Thursday, April 17, 2014
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Catching Up at Different Speeds

PARIS – With weak demand in advanced countries now impeding growth in emerging economies, including major players in Asia and Latin America, many are arguing that the era of income convergence has come to an end. Nothing could be further from the truth.

As I have argued before, convergence of emerging countries’ real average incomes, in the aggregate, with advanced countries’ incomes is likely to continue into the 2020’s. That process started in the late 1980’s, and continued unabated, except in the years around the Asian financial crisis in 1997-1998. The pace of convergence accelerated further during, and just after, the global financial crisis of 2008-2009: the aggregate average differential in per capita income growth increased to more than four percentage points in the 2008-2012 period, from a little more than two percentage points in the two decades before. As the advanced economies recover, however weakly, the growth differential is likely to narrow again, perhaps to about two percentage points, which still implies steady convergence at a decent pace.

In that sense, it is not “the end of the party” for emerging markets, as some claimed early last summer, when US Federal Reserve Chairman Ben Bernanke’s suggestion of a possible “taper” of the Fed’s policy of quantitative easing triggered a “mini-crisis” in several of the more vulnerable emerging markets. These economies have since recovered a significant part of the lost ground in terms of exchange rates and asset prices.

A major part of the economic-convergence process that has been taking place since the late 1980’s has been due to “catch-up” growth. The emerging markets developed the institutions and the skills base needed to import and adapt technology, which is easier than generating new technology from scratch. The pace of catch-up growth declines only gradually over time, as the less advanced economies slowly move closer to the technological frontier.

The catch-up process also takes place within countries, as labor moves from low-productivity rural activities to higher-productivity urban activities, and as low-productivity firms in all sectors emulate their more advanced domestic counterparts. Moreover, the transfer and diffusion of technology has been facilitated greatly over the last few decades by increased foreign direct investment, the information revolution, which has facilitated access to knowledge, increased trade, and the globalization of financial markets.

These factors apply to emerging countries generally. Why, then, do Latin American economists seem to share a cautious – even pessimistic – mood about future growth and convergence in the region, whereas most Asian economists, while conceding that further structural reforms are needed, believe strongly that Asia will continue to converge rather rapidly?

Beyond global factors that apply to all, rapid catch-up growth requires sufficient investment in both physical and human capital. New manufacturing techniques and new products or product improvements are usually embodied in new machines and skills. China has invested about 43% of its GDP, on average, during the 2000-2013 period. Emerging Asia, excluding China but including India, has invested about 28% of GDP over the same period, while the investment share for Latin America has been just 21%. That alone probably explains much of the difference among China, in a category of its own, emerging Asia, and Latin America. The quality of skills and education cannot be measured as easily by a single figure, but there is ample evidence that Latin America has also lagged behind most of Asia when it comes to skills accumulation.

Many other factors, of course, influence growth and convergence: macroeconomic stability, the efficiency and robustness of the financial sector, the terms of trade, the quality of public administration, demographic factors, and political factors. There also is variation within regions, including among provinces of China. (Likewise, Africa’s growth performance has improved spectacularly since the turn of the century, but variance within the continent is even larger than elsewhere.) Nonetheless, in terms of the likely strength of the convergence process that globalization has facilitated, it is important to distinguish between Latin America and Asia, and, within Asia, to distinguish China from the rest of the continent.

China’s economy will most likely continue to converge rapidly, though its annual growth rate may fall from 9% to 7%. The rest of emerging Asia will also converge reasonably quickly, though not as quickly as China. Latin America, however, will likely converge only very slowly in the absence of major structural reforms that increase its ability to invest and improve the quality of education.

There will surely be exceptions to this general trend, but there are some stable regional characteristics. Overall, however, basic economics, which has always stressed the need to save and invest in order to grow, still explains a lot. Latin America and Asia operate in the same global economy, with access to similar technology and markets. If Latin America invests around 20% of its national income in a sustained manner, while emerging Asia invests close to 30% – including investments in education – emerging Asia will converge significantly more rapidly.

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  1. CommentedPaul A. Myers

    Superb analysis that sets forth and stresses the importance of fundamentals. There are two different tracks to future convergence: a 20 percent track and a 30 percent track. As long as the overall effectiveness of the investment paths are similar, emerging countries will move forward relative to advanced economies.
    What about advanced economies? Many of them, particularly in Europe, are having a hard time generating sufficient investment just to reach their current "potentials." They have taken their collective eyes off the goal of effective public and social investment as the diddle about how to sustain public consumption.

  2. CommentedMr Econotarian

    Investment happens when business people feel safe about putting their money into a business that will produce profit. Most of Latin America has too much labor regulation (thus the high amount of illegal informal labor). And it has too little private property registration and rights, as well as courts that are slow and corrupt when adjudicating disputes.

    Chile is a significant exception, ranked by Heritage as the 7th most free economy in the world, and now has the highest nominal GDP per capita in Latin America. Hopefully Bachelet won't ruin it.

  3. CommentedKeshav Prasad Bhattarai

    I think globalization is a process of convergence of economies- but with divergent of income level. It has not only relieved millions of people out of poverty in the last 30 years but is expected more than one and half billion people reach at a level of middle income in within next decade. It means more convergence in years to come, and but how to make it smooth and inclusive is a challenge and scholars like Kemil Dervis is expected to write on this in Project Syndicate.

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