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News : Global Economy Last Updated: Jan 23, 2015 - 2:32 AM

Fast economic convergence is a myth in Europe and in emerging economies
By Michael Hennigan, Finfacts founder and editor
Jan 23, 2014 - 1:27 PM

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The chart plots each country's income per person (adjusted for purchasing power) relative to that of America, both in 1960 and in 2008.

Absolute economic convergence has been a mantra of policymakers in Europe for decades but it's generally a myth. The evidence shows that it is also an illusion in most emerging economies.

Poor countries that have joined the European Economic Community and its successor, the European Union, have gained from catch-up with richer economies as part of the benefits of globalisation and within the EU, gains from closer trading ties with neighbours plus subsidies and market access. However, there has been no convergence on a GDP (gross domestic product) per capita basis with the richest countries.

Robert Barro, a Harvard University economist, who has done extensive research on economic growth and convergence, in 2012 wrote in a paper [pdf]:

According to the 'iron law of convergence,' countries eliminate gaps in levels of real per capita GDP at a rate around 2% per year. Convergence at a 2% rate implies that it takes 35 years for half of an initial gap to vanish and 115 years for 90% to disappear. Convergence-rate parameters are important to pin down because they provide guidance on how fast countries like China and India are likely to catch up to richer countries. The convergence rate may also reveal how fast a poor African country could develop or how rapidly North Korea could catch up to the South, and so on."

Barro said in another paper [pdf] last year:

If all economies were intrinsically the same, except for their starting capital intensities, then convergence would apply in an absolute sense; that is, poor places would tend to grow faster per capita than rich ones. However, if economies differ in various respects - - including propensities to save and have children, willingness to work, access to technology, and government policies - - then the convergence force applies only in a conditional sense."

Germany post-unification in 1990 provides the best example where the GDP of the former German Democratic Republic (communist East Germany) is at about 70% of that in the former Federal Republic (West Germany) despite huge public spending transfers.

Prof Hans Werner Sinn, president of the Ifo Institute for Economic Research at the University of Munich, said in 2009 that, "East Germany’s privately produced GDP per capita is only about 66% of the West German level. Moreover, a substantial part of the convergence is explained by West Germany’s slow growth and the outmigration from East Germany."

Prof Michael Burda, a professor of economics at Humboldt University, Berlin, wrote on the 20th anniversary of the breach of the Berlin Wall, that while expectations on convergence hadn't been met, "progress has been remarkable in reintegrating the ex-GDR into the world economy after a half a century of deep economic distortions."

Prof Tobias Just in 2011 when an economist at Deutsche Bank Research, said that economic convergence moves at a snail’s pace, at best. "Even if the weakest regions were to grow a steady 4 percentage points faster than the strongest regions, it would take them more than 45 years to catch up."

A Deutsche Bundesbank discussion paper, published last April, shows that the expansion of the European Union (EU) has done little to bring the incomes of central and eastern European countries (CEEC) closer to older members.

The paper, The Evolution of Economic Convergence in the European Union (EU), by Mihály Tamás Borsi and Norbert Metiu, examined the path of real incomes per capita between the 27 current member states of the EU between 1970 and 2010.

The authors report no evidence of convergence between all member states. Instead, they identify groups of countries that each converge to different income levels.

They add that "regional linkages seem to play a significant role in determining the formation of convergence clubs. Yet, Eurozone countries belong to distinct subgroups, thus clustering is not necessarily related to EMU (European Monetary Union) membership. Moreover, there is a clear separation between the CEEC and the old EU members in the long run, suggesting that, even though the CEEC have exhibited higher real income growth than the EU average over the last 40 years, catching up was not sufficient to eliminate cross-country real income per capita differences. Finally, we observe a South-East vs. North-West division of European economies by the mid-nineties."

In a Word Bank paper [pdf] in 2001, prior to the admission of the former communist states of Eastern Europe to the EU, the authors wrote

Pending further empirical analysis, candidate countries may be ill advised to put excessive store by EU regional (policy) to fuel their convergence. The fact that the top beneficiary of EU funds, Ireland, also has the most outstanding convergence, should not conceal that Greece, the number two recipient had, until recently, much less to show for it. At a minimum, what this suggests, is that other factors (macroeconomic and institutional framework, competition, labor mobility) will be essential in determining the outcomes (of EU transfers).

In brief, while EU integration can be propitious for income convergence, it is not a substitute for the domestic policies necessary to achieve the latter."

Martin Wolf, 'There is no sunlit future for the euro,' FT, October 18, 2011:

True, if creditworthy members were to transfer resources to the uncreditworthy on a large enough scale, the Eurozone might be kept together. But even if such a policy could be sustained (which is unlikely), it would turn southern Europe into a greater Mezzogiorno (Southern Italy). That would be a calamitous outcome of European monetary integration."

