicity of steady states involving
persistent industrialisation. The selection of these could depend on expectations. This is
why it is difficult to characterise the industrialising paths of the economy. It is also difficult
to characterise the optimality, or otherwise, of industrialisation. Industrialisation clearly
involves foregone consumption in its initial periods. Therefore, to examine welfare issues
would involve some specification of household preferences. This issue is beyond the
scope of the current paper.
26
See Krugman (1991a) for an extensive discussion of this point.
22
In summary, the above model exhibits, in a certain sense, both the development
traps and persistent industrialisation that are the hallmark of the “big push” theories of
industrialisation. It is important to note, however, that the distinction between this model
and other models of coordination failure lies solely in the assumption of a time lag to
production.
27
With linear utility, this makes the steady state completely determinant. It is
worth noting therefore, that for a small open economy with perfect international capital
mobility and nontradable intermediate inputs,
28
that even with general utility functions the
interest rate will not depend on the state of industrialisation. In this case, the uniqueness
results of the linear utility case will hold.
VII Conclusion
This paper has done two things. First, a model that combines both the
modernisation and specialisation views of industrialisation has been constructed. In so
doing, it was shown that the qualitative characteristics and hence, conclusions of the both
views were essentially the same. Thus, both viewpoints are complementary.
Second, this model was put into an explicit dynamic framework. In order to prove
the existence of a dynamic equilibrium, time lags into final good production were
introduced. This change meant that the wage effect from industrialisation was delayed
relative to competition effect. Firms would then have an incentive to industrialise over time
rather than in a single period. This eliminated the possibility of unbounded utility as
discussed in Romer (1986). This change also implied that policies for industrialisation
based on indicative planning or optimistic expectations were unlikely to be successful.
Even if firms were optimistic about future industrialisation they would have an incentive to
delay their own decisions. Since this applied to all firms, optimistic expectations would not
be realised.
27
It also relies to some extent on condition (ii) as is demonstrated in the appendix.
28
As in RodriguezClaire (1996).
23
It is worth emphasising here that the proof of existence of a dynamic equilibrium
and its characterisation is distinct from those usually undertaken in the growth literature. In
the recent literature on industrialisation or new growth theory, persistent growth
conclusions are found by assuming a specific functional form for utility functions, and
solving for balanced growth paths of interest rates and other state variables. Then it is
shown how these imply that positive growth will persist over time. In contrast, here I used
the monotone methods of Milgrom and Roberts (1994), to show that momentum, once
begun, will persist over time. This allowed a characterisation of dynamic paths as
involving persistent growth without looking for balanced growth paths or imposing specific
functional form assumptions on utility. This approach allowed a clearer understanding of
the assumptions that allowed for persistent growth over time. A direction for future
research would be to use this approach directly on endogenous growth models (e.g.,
Romer, 1990) and examine the criticality of function form assumptions.
24
Appendix A
Proof of Proposition 1
Note first that the strategic complementarities and symmetry in payoff functions
ensure that any equilibrium is symmetric. Second, observe that any upstream firm who
enters into production chooses their technology according to the following best response
function,
F L
n
*
max , ( )
( )
( )
· − ℑ
( )
−
]
]
]
− −
−
− −
0 1 1
1
1
1
1 1
Λθ σ
α σ
σ
θ σ
.
Note that this is not positive under the condition for case (i). Moreover, under that
condition, π
n
( ; ) 0 0
0
ℑ <
for all n. This remains true so long as no upstream firm chooses
to enter or modernise further. Thus, ℑ· ℑ
0
is an equilibrium.
Now suppose that all k upstream firms entered but none invests in a more modern
technology than their initial level. In this case, ℑ· k and individual profits are
π
α σ
σ
n
k Lk ( ; )
( )
0 1
1
1
· −
− −
−
Λ . This is positive so long as, L k >
−
− −
− 1
1
1
Λ
α σ
σ
( )
. Observe, however,
that F L k
n
*
( )
( )
· ⇒ ≤
−
−
− −
−
0
1
1
1
1
θ σ
α σ
σ
Λ
. For there to exist a range of L such that these two
inequalities hold requires that:
1
1
1 1
1
1
1
1
1
θ σ σ
α σ
σ
α σ
σ
θ
( )
( ) ( )
−
− −
−
− −
−
− −
−
≥ > ⇔ >
Λ Λ
k L k .
Finally, suppose all producers of modern varieties enter and adopt some positive
level of modernisation, i.e.,
ˆ
F > 0. Then ℑ· +
−
k F (
ˆ
)
( )
1
1 θ σ
where,
ˆ
( )
( )
F Lk · −
( )
−
− −
−
−
θ σ
α σ
σ
θα
1 1
1
1
1
1
Λ . This is positive by the conditions of the proposition.
Proof of Proposition 2
Suppose that in period t, ℑ > ℑ ( )
*
t . Entry and technological choices are considered
in turn. First, given the shock in period t, new varieties enter in period t+1 until the
difference in discounted cash flows from entering in t+1 as opposed to t+2 fall to zero for
all firms. Without loss of generality, assume that entering firms do not adopt more modern
technologies, as would be case for ℑ( ) t close to ℑ
*
. Let ∆k t k t k t ( ) ( ) ( ) + · + − 1 1 . For an
25
upstream firm, the difference in discounted sum of cash flows between entering t+1 as
opposed to t+2 is Λ ∆ L t t k t ℑ ℑ + + −
−
−
+
( ) ( ( ) ( )) ( )
α
σ δ
δ
1
1
1
1
. Setting this equal to zero gives a
unique solution: ∆ Λ k t t L t ( ) ( ) ( )
( )
+ · ℑ − ℑ
− +
−
1
1 1
1
α
σ δ
δ σ
. ∆k t ( ) +1 is positive since ℑ > ℑ ( )
*
t .
This, in turn, implies that ℑ + > ℑ ( ) ( ) t t 1 , meaning that ∆k t ( ) + > 2 0 since the right hand
side of the equation is increasing in ℑ( ) t . Note too that the finiteness of ∆k t ( ) +1 puts a
bound on period by period utility. A similar reasoning applies to the technological
decisions. The proof then follows by induction.
Proof of Proposition 2’
First, observe that (i) guarantees that as ∆ℑ + → ∞ ( ) t 1 , g t t ( ( ), ( )) ∆ℑ + ℑ → ∞ 1 .
This along with (iv), the continuity of U(.) and the fact that ℑ > ℑ ( )
*
t ensures there exists at
least one solution to g t t ( ( ), ( )) ∆ℑ + ℑ · 1 0, with ∆ℑ + > ( ) t 1 0, by Theorem 1 of Milgrom
and Roberts (1994).
29
This, in turn, implies that ℑ + > ℑ ( ) ( ) t t 1 , meaning that
∆ ∆ ℑ + ≥ ℑ + ( ) ( ) t t 2 1 since the right hand side of the equation is nondecreasing in ℑ( ) t .
Note too that (i) guarantees the finiteness of ∆ℑ + ( ) t 1 and hence, puts a bound on period
by period utility. The proof then follows by induction.
29
That theorem shows that the result here would also hold for some relaxation of the continuity and
concavity assumptions on U(.), so long as the solution to the household’s problem was an interior one.
26
Appendix B
In this appendix, I derive π
n
(t). Under these assumptions of Section III,
x t X t
P t
p t
n
n
( ) ( )
( )
( )
·

