Convergence or Non-Convergence
Convergence hypothesis:
Poorer countries will grow at faster rates than rich countries and the gap
between Poor and Rich country standards of living will close.
- Simulation model by Lucas (2000) in "Overheads Set 2":
- Assumed that the convergence hypothesis was correct.
- He made the probability that a country will enjoy sustained growth
rise with World income.
- Countries that launched into sustained growth grow grew faster than
countries that were already growing.
- Key questions addressed in this section:
- Why might convergence occur? What processes might give convergence?
- What might stand in the way of convergence?
- What does the statistical evidence say? is convergence happening?
Why Might Convergence Occur?
- Solow growth model:
Convergence in steady state GDP per worker (Y/L) will occur if:
- Poor country savings rates rise relative to Rich country savings rates.
- Poor country labour force growth falls relative to that of Rich countries.
- Poor country technology and institutions (form of the aggregate production
function) become more like those of Rich countries.
- Long-run convergence if the variables determining the steady state converge
- If the same steady state: Y/L differences are transitional and
disappear over time.
Open, Economies, Globalization and Convergence
- The original Solow growth model is a closed economy model.
- Closed economy? no economic interaction with other countries.
- Could interactions between the Poor countries and the rest of the world give
convergence?
- Interactions of interest?
- flow of financial capital: foreign savings
- migration of labour
- transfer of technology
- trade in goods and services (indirect K, L mobility; some role in
technology transfer)
- Possible result?
“Globalization” may promote convergence.
- Historically: two major globalizations
(1) Mid-19th century to 1914: growth in trade, capital flows, international
migration.
e.g. Canada: 37% of investment foreign financed; higher share in Argentina; also high in Australia.
Mass migration: Europe to N. America, Argentina, Australia.
Trade: grows 3.8% per year 1850-1913.
(World War I and the Great Depression end and reverse this
globalization)
(2) Current era: growing importance of trade and factor flows.
- Trade: Weil Fig. 11.1 “World Exports as a % of World GDP”
- substantial growth since 1950 (6.2% per year 1950--2007).
- changes in who the major traders are (rise of E. Asia).
- Capital flows: significant
e.g. Foreign Direct Investment
1982: 5.2% of World GDP
2006 25.3% of World GDP
- but some questions about their direction!
( e.g. China to US in recent yrs.)
- Migration: flows increase late 1980s and early 1990s and remain
relatively high. (see WTO World Trade Report 2008)
- What drives globalization?
- Price differences and the “law of one price”.
- Flows of goods, services and inputs respond to price differences
between countries.
- Trade in goods and services: import goods if cheaper
Export goods if price abroad is high.
- Factor flows: factor owners transfer inputs from countries
where prices are low to those were prices are
high.
- Trade and factor flows tend to reduce price differences between
countries (Supply & Demand!)
- Other important considerations:
- Transport costs: price differences must be sufficient to cover
transport costs.
- falling transportation costs spur globalization.
e.g. pre-1914 globalization and steamships; containerization since the 1950s; air travel.
- Communication costs and transmission of information:
- Affects knowledge of foreign opportunities;
- Affects costs of dealing with those abroad.
- Pre-1914 globalization aided by telegraph; more recent
globalization and new information technologies.
- Trade Policy and Regulation: often limits trade and factor mobility.
- Trade protection e.g. tariffs on imports or import quotas
limit trade.
- Government policy can also affect factor mobility
- immigration policy affects labour mobility between
countries: a big barrier in practice!
- tax policy, rules governing foreign investment can
affect capital mobility.
- Global political factors:
- trade and flows of finance require stability.
- Geography can also affect openness to the world economy.
- can work via transport and communication costs.
e.g. landlocked or isolated countries.
- Culture and long-term history: Spolaore and Wacziarg (2013)
- can they limit cross-border interactions?
- Effect of Economic “Openness”:
- Weil Fig. 11.2: suggests that openness is associated with higher GDP per
capita.
- High growth countries in recent years: China, East Asian “tigers” (HK,
Singapore, Taiwan and S. Korea)
- producing for export an important part of the story.
- Late 19th early 20th century growth in Canada, US, Australia: factor mobility
important (migration from Europe, foreign investment in K).
