INFORMATION, THE DUAL ECONOMY, AND DEVELOPMENT

We examine the interactions between different institutional arrangemen ts in a general equilibrium model of a modernizing economy. There is a modern sector, where productivity is high but information asymmetries are. large, and a traditional sector where productivity is low but in formation asymmetries are small. Consequently, agency costs in the mod ern sector make consumption lending difficult, while such lending is r eadily done in the traditional sector. The resulting trade-off between credit availability and productivity implies that not everyone will m ove to the modem sector. In fact, the laissez-faire level of moderniza tion may fail to maximize net social surplus. This situation may also hold in the long run: in a dynamic version of the model, a ''trickle-d own'' effect links the process of modernization with reduction in mode rn sector agency costs. This effect may be too weak and the economy ma y get stuck in a trap and never fully modernize. The two-sector struct ure also yields a natural theoretical testing ground for the Kuznets i nverted-U hypothesis: we show that even within the ''sectoral shifting '' class of models, this phenomenon is not robust to small changes in model specification.