Linkages

Abstract

Economic activities in different industries are linked to each other through aggregate income (horizontal linkages) and input-output relationships (vertical linkages). Could such linkages give rise to vicious circles of underdevelopment or virtuous circles of development when there are increasing returns to scale at the firm level? A standard account of a vicious circle goes as follows. Small-scale production methods in industry A lead to low output and income. This translates into low demand for industry B, which therefore also ends up using smallscale production methods and generating low output and income. The result is low demand for industry A, which justifies the small-scale production methods used in this industry. Low aggregate output and income are seen as the result of a vicious circle because the same economic environment is thought to be compatible with a highincome equilibrium where all industries use technologies that achieve high productivity at large scale. This highincome equilibrium is sustained by a virtuous circle. Large-scale production methods in industry A are profitable because of high income in industry B, and vice versa.