Pierre Wunsch, director of the National Bank of Belgium, asked in a 2012 presentation [pdf]:

Why do we typically expect the Baltic countries, Slovakia and Slovenia to converge towards core EU countries in terms of GDP per capita... while we have gotten used to the fact that the Mezzogiorno is not converging to Northern Italy?"

Tal Sadeh, a senior lecturer at the Department of Political Science and Head of the Harold Hartog School of Government and Policy at Tel Aviv University, writes in a London School of Economics and Political Science blog, that despite early difficulties in accurately quantifying the trade benefits brought about by the euro, recent research shows that it has more than doubled trade among its member states. Moreover, while the Eurozone crisis has created more substantial problems in Southern Europe, the trade benefits derived from the single currency have been disproportionately larger in Eurozone periphery states.

Sadeh says that between 2001 and 2006 the euro added up to more than 100% among members of the Eurozone and more than 40% between members of the Eurozone and non-members (whether members of the EU or not).

In addition research shows that during 1999-2006 the euro increased trade among the periphery countries of the Eurozone (Greece, Italy, Ireland, Portugal and Spain) more than among its core member states (Austria, Belgium, Finland, France, Germany and the Netherlands).

Emerging economies

Dr Min Zhu, deputy managing director of the IMF, who is a former deputy governor of the People’s Bank of China, China's central bank, says in respect of diverging trends in Latin America and Asia:

A stark example of how elusive persistent strong growth can be is the lack of convergence of Latin American economies toward advanced economies. This chart (blog post link above) shows that this group’s GDP made a full reverse circle between 1962 and 2011. Their per capita income has remained stagnant compared to the United States. In contrast, emerging market economies in Asia saw their relative per capita income improve continuously, with the notable exception of the period of the Asian crisis in the late 1990s."

The head of emerging markets at Morgan Stanley Investment Management said this week: "After the average annual GDP growth rate in emerging nations peaked at 8.7% in 2007, it tumbled to roughly 4% in 2013. Yet to many observers, that pace still appears fast enough for these countries to catch up to the US, now growing at an annual pace of just over 2%."

Ruchir Sharma, who is also the author of "Breakout Nations: In Pursuit of the Next Economic Miracles" ( Norton, 2012), wrote in The Wall Street Journal that once you exclude China, GDP growth over the past two years has been no higher in emerging nations than in the US. Convergence has halted across a broad front, and after losing ground for much of the last decade, the US share of global GDP has stabilized since 2011 at 23%, while the share held by emerging markets excluding China has stabilized at 19%.

It's important to understand that the current post-Mao Zedong modernisation of China, is not a simple story of a backward country achieving an economic miracle. A vast unified country over a span of two thousand years, overwhelmingly dominated by one ethnic group, the Han, was a pioneer in bureaucratic modes of governance. According to the late eminent economic historian, Angus Maddison, in the tenth century, China was already recruiting professionally trained public servants on a meritocratic basis. The economic impact of the bureaucracy was very positive for agriculture.

Sharma wrote in the Journal: "Some of the biggest emerging market stars of the last decade, including Brazil, Russia and South Africa, are now growing at a pace slower than that of the US. This trend is unlikely to change in the foreseeable future. These countries are in fact 'deconverging.' Even China's reported 2013 growth rate of 7.7% looks increasingly unsustainable given the amount of debt it is taking on to hit this ambitious target."

Sharma notes that the normal state is that while some emerging economies are growing fast, others are slowing or retreating, while the 2005-2010 period was exceptional with only three countries that did not increase their GDP per capita relative to the US: Niger, Eritrea and Jamaica.

The Economist said in 2012 that poor countries tend to grow faster than rich ones, largely because imitation is easier than invention. "But that does not mean that every poor country of five decades ago has caught up, as today's chart shows (at top of page - - see also blog post). It plots each country's income per person (adjusted for purchasing power) relative to that of America, both in 1960 and in 2008. The chart appeared in the World Bank's recent China 2030 report [pdf]. If every country had caught up, they would all be found in the top row. In fact, most countries that were middle income in 1960 remained so in 2008 (see the middle cell of the chart). Only 13 countries escaped this middle-income trap, becoming high-income economies in 2008 (top-middle). One of these success stories, it should not be forgotten, was Greece."

Ruchir Sharma says many emerging markets rely heavily on commodities for the bulk of their exports, and they grow at catch-up speeds—at a rate faster than the world's leading economy - - only when commodity prices are rising. Commodity prices rose 160% in the 1970s, and the number of nations that were rapidly catching up to the West rose to 28, compared with the average of 22 in the typical decade. In the 1980s and 1990s, when commodity prices stagnated, the number of rapidly converging nations fell to just 11. Commodity prices then doubled in the 2000s, another golden age for convergence, with 37 nations catching up at a rapid pace."

The Morgan Stanley economist concludes: "Don't assume all emerging markets are destined to grow faster than the US - - or that some mythical force called 'convergence' will carry every emerging nation on a straight path to prosperity."

German per capita standard of living highest in Europe; Ireland below EU average

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