Industralisation Policy and the Big Push

8/14/2019 Industralisation Policy and the Big Push

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Paper Presented atIncreasing Returns and Economic Analysis:An International Conference in Honour of

Professor Arrow, Monash University

7-8 September, 1995

INDUSTRIALISATION POLICYANDTHE BIG PUSH*

by

Joshua S. GansSchool of Economics

University of New South WalesSydney, NSW 2052

Australia

E-Mail: [email protected]

First Draft: 25 January, 1994This Version: November 21, 1996

The economic development literature of the 1940s and 1950s wasconcerned with the question of whether industrialisation policy should have abroad or balanced orientation or if it should target a few key sectors, i.e., beunbalanced in its focus. This paper reconsiders this long-standing debate inlight of the recent formalisations of big push theories of industrialisation.A dynamic model of industrialisation exhibiting multiple Pareto-rankablesteady states is developed to consider this issue. It is shown that time lags inproduction mean that costless policies, such as indicative planning, areunlikely to be successful. This means that, under cost minimisation,industrialisation policy, will not be concentrated but more gradual over timeand that it will become progressively more balanced. Finally, it is found thatthe cost minimising industrialisation policy should be more unbalanced thestronger are increasing returns, the less scarce are entrepreneurial resources,and the smaller is the intrinsic market size but that the strength of linkages hasan ambiguous effect on the optimal degree of balance. Journal of Economic

Literature Classification Numbers: D10, O10, O14 & O20.

Keywords: industrialisation, balanced and unbalanced growth, transition,technology adoption, complementarities, linkages, increasing returns,gradualism.

* This paper is an amended version of Chapter 4 of my Ph.D. dissertation from Stanford University (seeGans, 1994a). I wish to thank Susan Athey, Antonio Ciccone, Avner Greif, Yingyi Qian, Philip Trostel,Graham Voss, seminar participants at Stanford University, Monash University and the World Congress of

the Econometric Society (Tokyo, 1995), and especially, Kenneth Arrow, Paul Milgrom and Scott Stern forhelpful discussions and comments. I also thank the Fulbright Commission for financial support. Allerrors are my responsibility.


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I . Introduction

The recent theoretical literature on industrialisation has formalised the long standing

idea that development traps are the result of a failure of economic organisation rather than a

lack of resources or other technological constraints. The so-called big push models of

industrialisation have shown how, in the presence of increasing returns, many equilibria are

possible with some Pareto dominating others. Such a view not only provides an

explanation for the co-existence of industrialised and non-industrialised economies, but also

a rationale for government intervention to coordinate investment in a big push towards

industrialisation (Murphy, Shleifer and Vishny, 1989, p.1024). Moreover, unlike

competing theories, these models emphasise the temporary nature of any policy.1 Thus,

industrialisation policy involves facilitating an adjustment from one equilibrium to another

rather than any change in the nature of the set of equilibria per se.

While the recent formalisation makes clear the possible role for the government in

coordinating economic activity, little has been said about the form such a policy should

take. Many have recently argued that intervention should target many sectors and that this

should occur more or less simultaneously (Murphy, Shleifer and Vishny, 1989). But an

earlier informal literature suggests that such conclusions are not obvious and perhaps that

even the reverse is true. That is, in the presence of coordination failure, industrialisation

policy might still be successful with a more limited focus and a more gradual application.

It is the purpose of this paper to construct a formal model to analyse the question:

what form should the big push take? In so doing, it will be shown here that the notion

that industrialisation policy should be broad and immediate is not a necessary implication

of such models. In this paper, it is argued that while many different industrialisation

policies can be successful in generating escapes from development traps, the form of the

policy that minimises the costs of this transition depends on the characteristics of the

economic situation at hand. Factors such as the strength of complementarities, externalities

1 This is in contrast to theories attributing the lack of industrialisation to a pure lack of incentives to adoptmodern technologies, leading to policies such as the building of new institutions for property rights and thelike (e.g., Rosenberg and Birdzell, 1986; Greif, 1992).


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and increasing returns, among others, all play a role in influencing the nature of

industrialisation policy.

Such ideas were present in the debates in development economics in the 1940s and

1950s regarding the form of industrialisation policy. The ideas underlying these less

formal debates inspired the recent formal literature but the policy elements of these have not

been addressed, to date, in any formal manner.

Principal among the earlier policy debates was that surrounding the efficacy and

costs involved in the alternative strategies of balanced versus unbalanced growth.

Rosenstein-Rodan (1943, 1961) and Nurkse (1952, 1953) provided the rationale for the

notion that the adoption of modern technologies must proceed across a wide range of

industries more or less simultaneously. It was argued that the neglect of investment in a

sector (or sectors) could undermine any industrialisation strategy.2

Reacting to this policy prescription was the unbalanced growth school led by

Hirschman (1958) and Streeten (1956, 1963). They saw the balanced strategy as far too

costly: The initial resources for simultaneous developments on many fronts are generally

lacking. (Singer quoted by Hirschman, 1958, p.53) By targeting many sectors, it was

argued that scarce resources would be spread too thin -- so thin, that industrialisation would

be thwarted. It seemed more fruitful to target a small number of leading sectors,

(Rostow, 1960)3 relying on their development to encourage technology adoption in other

sectors. To that school the existence of complementarity between investments and

increasing returns motivates an unbalanced approach.4 Curiously, at the same time,

[c]omplementarity of different industries provides the most important set of arguments in

favour of a large-scale planned industrialisation. (Rosenstein-Rodan, 1943, p.205)

It is not the task of this paper to reconstruct and piece together the lines of logic that

drove the past debate on balanced and unbalanced growth. Both sides appeared to have

2 Other work associated with the balanced growth school included Scitovsky (1954), Fleming (1955),

Chenery (1959) and Nath (1960).3 Also termed propulsive industries (Perroux, 1958) or development blocks (Dahmen, 1950).4 Other early opponents of balanced growth included Ellis (1958) and Myint (1960).


