by Chakravarthi Raghavan

Geneva, 2 May 2000 -- The process of "catch up" of economies "is certainly not an automatic process to be triggered by market liberalization, and the relative advantages of backwardness... as a stimulus to productive growth may be very elusive," according to the UN Economic Commission for Europe.

According to the ECE, after an initial period of catching up with the United States, western Europe has not only failed to make progress in closing the real income-gap with the US after 1973, but the gap has widened slightly since 1990.

And as for the transition economies of eastern Europe, there is not only no evidence of any catching up with western Europe, but in fact evidence of increasing divergence between them and the 15-member European Union during the 1990s.

In the UN regional body's "Economic Survey of Europe: 2000 No.1", the ECE economists say that available empirical evidence does not support the "universal convergence" hypothesis behind the policy advice of mainstream neo-classical economists to developing countries and transition economies that "the best way to ensure convergence of per capita incomes and steady economic growth over the long term is to allow market forces to operate as freely as possible." In a chapter in the report, "Catching Up and Falling Behind: Economic Convergence in Europe", the ECE economists note that after an initial period of catching up with the United States, per capita GDP in western Europe is about 30 percent behind.

Most studies projecting long-term growth trends of the transition economies of eastern Europe suggest that their process of convergence with the EU-15 is likely to be long and difficult and, even under more optimistic growth scenarios, the catch-up process could take decades even for the more advanced of the transition economies.

The issue of convergence or divergence is important from an economic policy point of view, notes the ECE.

Spontaneous convergence would point to existence of market forces that will eventually lead to similar living standards across countries. But persistently large widening gap between poor and rich economies would show the "need for economic policy measures, domestic and international, to stimulate a catch-up process."

The issue of convergence, the ECE notes, is important from the perspective of the transition economies, one of whose strategic policy goals is to achieve sustained and high economic growth rates to enable them to catch up with the living standards of the developed market economies of western Europe.

It is also relevant, says the ECE, in the context of west European integration, and the EU treaty mandate for promoting "high degree of convergence of economic performance... raising the standard of living and quality of life and economic and social cohesion and solidarity among member-states.... reducing disparities between levels of development of various regions and backwardness of least favoured regions, including rural areas..."

But the ECE analysis and data has also important implications for developing countries and transition economies in the on-going debates over 'globalization' and market liberalization policy advices from the IMF and World Bank, as well as the drive for trade liberalization and dismantling of barriers to trade and investments through a new multilateral round of trade negotiations at the World Trade Organization.

The dominant orthodox economic policy of the last 20 years or so has been influenced by the analysis of economic growth, based on the Solow neo-classical economic model.

In this model, the level of output is determined by labour force and fixed capital formation interacting within the framework of a given technology available to all and determined outside the economic system. And since fixed capital is subject to declining marginal productivity, each unique economy will converge on a unique long-run stable growth path -- the 'steady state', determined by growth of labour force and technical progress.

In the short-run growth rates above the 'steady state' can be achieved by more efficient use of capital and labour at a given level of technology. But after this 'catching up' with optimal level of output, growth in incomes per head will slow down to the rate of technical progress.

Since poorer countries are generally considered to have capital-labour ratios below their optimum and thus backward in adopting available technology, their rate of return on fixed investment should be higher than in richer countries. Hence, there should be a systematic tendency for poorer countries to grow faster than rich until they have 'caught up' with levels of per capita incomes in the rich.

Based on this convergence hypothesis, the policy advice to transition and developing economies from mainstream neo-classical school of economics is that the best way for convergence of per capita incomes and stead economic growth is to allow market forces to operate as freely as possible.

The presumption that poorer countries will on average grow faster than the rich is called by economists absolute or beta convergence. The tendency for the dispersion of per capita incomes across countries to fall over time is called sigma convergence - the latter depending not only on the differential rates of growth between poor and rich countries, but also size of initial income gaps.

Available empirical evidence, the ECE says, does not support the hypothesis of a systematic tendency for poor countries to grow faster than the richer ones.

Rather, a dominant feature has been for diverging productivity levels and real per capita incomes between the highly advanced industrial economies and the developing countries.

The lack of divergence is seen (and explained away) by policy advisers as the result of lack of commitment by national authorities to move sufficiently quickly in liberalizing their economies.

Critics have challenged the hypothesis that all countries have the same access to exogenous technology or that untrammelled market forces can trigger sustained growth and convergence. Innovative entrepreneurship and associated institutional structures have been seen as the key to nurture sustained economic growth.

