A Simple Theory of Economic Development at the Extensive Industry Margin

Dario Diodato, Ricardo Hausmann and Ulrich Schetter

No 20576, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We revisit the well-known fact that richer countries tend to produce a larger variety of goods and analyze economic development through (export) diversifcation. We show that countries are more likely to enter ‘nearby’ industries, i.e., industries that require fewer new occupations. To rationalize this finding, we develop a small open economy (SOE) model of economic development at the extensive industry margin. In our model, industries differ in their input requirements of non-tradeable occupations or tasks. The SOE grows if profit maximizing frms decide to enter new, more advanced industries, which requires training workers in all occupations that are new to the economy. As a consequence, the SOE is more likely to enter nearby industries in line with our motivating fact. We provide indirect evidence in support of our main mechanism and then discuss implications: We show that there may be multiple equilibria along the development path, with some equilibria leading on a pathway to prosperity while others resulting in an income trap, and discuss implications for industrial policy. We finally show that the rise of China has a non-monotonic effect on the growth prospects of other developing countries, and provide suggestive evidence for this theoretical prediction.

Keywords: Industrial policy; Structural change; Poverty trap; Economic complexity; Export diversification; Economic convergence; Product Space (search for similar items in EconPapers)
JEL-codes: F43 O11 O14 (search for similar items in EconPapers)
Date: 2025-08
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