JESP Vol. 1, No. 2, 2009 The Importance of Positive Externalities and Intersectoral Linkages in Determining Growth Path of Developing Economies Deden Dinar Iskandar __________________________________________________________________________________________ Abstract This paper is intended to explore the significance of intersectoral linkage in determining the growth path of developing economies. It is commonly believed that intersectoral linkages among firms and industries is importance since it provides the positive externalities that enables firms or industries to gain the increasing return to scale. Increasing return to scale is the characteristic that drives the process of growth. The paper describes the source of increasing return to scale, the relation between externalities and sectoral linkages, and the link between sectoral linkages and growth path in developing economies. The analysis of the paper is based on the literatures review. All the models reviewed suggest the importance of sectoral linkages from various points of view, and come to the similar conclusion that the weak or absence of sectoral linkages could lead developing economies to be trapped in low equilibrium economy and low growth path. The conclusion is how the government able to release the developing economies from the historical trap of low equilibrium economy and low growth path by establishing a rational policy. Keywords: increasing return to scale, externalities, sectoral linkages, growth path __________________________________________________________________________________________ The aim of this paper is to explain the increasing returns, and illustrates a few importance of intersectoral linkage in deter- relevant models that provide the link be- mining the growth path of developing econ- tween intersectoral linkages and growth omies and to build the rationale of how it path. This section aims to put a theoretical may release the developing economies from framework. The forth section analyzes in- the historical trap of low equilibrium econ- tersectoral linkage and growth path in de- omy and low growth path. According to the veloping economies based on the theo- new growth theory, economic growth retical framework. In this section I will results from increasing returns to scale make a general theoretical observation where a proportional increase in labor and based on the alleged characteristic of devel- capital as input of production would rise oping economies rather than go on details more than proportional yield in output. to analysis countries' cases, such as in These increasing returns drive the process Autant-Barnard, 2001; Combes, 2000; Hen- of growth (Cortright, 2001). The increasing derson, et al., 1995; Kim, 2008; and Vena- returns to scale could be driven by exter- bles, 1995). The fifth section briefly nalities aroused from interdependence a- describes the policy that could be beneficial mong firms within industry and economy. to overcome the historical growth path in The structure of the paper is ordered as developing economies. The last section is follows. The first section is introduction, the conclusion. followed by the second which is briefly explaining the source of increasing returns to scale. The third section briefly describes the types of externalities that generate the __________________________________________ Alamat korespondensi: Deden Dinar Iskandar. Fakultas Ekonomi, Universitas Diponegoro. E-mail: [email protected] JESP Vol. 1, No. 2, 2009 THE SOURCE OF INCREASING productivity, which could be applied to RETURNS TO SCALE mass-production by capitalist sector. In the absence of externalities from economy The source of increasing returns to expansion, the cost of providing trained and scale could be external or internal to the skillful worker would be much higher for firm. The internal increasing returns to any firm to acquire. scale of particular firm could be resulted from its huge fixed cost and volume of Rosenstein-Rodan model enables multi- production. It is the characteristic of firm or ple equilibrium to exist since capital stock industry that apply modern technology. The increase when market wage of trained and external source of increasing returns to skillful worker provided by the economy is scale could occur from interdependence lower than the required wage to enable firm where the progress in one firm creates generating the steady capital accumulation. beneficial externalities for others firms On the other hand, steady capital accumu- within industry simultaneously. Therefore lation would decrease if market wage provided by economy greater than the firms producing individually with constant 1 returns to scale could acquire increasing required wage. returns to scale at the sector or economy If the market wage is lower than the level if activities of firms collectively affect required wage, firm would get more profit their production conditions. Although and the rate of capital accumulation would production of the firm exhibits constant be higher over time. Capital intensity within return to scale, the externalities of industry economy would increase over time and growth would encourage the return to scale reach the high level of equilibrium at stable to increase (Ross, 2000). steady state point with high real wage and high capital intensity. On the contrary, at THE EXTERNALITIES AND the low level of capital stock where the INTERSECTORAL LINKAGES market wage is higher than the real wage required to generate the steady state of Externalities could be specified into accumulation, the rate of accumulation is technological and pecuniary externalities. less than depreciation and the size of Technological externalities are emerged capitalist sector would be narrower over from direct interdependence among pro- time. The capital intensity within economy ducers, and related to the production would declines and the equilibrium would function. While pecuniary externalities are reach the low equilibrium at subsistent in which the interdependence between level. producers occur through the market mechanism, providing lower cost, larger Pecuniary Externalities market size and higher demand for their Pecuniary externalities are externalities goods (Ross, 2000). in which interdependence between pro- Technological Externalities ducers occurs through the market mechan- ism, where the firms expand the market size The model of Rosenstein-Rodan (1943) and give benefit for other firms reci- states that externalities generate increasing procally. As a result, firms gain returns not return to scale is resulted from activities only by its own expansion but also with the such as industrial training. Arrow (1962) growth of industry and the whole economy. added further that these effects are emerged from learning by doing process which increase the stock of experience accrued 1 with the production activities. The expan- The required wage to enable firm generating the steady capital accumulation is a constant increasing function of capital stock. sion of economy that increases the re- The market wage of trained and skillful worker could be lower or sources of trained and skillful workers is higher than the required wage. This is due to the elasticity of labor supply and additional effect of capital stock caused by increasing beneficial for the firms. It improves the returns to scale due to expansion of economy. 62 JESP-Vol. 1, No. 1, 2009 Furthermore, Ross (2000) makes a profit, provides the large market size for the distinction between horizontal and vertical firm in first sector (Sachs & Warner, 1999). pecuniary externalities. Horizontal means This would lead to industrialized equilib- that the interdependence occurs horizontally rium, when modern technology production through the interrelated market of final in each sector produces at a full level of goods industries, where pecuniary exter- employment. This high level of equilibrium nalities entails demand spillover across would display higher output, wage, and final goods industries. Vertical means that profit in economy (Ross, 2000). the industry acts as supplier and costumer, However, if fixed labor input to initiate where firms provide the intermediate input the modern technology production is so to others firms. Horizontal interdependence large that the total wage cost of applying could be described by Big Push model from modern technology is higher than sales Murphy, et al (1989), while vertical inter- accrued by modernized firm at level of full dependence could be explained by model employment, the market is not profitable to from Venables (1996). apply modern technology. Therefore the industrialization would not emerge; econo- Big Push Model my would be set at low-income equilibrium There is multisectoral economy produc- with traditional technology. ing different final goods. There are two Here we have multiple equilibriums. The techniques in the production of each sector: economy equilibrium would be set at stable traditional technology with constant return high equilibrium or stable low equilibrium. to scale and modern technology with in- The temporary equilibrium beside those creasing return to scale. The modern tech- two would be temporary and moving to nology relates with industrialization and either stable high or stable low equilibrium. would be more productive at higher level of output but less productive at lower level. Venables Model Individual producer in the perfect compe- Venables (1996) illustrates that there tition market use traditional technology. On are