Convergence (economics)income
The idea of convergence in economics (also sometimes known as the
catch-up effect) is the hypothesis that poorer economies' per capita
incomes will tend to grow at faster rates than richer economies. As a
result, all economies should eventually converge in terms of per capita
income. Developing countries have the potential to grow at a faster
rate than developed countries because diminishing returns (in
particular, to capital) are not as strong as in capital-rich countries.
Furthermore, poorer countries can replicate the production methods,
technologies, and institutions of developed countries.
In economic growth literature the term "convergence" can have two
meanings. The first kind (sometimes called "sigma-convergence") refers
to a reduction in the dispersion of levels of income across economies.
"Beta-convergence" on the other hand, occurs when poor economies
grow faster than rich ones. Economists say that there is "conditional
beta-convergence" when economies experience "beta-convergence"
but conditional on other variables (namely the investment rate and the
population growth rate) being held constant. They say that
"unconditional beta-convergence" or "absolute beta-convergence"
exists when the growth rate of an economy declines as it approaches its
steady state. According to Jack Goldstone, "in the twentieth century,
the Great Divergence peaked before the First World War and continued
until the early 1970s, then, after two decades of indeterminate
fluctuations, in the late 1980s it was replaced by the Great Convergence
as the majority of Third World countries reached economic growth
rates significantly higher than those in most First World countries",[1]
thus the present-day convergence should be regarded as a continuation
of the Great Divergence.
Limitations
The fact that a country is poor does not guarantee that catch-up growth
will be achieved. Moses Abramovitz emphasised the need for 'Social
Capabilities' to benefit from catch-up growth. These include an ability
to absorb new technology, attract capital and participate in global
markets. According to Abramovitz, these prerequisites must be in place
in an economy before catch-up growth can occur, and explain why
there is still divergence in the world today.
The theory also assumes that technology is freely traded and available
to developing countries that are attempting to catch-up. Capital that is
expensive or unavailable to these economies can also prevent catch-up
growth from occurring, especially given that capital is scarce in these
countries. This often traps countries in a low-efficiency cycle whereby
the most efficient technology is too expensive to be acquired. The
differences in productivity techniques is what separates the leading
developed nations from the following developed nations, but by a
margin narrow enough to give the following nations an opportunity to
catch-up. This process of catch-up continues as long as the following
nations have something to learn from the leading nations, and will only
cease when the knowledge discrepancy between the leading and
following nations becomes very small and eventually exhausted.
According to Professor Jeffrey Sachs, convergence is not occurring
everywhere because of the closed economic policy of some developing
countries, which could be solved through free trade and openness. In a
study of 111 countries between 1970 and 1989, Sachs and Andrew
Warner concluded that the industrialized countries had a growth of
2.3%/year/capita, open economy developing countries 4.5% and closed
economy developing countries only 2%.[2]
Robert Lucas stated the "Lucas Paradox" which is the observation that
capital is not flowing from developed countries to developing countries
despite the fact that developing countries have lower levels of capital
per worker.[3] This statement, however, has received recently serious
objections.[4]
Examples
There are many examples of countries which have converged with
developed countries which validate the catch-up theory.[5] Based on
case studies on Japan, Mexico and other countries, Nakaoka studied
social capabilities for industrialization and clarified features of human
and social attitudes in the catching up process of Japan in Meiji era
(1868-1912).[6][7][8][9][10] In the 1960s and 1970s the East Asian
Tigers rapidly converged with developed economies. These include
Singapore, Hong Kong, South Korea and Taiwan - all of which are today
considered developed economies. In the post-war period (1945–1960)
examples include West Germany, France and Japan, which were able to
quickly regain their prewar status by replacing capital that was lost
during World War II.
Some economists criticise the theory, stating that endogenous factors,
such as government policy, are much more influential in economic
growth than exogenous factors. For example, Alexander Gerschenkron
states that governments can substitute for missing prerequisites to
trigger catch-up growth. A hypothesis by economic historians Kenneth
Sokoloff and Stanley Engerman suggested that factor endowments are
a central determinant of structural inequality that impedes institutional
development in some countries. Sokoloff and Engerman proposed that
in the 19th century, countries such as Brazil and Cuba with rich factor
endowments such as soil and climate are predisposed to a guarded
franchise with limited institutional growth. Land that is suitable for
sugar and coffee such as Cuba experienced economies of scale from the
establishment of plantation that in turn created the small elite families
with vested interest in guarded franchise. The exogenous suitability of
land for wheat versus sugar determines the growth rate for many
countries. Therefore, countries with land that is suitable for sugar
converge with other countries that also have land that is suitable for
growing sugar.
Sokoloff and Engerman explained this convergence in their article
"History Lessons: Institutions, Factor Endowments, and Paths of
Development in the New World." They explained that the United States
and Canada started out as two of the poorest colonies in the New
World but grew faster than other countries as a result of their soil
qualities. They argued that the United States and Canada had land
suitable for growing wheat which meant that they had small scale
farming, since wheat does not benefit from economies of scale, and
this led to a relatively equal distribution of wealth and political power
enabling the population to vote for broad public education. This
differentiated them from countries such as Cuba that had land suitable
for growing sugar and coffee. Such countries did benefit from
economies of scale and so had large plantation agriculture with slave
labor, large income and class inequalities, and limited voting rights. This
difference in political power led to little spending on the establishment
of institutions such as public schools and slowed down their progress.
As a result, countries with relative equality and access to public
education grew faster and were able to converge on countries with
inequality and limited education.[11]
Types of Convergence
- Absolute Convergence: Lower initial GDP will lead to a higher average
growth rate. The implication of this is that poverty will ultimately
disappear 'by itself'. It does not explain why some nations have had
zero growth for many decades (e.g. in Sub-Saharan Africa)
- Conditional Convergence: A country's income per worker converges to
a country-specific long-run level as determined by the structural
characteristics of that country. The implication is that structural
characteristics, and not initial national income, determine the long-run
level of GDP per worker. Thus, foreign aid should focus on structure
(infrastructure, education, financial system etc.) and there is no need
for an income transfer from richer to poorer nations.
- Club Convergence: It is possible to observe different "clubs" or groups
of countries with similar growth trajectories. Most importantly, several
countries with low national income also have low growth rates. Thus,
this is in contrast to the theory of conditional convergence, and would
suggest that foreign aid should also include income transfers and that
initial income does in fact matter for economic growth.