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agreed that a big push was warranted, but they disagreed as to its composition (i.e., how

many and what type of sectors should be targeted). My purpose here is to use the

guidelines provided by the recent formalisation of the big push theory of industrialisation

to clarify the issue of the appropriate timing and degree of focus for industrialisation policy.

After all, the recent literature has stressed the roles of complementarities and increasing

returns that both of the older schools saw lying at the heart of their policy prescriptions. 5

Nonetheless, throughout the paper, I will revisit aspects of the arguments of both schools

to link the formalism with the earlier discussions.

II . A Dynamic Model of Industrialisation

In this section, I present a simplified version of the model in Gans (1994a, 1995)

that itself is a dynamic version of Ciccone (1993). This model provides a rich array of

parameters to characterise the optimal choice of the government and weakens the strong

labour market assumptions made by Murphy, Shleifer and Vishny (1989). Moreover,

unlike that model (and similar models such as those of Matsuyama, 1992, and Ciccone and

Matsuyama, 1993) this model here allows for a clear separation of substitution and

complementary effects from entry.

Sectoral Structure and Technology

The economy consists of two production sectors. The first is a downstream sector

with a measure one continuum of firms producing a homogenous final good, Y. Firms are

competitive price-takers and employ both labour, LY, and a composite of intermediate

inputs, X, according to, Y t X t L t Y( ) ( ) ( )+ =1 1 , > 0. From the outset, the critical

feature to note about this production technology is that production of the final good takes

one period. The introduction of the lag structure here distinguishes this model from other

dynamic models of industrialisation (cf., Ciccone and Matsuyama, 1993). Nonetheless,

5 See Murphy, Shleifer and Vishny (1989) and Krugman (1992).


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this time element adds a small amount of realism to the model that will turn out to have

important policy implications. The final good, Y, is taken as numeraire.

The intermediate input composite is assembled by upstream producers according to,

X t x t dnn( ) ( ) , ,=

>

1

1

0

1

where xn denotes the amount of intermediate input of type n employed.

Households consume final goods not used in production and supply one unit of

labour inelastically for which they receive a wage, w(t) in period t. Here I make the simple

assumption that household utility is linear in total consumption so that households solve:

max ( )( )C t

t

tt

C t{ }

=

=

01

subject to 111

11

1

0+=

+=

( ) ( ) + r tt

t

r t

t

t

C t L w t v( ) ( )( ) ( ) ( ),

where v(0) is the value of share holdings in upstream firms, L is the constant total labour

endowment , and r(t) is the interest rate in t. Linear utility means that the interest rate is

constant over time and equal to r t( ) ( ) / = 1 .6

Each variety of intermediate input, n, is produced by a single monopolist in the

upstream sector. There is a continuum of such firms lying on the (extended) real line.

Apart from the usual pricing decisions, potential producers in this sector face the decision

of whether to enter into production or not. As such, as in Ciccone and Matsuyama (1993)

and Rodriguez-Clare (1993), the number of firms entering will constitute a measure of the

level ofindustrialisation.7

6 Many of the basic results of the model can be generalised beyond this specific assumption to generalutility functions. These issues are discussed in depth in Gans (1995). Because the focus here is on policyissues it is convenient to focus on this special case. Note, however, that if there is perfectly mobile capitalinternationally, then the interest rate will be fixed at its international level. The model here is s tillconsistent with this assumption if it is assumed that intermediate inputs are nontradables such as services.Such an approach is taken by Rodriguez-Clare (1993).7 In Gans (1994a, 1995), I develop a similar model that incorporates the view of industrialisation as theadoption of increasing returns technologies (Murphy, Shleifer and Vishny, 1989) as well as the view here

that industrialisation involves the use of a greater variety of inputs in production (Ciccone and Matsuyama,1993; Rodriguez-Clare, 1993). The decision to focus on a unidimensional measure of industrialisationsimplifies the exposition here, eliminating certain complicating factors addressed in Gans (1994a).


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The Decision to Enter

In order to facilitate a discussion of policy issues, I assume that there are two broadclasses of intermediate input varieties distinguished by their respective entry costs. First,

there are basic varieties with indexes n kB[ , ]0 . Such varieties are assumed to have

already entered into production. Such producers are assumed to be monopolists.8 Second,

there are modern varieties with indexes n kB [ , ) . For these varieties, entry is costly in

that they cannot be produced without incurring a charge ofFunits of the final good. Thus,

it is a pure sunk cost of entry and need only be incurred in the period of the firms start-up.

As will be apparent below, firms will find it optimal to enter production if and only if they

face non-negative profits upon entry (given their optimal pricing decision) and having

entered they find it optimal to produce in all subsequent periods.

The technologies of production are the same across intermediate input sectors

(whether basic or modern). Upstream producers, after they have entered production, can

generate output according to, x t l t n n( ) ( )= .

Having specified the sectoral structure, tastes and technology for this economy, it

can be shown that the possibility of industrialisation or non-industrialisation in this model

rests on the outcome of a game played among intermediate input producers in their entry

decisions. With a bit of work it can be shown how the payoffs of this game arise out of the

general equilibrium structure of the model.9 This is done by first solving for optimal

household and final good producer allocation decisions and the optimal pricing decisions of

intermediate input producers. Then good and labour market clearing is imposed. This

yields to a precise specification of the equilibrium prices in the economy in each period --

pn(t) for each intermediate input variety and wages, w(t) -- contingent on the number of

firms in the economy, k(t), itself a measure of the level of industrialisation in each period.

8 The assumption that basic producers are monopolists is made for notational simplicity. It could havebeen assumed that these sectors were perfectly competitive. This, however, would have served merely to

increase algebra in the pricing equations below without any change in the substantive results that are thefocus of this paper. Here k

Brepresents an initial condition.

