Start with the rich leader country and call it the US if you want. Given existing technologies that don't radically change --- a key assumption, please note --- the rich leader will have higher levels of capital accumulation than the follower countries and hence run into diminishing returns in its growth rate of per capita income far faster than they will. The reason? Increasing the number of steel mills from 1 to 2 might double steel output for any country with a new steel industry; adding 1 more to 12 steel mills might lead only to 8% more output, yet the cost of a steel mill remains the same. Similarly, the rich leader's firms --- being on the technological frontier --- have to spend a lot of capital in R&D, much of it leading to a dead-end or at best some incremental improvements in output . . . again, always assuming technologies aren't radically changing.
Enter the faster growth rates of the follower countries in the convergence club.
At lower levels of cumulative capital and hence higher rates of return on each dollar invested, they have far more investment opportunities at lower levels of cumulative capital. With higher marginal rates of return on their investments, their capital accumulation should grow rapidly without incurring diminishing returns --- at any rate, possibly for decades. They also have lower-wages and can import the technologies developed by the rich lead country and then diffuse them throughout their economy. No less important, they will likely be able to acquire the advanced technologies created with enormous expense by the firms of the rich lead country at much cheaper prices: either through licensing agreements with the lead country's firms, or through multinational implantation, or by reverse engineering (dismantling technologies embedded in machines, then rebuilding them in ways that skirt patents), or --- a Chinese specialty these days --- by outright piracy. In the upshot, they can build a new steel mill --- their first, second, or third, say --- with the most advanced technologies available; and if their managers, engineers, skilled workers, and others have the right know-how, they could do the same, in principle, with television sets, VCR's, pc's, or pc-peripherals and software.
More Catch-Up Stuff
There are other catch-up processes as well that can accelerate the rate of growth in GDP and per capita income.
Take productivity. Apart from technological progress, there are other fertile ways that a follower country can increase its efficiency and levels of productivity . . . especially at the outset. In particular, as new, more up-to-date industries implant themselves in their countries --- whether by importing technologies from the rich leader country or benefiting from its multinational firms locating there --- a dynamic follower country can reallocate a lot of redundant, low-productive labor into the more promising industries, to the benefit of overall national productivity growth. In the early 1980s, China's labor productivity leapt ahead precisely by reducing its labor force in agriculture --- roughly 65% of the population then --- and letting the former peasant farmers find jobs in the new, rapidly growing industrial firms owned privately or by towns and country-villages. Then, too, the follower country's work force is likely to be willing to work harder and for longer hours than its counterparts in rich countries. Simultaneously, its firms can also import "best practices" in management and business organization developed by the lead country, adapting them to local conditions. One other big opportunity is available as well, especially for follower countries with small domestic markets. As Taiwan, Singapore, and Hong Kong have shown, the ability to export into large rich economies allows their up-to-date firms to enjoy returns-to-scale and hence to compete on equal terms with the giant firms in the rich leader country (or countries in the case of Pacific Asia two decades ago
Thanks to all these advantages and opportunities of "relative backwardness" and catch-up processes, dynamic follower countries should be able to grow faster and continue to converge on the slower growing lead country's levels of productivity and per capita income.
Their rate of catch-up growth will, of course, begin to slow down as the follower countries close the gap in levels of productivity and per capita income and themselves approach the technological frontier. Two reasons bulk large here. First, the closer any one follower country's firms approach the frontier, the more they will have to rely increasingly on their own costly R&D and ability to compete on even terms with the rich leader country --- whether in its domestic market or in markets abroad. And second, diminishing returns will invariably begin to set in at some point for any follower country as its own capital stock grows and offsets more and more of its own firms' investment levels. The 2nd steel mill, remember, might double steel output; the 12th might bring only 8% increase in steel output for the same amount of investment capital.
The overall result, at any rate for all the advanced industrial countries --- the ones we're concerned with here? All of them will, in principle, tend to end up at the same technological frontier and enjoy similar levels of productivity and per capita income.
The Reality? Has Convergence with the US Occurred?
As the table below shows --- reproduced from a buggy article of May 6th, 2005 --- there's been no convergence whatever over the last century for West Europe as a whole. For Japan --- barely industrializing in 1905 and very poor still --- the record is more complex: it did engage in rapid catch-up growth after 1945 and continued doing so until the late 1980s. By then, the huge American lead had been cut to around 85% of American per capita income. People marveled. They even talked about Japan surpassing the US in per capita income by 2000, then pushing on at a faster growth rate until its national GDP --- for 120 million people --- would surpass the US on that score too. The outcome? Japan has endured 14 years of stagnant growth, and today its per capita income has fallen back to around 55% of the US's, roughly where it was in 1970.
