Intermediate Goods and Weak Links in the Theory of Economic Development

What explains the enormous differences in incomes across countries? This paper returns to two old ideas: linkages and complementarity. First, linkages between firms through intermediate goods deliver a multiplier similar to the one associated with capital in a neoclassical growth model. Because the intermediate goods share of output is about one-half, this multiplier is substantial. Second, just as a chain is only as strong as its weakest link, problems along a production chain can sharply reduce output under complementarity. These forces considerably amplify distortions to the allocation of resources, bringing us closer to understanding large income differences across countries.(JEL: D57, E23, O1O, O47)