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Externalities, Endogenous Productivity, and Poverty Traps

We present a version of the neoclassical model with an endogenous industry structure. We obtain multiple steady-state equilibria with 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 total factor productivity. A calibrated version of our model displays sizable differences in TFP and output across steady state equilibria.

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