Sources: Angus Maddison http://www.eco.rug.nl/~Maddison/ for the data in the first three columns; Bureau of Economic Analysis; CIA World Factbook; OECD.
*The first three columns of per capita income are taken from Maddison impressive work (a real achievement, worthy of a Nobel prize), with Maddison using a 1990 constant dollar that he converts into Purchasing Power Parity (PPP) back over the centuries. For 2004, by contrast, the buggy prof has used a later PPP-converter --- based on the US$ for 2001 --- which is found at the BEA web site. Hence the reason for the big jump in the per capita income for all the countries compared to Maddison's 1990 figure.
|Per Capita Income 1905 - 2004 |
| ||1905 ||1950 ||1990 ||2005* |
|USA ||4,565 ||9,561 ||23,740, ||40, 650 |
|W. Europe ||3,054 ||4579 ||16,872 ||26, 437 |
|Japan ||1,157 ||1,921 ||18,789 ||28, 230 |
|Germany ||3,104 ||3,810 ||18,596 ||27, 381 |
|Britain ||4492 ||6, 930 ||19,817 ||27, 490 |
Note that this is no sleight-of-hand. By using an updated dollar, Prof. Bug is able to draw on the more current figures for GDP and per capita income that are found at the BEA, the CIA World Factbook, Eurostat, the OECD, and the World Bank. Needless to say, the real percentage gaps in per capita income across these countries and regions remain what they would be if Maddison had extended his figures through 2004 .
Note the striking fact here. Contrary to all forms of mainstream economic growth, each of which variants postulate some form of convergence between dynamic follower countries and the lead country on the technological frontier, there has been no closing of the gap with the US by West Europe for a good century! As for Japan, yes it has closed the gap, but only because it was so poor in 1905. Essentially, it entered the 1950s with about 30% of the levels of US per capita income and productivity, closed on them impressively for about 40 years until the gaps were only about 15%, and then fell back abruptly to roughly where it was in the late 1960s.
One more point. In his more recent work, Maddison notes that the level of American per capita income and productivity surpassed Britain's at an earlier date, some time in the 1890s. Other economic historians find the US lead emerged in the 1880s.
A Supplemental View
Here's a more detailed look at what has happened to the gap between the US and the other major industrial countries since 1955, a good starting point when West Europe and Japan had recovered from WWII's devastation and were caught up in rapid catch-up growth . . . a trend that would last for roughly 30-35 years. Since then, the US has forged ahead again, and Canada, Japan, and the major EU countries are roughly where they were in 1970 compared to the US in per capita income ratios.
Real Per Capita Income As A Percent of the U.S. Level
Sources: OECD, CIA WorldFactbook
So We're Back To Square One: What Underlies The Gap?
The Problem For Mainstream Growth Theories
| ||1955 ||1960 ||1970 ||1980 ||1990 ||2004 |
|USA ||100 ||100 ||100 ||100 ||100 ||100 |
|Canada ||72 ||73 ||78 ||92 ||95 ||77 |
|Germany ||53 ||66 ||73 ||78 ||79 ||67 |
|Japan ||21 ||30 ||56 ||66 ||79 ||69 |
|France ||49 ||59 ||71 ||77 ||77 ||68 |
|UK ||64 ||69 ||66 ||66 ||73 ||68 |
|Italy ||37 ||46 ||58 ||67 ||69 ||66 |
What explains the failure of convergence catch-up processes to close the per capita income gap with the USA for a good century now for West Europe as a whole, and for the reversal of catch-up growth over the last 30 years for Japan?
One big hint appeared earlier in the buggy analysis of catch-up processes: it assumes that technologies are given, with no breakthroughs in new revolutionary technologies that the lead country might be pioneering and that the others --- the follower countries --- can't quickly emulate.
That's a big drawback of standard neo-classical growth theory of the Solow sort --- which agrees that technological progress will drive a country out of a steady-state of per capita income growth . . . without, however, being able to explain how and why technological progress occurs or in which countries. In statistical terms, the theory treats technology as exogenous: growth theory: it's the key driving force of long-run economic growth, but it operates from outside the model's explanatory variables of capital accumulation, labor force growth, and the quality of the labor force over time
But note: even more recent endogenous growth theory --- which does have technological progress has an explanatory variable --- still has a big problem when it comes to explaining why the US should be the richest country in per capita income for a century or more now.
