Why Don't Poor Countries Adopt Better Technologies?

In this paper we develop a simple heterogeneous-agent model with incomplete markets to explain the prevalence of a large low-productivity, informal sector in developing countries. In our model, the provision of public infrastructure creates a productivity premium for formalization, which increases with infrastructure quality. Our model breaks the symmetry of equilibria and offers endogenous differentiation of rich and poor countries' behavior. While the model supports multiple stable equilibria in `rich' countries with varying degrees of formalization, including full formalization, it indicates an absence of equilibrium with full formalization in `poorer' countries. If legislative intolerance alone suffices to jolt a rich country into the equilibrium with complete formalization, accompanying policies may be required in poor countries to first provide the conditions for existence of such equilibrium.