Working Paper: CEPR ID: DP3356
Authors: Ricardo Hausmann; Dani Rodrik
Abstract: In the presence of uncertainty about what a country can be good at producing, there can be great social value to discovering costs of domestic activities because such discoveries can be easily imitated. We develop a general-equilibrium framework for a small open economy to clarify the analytical and normative issues. We highlight two failures of the laissez-faire outcome: there is too little investment and entrepreneurship ex ante, and too much production diversification ex post. Optimal policy consists of counteracting these distortions: to encourage investments in the modern sector ex ante, but to rationalize production ex post. We provide some informal evidence on the building blocks of our model.
Keywords: development; industrial policy
JEL Codes: L50; O00
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| inadequate inducements for entrepreneurs to discover costs in new activities (O31) | underinvestment (G31) |
| reforms increasing market mobility (J62) | reduce incentives for investment in new activities (E22) |
| policy frameworks (D78) | levels of investment (G11) |