The poverty trap: The dual externality model and its policy implications

This paper analyzes poverty traps in a monopolistic competition general equilibrium model with aggregate demand externality. In our model, the central hypothesis is represented by the introduction of externalities in fixed costs that firms have to incur in order to industrialize as a spillover across sectors. By this we mean that the fixed cost incurred by a firm in order to start production can reduce the fixed cost that firms in other sectors of the economy must incur. With such an assumption, we can show the possibility for an economy to be locked in at different stages of development. We then proceed to discuss the policy implications and the possible role for government intervention. To this end we provide a potential framework of reference that, if properly developed, may be useful in policy design. (C) 1997 Elsevier Science Ltd. All rights reserved.