A perfect foresight model of regional development and skill specialization

Abstract

A perfect foresight model of a two-region two-sector economy with a continuum of overlapping agents is developed, where there are positive externalities in the acquisition of manufacturing skills. These externalities cause specialization, and over time the economy gets divided into a rich manufacturing region and a poor agricultural region. The introduction of a new manufacturing technology either reinforces or reverses this development pattern. Wealth differences are reinforced if, in spite of higher wages, the new technology locates in the advanced region, attracted by skills similar to the needs of the new industry. Otherwise the new technology locates where wages are lower, in which case the lagging region overtakes the leading one. History alone determines the outcome in this economy; there is no role for self-fulfilling expectations.