Development and Underdevelopment in the Globalizing Economy

Abstract

A Schumpeterian theory of development and underdevelopment in an open global economy with technology transfer, trade and investment is presented. Free trade provides a powerful force for convergence. However, foreign direct investment (FDI), which consolidated during the 19th Century and has increased rapidly since the 1980's, results in asymmetric incentives for innovation favoring leading countries that are strong enough to induce persistently unequal and divergent steady states. Innovators accessing lower wages through labor- and market-seeking FDI obtain higher profits generating higher incentives for innovation, for which FDI spillovers may not compensate the follower. Moreover, the follower's potential for innovation may be crowded out. For example, if all its labor is demanded by leading country innovators, all innovation will be crowded out (the banana republic). The typical colonial diktat imposed by Great Britain in the 19th and early 20th Centuries also generates persistent inequality and divergence.