Catch-up effect

Catch-up effect

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The idea of convergence in economics (also sometimes known as the catch-up effect) is the hypothesis that poorer economies
Economic system
An economic system is the combination of the various agencies, entities that provide the economic structure that defines the social community. These agencies are joined by lines of trade and exchange along which goods, money etc. are continuously flowing. An example of such a system for a closed...

' per capita income
Per capita income
Per capita income or income per person is a measure of mean income within an economic aggregate, such as a country or city. It is calculated by taking a measure of all sources of income in the aggregate and dividing it by the total population...

s 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
Diminishing returns
In economics, diminishing returns is the decrease in the marginal output of a production process as the amount of a single factor of production is increased, while the amounts of all other factors of production stay constant.The law of diminishing returns In economics, diminishing returns (also...

 (in particular, to capital
Capital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...

) aren't as strong as in capital rich countries. Furthermore, poorer countries can replicate production methods, technologies
Technology
Technology is the making, usage, and knowledge of tools, machines, techniques, crafts, systems or methods of organization in order to solve a problem or perform a specific function. It can also refer to the collection of such tools, machinery, and procedures. The word technology comes ;...

 and institutions currently used in developed countries.

In the economic growth
Economic growth
In economics, economic growth is defined as the increasing capacity of the economy to satisfy the wants of goods and services of the members of society. Economic growth is enabled by increases in productivity, which lowers the inputs for a given amount of output. Lowered costs increase demand...

 literature the term "convergence" can have two meanings however. 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 being held constant. They say that "conditional beta-convergence" exists when the growth rate of an economy declines as it approaches its steady state.

Limitations


The fact that a country is poor does not guarantee that catch-up growth will be achieved. Moses Abramovitz
Moses Abramovitz
Moses Abramovitz was an American economist. He was born in Brooklyn, New York. He studied economics at Harvard University and earned a doctorate at Columbia University. In 1945 and 1946, he was economic adviser to the United States representative on the Allied Reparations Commission...

 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 followed nations have something to learn from the leading nations, and will only cease when the knowledge discrepancy between the leading and follower nations becomes very small and eventually exhausted.

According to professor Jeffrey Sachs
Jeffrey Sachs
Jeffrey David Sachs is an American economist and Director of The Earth Institute at Columbia University. One of the youngest economics professors in the history of Harvard University, Sachs became known for his role as an adviser to Eastern European and developing country governments in the...

, the reason for the convergence not occurring everywhere is that some developing countries have a closed economic policy, and free trade
Free trade
Under a free trade policy, prices emerge from supply and demand, and are the sole determinant of resource allocation. 'Free' trade differs from other forms of trade policy where the allocation of goods and services among trading countries are determined by price strategies that may differ from...

 and openness would solve the problem. In a study of 111 countries in 1970 - 1989, Sachs and Andrew Warner concluded that the industrialized countries had a growth of 2.3 %/year/capita, open economy
Open economy
An open economy is an economy in which there are economic activities between domestic community and outside, e.g. people, including businesses, can trade in goods and services with other people and businesses in the international community, and flow of funds as investment across the border...

 developing countries 4.5 % and closed economy developing countries only 2%.

Robert Lucas stated the «Lucas Paradox
Lucas paradox
In economics, the Lucas paradox or the Lucas puzzle is the observation that capital does not flow from developed countries to developing countries despite the fact that developing countries have lower levels of capital per worker....

» 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.

Examples


There are many examples of countries which have converged with developed countries which validate the catch-up theory. In the 1960s and 1970s the East Asian Tigers
East Asian Tigers
The Four Asian Tigers or Asian Dragons is a term used in reference to the highly developed economies of Hong Kong, Singapore, South Korea and Taiwan. These nations and areas were notable for maintaining exceptionally high growth rates and rapid industrialization between the early 1960s and 1990s...

 rapidly converged with developed economies. These include Singapore
Singapore
Singapore , officially the Republic of Singapore, is a Southeast Asian city-state off the southern tip of the Malay Peninsula, north of the equator. An island country made up of 63 islands, it is separated from Malaysia by the Straits of Johor to its north and from Indonesia's Riau Islands by the...

, Hong Kong
Hong Kong
Hong Kong is one of two Special Administrative Regions of the People's Republic of China , the other being Macau. A city-state situated on China's south coast and enclosed by the Pearl River Delta and South China Sea, it is renowned for its expansive skyline and deep natural harbour...

