Context

Sound policies are needed to put emerging economies back on a higher growth path and ameliorate regional inequalities.

The theory of convergence

• The theory of convergence is one of the most powerful and noblest ideas in economics.
  • What is it? It is the concept that other things being equal, poorer economies should catch up with richer ones so that inequality between the rich and the poor attenuates, and conceivably even disappears over time.
• Capital is more productive in poor economies: The premise driving convergence is that capital (whether physical or human) is more productive in poor economies than rich ones due to what economists call “diminishing marginal productivity”.
  • In layman’s terms, a small amount of investment yields a greater increase in output where there is less capital than where there is more.
  • Lesser the development more the development: Even more simply, the rate of return on investment is inversely related to the level of economic development.
• Experience of Japan and Germany after WW 2: The experience of advanced economies gave economists reason to be optimistic that convergence occurs according to the script.
  • Thus, the devastated economies of Europe, along with Japan, quickly caught up with the advanced economies that had not been ravaged by World War II, most notably, the US.
  • Germany and Japan closing the gap: At the end of the war, with their capital stocks destroyed, Germany and Japan were much poorer than the US; by the 1960s, they had closed the gap.

Globalisation and the unfulfilled hopes of convergence

• Replication of the rise of Japan and Germany? At one time, it appeared that the same play was at work between emerging economies and advanced economies.
  • Rise of India and China: Economies such as China and India, as well as others, were far outstripping the growth rates of the US and other rich economies,
  • Hope of closing gap: India and China gave hope that at least the more rapidly growing of the emerging economies would close the gap with the rich world within decades rather than centuries.
• Adoption of technology at low cost: There was presumed to be an additional powerful force working toward convergence.
  • Poorer economies are, almost by definition, far away from the technological frontier at which the richest economies operate.
  • There is thus ample room to absorb newer technologies at relatively low cost and in a relatively short span of time, without encountering slowing growth like the rich economies,
  • In simpler terms, it is difficult and costly to innovate the latest Apple iPhone, but relatively easy to reverse engineers at least some of Apple’s technology.

Reality: Convergence is faltering

• Recent evidence suggests that convergence is faltering.
• World Bank report of retarding convergence: A recent World Bank report documents a worrying slowdown in productivity growth in emerging economies, significantly retarding convergence.
  • Lower productivity: The report’s calculations suggest that emerging economies have 14% lower productivity than they would have had if previous trends of high productivity growth were maintained.
  • Lower commodity exports: For commodity exporters, this is a whopping 19%.
• The silver lining for faltering economies: According to the World Bank, the main driver of falling productivity are-
  • Insufficient investment in physical and human capital.
  • Insufficient mobility of machines and workers from less productive to more productive sectors of the economy.
• India’s case: The Indian case clearly bears this out, with languishing investment and unfinished productivity-enhancing reforms, especially in the country’s labour market, being the key culprits behind the sharp slowdown in growth.

Way forward

• Repair financial systems: Governments, including India’s, need to do the heavy lifting of repairing damaged financial systems overladen with bad debt.
• Restore fiscal rectitude.
• Inflation focused monetary policy: Ensure that monetary policy remains focused on stable inflation rather than being excessively loose as a risky substitute for structural reforms.
• Reforms: Press ahead with unfinished reforms to capital, land and labour markets.
• Address the regional disparities: There is a further critical dimension in the case of large multi-region economies such as India.
  • Not only has convergence been faltering between nations, but it has also been faltering between the richer and poorer regions of large nations such as India.

Conclusion

The data does not present an epistle of despair, but of hope. The pursuit of sensible and conventional sound economic policies ought to put emerging economies as a group back on a higher growth trajectory. Convergence may yet end up being a parable of promise rather than a fable of folly.

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