progress results mainly from copying and adapting foreign ideas, to an innovationbased, high-skill economy, where technological progress now occurs mostly by inventing new ideas domestically. Using a model of endogenous growth, industrial transformation was measured by changes in an index of industrial structure, defined as the ratio of the variety of imitation- to innovation-based intermediate goods. In the model, a key mechanism through which productivity increases initially in both the imitation and innovation sectors is through a knowledge externality associated with learning by doing in the imitation sector. The process of industrialization was shown to increase the demand for high-skill labor, inducing individuals to invest in education. In turn, education stimulates further productivity and technological advancement in the innovation sector. The model also emphasized the distinction between basic or core infrastructure, which promotes imitation, and advanced infrastructure, which promotes innovation. In this setting, investment in human capital is not a prerequisite for promoting growth and development in its initial stages.

The model was calibrated for a “typical” low-income country and used to perform a variety of policy experiments, involving an increase in investment in basic infrastructure, a reduction in the cost of training, and improved enforcement of property rights. An illustrative composite reform program, combining these policies sequentially, together with investment in advanced infrastructure, was also analyzed. The results showed the importance of improved access to basic infrastructure to initiate a growth and development process based on imitation, in a first stage, and higher investment in advanced infrastructure to promote a shift to an innovation-based process, at a later stage. The broader policy implications of the analysis were also discussed. A key point of our analysis (largely corroborated by the evidence) is that the lack of skills is not a binding constraint for launching a two-pronged growth strategy, aimed in a first phase at promoting the development of labor-intensive manufacturing industries and, in a second phase, at promoting skill-intensive domestic innovation. At the same time, our analysis helps to emphasize the importance of access to advanced infrastructure and enforcement of intellectual property rights to achieve that second phase.

An important extension of our framework would be to introduce explicitly financing constraints, both at the level of the production of goods and the production of ideas. The evidence collected in Dinh and Clarke (2012) shows that in Sub-Saharan Africa, while start-up firms can survive and grow without access to bank loans or other support from the formal financial sector, for them to grow bigger they need access to finance. Beck et al. (2005) also found that the growth of small firms is particularly affected by lack of credit. There is also much recent evidence, as discussed in Agénor and Canuto (2013), to document the fact that firms engaged in innovation suffer from a variety of frictions that may limit their ability to resort to external finance. Indeed, although information asymmetries matter for external financing of all types of investments, they are particularly significant in limiting financing of innovation investments due to the complexity and specificity of the innovation process.

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