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Summary Convergence and divergence in the World economy

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The Solow model predicted convergence and higher growth rates for lagging countries. How did economists justify the empirical evidence that catch-up by lagging countries was not happening at the rate predicted by Solovian growth?

Neo-classical reasoning would predict that the poorer countries would catch up with the richer countries due to diminishing returns on reproducible capital.

Poor countries tend to have low ratios of capital to labor, and consequently have high marginal products of capital. Therefore, they tend to grow at relatively high rates.

According to Gerschenkron (1962), catch-up by poor countries is not automatic, but requires a significant amount of effort and institution building. Later on, Ohkawa and Rosovsky (1973) coined the term ‘social capability’ “to designate those factors constituting a country’s ability to import or engage in technological and organizational progress”. As important factors of social capability, Abramovitz (1986) indicates technical competence, and political, commercial, industrial, and financial institutions. Consequently, an important argument made by Abramovitz is the following: because technologies are shaped by the environment in which they develop, countries that differ much from the leader country in factor supply, market size, etc. may sometimes find it difficult to apply leader country technology. This latter is referred to with ‘technological congruence’. When this congruence is low, it is hard for a backward country to adopt a technology from abroad.

It is thus hard for a country, which has a low social capability, to catch up with the leading country. This conclusion is not in line with the traditional neo-economical reasoning. Neo-classical reasoning would predict that the poorer countries would catch up with the richer countries due to diminishing returns on reproducible capital. This new reasoning however, would be in line with neo-classical theory, only when the country has enough social capability to imitate the leader country. In the case that a sufficient level of social capability is absent, a low initial GDP would not directly lead to a higher growth in the future. Or to explain the absence of convergence of growth rates of different countries in other words: the beneficial external effects of capital accumulation outweigh the detrimental consequences of increasing capital per worker (Scott, 1989). Thus, convergence between growth rates of different countries does not have to been as a given.

Trace the contribution of both neo-classical/ formal theories and of appreciative/evolutionary theories to the catch-up debate. Which are the key differences between the two approaches?

Neoclassical/formal theories – endogenous growth Evolutionary/appreciative theories – technology gap
-          Assumption/reasoning:

Where neo-classical reasoning sees technology as a public good, which does not cause differences in growth rates across countries

In the analyses based on the traditional neoclassical theory of economic growth, the cross-country differences can be caused by several things, but not by technology. Since technology is a public good, it cannot evoke differences among countries in this growth.

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-          Assumption/reasoning:

sees technology as the most important factor. In the latter, emphasis is put on social capabilities of countries, where in the first these are not so prominently present.

The technology-gap theorists on the other hand see technology as the main cause for differences in the GDP per capita growth across countries. They argue that technology is not only an artefact, but it is also embedded in organizational structures, and to successfully use it, people need some know-how. This makes it difficult to simply ‘copy’ the technology. According to Nelson (1981), it is more often than not difficult and costly to transfer technology from one setting to another. In this approach, technological change is analyzed as “the joint outcome of innovation and learning activities within organizations, especially firms, and interaction between these and their environments.”

The theoretical debate was also spurred by the increasing availability of internationally comparable datasets and running growth regressions became the most-common empirical exercise among neo-classical economists. Discuss what growth regressions can do and what their limitations are.

Neoclassical – endogenous model Evolutionary – Technology gap  model
-          Works a lot with correlations

It is hard to identify causality by means of correlations. In addition, multicollinearity can be a serious problem. these kinds of correlations are so high that regression methods are limited, especially given the fact that a lot of these factors in endogenous growth models are interdependent, so these correlations occur relatively often.

that factors that are taken into account are interdependent, while one assumption of growth accounting says that they are independent. An example of this interdependency is that in the 20th century, the US developed technologies which were capital- and scale-intensive. In order to successfully diffuse these technologies, large investments and large markets were required. In other words, the investments and the technological progress were interdependent. The reason why this is a real problem for growth accounting is that these interdependencies make it impossible to assess the magnitude of the influence of different factors. If one would first look at the share of investments on growth, and afterwards at technological progress, (too) much emphasis would be put on the investments (the technological progress would only be there to explain the ‘left-over’ from the investments). Thus the decompositions made by growth-accountants and the policy conclusions based on their work, rest on shaky ground. Several authors have stressed this point, and Maddison (1987) concluded “that there is a great deal of interaction between causes, and particularly between capital growth and technological progress, which makes it difficult to assign separate significance to each.”. Note that this interdependency is also risky with other methods like linear regression due to multicollinearity.

The second approach tries to provide a better understanding of mechanisms underlying economic growth differences across countries. According to Verspagen (1991) the new model explains the empirical observations better, but the new model still poorly fits the data in absolute terms. Therefore this method helps to increase understanding of the phenomenon, which is a strength, but it gives little predictive power.

The two approaches also differ with respect to policy implications. For example, from the research of Verspagen (1991) some concrete policy implications are derived. When the technology gap between your country and a richer country is big, you should first increase the intrinsic learning capability. Then your country can start to catch up, and in the end your own country should invest in research to completely close the gap. It then also gives insights for successful cooperation with developing countries.

The research of Barro (1991) on the other hand provides some interesting regularities, but policy implications cannot simply be derived. Especially since causality is not easy to show, other theories should be combined with the findings to come to reasonable policy implications.

On a more general level, the approaches also differ in their strengths. Although the technology-gap approach might explain the influence of technology (gaps) on economic growth more successful than endogenous growth models, it does not say anything about other factors related to growth, which is done by endogenous growth models. With the assumption that technology is the only real cause of differences in economic growth, this stand could be defended, but I personally doubt whether that assumption holds.

Furthermore, the technology-gap approach says something about gaps, but hardly anything about the growth of a leading country. In other words, it is useful to analyze convergence and divergence between countries, but on an absolute scale it is not as useful.

Written by ibu didin

June 24th, 2010 at 4:07 pm