Why are Some Countries Richer than Others? Intermediate Goods and Weak Links in the Theory of Economic Development

University Of California-Berkeley, Berkeley CA

Investigators

Abstract

By the end of the 20th century, per capita income in the United States was more than 50 times higher than per capita income in Ethiopia and Zaire. What explains such profound differences in incomes across countries? In the recent economics literature, differences in property rights, corruption, and incentives are suspected as causes. But in standard models, differences along these dimensions typically lead to 10-fold income differences rather than the 50-fold differences we observe in the data. This project develops a model in which intermediate goods provide links between sectors that create a multiplier effect. For example, corruption in electric power generation reduces output in that sector, which in turn reduces output in banking and construction -- sectors that rely on electricity as an input. But this reduces the ease with which the electricity industry can build new dams and therefore further reduces output in electric power generation. This multiplier effect is similar to the multiplier associated with capital accumulation in a standard growth model. However, because the intermediate goods' share of revenue is approximately 1/2, the intermediate goods multiplier is large. Preliminary analysis suggests that these forces will indeed be able to explain enormous differences in incomes across countries. A typical firm in Kenya may be roughly half as good as a typical firm in the United States at producing bicycles or sweaters. But output per worker in Kenyan firms may be 32 times lower than in the United States because intermediate inputs like electricity, aluminum tubes, and rubber tires are also produced with this 1/2 efficiency. This is the intermediate goods multiplier at work. The research also attempts to explain why solving the economic development problem has proved to be so difficult. Here, the explanation is related to complementarity --- the notion that a chain is only as strong as its weakest link. High productivity in a firm requires a high level of performance along many dimensions. Textile producers require raw materials, knitting machines, a healthy and trained labor force, knowledge of how to produce, security, business licenses, property rights, transportation networks, electricity, etc. These inputs enter in a complementary fashion, like the weak links in a chain. Problems along any dimension can substantially reduce overall output: Without electricity or production knowledge or raw materials or security or business licenses, production is likely to be severely hindered. In the poorest countries of the world, problems may occur along many dimensions at once. Reforms that address only one or two dimensions, then, may have small effects on overall economic performance. Broader Impacts Questions related to economic growth and development are among the most important economic policy issues in the world today. Understanding why the economic forces that lead to enormous wealth in the richest countries of the world are absent in the poorest offers a tremendous opportunity.