Specialization on a technologically stagnant sector need not be bad for growth

This paper presents a two-sector, North-South model of endogenous growth, where the investment goods sector features learning by doing. There are no technological spillovers across countries that are integrated only via goods markets. In equilibrium, South specializes on the consumption sector. Despite strict concavity of the production function for consumption goods, the endogenous decline in the relative price of investment goods maintains the incentives for capital accumulation. Hence, specialization on the stagnant consumption sector does not entail a growth penalty. The model is consistent with a number of empirical observations: (i) the relative price of investment goods has been declining in many countries; (ii) poor countries are net importers of investment equipment; (iii) per capita income convergence has stopped in the sample of open economies. Copyright 2007 , Oxford University Press.