Optimal Growth Strategy under Dynamic Threshold

• Published date: 01 December 2016
• Date: 01 December 2016
• Author: ÇAĞRı SAĞLAM,CUONG LE VAN,AGAH TURAN
• DOI: http://doi.org/10.1111/jpet.12167

OPTIMAL GROWTH STRATEGY UNDER DYNAMIC THRESHOLD

CUONG LE VAN

IPAG Business School, CNRS, PSE, VCREME

C¸A˘

GRı SA ˘

GLAM

Bilkent University

AGAH TURAN

Bilkent University

Abstract

We consider an economy in which the technology exhibits nonconvex-

ities due to fixed costs associated with production. Taking into account

the incentives for investment to decrease fixed costs, we characterize

the circumstances under which an underdeveloped economy can catch

up with the developing ones. We show that it is optimal to get rid of the

fixed costs inherent in production in finite time provided that the ini-

tial level of fixed costs are not too high and the technology for reducing

fixed costs is sufficiently efficient. Indeed, we obtain that even though

the income disparities may be very persistent and can be perceived as

poverty traps, economies with not very high initial fixed costs and suf-

ficiently efficient technology for reducing fixed costs would ultimately

converge to the same steady state level of per capita income.

1. Introduction

Consider an economy in which the technology exhibits nonconvexities due to fixed

costs associated with production. According to Dechert and Nishimura (1983) and its

extensions (e.g., Mitra and Ray 1984; Kamihigashi and Roy 2007; Hung, Le Van, and

Michel 2009; Akao, Kamihigashi, and Nishimura 2011), such an economy can fall into

a poverty trap if its initial capital or income falls short of the fixed cost inherent in

production. However, to what extent these analyses are robust to the considerations of

incentives for investment to decrease the fixed costs in production, still remains unan-

swered: Can such an underdeveloped economy eventually catch up with the developing

ones if endowed with a technology to reduce the fixed costs? If so, how and how long

will it take? If not, why not? To account for these seminal questions we consider a non-

classical optimal growth model which takes the incentives for investment to decrease

fixed costs explicitly into account.

Fixed costs associated with production stem mainly from the lack of core infrastruc-

ture such as road, rail, power supply, telecommunications, irrigation, sanitation, and

Cuong Le Van, IPAG Business School, CNRS, PSE, VCREME, France (Cuong.Le-Van@univ-paris1.fr).

C¸a

˘

grı Sa˘

glam, Department of Economics, Bilkent University, Ankara, Turkey (csaglam@bilkent.edu.tr).

Agah Turan, Department of Economics, Bilkent University, Ankara, Turkey (agah@bilkent.edu.tr).

Received July 26, 2014; Accepted April 20, 2015.

C2016 Wiley Periodicals, Inc.

Journal of Public Economic Theory, 18 (6), 2016, pp. 979–991.

979