9 See Gans (1995) for a derivation.


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Using this can be shown that, in each period, the operating cash flow of a producer

of modern varieties is, n n nt p t w t x t w t L k t ( ) ( ) ( ) ( ) ( ) ( )= ( ) = ( )1 , with the charge ofF

being deducted in ns first period of production. Substituting the relevant aggregate

variables into this equation gives a convenient reduced form for the payoffs of an

intermediate input producer producing a positive output in period t,

n tk t

k t( )

( )

( )=

1 1 .

where = ( ) ( ) L

( ) ( ) ( )1 11

. Observe that if 1 , then, from a

system-wide point of view, there exists apositive feedbackbetween the past entry choices

of intermediate input producers and the firms current choice, if it is a modern variety

producer. To see this more clearly, suppose that there is no further increase in overall

industrialisation in period t. Then operating cash flow is increasing in k t( ) 1 if and only

if k t k t ( ) ( ) 1 1 1

is nondecreasing in k t( ) 1 . Holding the current increment to

industrialisation, k t k t k t ( ) ( ) ( ) 1 , constant, this is equivalent to requiring that,

k t k tk t k t

( ) ( )( ) ( )

+

1 11

0

1

,

which is true if and only if 1 . Then, ceteris paribus, the greater the past level of

industrialisation, the greater is the return to entry. Thus, if the so-called increasing returns

due to specialisation (( ) 1 1) outweigh the decreasing returns to additional use of the

intermediate input composite (), the game between intermediate input producers exhibits,

in this sense, strategic complementarities. I will have more to say about these parameters in

a later section. For the rest of this paper, it is assumed that 1 .

It is worth noting, however, that the decision to enter in the current period is a

strategic substitute with the current entry choices of other intermediate input producers. So

while a greater level of past industrialisation raises the return to entry today, greater current

entry dampens those incentives. The former (complementary) effect emerges because

greater past industrialisation pushes up current wages which in turn raises demand for

intermediate inputs through higher aggregate demand. On the other hand, the latter


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(substitution) effect occurs because of the reduction in current intermediate input prices

caused by lower marginal costs of production and the competition of entrants.

Equilibria

Having derived the payoff functions, the equilibria in the game between

intermediate input producers can be considered. A sequence of entry decisions translates

into a sequence of states, { ( )}k t . Such a sequence, {( )}k t , constitutes a pure strategy

Nash equilibrium results if, for each t, (i)

t

ntk k F n k t

< > ( ( ), ( )) , ( )1 and

(ii)

t

nt k k F n k t

(

( ),

( )) ,

( )1 . Thus, in equilibrium, if they chose to

enter, non-active firms would earn negative profits and all active firms earn non-negative

total discounted profits.

Two broad types of equilibria are possible. If <

F kB( )11

1

(i.e., the number

of basic varieties is small, the market size is small and fixed costs are large), then the

economy will be in a development trap with only firms producing basic varieties active.

However, persistent industrialisation is also possible. It can be shown (see Gans,

1995), that if at some time k(t) becomes greater than some critical level, k* where

kF

*

( )= ( )

1

1

11

, the level of industrialisation will continue to expand thereafter.10 Thus,

in the spirit of big push theories of industrialisation, the economy can be stuck in a

development trap from which an escape could be made provided sufficient coordination of

the decisions of intermediate input producers is achieved.11

Note, however, that this model of dynamic coordination failure differs from

analogous static models in that optimistic expectations would not generate an escape from

the development trap. In many models of coordination failure, there exist rational

10 This result is related to the Momentum Theorem, initially stated in Milgrom, Qian and Roberts (1991)for contracting problems, and was extended, in Gans (1994b), to game theoretic contexts. It provides asimple method of proof of the existence of a steady state in a discrete time framework.11 Indeed, using the zero profit condition, it is easy to see that for the case of persistent industrialisation the

dynamic equation for k(t) is: k t k t F

( ) ( )( )

= 1

11 1

.


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expectations paths between equilibria. Here, however, there exists no rational expectations

or perfect foresight paths from non-industrialisation to industrialisation.

To see this, beginning in the development trap, suppose that all potential modern

intermediate input producers expect k kB others to enter in the current period. Suppose

that k > k*, so that expected level of industrialisation would make these entry decisions

profitable when considered over time. The question must be asked: is it profitable for a

given modern input producer to enter this period? The alternative would be to wait one

period. To consider the optimal decision, all that is relevant are the cash flows of firms in

the current and next period. The two period cash flow from entering today is,

k k k F B

+

+ 11

11 , and the two period cash flow from waiting until tomorrow to enter

is,

k F+

1

1 . Thus, there is a trade-off between the earnings from production today

and deferring the sunk costs of entry. An intermediate input producer will choose to wait

rather than produce if ( )1 1 1

F k kB . This inequality holds for any k kB , strictly,

by the condition for the development trap. This makes it always optimal to wait.

This argument leads to the following proposition.

Proposition 1. Given any initial level of industrialisation, k(0), if k k ( ) *0 < then theeconomy is in a development trap for all t. Otherwise, it is in a state of persistentindustrialisation.

The optimality of waiting means that no decentralised rational expectations/perfect foresight

path exists from the development trap to persistent industrialisation. The reason for this is

that if it is always optimal for one intermediate input producer to wait, by symmetry, it is

optimal for all firms to do so.12 As a consequence no industrialisation occurs and hence,

any expectations to the contrary would not be fulfilled. Observe that this result holds for

any positive discount rate.13 Thus, the non-industrialisation equilibrium is absorbing in the

12 This distinguishes the model from Matsuyama (1991, 1992) and Krugman (1991) both of whom rely onan exogenously specified adjustment cost to generate their results. Here the inertia is endogenous arisingout of general equilibrium interactions. This result is similar in flavour to the example of Rauch (1993)although he assumes the differing substitution and complementary effects rather than deriving them as isdone here.