The theory has the advantage of trying to account for technology's key impact on long-term growth: countries will grow richer as technology developed elsewhere spreads to their own economies and their own firms make good use of it. By the same token, it even explains the failure of countries around the world to converge in levels of productivity and per capita output: tersely put, their different levels on these scores are due to technological gaps that can't be easily bridged. All these are sound insights. For all that, it can't account for the huge gap the US has enjoyed --- despite some ups and downs in its lead, especially from 1945 until 1975 --- over the other industrial countries in per capita income for over a century now. And that persistent gap, as great over West Europe today as it was in 1905, is what needs to be explained.
So What Then Does Explain It?
The buggy answer: a combination of any industrial country's institutions and dominant political ideologies
, which --- over history --- will shape any one country's economy and above all the relations between its state and its markets and hence the logic of political maneuvering and calculations as opposed to market incentives and adaptability to radical or turbulent change: whether found in revolutionary new technologies, globalizing forces, the emergence of dynamic competitor countries as in Pacific Asia, or even major political and diplomatic dislocations right down to large regional or global wars.
In the upshot, different kinds of capitalisms will emerge --- above all, in the industrial world these days, various forms of statist-capitalism that exist in the EU-15 and throughout Pacific Asia and, alternatively, market-oriented capitalism that prevails in the English-speaking countries . . . above all, in more pronounced form, in the US.
Again and again, since the early 1980s, the English-speaking model has outperformed the statist-capitalisms of the advanced industrial countries --- meaning Japan and the EU-15 Continental countries. More to the point, the American variant of that model has outperformed the West European statist-capitalisms for well over a century, and for that matter --- as we just saw --- Japan and West Europe since 1975.
Agreed, these points need to be clarified. And the best way at this juncture is to note what some recent growth theory has tried to do with the role of institutions in explaining economic growth, at any rate for developing countries. (Note quickly in passing, though, that if you're interested in what we mean by institutions --- political, administration, legal, financial, business organization, and the like --- click on this buggy link
. This link
adds some more clarifying remarks. As for the concept of ideologies and the various types, it too has been clarified in a variety of earlier buggy articles: click here
for the one that's the most encompassing, with some diagrams as added illumination Be sure to look at both diagrams
More Recent Growth Theory Does Try To Grapple With Institutions, But . . . Unsatisfactorily
Starting roughly in the late 1990s, some growth theorists did begin to recognize the importance of not just proper government policies in creating the conditions of sustained long-term growth --- such as fiscal and monetary discipline, privatization of nationalized industries, openness to international trade, and the like: all policies embodied in the Washington Consensus a decade earlier --- but of institutions as equally important, or even more so. (In a burgeoning literature, the two that will be easier for a general visitor to this site to grasp are by Dani Rodrik. see Institutions Rule: The Primacy of Institutions Over Geography and Integration in Economic Development (2002) and Getting Institutions Right (2004), both of which are available at his web site. )
The turn toward institutions by certain theorists marks a big step in advance over earlier growth theories, particularly since the role of institutions as a deep determinant of sustained long-term economic growth and convergence on the rich lead (or leader) countries can be put against the other two candidates for deep determinant influences: 1) geography
, tropical countries having too many disadvantages compared to those further from the equator; and 2)openness to the global economy in trade and investment
Even so, lots of problems remain --- particularly in accounting for our main concern here: why the US has been the rich lead country for well over a century now, with no convergence at all showing up in that long period for West Europe as a whole, and for Japan only down to 1975 . . . since which time it has fallen back to less than 70% of the US level of per capita income (and lower still for labor productivity).
But Big Problems
Specifically --- without getting too pedantic --- the drawbacks in the recent burgeoning literature here are several in number, three of which are especially relevant for us:
1. Institutions are treated too narrowly in terms of their good outcomes: a rule of law, protection of private property, limited corruption, or constraints on the role of the executive. Worse, when factored into statistical models, the standard measure is even more narrowly defined --- as in a couple of recent papers by Daron Acemoglu and co-authors, which looks at European colonies and finds that European settler immigration and longevity (mortality rates) can proxy good institutions. Operationalizing institutions will always remain a big challenge, with predictably lots of disagreement among theorists.
2. Those theorists stressing institutions deal only with developing countries, to determine which ones qualify for membership in the convergence club and those that don't. It's as if all advanced industrial countries have equally good institutions --- political, administrative, legal, financial, business organization, educational, and so on. That isn't just an omission; it's a serious problem in theorizing and ignores, among other things, different kinds of advanced capitalisms.