The endogenous growth theories see the key to catch-up as lying in closing the technology gap between rich and poor countries by import of capital goods and by foreign direct investment (FDI) - but whose effectiveness depends on 'absorptive capacities' and 'social capabilities'.

This view about importance of institutions and policies on fixed investment, Research and Development (R & D) and access to foreign technology, allows for greater role for government policy in creating conditions for sustained growth and catch-up.

This view of economic growth as a complex function, over and above traditional factor inputs, has led to the conditional convergence theories - of tendency of countries to converge on their own long-term equilibrium paths, based on their pre-conditions.

This implies that in groups of countries with similar long-run equilibrium positions, there will be a tendency for absolute convergence. Studies of such convergence suggest an annual two percent speed of convergence - or the rate at which they close the gap - or 35 years to close half the gap between their initial incomes and steady state income levels.

Studies for evidence of such conditional convergence and choosing 'variables' often on ad hoc basis, suggest some positive correlation between investment to GDP and trade to GDP ratios and long-term growth.

However, empirical estimates of long-term growth, the ECE economists say, have to be treated with scepticism "since they still assume that technology is similar across countries." "Perhaps, the main lesson from such work is that the process of catchup is certainly not an automatic process to be triggered by market liberalization and that the relative advantages of backwardness... as a stimulus to productivity growth via a process of imitation and adaptation may be very elusive."

Analysing the convergence process of western Europe with the US, the ECE report notes that despite considerable progress since 1950, there still remains a sizeable gap between real per capita GDP in the US and western Europe.

In 1998, the gap averaged some 40 percent for the aggregate of the 19 western European economies and 33 percent for the EU.

Most of the narrowing of the gap over nearly five decades took place between 1950 and 1973. The process slowed down considerably since then. The weakening of convergence since 1973 has been associated with the impact of successive shocks to macro-economic stability and longer-term growth expectations. In turn these have reduced the incentives for fixed investment, the main carrier of technical change.

Within western Europe, progress has been uneven at the periphery - broad stagnation in Greece after 1973, catch-up never really taking off in Turkey, but a more satisfactory performance in Spain and Portugal.

The better performance of the latter two, compared to Greece within the EU, has been associated with a greater emphasis on institutional adaptation, macro-economic stabilization, structural reforms and trade liberalization, and a more favourable environment for FDI.

Ireland has been a prime example of convergence, but its success has been the result of favourable interaction of a host of specific factors, which are unlikely to be replicated elsewhere.

Empirical evidence points to inter-relatedness of short-term cyclical developments and longer-term growth performance. Growth generally was uneven over 1950-1998 - with episodes of weaker growth followed by more or long periods of sustained dynamism or vice versa.

These point to the role of country-specific characteristics, including shocks and policies in determining long-term growth outcomes apart from common factors such as technological change.

As for the ECE transition economies, they have followed divergent growth paths. Whatever the causes, the outcomes have been different: some are on a path of sustained recovery, while others are still struggling with the recession that came in the transformation - from centrally planned to market economies. Coupled with the initial differences in per capita incomes, this has led to economic heterogeneity.

In regard to 'absolute convergence', the period since the beginning of the transition to market has been one of increasing divergence and increasing disparities in per capita incomes. The situation is similar in terms of 'conditional convergence'.

The empirical analysis of convergence and patterns of long-term economic growth, in academic literature, is not only to seek better understanding of the past but try to project it into the future. A number of studies have attempted to do this for transition economies.

"Most of them suggest that the process of convergence with west European per capita levels will be long and difficult. The time required to achieve this target is estimated in decades, even for the more advanced transition economies and under the more optimistic growth scenarios....The experience of some of the present EU members has shown that EU membership by itself is not a sufficient condition for catching up quickly with the more developed European economies."

The ECE economists add that in terms of policy implications and conclusions: "...regrettably, neither economic theory nor policy practice have discovered 'easy fixes' and practical recipes for success in accelerating the process of catching up.

"Past experience has shown that previous 'growth miracles' have always combined country-specific factor endowments, prudent and forward-looking public policies, specific geographic location and, often, a lucky coincidence of circumstances, all of which have always been placed in a specific historic context.

"Ex-post, growth miracles can be explained but it is next to impossible to reproduce them; new success stories may draw from the lessons of the past ones, but they will always contain unique and innovative elements. What is clear, however, is that potential for catching up and economic convergence in Europe exists, and it is up to imaginative political leaders and creative policy makers in the transition economies to find the keys to success." (SUNS4659)

The above article first appeared in the South-North Development Monitor (SUNS) of which Chakravarthi Raghavan is the Chief Editor.

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