In search of con­ver­gence

Financial Mirror (Cyprus) - - FRONT PAGE -

One puzzle of the world econ­omy is that for 200 years, the world’s rich coun­tries grew faster than poorer coun­tries, a process aptly de­scribed by Lant Pritch­ett as “Di­ver­gence, Big Time.” When Adam Smith wrote The Wealth of Na­tions in 1776, per capita in­come in the world’s rich­est coun­try – prob­a­bly the Nether­lands – was about four times that of the poor­est coun­tries. Two cen­turies later, the Nether­lands was 40 times richer than China, 24 times richer than In­dia, and ten times richer than Thai­land.

But, over the past three decades, the trend re­versed. Now, the Nether­lands is only 11 times richer than In­dia and barely four times richer than China and Thai­land. Spot­ting this re­ver­sal, the No­bel lau­re­ate econ­o­mist Michael Spence has ar­gued that the world is poised for The Next Con­ver­gence.

Yet some coun­tries are still di­verg­ing. While the Nether­lands was 5.8, 7.7, and 15 times richer than Nicaragua, Cote D’Ivoire, and Kenya, re­spec­tively, in 1980, by 2012 it was 10.5, 21.1 and 24.4 times richer.

What could ex­plain gen­er­alised di­ver­gence in one pe­riod and se­lec­tive con­ver­gence in an­other? Af­ter all, shouldn’t lag­gards grow faster than lead­ers if all they have to do is im­i­tate oth­ers, even leapfrog­ging now-ob­so­lete tech­nolo­gies? Why didn’t they grow faster for so long, and why are they do­ing so now? Why are some coun­tries now con­verg­ing, while oth­ers con­tinue to di­verge?

There are po­ten­tially many an­swers to th­ese ques­tions. But I would like to out­line a pos­si­ble ex­pla­na­tion that, if true, has im­por­tant im­pli­ca­tions for devel­op­ment strate­gies to­day.

The economic ex­pan­sion of the last two cen­turies has been based on an ex­plo­sion of knowl­edge about what can be made, and how. An apt metaphor is a game of Scrab­ble: Goods and ser­vices are made by string­ing to­gether pro­duc­tive ca­pa­bil­i­ties – in­puts, tech­nolo­gies, and tasks – just as words are made by putting letters to­gether. Coun­tries that have a greater va­ri­ety of ca­pa­bil­i­ties can make more di­verse and com­plex goods, just as a Scrab­ble player who has more letters can gen­er­ate more and longer words.

If a coun­try lacks a let­ter, it can­not make the words that use it. More­over, the more letters a coun­try has, the greater the num­ber of uses it could find for any ad­di­tional let­ter it ac­quired.

This leads to a “qui­es­cence trap,” which lies at the heart of the Great Di­ver­gence. Coun­tries with few “letters” lack in­cen­tives to ac­cu­mu­late more letters, be­cause they can­not do much with any ad­di­tional one: you would not want a TV re­mote con­trol if you didn’t have a TV, and you would not want a TV broad­cast­ing com­pany if your po­ten­tial cus­tomers lacked elec­tric­ity.

This trap be­comes deeper, the longer the al­pha­bet and the longer the words. The last two cen­turies have seen an ex­plo­sion in tech­nolo­gies – letters – and in the com­plex­ity of goods and ser­vices that can be made with them. So the techies get techier, and the lag­gards fall fur­ther be­hind.

Why, then, are some poorer coun­tries now con­verg­ing? Is the tech­no­log­i­cal al­pha­bet get­ting shorter? Are prod­ucts get­ting sim­pler?

Ob­vi­ously not. What is hap­pen­ing is that glob­al­i­sa­tion has split up value chains, al­low­ing trade to move from words to syl­la­bles. Now, coun­tries can get into busi­ness with fewer letters and add letters more par­si­mo­niously.

