Author(s): Jeffrey Sachs and Xiaokai Yang

Source: Journal of Economic Integration , June 2002, Vol. 17, No. 2 (June 2002), pp. 223-242

Published by: Center for Economic Integration, Sejong University

Abstract

The paper introduces asymmetric production conditions between firms and asymmetric transaction conditions between countries into the Murphy-Shleifer Vishny model of industrialization. It explores a general equilibrium mechanism that generates circular causation loop that each firm's profitability and its decision of involvement in a network of industrial linkages is determined by the size of the network, while the network size is in turn determined by all firms' decisions of participation. It shows that the very function of the market is to network relevant self-interested decision-makers and to utilize the network effects of industrialization, though this function is not perfect. Hence, market led industrialization will gradually spread until the whole world economy is integrated in a single network of trade and industrial linkages as trading efficiency is improved. This paper devises a new approach to specifying zero profit condition for a marginal modern firm, while keeping original feedback loop between positive profit and the extent of the market of the MSV model. Hence, this new method and the trade off between economies of scale and transaction costs can be used to endogenize the number of modern sectors, thereby increasing applicability of this type of models.

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