Neighborhood Effects in Economic Growth

One of the most striking features of the international economy is that wealthy countries are clustered together. This paper empirically explains a mechanism for this clustering by extending the Acemoglu and Ventura model so that it takes real geography into account. Coun- tries close to fast growing economies experience faster growth in ag- gregate demand for their exports stimulating faster domestic growth. As a result, a poor country that is surrounded by other poor countries flnds it more di-cult to grow because its terms of trade shift against it. When this model is estimated on data for 1965 to 1985, we flnd statistically and economically signiflcant efiects. If the typical Euro- pean country were located in Africa these terms of trade efiects would have lowered its growth rate by 1 percentage point per year. The re- sults strongly suggest that it is very di-cult to raise income in poor countries without dealing with regional problems.