Economics: Why China and India could remain poor relations

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As the annual meeting of the IMF and World Bank gets under way in Hong Kong, the flow of reports and books about globalisation has swollen to a torrent. One of the most interesting streams of thought concerns how individual countries can make sure they gain rather than lose from increasingly international investment and production. To put it in sharper focus, is it possible to pick out a new set of "tiger" economies which will put on a spurt of growth to catch up with countries already well down the road to developed status?

Many economists believe the key to development is that levels of income in poor countries tend to converge on rich ones. If places like Singapore, Taiwan and Korea have done this during the past couple of decades, whose turn is it next?

The assumption that developing countries will steadily catch up, is derived from from the conventional theory of economic growth. Growth depends on the pace of technical change in the long run, and for a given state of technology diminishing returns to additional production mean that less developed countries will grow faster than the developed ones, converging towards the most advanced.

The question - who's next? - makes no sense, however, if convergence turns out to be the exception rather than the rule. And some of the recent research into the globalisation phenomenon suggests precisely this. The new Trade and Development Report from Unctad looks at the evidence from both the years 1870-1913, which many economists have suggested as the closest parallel to the current episode of globalisation, and from the past 30 years. It concludes that divergence, rather than convergence, has been the dominant pattern.

The dominant feature of industrialisation at the turn of the last century was the industrial take-off in the United States. This allowed it to overtake Britain as the world's biggest economy and to pull further ahead of all the other successful industrial economies. The only catch-up occurred within northern and western Europe, where Germany and Scandinavia came from behind to match the performance of their more advanced neighbours.

During the past 30 years, too, the Unctad report concludes, "Poorer countries grew on average more slowly than richer ones, giving rise to a trend of divergence in the world economy". Although South-east Asia accounts for a bigger share of world output, the gap between rich and poor has widened, with the rich getting ever richer. Again, there are some exceptions. Within the small group of OECD economies there has been convergence. Southern Europe, for instance, has drawn closer to the rest of western Europe by shifting economies away from agriculture into manufacturing and subsequently services.

The report also presents evidence that inequality between developing countries has increased, with the very poorest countries in the world falling further and further behind, suggesting that, contrary to conventional economic theory, there is no guarantee that there will be successive waves of "tigers". If some countries do manage to catch up, the evidence suggests there is nothing automatic about it. Most of the countries that were richest in 1965 still are the richest, and most of the poorest 30 years ago are even poorer relative to the rest of the world. Almost as many nations have lost ground as have caught up in any way.

Luckily, new theories of economic growth have an answer to this now. It lies in replacing the conventional assumption of diminishing returns with the assumption of increasing returns to scale. This means that productivity rises rather than falls as output rises. Instead of an extra worker in a factory producing less extra value than the previous worker because both are using a given amount of capital, the typical pattern is an extra worker producing more extra value.

It is very plausible to suggest that increasing returns have become more important in modern economies. For example, in much of the weightless or "knowledge-based" production which accounts for more than half of the OECD economies' output, the benefits of exchanging ideas, brainstorming or stimulating somebody else's creativity make productivity rise in industries like the media, education or software. In addition, there are big increasing returns to scale in marketing products and services for which global brands can be created.

This type of framework can explain the divergence noted by the Unctad report. Economies which manage to get on a path that allows them to exploit increasing returns to scale in some sectors will get richer. But there is nothing to guarantee that they get there. What's more, where you get to depends on where you start: future growth depends on past history.

The evidence of the post-war years indicates that it is possible to mark countries down as winners and losers, according to research by Monojit Chatterji, professor of economics at Dundee University. Some, with favourable starting conditions, tend to cluster at a high per capita income level. Others tend to cluster at a low level. There might be convergence within each group, but not between them.

There are few surprises in his two lists based on figures for national income per head over the years 1960-1990. But those surprises are instructive. On the margins are countries like Guatemala, Colombia and Malaysia, which with a bit of effort could still make it into the rich club.

Firmly in the poor nations' club, however, are China and India. Although many people - including investment managers - are betting on a rapid and dramatic catch-up on the part of these two emerging giants, by Professor Chatterji's reckoning there is nothing in their economic history to suggest they can make it. The position they start from means the leap needed to catch up to the richest economies in their most advanced sectors is simply too great to be feasible. Nor is there any inexorable force of economic development that guarantees years of rapid growth in these two giants as they converge towards Western standards of living. Here is a challenge to the assumption at the IMF meeting that China's catch-up will be one of the certainties of the economic landscape in the next 20 years.

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