Saturday, November 22, 2014

A World of Convergence

WASHINGTON, DC – For almost two centuries, starting around 1800, the history of the global economy was broadly one of divergence in average incomes. In relative terms, rich countries got even richer. There was growth in the poorer countries, too, but it was slower than rich-country growth, and the discrepancy in prosperity between rich and poor countries increased.

This “divergence” was very pronounced in colonial times. It slowed after the 1940’s, but it was only around 1990 that an entirely new trend could be observed – convergence between average incomes in the group of rich countries and the rest of the world. From 1990 to 2010, average per capita income in the emerging and developing countries grew almost three times as fast as average income in Europe, North America, and Japan, compared to lower or, at most, equal growth rates for almost two centuries.

This has been a revolutionary change, but will this 20-year-old trend continue? Will convergence remain rapid, or will it be a passing phase in world economic history?

Long-term projections based on short-term trends have often been mistaken. In the late 1950’s, after the Soviet Union launched the first spacecraft, eminent Western economists predicted that Soviet income would overtake that of the United States in a few decades. After all, the Soviet Union was investing close to 40% of its GDP, twice the ratio in the West.

Later, in the 1980’s, Japan’s spectacular growth led some to predict that it would overtake the US, not only in per capita terms, but even in terms of some measures of “economic power.”

These kinds of projections have often been based on simple extrapolations of exponential trends. Over two or three decades, substantial differences in compound growth rates quickly generate huge changes in economic size or per capita income.

Will the recent predictions of rapid ongoing global convergence similarly turn out to be wrong, or will most of the emerging countries sustain a large positive growth differential and get much closer to the advanced economies’ income levels?

Understanding the phenomenon of “catch-up” growth is key to answering this question. Trade and foreign direct investment have made it much easier for emerging countries to absorb and adapt best-practice technology invented in the advanced economies. The information revolution, allowing much easier access to and diffusion of knowledge, has accelerated the process.

Once they developed the basic institutions needed for a market economy and learned how to avoid serious macroeconomic policy mistakes, emerging countries started benefiting from catch-up growth. Those with very high investment rates, mostly in East Asia, grew faster than those with lower investment rates; but, overall, catch-up growth probably has been adding 2-4 percentage points to many emerging and developing countries’ annual growth rates. At the same time, population growth decreased, adding at least another point to the pace of per capita growth.

This process will likely continue for another decade or two, depending on where in the process particular countries are. It is true that catch-up growth is easier in manufacturing than in other sectors, a point recently emphasized by Dani Rodrik of Harvard University, and it may be that a good portion of it has been exhausted in manufacturing by the best-performing firms in emerging countries.

But there is still a lot of “internal” room for catch-up growth, as less efficient domestic firms become more competitive with more efficient ones. The dispersion of “total factor productivity” – the joint productivity of capital and labor – inside emerging countries has been found to be large. Moreover, sectors such as agriculture, energy, transport, and trade also have catch-up-growth potential, through imports of technology, institutional know-how, and organizational models.

Of course, temporary disturbances, a worsening of global payments imbalances, or macroeconomic policy mistakes, including those made in advanced economies and affecting the entire world economy, could undermine global growth. But the underlying “convergence differential,” owing to catch-up growth, is likely to continue to reduce the income gap between the old advanced economies and emerging-market countries.

The Soviet Union never was able to build the institutions to allow for catch-up economic growth. Japan slowed down after it had basically caught up. China, India, Brazil, Turkey, and others may have firms operating close to the world’s technological frontier, but they still have a lot of unused catch-up potential.

The more that these countries can invest while ensuring macroeconomic stability and balance-of-payments sustainability, the faster they can adopt better technology and production processes. In that case, they can continue to catch up, at least for the next decade or more. The convergence process is going to slow, but not yet.

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    1. CommentedZsolt Hermann

      The problem is that we are trying to identify laws, patterns, regularities in our present human system, but such laws, patterns can only be predicted in natural systems, which are truly working according to independent, unbending natural laws.
      But our human system does not work this way.
      First of all our present "free market, constant growth, expansive" economic model is vastly artificial, way above necessities and resources, over 90% producing unnecessary and harmful products, that are only consumed due to an artificial, sophisticated mass hypnosis marketing machinery.
      Additionally the access to possibilities, resources, markets is not natural either, those who got to the "treasures" first set up a system that keeps the access limited to them or to whoever they allow getting close, so "catching up" is not happening naturally but only according to the open channels, which channels are open by the interest of a minority.
      What we have arrived to today is the breakdown of this whole system, since its whole foundation is false, bubbles, built on bubbles.
      And since humanity is just a compartment within a vast natural system around us, that truly works based on strict, natural laws and patterns, now as we, in our fabricated system reached a critical saturation, a tipping point in our false system, it cannot progress, expand any longer, but it started self destructing.
      Our only way out of this mess is forgetting about our false human system, and base the building of a new system on the natural laws surrounding us.
      We have to get back to the drawing board, fortunately we already have enough information from multiple sources about the laws of integral systems so we are not completely blind in the dark, we just need to use the information wisely in a transparent manner.