13 Moreover, this result holds for more general utility functions (see Gans, 1995) and for the case of ansmall open economy with non-tradable intermediate inputs and perfect capital mobility since, in that case,interest rates are exogenously determined.


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sense of Matsuyama (1991, 1992).14 Note also that there is no rational expectations path

from industralisation back to the development trap. This latter feature is a direct

consequences of the irreversibility of entry.

The above result follows directly from the assumed time lag in production of the

final good. This assumption makes entry today a strategic substitute with similar decisions

on the part of other producers. That is, each individual producer of modern varieties

benefits from the current entry of others in that it makes future entry profitable. However,

for each, the current entry decision is dominated by the decision to wait an additional

period. Therefore, there exists a multiperson prisoners dilemma among intermediate input

producers with a resultant failure to industrialise.

The Impossibility of Successful Indicative Planning

When a development trap is purely the result of coordination failure, it is often

argued that the role for the government is to coordinate the expectations of individual

agents, making them consistent with those for persistent industrialisation. This is also the

stated goal of indicative planning. If possible, such a policy would be costless (save,

perhaps, the costs of communication), and firms would modernise on the basis of

optimistic expectations.

Proposition 1 shows that this solution will not work. This is essentially because the

problem, while one of a failure to coordinate investment, is not one of a failure to

coordinate expectations. If a government were to announce that a sufficient number of

firms should start-up, even if this were believed perfectly by firms , each individual firm

would still have an incentive to wait one period before entering into production. And, in

that case, the optimistic expectations created by the government would not be realised and

the policy would be ineffective.

14 Matsuyama (1991) states that one state is accessible from another if there exists a rationalexpectations/perfect foresight equilibrium path from one that state that reaches or converges to the other. Astate is absorbing if, within a neighbourhood of it, no other state is accessible.


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Irreversibility and the time lag of production mean that history rather than

expectations matter for equilibrium selection.15 The previous level of industrialisation

determines what path the economy will take in the future. This is why it is difficult to

characterise the industrialising paths of the economy. It is also difficult to characterise the

optimality, or otherwise, of industrialisation. Therefore, I will simply assume here that

preferences are such that industrialisation is a desirable policy goal.

III. Engendering Transition

Using this model of industrialisation, it is now possible to consider the policy

issues and decisions facing a government. As discussed earlier, the aim of this paper is to

address the issue of how a government can facilitate a transition from the development trap

to a state of persistent industrialisation. Thus, it is imagined that, for historical reasons, the

economy, while producing some of the final good, has not industrialised. Given this

situation, what should a government do to facilitate a transition to an industrialising path?16

Proposition 1 implies that if a level of industrialisation greater than the critical level,

k*, can be generated, then the economy will escape from the development trap. The issue

for the government, therefore, is to intervene when the economy is in the development trap

so as to generate the critical level of industrialisation. After this, no more intervention is

required to ensure that the process of industrialisation persists. Nonetheless, generating the

critical level of industrialisation may involve certain costs. It is the nature of these costs that

drives the policy choices a government must make.

The Costs of Inducing Change

Here it is assumed that the costs of inducing a firm to enter into production can be

represented by the function, c k tn( ( ), )1 . This function is the individual (transition)

15 See Krugman (1991) for an extensive discussion of this point.16 For a general discussion of the policy issues in the face of coordination failure see Gans (1994b).


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cost for period t and it is everywhere positive. represents the vector of exogenous

parameters, , , , Fand L .

What are the potential sources of such costs? One could suppose that in order

convince a firm to enter and adopt more modern technologies one would need to

compensate it for its perceived potential losses. Thus, the cost could take the form of an

investment subsidy. On the other hand, since in many respects the reason individual firms

do not enter and adopt more efficient technologies is due to insufficient demand, this cost

could take the form of a direct demand stimulus. Finally, these costs could represent the

transactions costs associated with insurance or loan policies of government.17

Of course, these alternative mechanisms for inducing individuals to change their

behaviour would involve different costs in of themselves, but in considering the issue of

the degree of balance in industrialisation policy and its timing, the significant point is that

there are such costs. After all, it was the fear that scarce resources would be spread too thin

that drove the entire logic the unbalanced growth school.

In order to characterise the optimal policy choices of the government, the way the

level of industrialisation influences these individual transition costs, cn , deserves some

comment. A complete specification might also have the current level of industrialisation in

the cost function. The effect of this on costs is, however, a complicated manner. If firms

were somewhat myopic, greater current levels of industrialisation might raise individual

transition costs. But if they were farsighted it may reduce them. To avoid these

difficulties, it is assumed that the current level of industrialisation influences future but not

present costs.

As for the past level of industrialisation, as was discussed in Section II, there exists

a positive feedback between the past level of industrialisation and the entry decisions of

firms. The marginal returns to entry are raised by greater past industrialisation. Therefore,

17 If there were no time lags in production and the model was one of pure coordination failure, theconsiderations here would still apply if one believed that the cost functions represented the expenses ofcommunicating plans to additional sectors.


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it reasonable to assume that greater past levels of industrialisation lower individual

transition costs of entry. That is,

(A) c k tn( ( ), ) 1 is nonincreasing in k t( )1 , n t, .

The precise way the exogenous parameters enters into the cost function turns out to have no

influence on the results that follow, so no restrictions are imposed here.

