Abstract
Many middle-income countries are caught in the middle-income trap, facing a slowdown in growth. Although they are undergoing a structural transformation from labor-intensive to capital-intensive sectors, existing literature does not provide theoretical guidance on which capital-intensive sectors to enter first. This study builds on Schumpeterian sectoral heterogeneity to develop a two sector, two country trade model. A static model shows the comparative advantage of an emerging economy in a sector with a short cycle time of technology (CTT), which is associated with high rates of depreciation of knowledge embodied in capital and thus, low entry barriers for an emerging economy. The dynamic model then shows that as an emerging economy accumulates more capital stock, it eventually loses its comparative advantage in short CTT sectors, and it becomes optimal to specialize in the long CTT sectors as many advanced economies do.
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