Why Income Gaps Persist: Productivity Gaps, (No-)Catch-up and Industrial Policies in Developing Countries

Abstract

Driven by productivity gaps, absolute income gaps between developing and developed economies have remained persistent hindering catch-up. Export products mostly consisting of low value-added products; developing countries suffer even when they are part of global value chains. The so-called Fourth Industrial Revolution may further exacerbate their position. As a result, many developing countries have been in low- or middle-income traps for decades and this is likely to persist. So, why has the traditional productivity explanation not been able to explain the no-catch-up phenomenon?

To explain lack of catch-up, we decompose productivity into price and technical efficiency components. Adopting a product differentiation strategy, the developed countries focus on price, while developing countries focus on technical efficiency; prices of products of advanced firms in developed countries are determined not in perfectly competitive markets but rather in monopolistically competitive markets granting them with pricing power through three tools: technology (R&D), design, and branding. By virtue of this pricing power, advanced firms generate non-zero economic profits and “pseudo-productivities” which drive the income gaps. We suggest key lines of industrial policy sets such as focusing on design, branding, and product differentiation strategies, fast cycle technologies, and development-based public procurement coupled with educational policies.

Keywords:

• absolute income gaps
• monopolistic competition
• industrial policy
• global value chains
• branding
• design

JEL Classification Codes:

• O25
• D24
• D41
• F63
• L12
• O14

Notes

1 This is the simple case for an economy producing one product. More generally in a multi-product economy, p and q can be considered as vectors of quantities and prices of products. In that case (2) would look like below: (2′) where N represents the number of goods and services produced in the economy. A multiproduct modeling of the economy would not change the conclusions that will follow.

2 Note that, in the long run, the smile curve may get flattened, as competing firms reverse engineer and master the technology or create alternative brands.

3 Displacement of the minicomputers is a good example of disruptive technologies that provided benefits to the society. Minicomputers were initially developed by various North American companies, one of which was Digital Equipment Corporation. High-performance minicomputers were purchased by small- and medium-sized companies and provided their employees with access to them through a terminal with a screen and keyboard. The commercialization of personal computers (PCs) developed by IBM appeared as a disruptive technology and companies stopped buying minicomputers to provide each employee with a personal computer and link them through a communications digital network. In addition, consumers bought personal computers. Due to this, and for not being able to change its business strategy, Digital Equipment Corporation (DEC) went bankrupt in the 1990s.

4 Ronald McKinnon (1973) and Edward Shaw (1973) argue that Japanese financial markets were financially liberal during Japan’s rapid industrialization period. Murat Yülek (1997) clearly demonstrates that Japanese financial markets were repressed as a result of financial policies that changed the institutional structure in order to accelerate economic development. Further, Yülek (2017) provides a theoretical argument to how financial repression can accelerate development and improve economic welfare.

5 Veblen defined institutions in a wide way that became the norm afterwards. In his earlier works, he defined institutions as “habits of thought common to the generality of men” whereas subsequently as “of the nature of a usage which has become axiomatic and indispensable by habituation and general acceptance” (Waller 1982).

6 Veblen ([1915] 1964).

Additional information

Notes on contributors

Murat A. Yülek

Murat A. Yülek is at Ostim Technical University. Gilberto Santos is at Polytechnic Institute Cávado and Ave, Portugal.

Gilberto Santos

Murat A. Yülek is at Ostim Technical University. Gilberto Santos is at Polytechnic Institute Cávado and Ave, Portugal.