- Weil Figures 11.3 and 11.4: suggests that “open” countries show evidence
of catch-up or convergence
i.e. low initial GDP per capita leads to fast growth.
- Regression approaches: some weak support for this result (see end of this
set of notes on regression studies of convergence)
- Billmeier and Nannicini Review of Economics and Statistics 2013:
- effect of liberalization on GDP 5 years and 10 years after
liberalization.
- compares country that liberalizes to experience of a "control" group
from the same region in the same time period.
- suggests: opening up (liberalizing) raised GDP growth (handouts).
(but some exception especially in Africa)
Opposition to Globalization: Some Reasons for Opposition
- Distributional effects:
- Trade: some industries shrink as a result of trade (lower profits, wages,
fewer jobs in these industries)
- Heckscher-Ohlin results: owners of scarce inputs lose due to trade with
countries where that same input is abundant.
e.g. low skill workers in Rich countries may lose from trade with
poor countries (where low-skill labour is abundant)
- Labour and capital mobility will reduce input prices in the countries
labour and capital moves to (so input owners lose in these countries).
- Concerns about instability of (financial) capital flows.
- can outflows lead to crises? e.g. East Asian in 1997-98, past Latin
American crises.
- ‘Standard model’ (Allen) and start-up industries: do they need protection?
- Brain drain concerns: could selective migration damage development prospects
of Poor countries?
- Environmental concerns: does production shift to where laws are weaker?
- Exploitation and market power concerns: are poor country producers and buyers
likely to be exploited by large Rich country corporations?
How Might Globalization and Openness Affect Living Standards?
- Production function framework suggests via:
- Accumulation
- Openness has effects on inputs per unit of labour.
- Productivity
- Openness affects total factor productivity (TFP)
e.g. technology transfer ; efficiency effects of international
competition; producing for export as a new, possibly
higher value use of inputs.
The Model of Resource Allocation and Convergence
- Convergence in savings and labour force growth rates may occur if factors of
production are mobile between countries.
- The microeconomic model of resource allocation predicts this result.
- diminishing returns: a key underlying assumption.
International Labour mobility:
- Migration from poor countries to rich countries.
- Sizable for some countries and in some time periods.
- Demand to move appears to be there! (but major barriers)
Migration in the Factor (Input) Allocation Model:
- Say have a fixed amount of labour of any given skill level: L*
- total amount of labour in Rich and Poor countries combined.
- Two uses of labour with a given skill level:
- Work in a Rich country
- Work in a Poor country
- Diminishing returns: value of marginal product (VMP) curves slope
downward in both sets of countries.
(note: higher K/L, more advanced technology may make VMP higher at any
given L in rich countries than in poor countries)
- In the model: Wages = Value of Marginal Product
- competitive labour markets: this will hold.
- Wages are higher in Rich countries than in Poor countries for similar workers.
- Workers will want to migrate from Poor to Rich countries.
- Migration will lower Rich country wages and raise wages in Poor Countries
- The value of world output and income rises as a result of migration.
(labour transferred from low to high VMP countries)
- International migration and the Solow model steady state:
- Emigration from Poor countries lowers Poor country labour force growth.
- new Poor country steady state: higher K/L, higher Y/L !
(given: investment rate and technology)
- Immigration to Rich countries raises Rich country labour force growth.
- new Rich country steady state: lower K/L, lower Y/L.
(given: investment rate and technology)
- This will help close the standard of living gap.
- How important a factor is migration?
- Historical importance?
Taylor and Williamson (1997)”Convergence in the Age of Mass
Migration” European Review of Economic History.
- Substantial migration between Europe and the “new world”: 1870-
1910.
- Simulates effects on real wages, GDP per capita and GDP per
worker: reduced inter-country dispersion (convergence!).
- Potential importance?
- Rodrik (2001) “Immigration Policy and the Welfare State” (website)
- Potentially a bigger factor than trade liberalization and K flows.
- Why? “Price” difference is especially large between Rich and Poor
country wages (more so than differences in goods prices
or rates of return on capital).
- Hamilton and Whalley (1984) Journal of Development Economics study:
allowing completely free labour flows could double world income.
