Demand‐led industrialisation policy in a dual‐sector small open economy

Abstract

This article models the process of structural transformation and catching‐up in a demand‐led Southern economy constrained by its balance of payments. Starting from the Sraffian Supermultiplier Model, we model a dual‐sector small open economy with a traditional and a modern sector that interacts with a technologically advanced Northern economy. We propose two (alternative) autonomous elements that define the growth rate of this demand‐led economy: government spending and exports. Drawing from the Structuralist literature, productivity in the technologically laggard Southern economy grows by absorbing technology from the Northern economy, by both embodied and disembodied spillovers, and potentially closing the technology gap. The gap affects the income elasticity of exports, bringing a supply‐side mediation to the growth rates in line with the Balance of Payments Constrained Model. We observe that a demand‐led government policy plays a central role in structural change, pushing the modern sector to a larger share of employment than what results under export‐led growth. Such a demand policy is the only way in which partial catching up (in productivity and GDP per capita) can result, and this is facilitated by a global market place in which the balance of payments constraint is relatively soft.