Melitz meets Lewis: The impacts of roads on structural transformation and businesses

This paper examines the impact of roads on structural transformation and business composition both empirically and theoretically. Empirically, we find that major highway programs in India and China led to declines in the number of businesses where structural transformation is weak, and increases where it is strong. We develop a two-sector model of regional trade with endogenous firm entry that highlights two opposing forces. Ceteris paribus, lower trade costs in non-agriculture lead to fewer firms, but cheaper agricultural imports release labor from local agricultural production, leading to more firms. We show that the model-simulated outcomes reasonably replicate the empirical results, and that more rapid agricultural productivity growth in China differentiates the two countries.