IV . The Governments Optimisation Problem

A government with utilitarian goals would aim to maximise the utility of the

representative household over time. This would involve, not only engendering transition,

but undertaking policies that ensured optimal growth thereafter. Since the concern of this

paper lies solely with the former policy, here I choose to focus on a more restricted goal for

the government -- cost minimisation. That is, the government chooses the

industrialisation policy that minimises the sum of individual transition costs incurred over

time subject to the constraint that a big push, (i.e., critical level of industrialisation) is

realised. From that point, industrialisation will proceed of its own accord. This goal is

reasonable since these costs may involve the sacrificing of consumption or may be funded

from some resource constrained external source.18

Funding

If cost minimisation is the goal of the optimal transition policy, then the precise

source of funding is immaterial. The early debate on industrialisation policy often implicitly

supposed that the funds or goods needed for industrialisation would come from some

external source. This implied some sort of foreign aid or loans. Such external resources

18 The instruments of inducing individual change may also be imperfect mechanisms involving somedeadweight losses for the economy.


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might be limited, especially if they were in the form of final goods, and thus, minimising

costs was considered an explicit goal.

A similar criterion applies for internal funding (which is possible since there is

some production even in the development trap). Suppose that the funds for transition are

raised internally through a lump sum tax on the incomes of households. The aggregate

revenues from this tax at time tis denoted by (t). Note, however, that it must be assumed

that (t) < Y(t) always. In each period, household consumption is reduced by (t).

Nonetheless, regardless of whether the instrument for inducing change is an investment

subsidy or direct demand stimulus,19 the total transition costs are being added to the

aggregate cash flow of intermediate input producers. Thus, there is no direct effect on

aggregate income (apart from any dead-weight losses from intervention), only a re-

distribution of it from households to firms. In this respect, there is an effect on aggregate

consumption, making it desirable to minimise the costs of transition and, hence, the level of

the tax.

The Cost Minimising Industrialisation Policy

In general, in addition to the length of the intervention, the government chooses the

number of firms targeted for change in each period. That is, in each period, t, the

government chooses a set of firms, K t( ) + , that have not entered into production in the

past, to induce to do so.

Suppose that the government chose to intervene from period t to period T.20 Then

in order to generate persistent industrialisation after period T, the total number of firms

targeted, K ss t

T( )

= , must be greater than k kB* . Thus, for this application, the level ofk kB

* defines the magnitude of the big push required to generate persistent

industrialisation. It is important to note that the goal of achieving this minimal level of

19 Since the governments additional demand would be inelastic, I am assuming implicitly that firmscontinue to charge the same price to them as to final goods producers.20

The actual choice ofTwill be governed by preference considerations as well as costs. As such, it is notconsidered explicitly here. Nonetheless, if persistent industrialisation is a desirable long-run outcome, it isreasonable to suppose that Tis finite.


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industrialisation is independent of the issue of timing. Given the effective irreversibility of

entry, the minimal level of industrialisation need not be generated in a single period. While

not an issue with respect to whether an escape from the development trap will be

successful, by smoothing the costs of transition over a period of time, the government can

take advantage of the fact that the individual transition costs fall with past entry.

Formally, given a choice of the length of intervention, T - t, the governments

choice of industrialisation policy is determined by the solution to the following optimisation

problem,

min ( ( ), )( )

( )

K s n

K ss t

T

s t

T c k s dn{ }

==

1 subject to K s k k s tT

B( )*

= .

This is quite a complicated problem. Nonetheless, the nature of the model of

industrialisation yields some simplifying information as regards the optimal policy.

Symmetry among firms makes it reasonable to suppose that their individual cost functions

are symmetric as well. Moreover, this also makes it reasonable to imagine that firms are

targeted in order of their index. Therefore, K t k k t B( ) [ , ( )]= , K s k s k s( ) [ ( ), ( )]= 1 and

K s k k T

s t

T

B( ) [ , ( )]= =U . With this information, the governments optimisation problem can

be re-written as,

min ( ( ), )( )

( )

( )

k s

k s

k s

s t

T

s t

T c k s dn{ }

==

11

subject to k T k( ) * .

Even with these simplifications this problem is rather complicated. Using the

characteristics of the model of Section II, however, some analysis of its properties is

possible. First, the issue of the timing will be addressed, while Section VI will turn to a

characterisation of the optimal degree of balance in industrialisation policy.

V . The Timing of Intervention

This section examines the notion that industrialisation should proceed

simultaneously across targeted sectors. As noted earlier, actually achieving a successful


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escape from the development trap is independent of the issue of timing. Nonetheless, how

quickly should the critical aggregate be generated given cost side considerations?

Consider the optimisation problem when the government chooses to intervene for

one period only. This policy is referred to as a big bang, in which the government solves,

min ( , )( )

( )

k t B

k

k t

c k dn

B

( ) subject to k t k( )* .

Nonetheless, such a big bang policy never minimises the total costs of transition.

Proposition 2. Assume (A) and suppose that the intervention begins in period t.

Then the cost minimising industrialisation policy always involves a choice of T > t.

To see this, start from a big bang industrialisation policy with T= t. Then imagine that

rather than targeting a few upstream firms in period t, they were targeted in period t + 1

instead. Note that the big push constraint remains satisfied after this change. In this

case, (A) guarantees that the individual transition costs for this firm are lower if it is

targeted in period t+ 1 rather than t. This is because the level of industrialisation, k t( ) is

necessarily larger than k t kB( ) =1 . Thus, total costs are reduced by extending the period

of the intervention. Concentrating intervention in a single period does not yield any of the

benefits associated with this fall in marginal costs. As such, this provides a reason why a

more gradual policy would be optimal.

Such cost-side considerations may be supported by other reasons for smoothing.

For instance, a government concerned about the utility of the population over time as well

as cost minimisation could be motivated for a gradual industrialisation policy for the

traditional taste-side reasons favouring less period-by-period saving -- i.e., low discount

rates and elasticities of intertemporal substitution. Finally, it should be noted that

depreciation in the initial start-up investment would mitigate against the irreversibilities

assumed in Section II and may make a less gradual approach more desirable.

