Explaining the Paths of Deindustrialization: a Transitional Institutional Dynamics Approach

Abstract: We examine the contrasting paths of deindustrialization across and within countries in a transitional dynamics framework. Our argument emphasizes that equilibrium income increases lead to the relative strengthening of transaction-cost reducing institutions. We specifically distinguish between three evolutionary equilibria: benchmark deindustrialization, premature deindustrialization and extended industrialization. Rising income from sources other than manufacturing below the TFP frontier tends to suppress transaction costs, encourage service-intensive specialization, and lead to premature deindustrialization. Our framework predicts the level of industrialization drives the choice of institutional framework. In more tangible-asset environment, property-rights strengthening institutions arise as the agents in such environment disproportionately favor secure long-term investments. Our identification strategy is to use industry-level panel data to identify the transition paths towards industrialization equilibria using the variation in transaction costs and property rights to identify the structural shifts between benchmark deindustrialization, premature deindustrialization and extended industrialization.We show that countries with the most rapidly decreasing transaction costs at the low levels of industrialization are more prone to deindustrialize prematurely compared to the countries with greater advantage in secure property rights and with relatively higher transaction costs.