Working Paper: CEPR ID: DP1426
Authors: Daron Acemoglu; Fabrizio Zilibotti
Abstract: This paper offers a theory of development which links the degree of market incompleteness to capital accumulation and growth. At early stages of development, the presence of indivisible projects limits the degree of risk-spreading (diversification) that the economy can achieve. The desire to avoid highly risky investments slows down capital accumulation and the inability to diversify idiosyncratic risks introduces high uncertainty in the growth process. The typical development pattern will consist of a lengthy period of ?primitive accumulation? with highly variable output, followed by take-off and financial deepening and lastly, steady growth. ?Lucky? countries will spend relatively less time in the primitive accumulation stage and develop faster. Although all agents are price-takers and there are no technological spillovers, the decentralized equilibrium is inefficient because individuals do not take into account their impact on the diversification opportunities of others. We also show that our results generalize to economies with international capital flows.
Keywords: chance; development; diversification; financial intermediaries; growth; incomplete markets; international capital flows; pecuniary externalities; risk
JEL Codes: D82; E44; G20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| lack of adequate diversification opportunities in poor countries (F63) | high volatility and slow growth (E32) |
| limited access to imperfectly correlated projects (G19) | risk-averse agents investing in low productivity but safer investments (G11) |
| risk-averse agents investing in low productivity but safer investments (G11) | lower productivity and growth (O49) |
| lucky economies that receive favorable draws of uncertainty (D89) | accumulate more capital (E22) |
| accumulate more capital (E22) | enhance ability to diversify risks and achieve higher productivity (D29) |
| opening of new sectors (O17) | increases attractiveness of existing projects relative to safe assets (G19) |
| increases attractiveness of existing projects relative to safe assets (G19) | underinvestment in risky projects (G31) |
| decentralized equilibrium is inefficient due to a pecuniary externality (D59) | individual actions impact collective diversification opportunities (F61) |