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Catching Up at Different Speeds

By -Kemal Derviş-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.

Kemal Derviş, former Minister of Economic Affairs of Turkey and former
Administrator for the United Nations Development Program (UNDP), is Vice
President of the Brookings Institution.

source : Project Syndicate, 2013

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