A Dynamic Model of Specialization and Market Development as Engines of Economic Growth

This paper constructs a model of growth based on Adam Smith's notions of specialization and extent of the market. We seek to explain the following stylized facts. 1) The share of household production in total output has fallen over time as the economy has grown. 2) Services as a percent of GDP have risen at the same time. In this paper growth depends on specialization of labor according to comparative advantage in production and learning-by-doing in transactions services. It is a model of sustained, but not infinite, growth. Indeed, the main point of the paper is that it is possible to build growth models that match the historic experience without relying in unbounded growth. The model can replicate the above stylized facts for reasonable annual GDP growth rates. Simulations show that inequality over the growth episode is characterized by an inverted U-shaped curve.