.
`
,
σ
P t p t x t dn x t dn p t dn
x t n n
k t
n
k t
n
k t
n n
k t ( ) min ( ) ( ) ( ) ( )
{ ( )}
( ) ( ) ( )
( ) · ·
¹
'
¹
¹
¹
¹
'
¹
¹
¹
·

.
`
,
·
−
∫ ∫ ∫
−
−
0
1
0 0
1
0
1
1
1
σ
σ
σ
σ
,
where here it is supposed that only a subset [0,k(t)] of firms choose to produce in period t.
Using the optimal pricing rule, some simple substitutions show that, P t w t t ( ) ( ) ( ) · ℑ
−
−
σ
σ
σ
1
1
1
and
x t F t X t t
n n
( ) ( ( )) ( ) ( ) · ℑ
−
−
Ψ
σ
σ
σ 1
, where now,
ℑ · · ℑ
{ ¦
( )
[ ]
−
≤ ∫
( ) ( ( )) ( ), ( )
( )
( )
t F t dn k t F t
n
k t
n
n k t
Ψ
1
0
σ
.
The aggregate, ℑ( ) t , is therefore a measure of the overall level of industrialisation in period
t.
Now consider the labour market. As before,
l t F t X t t
n n
( ) ( ( )) ( ) ( ) · ℑ
−
−
Ψ
1
1
σ
σ
σ
and L t l t dn X t t
X n
k t
( ) ( ) ( ) ( )
( )
· · ℑ
∫
−
0
1
1 σ
.
For the final goods sector, since production is lagged one period, producers choose
intermediate inputs and labour to maximise:
1
1 1
1
+ +
( )
+ − −
r t Y
Y t w t L t P t X t
( )
( ) ( ) ( ) ( ) ( ).
The CobbDouglas assumption means that the interest rate drops out with,
L t
P t X t
w t
X t t
Y
( )
( ) ( )
( )
( ) ( ) · ( ) · ( )( )ℑ
− −
−
−
1 1
1
1
1
α
α
α
α
σ
σ
σ
.
with period by period labour market clearing implying X t L t ( ) ( )
( )
·
( )
ℑ
−
−
−
α σ
σ α
σ
1
1
1
.
Finally, it remains to find the wage level each period. Observe, first, that in each
period the cash flow of an upstream firm is,
π
σ α
σ α n n n
t w t F L t f t ( ) ( ) ( ) ( ) ( ) · ( )ℑ −
−
−
−
Ψ
1 1
.
27
Inserting this into the national income identity,
Y t F t k t k t w t L t k t k t ( ) ( ) ( ( ) ( )) ( ) ( ) ( ( ) ( )) − − − − · + − − − 1 1 Π
where
Π Ψ ( ) ( ) ( ) ( ) ( )
( ) ( )
t w t L t F dn f t dn
n
k t
n
k t
· ℑ ( ) −
−
−
−
∫ ∫
1 1
0 0
α
σ α
σ
and Y t L t ( ) ( ) ( ) ( ) · − ( ) − ( ) ( ) ℑ −
− −
−
−
1 1 1
1 1
1 1
α σ α σ
α α
σ α
α
σ
.
Therefore,
w t
Y t
L
t ( )
( )
( ) ( ) ( ) · ( ) · − ( ) − ( ) ℑ −
−
−
− σ α
α α
α α
α σ α σ
α
σ 1
1
1 1 1
1
.
Wages reflect the previous technological choices of intermediate input producers only
because of the time lag in final good production. Substituting w(t) into the above yields the
relevant equation.
28
Appendix C
The first result here will show what conditions on g(.) guarantee persistent positive
growth as opposed to rising increments to consumption over time (as proved in Proposition
2’). For this purpose, condition (iii) can be dropped as g need not increase over time, but it
needs to be replaced with (iv) below to ensure that it remains positive as the level of
industrialisation rises.
(iv) For all ℑ > ℑ ( )
*
t ,
g t L t t
U L t
U LL t k t
( , ( )) ( ) ( )
( )
( )
( ) ( )
0 0
1
1
1
1
1
1
1 ℑ ·

