Institutions and Long-Term Development Policy

Market failures in human capital investment and innovation explain the main features of human development and economic growth. This is shown in a Schumpeterian multi-country model with technology transfer and trade. Thus, only institutions expanding investments in nutrition, education, health, skills, know-how and research in LDC's, beyond what markets can supply, will succeed in promoting long-term development. It is in the interest of leading countries to supplement home investments with concerted transfers, since the long-term world growth rate increases with world-wide knowledge levels and living standards. Underdevelopment consists of a series of policy-dependent lower steady states, with parallel or divergent growth rates, and with or without a human development trap. Free commerce raises the growth rate of countries able to support production at the global scale. Smaller or more backward countries grow slower and require aid to emerge. Skilled and unskilled workers in LDC's have a conflict of interest between supporting innovation or human capital investment. If innovation is favored, the human capital trap can persist, provoking opposition to globalization. If human capital investment is prioritized, a switch to innovation will eventually be necessary, requiring institutional change.