The Form of the Intervention Over Time

The motive for spreading intervention over time raises another important issue: how

should the number of upstream sectors targeted for change move over time? Assuming


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(A), it is not difficult to see that the number of sectors targeted in each period will grow

over time. The reasoning here is similar to that leading to the motivation for gradualism.

That is, consider any two time periods, > s , and start from the situation in which

k s k( ) ( )= . Targeting a firm for entry in a later time period has a lower marginal cost

since the industrialisation level is higher. Therefore, in the optimal policy, k s k( ) ( ) .

The remainder of this argument follows by induction.

V . The Degree of Balance in Industrialisation Policy

The debate over whether industrialisation policy should be balanced or unbalanced

was effectively concerned with the number of sectors that needed to be targeted for change.

... both doctrines are examples of an acceptance of the necessity for a big push (broadlydefined) in economic development. The overt difference seems to be where and over howwide a field the push is to be applied. Thus on a cardinal issue the two doctrines areunited in their rejection of economic development by piecemeal marginalism. (Sutcliffe,1964, pp.627-628)

The balanced growth school argued that the neglect of too many sectors could thwart a

successful transition, while the unbalanced growth school believed that the targeting of a

few key sectors could generate sufficient momentum for industrialisation to proceed of its

own accord. The model of Section II argues that a big push is required to generate

persistent industrialisation. This section will show that the cost minimising composition of

the big push depends on the underlying economic parameters at hand.

The degree of balance was often ill-defined in the early informal literature. While

some proponents (e.g., Rosenstein-Rodan, Nurkse) have focused on a balance between

horizontal sectors (e.g., among final goods producers), others have focused on

intermediate input sectors versus final good sectors or other forms of heterogeneity (e.g.,

Hirschman, Rostow). The model here focuses on horizontal linkages -- the

interdependencies between decisions of sectors at the same production level -- even though

these may be derived from upstream and downstream interactions. In this sense, the

symmetry between the sectors being considered biases one towards a definition of the


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degree of balance based on the number of sectors targeted for change at the same level of

the economy. Thus, a bias is introduced in the following discussion towards the balanced

growth school by omitting the differences between sectors.21

On this basis, the model presented in Section II provides a clear definition of the

degree of balance. Proposition 1 showed that if the government targeted a critical mass of

sections, k*, for change, then industrialisation would persist thereafter. This number,

therefore, is the natural measure of the degree of balance in my model.22 It defines

precisely what is required for a big push to take place. Therefore, one way to

conceptualise the debate between the balanced and unbalanced schools is to reduce it to a

debate over what determines the magnitude of k*. Nonetheless, the way in which the

model determines k* could potentially neglect some effects and trade-offs that play a role in

the governments policy choices. I will return to this issue later.

For now, it is instructive to reflect upon how the parameters of the model determine

k* and how this relates to earlier discussions over the appropriate degree of balance. Recall

that: k F*

( )= ( )

11

11

. The relationship between the exogenous parameters of the model

and k* is summarised in the following proposition.

Proposition 3. The degree of balance ( k*) in the cost minimising industrialisation

policy is nonincreasing in and L , and nondecreasing in F.

This simplicity of the model of Section II yields a clear characterisation of the optimal

industrialisation policy. The cost minimising policy will be more unbalanced the less

upstream firms discount future earnings (higher ), the higher is the fixed size of the labour

force (higher L ) and the lower are the sunk costs of entry (lower F). Also, note that no

clear result is possible for the parameters and . Why this is so and the significance of

these will be discussed at the end of this section.

21 Nonetheless, this definition is closely related to notions of balance in other recent formal models (e.g.,the number of final goods sectors in Murphy, Shleifer and Vishny, 1989 and Matsuyama, 1992; and thenumber of intermediate input producers in Rodriguez-Claire, 1993, and Ciccone and Matsuyama, 1993).

See Sutcliffe (1964) for an interesting discussion of the earlier informal literature on this point.22 Rauch (1992) and Litwack and Qian (1993) also consider similar definitions of the balance of governmentindustrial policy but their analyses are made in very different contexts.


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All of the results of Proposition 3 is driven by the monotonic relationship between a

parameter and k*. Increasing L , raises the operating profits earned in each period of

production but, more importantly, raises n t t( ) / ( ) 1 , the strength of strategic

complementarity among upstream sectors. Likewise, by lowering the cost of entry, a

smaller Fraises the returns to entry regardless of the level of industrialisation. Finally, a

lower discount rate (higher ) shifts weight to the future benefits of entry and away from

current costs, again raising the incentive to enter. Each of these forces has the effect of

lowering k*, the critical level of industrialisation making entry profitable. This means that

the incentives of individual firms to enter production at low levels of industrialisation are

more sensitive to positive entry decisions by a few firms and hence, more unbalanced

policies will be successful. Of course, the goal of cost minimisation means that a

government would not wish to target more than k* firms in any industrialisation policy.

Of these parameters Fhas probably received the most discussion. In many ways,

this parameter represents the strength of increasing returns in the production technology of

producers of modern varieties. This is because lower levels ofF imply lower sunk entry

costs. Therefore, while one requires some degree of increasing returns to generate the

rationale for a big push intervention, the stronger these are the more an unbalanced

industrialisation policy is preferred (Hirschman, 1958).

Another parameter that seems to have been given a potential role in the past debate

on industrialisation policy is the discount rate, . Matsuyama (1992) interprets the discount

rate as a measure of the effectiveness of entrepreneurship in coordinating investment -- a

low discount rate indicating the existence of greater entrepreneurial resources, i.e.,

farsighted decision-making.23 If this is so, then the above result implies that with a relative

scarcity of entrepreneurial talent a more balanced approach ought to be followed.

Curiously, it was, however, the relative scarcity of entrepreneurial talent that seemed to

Hirschman at make the success of a balanced strategy unlikely: ... the major bone that I

23 Matsuyamas (1992) definition also encompasses adjustment costs which are not part of the model here.Using different language, Bresnahan and Trajtenberg (1994) have a similar interpretation of the discount rate.


