4048 Ann Harrison and Andrés Rodríguez-Clare

Imagine first that there are no Ricardian productivity differences, lji ¼ 1 for all
j ¼ S, N and i ¼ 1, 2. Using (1) it is easy to confirm that there are multiple equilibria
in South (since p" ¼ 1/y then condition (1) is 1/y # 1 # 1), but since the second part
of (1) is satisfied with equality, then the wage is the same in both equilibria. Thus,
although there are multiple equilibria, the wage is not higher in the equilibrium with
specialization in good 2. This is because even though the economy benefits from clus-
tering in this equilibrium, this is exactly compensated by the lower price of this good,
which in turn arises from the higher productivity in North derived from clustering.
The equilibrium with specialization in good 2 may yield higher wages than to the
one with specialization in good 1 if we allow for exogenous productivity differences. In
particular, the equilibrium with specialization in good 2 will have higher wages if the
South has a latent comparative advantage in the good subject to clustering. To see this,
drop the assumption that lji ¼ 1 for all j, i, and assume instead that

l2S =l1S > l2N =l1N ðCAÞ

The condition for multiple equilibria (i.e., condition (1)) is now (using p" ¼ l1N/yl2N)

l1N =yl2N # l1S =l2S # l1N =l2N ð2Þ

The second inequality is satisfied given (CA), so there is always an equilibrium with
specialization in good 2. The first inequality (needed for there to be an equilibrium
with specialization in good 1) is satisfied if and only if

l2S =l1S
#y ð3Þ
l2N =l1N

That is, the South’s comparative advantage in sector 2 must be weaker than the benefits
of clustering.
The analysis here is exactly as above, with condition (2) replacing condition (1).
Condition (CA) is necessary for South to have a latent comparative advantage in good
2, and this is necessary for the wage with specialization in good 2 to be higher and for
IP to raise wages for South.
An important point to note is that for the gains from IP to be large we need South
to have a strong latent comparative advantage in good 2. But then condition (3) implies
that Marshallian externalities must also be high for there to be multiple equilibria. We
can conclude that IP generates large gains only if the sector that would be promoted exhibits
both a strong latent comparative advantage and large externalities.
One can enrich the model to generate some additional implications. For example, if
sector 2 is intensive in physical and human capital relative to sector 1, then if South is