ends with some extensions and a list of empirical predictions. Section 3 shows some
supportive empirical evidence. Section 4 concludes.
2 The Model
2.1 Autarky
Consider Hrst the set N of rich countries (the North). The North is assumed to
be a collection of perfectly integrated economies with similar characteristics, whose
total population is L^. The subscript N is suppressed where it causes no confusion.
Consumers have identical isoelastic preferences:
ʃ ln c (t) e ρtdt.
There is a continuum [0,1] of sectors, indexed by i. Output of each sector, у (i), is
aggregated in bundle Y used both for consumption and investment:
7 у (i) - di
€
€-1
(1)
where e > 1 is the elasticity of substitution between any two goods. The relative
demand obtained by maximizing (1) is:
P (i)
P (j )
’ у (i) Γv'
У (j )_
(2)
The aggregate Y is taken as the numeraire and its price index is therefore set equal
to one:
j P (i)1-e di
1
1-€
= 1.
(3)
Each good у (i) is homogeneous and produced by competitive Hrms using machines
x (i) and labor I (i):
у (i) = A (i)β x (i)1-β I (i)β ,
(4)
where A (i) is an index of machine productivity in sector i. Machines are sector-
speciHc, non tradeable and depreciate fully after use. Demand for machine x (i)
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