As we've argued, two kinds of capitalisms can be distinguished among the advanced industrial countries --- the EU-15, Japan, the US, and the rest of the English-speaking countries: statist-capitalism and market-oriented capitalism.
In the former, politics trumps economics, and the logic of political calculations and maneuvering dominates the logic of market incentives and adaptability to swift changing conditions, often turbulent and full of dislocations . . . whether those conditions derive from radical changes in technologies or from big shifts in economic dynamism around the world or from other fast-moving globalizing forces such as multinational activity or outsourcing of jobs. The result? The economic status quo is hard to alter and make it adapt fairly quickly --- or even at all --- to these turbulent.
In the alternative form of capitalism --- embodied most vividly by the US --- market-oriented capitalism loosens considerably the ties between state and economy and puts clear limits on political calculations and maneuvering as determining economic activities . . . above all, when it comes to adapting to the sorts of turbulent, fast-moving conditions just mentioned.
3. Finally, institutions are not only defined narrowly --- and even more narrowly still when coded into a standard measure for statistical treatment --- they are also, as it happens, treated in isolation from political ideologies and, if you want, more generally, cultural influences as well such as prevailing social norms, social values, social networks, social trust or distrust, social capital, and so on. We prefer here to focus on ideologies, with culture itself --- defined this way --- not so much unimportant as vague and very hard to pin down, not just for quantitative treatment, but also even as an explanatory concept. ( See M.G. Quibria, The Puzzle of Social Capital: A Critical Review
(Asian Development Bank) for one big exception.)
Ideologies, by contrast, are not only significant in shaping the kinds of economic systems countries may have --- whether capitalist or not, and (if capitalist) whether statist-capitalism or market-oriented capitalism --- but are easy to observe and study in depth: they are embraced by political parties and show up in the kinds of institutions and links between states and markets as well as in specific government policies: regulatory, redistributive, fiscal, monetary (if the government controls the central bank), trade, regional, educational, and the like.
When it comes to using institutions and relating their nature and behavior within any country to account for its overall economic performance --- especially in the advanced industrial countries, and in particular why the US has outperformed all its rivals among them for over a hundred years --- the recent developmental literature on institutions is of little help. All of which brings us to the . . .
BUGGY TAKE ON INSTITUTIONS AND POLITICAL IDEOLOGIES IN EXPLAINING THE SUPERIOR US ECONOMIC PERFORMANCE
No Need To Repeat Everything
The buggy take on all this matter stretches back now over 9 articles all the way to December 2004, so there's little to be gained from repeating the key points. Consider it enough to note the US's unique institutional system --- in both economics and politics --- is directly related to the pragmatic ideological heritage that mark this country's history for the last 216 years, except of course during the civil war. That heritage immunized the American left to Marxist and other socialist appeals, something that we've grappled with over several of those 9 earlier articles. On the right, there has been nothing equivalent to the statist conservatisms found all over Japan and West Europe --- even in the Tory wing of the British Conservative Party.
True, the causal nexus here is hard to separate. The influences ran both ways: from institutions to ideological outlooks and vice versa.
Consider briefly a few examples. Certain institutional trends like the protection of private property and its uncommonly wide distribution in the US during the 1800s and later --- always comparatively viewed --- predate the Constitution itself, even as it worked against socialist appeals that surged in Europe and later Japan from the mid-19th century on. Similarly, a large and dynamic middle class --- full of bold, often ruthless and grasping inventors and entrepreneurs --- meant that American industrialization needed little of the state-guided role that dominated in Japan or the Continental European countries . . . the state almost always ruled in those countries by elites of the right, moderate or otherwise, to which left-wing parties (socialist or otherwise) had to accommodate themselves before 1945. The limited state role, in turn, was reinforced by Constitutional law: strong federalism and a division of powers at the center, all of which not only worked against a strong central government of the sort that emerged everywhere in West Europe and Japan before WWII (even in Britain after 1918), but moderated any strong statist tendencies that conservative parties in this country might have been inclined too.
In the end, though, the causal interactions don't matter that much for our purposes. What does matter is the . . .
Resulting Complex of Institutions and Ideological Heritages:
As we noted ---with one exceptional breakdown, the Civil War to destroy slavery --- both the left and right eschewed the kinds of statist ideologies that flourished all over Europe by the late 19th century: Marxist socialisms of various kinds on the left and hierarchical statist beliefs on the right that had long roots in European feudalism and the reactions to the French and Industrial Revolutions in the late 18th and early 19th centuries.
