Start-up costs and pecuniary externalities as barriers to economic development

We use a dynamic monopolistic competition model to show that an economy that inherits a small range of specialized inputs can be trapped into a lower stage of development. The limited availability of specialized inputs forces the final goods producers to use a labor intensive technology, which in turn implies a small inducement to introduce new intermediate inputs. The start-up costs, which make the intermediate inputs producers subject to dynamic increasing returns, and pecuniary externalities that result from the factor substitution in the final goods sector, play essential roles in the model.