WAS PROMETHEUS UNBOUND BY CHANCE - RISK, DIVERSIFICATION, AND GROWTH

This paper offers a theory of development that links the degree of mar ket incompleteness to capital accumulation and growth. At early stages of development, the presence of indivisible projects limits the degre e of risk spreading (diversification) that the economy can achieve. Th e desire to avoid highly risky investments slows down capital accumula tion, and the inability to diversify idiosyncratic risk introduces a l arge amount of uncertainty in the growth process. The typical developm ent pattern will consist of a lengthy period of ''primitive accumulati on'' with highly variable output, followed by takeoff and financial de epening and, finally, steady growth. ''Lucky'' countries will spend re latively less time in the primitive accumulation stage and develop fas ter. Although all agents are price takers and there are no technologic al spillovers, the decentralized equilibrium is inefficient because in dividuals do not take into account their impact on others' diversifica tion opportunities. We also show that our results generalize to econom ies with international capital flows.