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have to pick with the balanced growth theory: its application requires huge amounts of

precisely those abilities which we have identified as likely to be in very limited supply in

underdeveloped countries. (Hirschman, 1958, p.53) While I do not argue that the logic

of Proposition 3 contradicts the line of argument of Hirschman, it does indicate that the

issues here are quite subtle.24

The Strength of Linkages and Complementarities

The existence of a complementarity among the decisions made in different sectors

drives the rationale for a big push into persistent industrialisation. But a major dispute in

the earlier industrialisation policy literature is whether this very fact implies the optimality of

a balanced or unbalanced approach. Therefore, a natural question to ask is how the

strength of complementarities affects the degree of balance in industrialisation policy?

The model of Section II, like many recent models, shows that the determinant of the

success of industrialisation policy is the size of variables such as k*, the critical level of

industrialisation to achieve any escape. This leaves no room for any choice regarding the

total number of sectors targeted for change and hence, a first approximation to answering

the above question is to understand the relationship between the strength of

complementarities and k*.

It has been argued by several authors with similar models (e.g., Romer, 1987;

Ciccone and Matsuyama, 1993; and Ciccone, 1993) that the parameters and are

measures of the strength of complementarities or linkages among sectors (see Ciccone and

Matsuyama, 1993, and Romer, 1994). These parameters are, however, only imperfect

measures of the linkage strength. Take, for example, which parameterises the technical

complementarity between intermediate input varieties in the production of the composite,X,

with a lower implying stronger technical complementarities.25 The stronger are these

24 Although if one were to interpret the quote as emphasising the importance of the existence of basic

varieties then Hirschmans argument would be supported by Proposition 3.25 This can be seen most clearly be observing that the derivative ofX with respect to a simultaneous

increase in the quantity employed of some (non-measure zero) group of varieties is larger the lower is .


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complementarities the closer the market linkage between the demand for any given variety

and the demand for other varieties. This effect is sometimes referred to as the returns to

specialisation (Ethier, 1982; Romer, 1987). The idea here is that a lower raises the

marginal returns to employing a greater variety of inputs in production.26 Thus, lowering

should result in a lower k*.

But lowering also influences the total wage workers receive and hence, total

profits. This effect is ambiguous, but it is possible that a reduction in , could reduce

wages by enough so as to lower the marginal returns to entry favouring a more balanced

approach. Similar considerations apply to .

The model then does not contain a parameter that measures perfectly the strength of

complementarities or linkages among sectors. Despite this, the considerations addressed

thus far can shed some light on the issue at hand. As discussed earlier, the lower is k*, the

more likely will individual upstream producers enter in response to similar past entry

decisions by others. Therefore, there is a sense in which the level of k* itself describes the

strength of complementarities among upstream sectors (i.e., a lower k* means a greater

strength of complementarity). One might describe this as essentially a Hirschman effect in

industrialisation policy. As more entry takes place, those investments would ... call forth

complementary investments in the next period with a will and logic of their own: they block

out a part of the road that lies ahead and virtually compel certain additional investment

decisions. (Hirschman, 1958, p.42) That is, the stronger are strategic complementarities

or linkages among sectors (as represented by a smaller k*

), the more forcefully will

individual firms react to small increases in industrialisation.

But the focus on this effect is an artifact of the model presented here -- an artifact

shared by most other big push style models of industrialisation. The uni-dimensional

choice of entry means that k* is fully determined by the parameters of the model. Thus,

26 Alternatively, one could argue, as does Romer (1994), that a lower (higher ) means that a greaterproportion of the returns to entry are appropriatedby individual firms rather than workers. This is because

the ratio of profit to wage income is decreasing in .


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varying any parameter directly influences the level of k* and hence, the magnitude of the

big push. The larger the required big push, of necessity, the greater are the number of

sectors that need to be targeted for change over time. Cost-side considerations do not enter

into the calculus here nor is there any degree of freedom regarding the ultimate composition

of the big push.

In Gans (1994a), in addition to entry, firms can also undertake investments to raise

labour productivity (i.e., adopt more modern technologies).27 This gives a second

dimension to industrialisation. To obtain a target level of industrialisation, the government

can choose both the firms targeted for entry and also firms targeted for modernisation.

Indeed, to achieve the critical level of industrialisation, the government faces a trade-off

between these two dimensions. A big push can be achieved by many alternative

strategies: for instance, targeting a smaller number of firms to enter and modernise to a

large degree (an unbalanced strategy) or targeting many firms to enter and modernise just a

little (a balanced strategy). In this case, the big push constraint does not uniquely

determine the degree of focus in industrialisation policy but leaves numerous options open

to the government with the final choice resting on cost-side considerations.

In a general setting, changing parameters can potentially have three important

effects.28 First, as with the simple model here, the magnitude of the big push, i.e., the

critical level of industrialisation, can rise or fall, directly influencing the number of sectors

that need to be targeted for change. This is the Hirschman effect. Second, a parameter

change can raise the returns to both entry and modernisation. This reduces the costs to

obtaining a given level of entry and modernisation for an individual firm making it possible

to achieve the critical aggregate by focusing on fewer firms. Finally, parameter changes

alter the trade-off between entry and modernisation levels in the make-up of the big push.

27 This more general model, however, involves many complications that make the proofs of all thepropositions here and the discussion throughout much more cumbersome. Therefore, I chose in this paper

to focus on a simpler model, commenting on the potential differences as they arose.28 It turns out that the analogs of the other parameters in the model of Gans (1994a) while having some thepotential effects outlined here, do not possess the same difficulties as presented by and .


