Capital Mobility and Catching Up in a Two-Country, Two-Sector Model of Endogenous Growth

Global knowledge spillovers allow backward countries to catch up by accumulating knowledge faster than leading countries. International growth differentials will fall as diminishing returns with respect to the national knowledge stock apply. The domestic growth rat e will finally equal the world-wide growth rate, which is endogenous if constant returns apply with respect to all world knowledge stocks taken together. In our two-country two-sector model with firm-specific knowledge, we show that there is convergence to a symmetric steady state under balanced trade. Under perfect mobility of financial capital, however, there is leapfrogging in the sense that the initially backward country reaches a higher productivity level in the steady state than the initially leading country. This leapfrogging result is found for countries that are perfectly symmetric in all respects except for initial knowledge stocks. The result is therefore path-dependent, implying that overtaking is higher the larger the initial productivity gap. The existence of a nontradables sector is driving the result. During the catch-up process, the backward economy accumulates a foreign debt to smooth consumption. To service this debt, labor is shifted from nontradables to tradables production and investment in firm-specific knowledge