.
`
,
ℑ − ℑ >
+
′ ℑ

.
`
,
′ ℑ − −

.
`
,
−
−
−
+ Λ
Λ
Λ ∆
δ
α
σ
α
σ
α
σ
α
σ
α
σ
;
Figure 3(a) provides an example of what happens under these new conditions
demonstrating graphically the following result.
Corollary 1 (Persistent Positive Growt h). Assume conditions (i), (ii) and (iv)
hold and suppose that at some time t, ℑ > ℑ ( )
*
t , where ℑ ·
( )
+
−
− − *
ΛL
1
1
1
δ
δ
σ
σ α
. Then
ℑ < ℑ + < ( ) ( ) ... τ τ 1 for τ > t.
PROOF: (i) and (iv) ensure that ∆ℑ + > ( ) t 1 0 for all t, by the intermediate value
theorem. Hence ℑ + > ℑ ( ) ( ) t t 1 for all t. Note too that the finiteness of ∆ℑ + ( ) t 1
puts a bound on period by period utility. The proof then follows by induction.
A version of Proposition 3 can be proved for this case.
Turning to examine the role of condition (ii), if is removed one can prove the
following corollary.
Corollary 2 (No Guaranteed Development Trap). Assume that only (i) and (iii)
hold and suppose that at some time t, ℑ( ) t is such that g t t ( ( ), ( )) ∆ℑ + ℑ > 1 0 for some
∆ℑ + > ( ) t 1 0. Then ℑ − ℑ ≤ ℑ + − ℑ ≤ ( ) ( ) ( ) ( ) ... τ τ τ t 1 for τ > t.
PROOF: (i) and the condition of the corollary ensure that ∆ℑ + ( ) t 1 is positive and
finite by the intermediate value theorem. Hence ℑ + > ℑ ( ) ( ) t t 1 . By (iii) and
Theorem 1 of Milgrom and Roberts (1994), this implies that ∆ ∆ ℑ + > ℑ + ( ) ( ) t t 2 1 .
The proof then follows by induction.
Figure 3(b) demonstrates this possibility. What Corollary 2 says is that if it is ever the case
that industrialisation rose to a high enough level (perhaps due to a temporary shock), then
persistent industrialisation will persist thereafter. It differs from Proposition 2’, in that it
does not rule out the possibility that a path to persistent industrialisation could exist from
29
the development trap equilibrium. In this case, Proposition 3 would not hold and indicative
planning could succeed.
Finally, a similar version of Corollary 1 holding for persistent positive growth can
be proved using the following condition.
(iv)’ If there exists some ℑ
*
such that g( , )
*
0 0 ℑ > , then g t ( , ( )) 0 0 ℑ > , for all ℑ > ℑ ( )
*
t .
Corollary 3 (No Guaranteed Development Trap/Persistent Positive Growth).
Assume that only (ii) and (iv)’ hold and suppose that at some time t, ℑ( ) t is such that
g t ( , ( )) 0 0 ℑ > .. Then, ℑ < ℑ + < ( ) ( ) ... τ τ 1 for τ > t.
PROOF: (ii) and (iv)’ ensure that ∆ℑ + > ( ) t 1 0 for all t, by the intermediate value
theorem. Hence ℑ + > ℑ ( ) ( ) t t 1 for all t. Note too that the finiteness of ∆ℑ + ( ) t 1
puts a bound on period by period utility. The proof then follows by induction.