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In order to obtain an unambiguous characterisation of the cost minimising policy, all

three effects need to operate in the same direction. While this might be true for other

parameters,29 at a fundamental level it will not be true for any parameter that might measure

the strength of complementarities. For while the Hirschman effect and the cost-side effect

are likely to be correlated in many models, as they are plausibly in the model of this paper,

this will not be true for the third effect. That effect concerns the marginal influence of a

firms decisions in the production of a given level of industrialisation. Thus, an

industrialisation policy choice will be more unbalanced the more an individual firms entry

raises the measure of the aggregate level of industrialisation. But the weaker are the

linkages among intermediate input sectors, the more this will be the case. When linkages

are strong, a firms entry will have a small influence on the aggregate level of

industrialisation if other firms have not entered. This is essentially a Rosenstein-Rodan

effect: complementarity makes to some extent all industries basic. (Rosenstein-Rodan,

1943, p.205) Neglect of sectors in an industrialisation policy may make it highly costly to

achieve the critical level of industrialisation.30 This effect emphasises the trade-off between

the number of sectors and their degree of modernisation in producing the critical level of

industrialisation with stronger linkages implying that a broad approach with shallow

modernisation will generate this level in a less costly manner.31

29 In Gans (1994a), it is shown that these effects all reinforce each other for the parameters, thus, generatingthe same conclusions as Proposition 3.30 In contrast to the model here, the model in Gans (1994b), eliminates the Hirschman effect and focusesexclusively on the Rosenstein-Rodan effect.31 There is evidence that the tension between the two effects was recognised. Hirschman clearly recognisesthe possibility of a Rosenstein-Rodan effect: We are not thinking here of situations where A andB must

be employed jointly in fixed proportions. In this case it would not make much sense to say that demand forA and the subsequent increase in its output provide an incentive for the production ofB, as it is rather the

demand for the good or service into which A and B enter jointly which explains the demand for both

products. This is the familiar case of derived demand.... An example of the rigid type of complementarity

in use (best treated as derived demand) is cement and reinforcing steel rods in the construction, say, ofdowntown office buildings. Examples of the looser, developmental type of complementarity (entrained

want) can be found in the way in which the existence of the new office buildings strengthens demand for a

great variety of goods and services: from modern office facilities, stylish secretaries, and eventually perhapsto more office buildings as the demonstration effect goes to work on the tenants of the older buildings.(Hirschman, 1958, pp.68-69; the italics are mine)


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The Hirschman and Rosenstein-Rodan effects capture two sides of the

complementarity coin. Complementarities and linkages are stronger when (i) increases

aggregate activity raise the marginal returns to further activity by more; and (ii)

simultaneous increases in individual activity raise levels of aggregate activity by more.

Moreover, one effect favours an unbalanced and the other a balanced policy. Thus, the role

of an informal concept such as the strength of linkages and complementarities must be

considered carefully before its role in industrialisation policy can be assessed properly.32

VII . Conclusions and Future Directions

The central message of this paper is that conclusions regarding the timing of

industrialisation policy and its degree of focus are complex and dependent on the

characteristics of the economy under study. A big push perspective on industrialisation

does not necessarily imply that transition can be a simple matter of coordinating

expectations via some kind of indicative planning. Nor does it mean that policy must be

balanced and take a big bang form in order to be successful. A wide variety of

industrialisation policies can generate a big push and the choice between them is,

therefore, a matter of costs.

In a dynamic model, however, this wide variety of industrialisation policies makes a

characterisation of the optimal policy quite difficult. To take advantage of falling entry

costs, a gradual policy is always optimal. Moreover, in such a gradual policy, the number

of sectors targeted in each period is rising over time. But pairwise interactions between

choice variables and exogenous parameters tend to be qualitatively ambiguous in more

general dynamic settings. So while the simplicity of the model presented here identified

some characterisations of the degree of balance, there was reason to believe that with regard

32 The model here also assumes that linkages among sectors are global with one sector affecting and being

effected by all others. In Gans (1994a), the model is amended to a parameter allowing a variation the degreeof localisation of linkages. It was found that as linkages became more localised in nature, a moreunbalanced policy was cost minimising.


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to some parameters, ambiguities are more fundamental. For instance, weak sectoral

linkages tend to reduce the sensitivity of individual firms to small changes in the level of

industrialisation favouring a more balanced approach in order to minimise costs. But at the

same time, weaker linkages allow individual firm technology adoption decisions to have a

greater impact on the level of industrialisation itself, favouring an unbalanced strategy.

Thus, the tensions are complex and more ambiguous than the (sometimes contradictory)

conclusions drawn by either side in the earlier informal debate.

Nonetheless, there is a sense in which the above model does not capture potentially

important ingredients of the industrialisation policies described by both sides of the earlier

debate. The model here has been symmetric. Thus, the emphasis on the heterogeneity

between sectors that pervades the work of Hirschman (1958) is excluded. So questions

such as: what are the characteristics of sectors that should form a critical mass and how do

they use the information of other sectors investments, are not addressed here. Also, the

hierarchical relations among many sectors are not a feature of the model. Should one target

final or intermediate good producers when both face modernisation choices?33

Another important range of issues not addressed in this paper are those concerned

with the international trade aspects of industrialisation. If one assumes that the intermediate

input sectors produce non-tradable goods then the model here sits easily within an open

economy setting (as in Rodriguez-Clare, 1993). Nonetheless, a more complete treatment

would construct a model more suitable to address open economy matters. 34 For instance,

the appropriateness of policies of import substitution versus export promotion remains an

open question for big push theories. The questions of which sectors might be

appropriate targets in such policies remains an open area for formal analysis.

33 Of course, by focusing on intermediate input sectors rather than on final good production, I haveimplicitly concerned the analysis with issues closer to the discussion in Hirschman (1958).34 See Nurske (1958), Hirschman (1958), Sheahan (1958), Scitovsky (1959) and Montias (1961).


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Industralisation Policy and the Big Push