Economic Growth under Factor Reallocation Costs

The implications of intersectoral factor reallocation costs (FRC) for economic growth are investigated by employing a stylised two-sector growth model with explicit FRC. It is shown that FRC are important to understand a number of empirical facts on economic growth: (i) Flexible economies are more likely to take advantage of favourable technology shocks. This mechanism might explain why some economies experience higher output growth in response to the introduction of new technologies compared to others; (ii) It is demonstrated that FRC give rise to hysteresis (i.e. a continuum of stationary equilibria). Hence increasing returns to scale are not necessary to generate a multiplicity of equilibria; (iii) FRC do also shed some light on the fact that economic development is associated with regular downturns.