To Be or Not to Be at the BOP: A One-North-Many-Souths Model with Subsistence and Luxury Goods
Adriaan van Zon & Tobias Schmidt
#2008-046
In this paper we seek to explain the causes and consequences of Northern
penetration in Southern subsistence markets in order to reach the
countless masses at the Bottom of the (Income) Pyramid. To this end we
formulate a One-North-Many-Souths model, inspired by the Krugman (1979)
North-South model. In our model, Southern countries are differentiated
with respect to population size, but also the degree of internal
connectedness as a proxy for the cost involved in reaching the local
subsistence market. Northern subsistence goods production in Southern
countries takes place under increasing returns to scale, why local
production of subsistence goods takes place under constant returns to
scale. Using this set-up, we show what kind of Southern countries would
be penetrated first, and under which conditions this would happen. From
the point of view of Northern producers, Southern countries can be
divided into three classes: the broad class of partner- and non partner
countries, and within the class of partner countries, the sub-classes of
small and large partners. In this context, small partners are so small,
that all of local subsistence production is taken over by the North,
while in large countries part of subsistence consumption must still be
met out of local subsistence production. The main insights coming from
numerical simulations with the model are that Northern penetration on
Southern markets releases (labor) resources that can then be used for
producing tradable luxury goods. This has a negative terms of trade
effect for the South, but a positive income effect, while, moreover, the
latter effect tends to outweigh the former. In addition, small partner
countries generally stand to gain more from Northern penetration than
large countries, as in small partner countries relatively more resources
would be released when shifting production of subsistence goods from
local to Northern technologies. Using numerical simulations in which we
increase the rate of imitation, we show that this leads to higher terms
of trade for the South, and consequently, a higher penetration of the
North in Southern countries with respect to subsistence production. The
reason is that the opportunity cost of using Northern labor in Northern
luxury goods production falls, and consequently more Northern labor is
allocated to its alternative use of managing subsistence goods
production in Southern countries. Thus we are able to ‘explain’ the
recent penetration of Northern firms in subsistence goods production in
countries like India and China (which have become increasingly important
as manufacturing trading partners), as the latter countries are both
large in population terms as well as relatively well connected.
JEL-codes: D58,F12,F16,F23,O33.
Key words: Bottom of the Pyramid, North-South model, luxury goods,
subsistence goods.
UNU-MERIT Working Papers
ISSN 1871-9872