A north-south model of structural change and growth

This paper is motivated by a set of cross-country observations on economic growth, structural transformation, and investment rates in a large sample of countries, We observe a hump-shaped relationship between a country’s investment rate and its level of development, both within countries over time and across countries. Advanced economies reach their investment peak at a higher level of income and at an earlier point in time relative to emerging markets. We also observe the familiar patterns of structural change (a decline in the agricultural share and an increase in the services share, both relative to manufacturing). The pace of change observed in the 1930 to 1980 period in advanced economies is remarkably similar to that in emerging markets since 1960. Motivated by these facts, we develop a two-region model of the world economy that captures the dynamics of investment and structural change. The regions are isolated from each other up to the point of capital market liberalization in the early 1990s. At that point, capital flows from advanced economies to emerging markets and accelerates the process of structural change in emerging markets. Both regions gain from the liberalization of financial markets, but the majority of the gains accrue to the emerging economies. The overall magnitude of gains depends on the date of liberalization, the relative sizes of the two regions and the degree of asymmetry between the two regions at the point of liberalization. Finally, we consider the impact of a “second wave” of liberalization when China fully opens its economy to capital inflows.