WP-1998-03

The main question asked in economic development is whether poor countries catch up with the rich. Empirical evidence suggests a negative answer, displaying a bimodal, ergodic cross-country distribution of income per capita. The poor on average stay poor, but it is still possible to observe intra- distribution mobility. How does growth theory explain this empirical evidence? The standard neoclassical model, in its augmented versions, do predict club convergence, but cannot explain economic miracles, reversal of fortunes and growth disasters, due to the non- ergodic properties of the predicted stationary distribution. In the standard stochastic version of the neoclassical model, every distributional characteristic is fully explained by nature, leaving little room for economics.

In this paper I present a refinement of the neoclassical, stochastic growth model, in which the likelihood of adverse shocks to production is postulated higher when an economy is in early stages of development. The assumption is justified economically arguing that a developing country may suffer from lack of diversification and missing markets and institutions, which may leave the economy overly exposed to the occurrence of adverse shocks. Empirical evidence (e.g. Quah, EER '93) indeed confirms an intrinsic higher fragility of less developed countries.

The paper contributes to the convergence debate by identifying the conditions for the emergence of club convergence, without relying on multiplicity of steady states. In addition, the predicted stationary distribution is ergodic, allowing for intra- distribution mobility. The paper also identifies conditions for equilibrium indeterminacy, considered as a possible alternative explanation for club convergence and intra- distribution mobility.

Working Paper (PDF,380KB)