This paper studies the role of public policy in promoting
industrial transformation from an imitationbased,
low-skill economy to an innovation-based, high-skill
economy, where technological progress now occurs
through the domestic invention of ideas. Industrial
transformation is measured by changes in an index of
industrial structure, defined as the ratio of the variety
of imitation- to innovation-based intermediate goods.
A key mechanism through which productivity increases
initially in both the imitation and innovation sectors
is through a knowledge externality associated with learning by doing in the imitation sector. The process
of industrialization increases the demand for high-skill
labor, inducing individuals to invest in education. The
model also emphasizes the distinction between basic
or core infrastructure, which promotes imitation, and
advanced infrastructure, which promotes innovation. A
calibrated version for a low-income country is used to
perform several policy experiments, including an increase
in investment in infrastructure, a reduction in the cost of
training, and improved enforcement of property rights.