Limits of Knowledge Spillovers: Why Developing Economies Struggle to Catch Up

We examine the role of knowledge spillovers in shaping economic growth in developing countries, with a focus on their limitations in promoting convergence with advanced economies. Extending Romer (1986) and the North–South model, we construct a theoretical model in which government-funded knowledge accumulation drives long-run growth, while developing countries benefit from costless technology diffusion from advanced economies. Within this framework, we derive steady states for each economy and analyze how policy choices—such as taxation, savings, and technology protection—affect the growth trajectory of both economies through the spillovers. We then test the model’s predictions, setting the United States as the technological frontier. The analysis utilizes fixed-effects regression and incorporates foreign direct investment inflows and imports from the U.S. as proxies for openness to spillovers. Our results suggest that knowledge spillovers alone are insufficient for convergence, requiring substantial domestic investment by developing countries. This highlights the structural challenges these countries face in catching up to advanced economies. Additionally, technology protection ensures the long-term economic dominance of developed countries, but only when paired with significant domestic investment. Finally, we empirically demonstrate a complementary relationship between openness and technological disparity in determining the magnitude of spillovers, lending further support to our findings.