A Theory of Intermediate Services and the Inequality of Nations

Abstract

An iceberg theory of intermediate services that bridge the transaction cost gap between producers and consumers is immersed in a symmetric two country-two sector model with a monopolistically competitive manufacturing sector producing an endogenous number of varieties. With a proportion of the expenditure of produced goods effectively 'melting' on their way to the consumer, firms can choose to invest scarce resources and create intermediate market services that inhibit the loss, thereby improving demand for their product. Their ability to do so depends on the exogenous productivity of labour in creating these market services, with the inequality across nations distinguished by this parameter. The general equilibrium effects of improvements in this productivity are analysed. For poor countries, two equilibria emerge with one involving much higher welfare. As productivity improves, the poor do catch up with the rich on their single equilibrium path, but may suffer in transition.