, South Korea
South Korea
The Republic of Korea , , is a sovereign state in East Asia, located on the southern portion of the Korean Peninsula. It is neighbored by the People's Republic of China to the west, Japan to the east, North Korea to the north, and the East China Sea and Republic of China to the south...

 and Taiwan
Taiwan
Taiwan , also known, especially in the past, as Formosa , is the largest island of the same-named island group of East Asia in the western Pacific Ocean and located off the southeastern coast of mainland China. The island forms over 99% of the current territory of the Republic of China following...

 - all of which are today considered developed countries or cities. In the post-war period (1945–1960) examples include Germany
Germany
Germany , officially the Federal Republic of Germany , is a federal parliamentary republic in Europe. The country consists of 16 states while the capital and largest city is Berlin. Germany covers an area of 357,021 km2 and has a largely temperate seasonal climate...

, France
France
The French Republic , The French Republic , The French Republic , (commonly known as France , is a unitary semi-presidential republic in Western Europe with several overseas territories and islands located on other continents and in the Indian, Pacific, and Atlantic oceans. Metropolitan France...

 and Japan
Japan
Japan is an island nation in East Asia. Located in the Pacific Ocean, it lies to the east of the Sea of Japan, China, North Korea, South Korea and Russia, stretching from the Sea of Okhotsk in the north to the East China Sea and Taiwan in the south...

, which were able to quickly regain their prewar status by replacing capital that was lost during World War II
World War II
World War II, or the Second World War , was a global conflict lasting from 1939 to 1945, involving most of the world's nations—including all of the great powers—eventually forming two opposing military alliances: the Allies and the Axis...

.

Some economists criticise the theory, stating that endogenous
Endogenous
Endogenous substances are those that originate from within an organism, tissue, or cell. Endogenous retroviruses are caused by ancient infections of germ cells in humans, mammals and other vertebrates...

 factors, such as government policy, are much more influential in economic growth than exogenous factors. For example, Alexander Gerschenkron
Alexander Gerschenkron
Alexander Gerschenkron was a Russian-born American Jewish economic historian and professor in Harvard, trained in the Austrian School of economics.Gerschenkron kept to his roots - in his economics, history and as a critic of Russian literature...

 states that governments can substitute for missing prerequisites to trigger catch-up growth. A hypothesis by economic historians Kenneth Sokoloff
Kenneth Sokoloff
Kenneth Lee Sokoloff was an American economic historian who was broadly interested in the interaction between initial factor endowments, institutions, and economic growth...

 and Stanley Engerman
Stanley Engerman
Stanley Lewis Engerman is an economist and economic historian at the University of Rochester. He received his Ph.D. in economics in 1962 from Johns Hopkins University. Engerman is known for his quantitative historical work along with Nobel prize winning economist Robert Fogel...

 suggested that factor endowment
Factor endowment
In economics a country's factor endowment is commonly understood as the amount of land, labor, capital, and entrepreneurship that a country possesses and can exploit for manufacturing. Countries with a large endowment of resources tend to be more prosperous than those with a small endowment, all...

s are a central determinant of structural inequality that impedes institutional development in some countries. Kenneth Sokoloff
Kenneth Sokoloff
Kenneth Lee Sokoloff was an American economic historian who was broadly interested in the interaction between initial factor endowments, institutions, and economic growth...

 and Stanley Engerman
Stanley Engerman
Stanley Lewis Engerman is an economist and economic historian at the University of Rochester. He received his Ph.D. in economics in 1962 from Johns Hopkins University. Engerman is known for his quantitative historical work along with Nobel prize winning economist Robert Fogel...

 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 counties 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.

See also

  • Economics
    Economics
    Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...

  • Investment
    Investment
    Investment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time...

  • Return on investment
    Return on investment
    Return on investment is one way of considering profits in relation to capital invested. Return on assets , return on net assets , return on capital and return on invested capital are similar measures with variations on how “investment” is defined.Marketing not only influences net profits but also...

  • Productivity
    Productivity
    Productivity is a measure of the efficiency of production. Productivity is a ratio of what is produced to what is required to produce it. Usually this ratio is in the form of an average, expressing the total output divided by the total input...

  • Emerging nation
    Emerging nation
    An emerging nation is a country that is on its way to becoming an industrialized nation. An emerging nation is a developing country that has achieved some industrial capacity like Brazil and India....

  • Sow's ear effect
    Sow's ear effect
    The sow's ear effect is a term used in economics to describe when a country is unable to raise its productivity or per capita gross domestic product relative to other countries of similar development despite adjustments in macroeconomic policy, such as the exchange rate or the interest rate. This...

  • Endogenous growth theory
    Endogenous growth theory
    Endogenous growth theory holds that economic growth is primarily the result of endogenous and not external force. In Endogenous growth theory investment in human capital, innovation and knowledge are significant contributors to economic growth. The theory also focus on positive externalities and...