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.

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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.