Structural change and economic growth with relation-specific investment

• We model a multi-sector endogenous innovation model.
• The economy gets stuck in the “growth trap.”
• The remedies are relation-specific investment and a low degree of specialization.
• Subsidies on relation-specific groups and permanent R&D taxes are effective.

This article develops an inter-sectoral endogenous innovation model that is able to account for changing productive relations among sectors and examines how the relation-specific investment affects the evolution of industry structure. It is shown that in the steady state, the economy gets stuck in the “growth trap” where the economy still achieves positive growth, but at the lowest level. The most efficient remedies for the growth trap are to facilitate relation-specific investment among sectors and to decrease the degree of specialization in the economy. Thus, the relation-specific investment is indeed instrumental in improving economic efficiency in the face of the growth trap. These remedies could be implemented by subsidies on relation-specific groups and permanent R&D taxes.