Engel's Law in the Global Economy: Demand-Induced Patterns of Structural Change, Innovation and Trade

Endogenous demand composition across sectors due to income elasticity differences, or Engel's Law for brevity, affects (i) sectoral compositions in employment and in value-added, (ii) variations in innovation rates and in productivity change across sectors, (iii) intersectoral patterns of trade across countries, and (iv) product cycles from rich to poor countries. Using a two-country model of directed technical change with a continuum of sectors under nonhomothetic preferences, which is rich enough to capture all these effects as well as their interactions, this paper offers a unifying perspective on how economic growth and globalization affect the patterns of structural change, innovation, and trade across countries and across sectors in the presence of Engel's Law. Among the main messages is that globalization amplifies, instead of reducing, the power of endogenous domestic demand composition differences as a driver of structural change.