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Photo: Pradeep Gaur/Mint
Photo: Pradeep Gaur/Mint

Opinion | The convergence of rich nations with the rest has gone off track

Sound policies are needed to put emerging economies back on a higher growth path and ameliorate regional inequalities

The theory of convergence is one of the most powerful and noblest ideas in economics: The concept that, other things being equal, poorer economies should catch up with richer ones so that inequality between the rich and the poor attenuates, and conceivably even disappears over time. The promise is of a world, at some point in the future, wherein inequality among nations has disappeared—not due to socialist diktat, but due to the forces of free-market capitalism.

The premise driving convergence is that capital (whether physical or human) is more productive in poor economies than rich ones due to what economists call “diminishing marginal productivity". In layman’s terms, a small amount of investment yields a greater increase in output where there is less capital than where there is more; or, even more simply, the rate of return on investment is inversely related to the level of economic development.

The great economist Paul Samuelson used the analogy of a series of trains running on parallel tracks, all of which start off at different points. A train that starts off behind another one will, necessarily, have to move faster if it is to overtake the train with a head start. If it moves slower, it will perpetually fall behind; and if it manages to grow at the same pace, it will maintain the same relative disadvantage over the faster train.

The experience of advanced economies gave economists reason to be optimistic that convergence occurs according to script. Thus, the devastated economies of Europe, along with Japan, quickly caught up with the advanced economies that had not been ravaged by World War II, most notably, the US. At the end of the war, with their capital stocks destroyed, Germany and Japan were much poorer than the US; by the 1960s, they had closed the gap.

At one time, it appeared that the same play was at work between emerging economies and advanced economies. In the heyday of globalization, before the great financial crisis, economies such as China and India, as well as others, were far outstripping the growth rates of the US and other rich economies, giving hope that at least the more rapidly growing of the emerging economies would close the gap with the rich world within decades rather than centuries.

What is more, in addition to the classical mechanism of diminishing marginal productivity, there was presumed to be an additional powerful force working toward convergence: Poorer economies are, almost by definition, far away from the technological frontier at which the richest economies operate. There is thus ample room to absorb newer technologies at relatively low cost and in a relatively short span of time, without encountering slowing growth like the rich economies, which are at or near the frontier. In simpler terms, it is difficult and costly to innovate the latest Apple iPhone, but relatively easy for a maker in China to cheaply produce a knock-off that reverse engineers at least some of Apple’s technology at lower cost and delivers a cheaper and more productive smartphone to the Chinese or Indian consumer.

Unfortunately, after the first flush of enthusiasm for the idea, recent evidence suggests that convergence is faltering, and this is bad news for the prospects of poor economies catching up with rich economies anytime this century. A recent World Bank report documents a worrying slowdown in productivity growth in emerging economies, significantly retarding convergence. The report’s calculations suggest that emerging economies have 14% lower productivity than they would have had if previous trends of high productivity growth were maintained; for commodity exporters, this is a whopping 19%.

The only silver lining is that, according to the World Bank, the main driver of falling productivity in emerging economies is not flagging adoption of new technology, but the much more familiar—and more classical—culprit of insufficient investment in physical and human capital, and insufficient mobility of machines and workers from less productive to more productive sectors of the economy.

The Indian case clearly bears this out, with languishing investment and unfinished productivity-enhancing reforms, especially in the country’s labour market, being the key culprits behind the sharp slowdown in growth.

While there is no mystery, there is also, alas, no magic bullet. Governments, including India’s, need to do the heavy lifting of repairing damaged financial systems overladen with bad debt, restore fiscal rectitude, ensure that monetary policy remains focused on stable inflation rather than being excessively loose as a risky substitute for structural reforms, and press ahead with unfinished reforms to capital, land and labour markets.

There is a further critical dimension in the case of large multi-region economies such as India. Not only has convergence been faltering between nations, it has been faltering between the richer and poorer regions of large nations such as India, as research by Praveen Chakravarty and I published in these pages and elsewhere has clearly documented.

The challenges are daunting. However, the data does not present an epistle of despair, but of hope. The pursuit of sensible and conventional sound economic policies ought to put emerging economies as a group back on a higher growth trajectory, while suitable “place-based" policies must work to ameliorate regional inequalities within large economies such as India. Convergence may yet end up being a parable of promise rather than a fable of folly.

Vivek Dehejia is a Mint columnist.

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