(simulation model)
- Walmsley and Winters (2002): (see website)
- Simulate effects of allowing additional immigration equal to 3% of
Rich country workforces:
- raises World GDP by $150 billion US (0.6%);
- this is 50% larger than estimated effects of world free trade.
- Importance of migration in practice?
- International migration is heavily controlled.
(but a big factor for some countries: handout)
- Significant Rich country resistance:
- Model: depresses Rich country wages.
e.g. Aydemir and Borjas (2007) evidence for US, Canada and
Mexico: 10% rise in supply gives 3%-4% fall in wages.
(if depressed economy: possibly job loss for domestic workers)
- Non-economic reasons for opposition.
- Seems unlikely to change soon:
pessimism about migration as a major world-wide factor promoting
convergence between countries.
- Recent policy developments:
- current globalization: rose late 1980s, earl 1990s (stayed high)
- measures allowing temporary migration from Poor to Rich countries.
e.g. US and temporary permits for Latin American immigrants.
Similar discussions in Europe.
- Migration may prove important in specific cases:
- Mobility within the Euro-zone now.
- Korea: if unification should occur in the future?
- Importance of migration within countries:
- migration between regions within a country can create regional
convergence.
- a current issue in China: coastal regions vs. in-land.
- Germany: East to West after unification.
- greater internal mobility as a possible source of growth.
e.g. Lewis model
- Additional effects of migration on Poor countries:
- Remittances as a major benefit of migration to source countries.
World Bank:
- total $ value of remittances largest China, India,
Philippines, Mexico, Nigeria.
- Tajikistan remittances 48% of GDP !
Kyrgyz Republic 31% of GDP
Lesotho and Nepal 25% of GDP
- “Brain drains” could harm Poor country growth prospects.
- who migrates? Who is allowed to migrate?
- Selective immigration policies in Rich countries.
- Could this work against convergence?
- Migration flows: can it transfer skills and technology as well?
International Capital Mobility and Resource Allocation
- Two uses for capital: Rich or Poor Country
- Physical capital is relatively abundant in Rich countries.
- Capital shortage in poor countries: potentially many high return opportunities.
- Abundant, cheap labour for capital to work with in Poor Countries.
- So assume diminishing returns:
VMP of capital low in Rich, high in Poor countries.
- So the return to investment in physical capital higher in Poor countries.
i.e. the rental price (r) that K owners receive for K will be higher in Poor
countries.
- Rich country K owners have incentives to invest in plant and
equipment in Poor rather than Rich countries.
i.e., foreign direct investment, joint ventures etc.
- Poor country projects can afford to pay foreign savers a higher rate of
interest for finance.
- Poor countries should be able to attract savings from Rich
countries.
(Portfolio investment: in financial assets)
- Result?
- financial capital (foreign investment and foreign saving) flows into
Poor countries from Rich countries.
- with complete mobility K flows continue until the rental rate
and VMP of K is the same across countries.
- This pushes up the effective savings and investment rate ("s" in Solow)
in Poor countries.
- Solow model: this will help produce convergence (in K/L and Y/L).
- Capital inflows as foreign direct investment also advance technology.
- Policy?
-This argument suggests that Poor countries should encourage capital inflows.
e.g. avoid restrictions on foreign ownership or borrowing from
foreigners.
How Important is K Mobility?
- Historical record: some cases where it was important for growth
- 19th century, early 20th century: international capital flows fuelled growth in
US, Canada, Australia, N.Z., South Africa, Argentina etc.
- high returns from combining capital with abundant natural
resources.
- are there similar high returns now to combining K with abundant
LDC labour?
- how about K with resources? (Collier: Africa underutilized
natural resources)
- More recently? Singapore and foreign direct investment (FDI).
- Low investment returns in Rich countries in recent years: has it encouraged
flows to poorer countries?
- Feldstein and Horioka exercise:
- Looks at correlation between domestic savings and domestic investment.
- completely closed economy: correlation perfect (+1) !
- capital completely mobile: no relationship between domestic savings
and domestic investment.
(correlation = 0)
- What does the data say?
- Correlation very high 1960s to 1990s (Weil: +.89)
- inconsistent with much K mobility!