It used to be that if you wanted to ex­port a shirt, you had to be able to de­sign it to the taste of peo­ple you didn’t re­ally know, pro­cure the ap­pro­pri­ate ma­te­ri­als, man­u­fac­ture it, dis­trib­ute it through an effective lo­gis­ti­cal net­work, brand it, mar­ket it, and sell it. Un­less you per­formed all of th­ese func­tions well, you would go out of busi­ness. Glob­al­i­sa­tion al­lows th­ese dif­fer­ent func­tions to be car­ried out in dif­fer­ent places, thereby al­low­ing coun­tries to par­tic­i­pate ear­lier, when they still have few lo­cally avail­able ca­pa­bil­i­ties, which can then be ex­panded over time.

A re­cent ex­am­ple is Al­ba­nia. Known as the North Korea of Europe un­til the early 1990s, when Al­ba­nia aban­doned its quixotic quest for au­tarky, it started cut­ting and sow­ing gar­ments and shoes for Ital­ian man­u­fac­tur­ers, grad­u­ally evolv­ing its own fully in­te­grated com­pa­nies. Other coun­tries that started in gar­ments – for ex­am­ple, South Korea, Mex­ico and China – ended up reusing the ac­cu­mu­lated letters (in­dus­trial and lo­gis­ti­cal ca­pa­bil­i­ties) while adding oth­ers to move into the pro­duc­tion of elec­tron­ics, cars, and med­i­cal equip­ment.

Con­sider this a stylised ver­sion of the sale of IBM’s Thinkpad to China’s Len­ovo. Once upon a time, IBM asked a Chi­nese man­u­fac­turer to as­sem­ble its Thinkpad – us­ing the com­po­nents that it would sup­ply and fol­low­ing a set of in­struc­tions – and send the fi­nal prod­uct back to IBM.

A cou­ple of years later, the Chi­nese com­pany sug­gested that it take re­spon­si­bil­ity for procur­ing the parts. Later, it of­fered to han­dle in­ter­na­tional dis­tri­bu­tion of the fi­nal prod­uct. Then it of­fered to take on re­design­ing the com­puter it­self. Soon enough, it was no longer clear what IBM was con­tribut­ing to the ar­range­ment.

Learn­ing to mas­ter new tech­nolo­gies and tasks lies at the heart of the growth process. If, while learn­ing, you face com­pe­ti­tion from those with ex­pe­ri­ence, you will never live long enough to ac­quire the ex­pe­ri­ence your­self. This has been the ba­sic ar­gu­ment be­hind im­port-sub­sti­tu­tion strate­gies, which use trade bar­ri­ers as their main pol­icy in­stru­ment. The prob­lem with trade pro­tec­tion is that re­strict­ing for­eign com­pe­ti­tion also means prevent­ing ac­cess to in­puts and knowhow.

Par­tic­i­pat­ing in global value chains is an al­ter­na­tive way to learn by do­ing that is po­ten­tially more pow­er­ful than clos­ing mar­kets to for­eign com­pe­ti­tion. It en­ables a par­si­mo­nious ac­cu­mu­la­tion of pro­duc­tive ca­pa­bil­i­ties by re­duc­ing the num­ber of ca­pa­bil­i­ties that need to be in place in or­der to get into busi­ness.

This strat­egy re­quires a highly open trade pol­icy, be­cause it re­quires send­ing goods across bor­ders many times. But this does not im­ply lais­sez-faire; on the con­trary, it re­quires ac­tivist poli­cies in many ar­eas, such as ed­u­ca­tion and train­ing, in­fra­struc­ture, R&D, busi­ness pro­mo­tion, and the devel­op­ment of links to the global econ­omy.

Some dis­miss this strat­egy, ar­gu­ing that coun­tries end up merely as­sem­bling other peo­ple’s stuff. But, as the fa­mous as­tronomer Carl Sa­gan once said: “If you want to make an ap­ple pie from scratch, you must first in­vent the uni­verse.”

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