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Heterogeneous Firms, Productivity, and Poverty Traps

We present a model of endogenous total factor productivity which generates poverty traps. We obtain multiple steady-state equilibria for an arbitrarily small degree of increasing returns to scale. While the most productive firms operate across all the steady states, in a poverty trap less productive firms operate as well. This results in lower average firm productivity and lower total factor productivity. In our model a growth miracle is accompanied by a shift of employment from small to large firms, consistent with the empirical evidence. We calibrate our model and relate entry costs to the price of investment goods. The resulting distributions of output, TFP, and capital-to-output ratio across steady states are similar to the ergodic distributions we estimate from the data. Rewritten as Working Paper 2008-023.

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