Rational Underdevelopment

Abstract

We propose a two-region two-sector model of uneven development, where technological change benefits either the lagging or the leading region. In this framework interregional transfers may lead to persistent underdevelopment; by raising wages, transfers reduce the chance of the backward region adopting a new technology and taking off. Due to uncertainty about which region benefits from technological change, the backward region may rationally choose to remain underdeveloped, while the advanced region continues to pay transfers. The model provides a rationale for cases, such as Italy's Mezzogiorno, where the same rich region subsidizes the same poor region on a continuous basis.