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.