In their place, the American right adopted a pragmatic approach to free-market capitalism . . . including the need, starting in the late 19th century and intensifying in the presidency of Teddy Roosevelt, to develop a limited regulatory apparatus to deal with the new giant corporations that had blazed into existence by 1900: not least, anti-monopoly legislation, a Federal banking system, and even some environmental protection while opting for free trade openings. Similarly, the American left not only renounced Marxist socialisms, but socialist appeals of any sort. In their place, it entered the 20th century as a pragmatic reformist party, accepting the basics of American capitalism but pushing for more regulatory responses to giant corporate power, just as it worked hard in cooperation with moderate Republicans in the Progressive era to clean up and modernize city government all around the country. Not that the progressive agenda stopped there. It went much further. Progressives in both the Democratic and Republican parties made sustained efforts also made to bring a centralizing Federal government and state governments closer to the grass-roots electorate.
The New Deal of Franklyn Roosevelt and later the Great Society of Lyndon Johnson led to the creation of the modern, fairly modest welfare-state in the US --- modest in scope, not in expenditures: above all, unemployment insurance, social security, and Medicare for the aged and Medicaid for the poor. Welfare for families with dependent children was also added in Johnson's era, with disastrous results: by the mid-1990s, a definitive study put out by the National Academy of Sciences found that every 10% increase in such welfare entailed an 11% increase in illegitimacy. It turned out to be the single biggest cause of the abrupt decline of the two-parent black family, which in the early 1950s was scarcely distinguishable from the two-parent white family as a percentage of the total: about 88% for both. By the mid-1990s, 70% or so of black children were born out of wedlock, usually to poorly educated mothers with no father present or offering financial support. The first result? While two-parent black families earn essentially the same level of income as their white counterparts --- taking into account age and education --- the level for African Americans overall is about 60%.
Fortunately, the second result will help to reverse this trend in the future, however slowly: the bi-partisan legislation in the Clinton presidency to reform the welfare system and reign in the length and benefits of eligibility. Overwhelmingly, Democrats went along with the reform, and a Democratic president signed the new legislation.
Other Signs of Pragmatism and Its Benefits for American Institutional Development: Grass-Roots Democracy That Has No Parallel Elsewhere
Before World War II, a series of unique institutional innovations took root that have no parallel at all in the EU or Japan, all intended to give average citizens more say in government: the referendum, the initiative, the recall election of a governor --- as happened in California in 2003 --- and direct primaries for selecting political leaders among them. (Switzerland, it needs to be added immediately, incorporates the first three instruments in its own political system.)
Come to that, there's also no equivalent abroad in the way we hold the judicial system politically accountable: all judges and prosecutors as well as country sheriffs are elected directly at the local and state levels, while their counterparts --- all the way up to the Supreme Court --- are elected indirectly by the need for Congressional approval. Just as, recall, there is no equivalent anywhere in West Europe or Japan to the usual legislative powers that Congress enjoys here . . . in shaping legislation, in approving it, in matters of budget control, and not least in being able to monitor and hold accountable the executive. You think this is an exaggeration? Ask Richard Nixon, who resigned in 1974 to avoid impeachment. Ask the National Security advisers and others around Ronald Reagan who were all found in contempt of Congress during the Iran-Contra affair in the mid-late 1980s. And ask Bill Clinton, who narrowly escaped full impeachment when the House voted on it in 1999.
And if you want, ask George W. Bush why his scare-tactics on social security have all but collapsed both in public opinion and among Congressional Republicans who are, after all, mainly interested in re-election next year or in 2006.
What Follows For Economic Institutions and Structures?
Here we can be brief --- in part, because the previous two clues in this buggy series on ideologies and economic performance dealt at length with the outcomes, but in part too because the next article in this series --- a direct follow-up of the current argument --- will unfold a new twist or two into those earlier observations, using a Schumpeterian analysis. That article, to repeat what was said at the outset today, is already done, lacking only the HTML formatting before it's published.
I really enjoyed reading this article. I'm a Law student in the University of São Paulo (Brazil), and I found it while researching for my thesis on Notification of Regional Trade Agreements in the WTO.
I really was wondering if you could send me some bibliography on the theories commented, since I'm in a deadlock in describing the interest a large developed country has in maintaining an open international trade structure. I would really appreciate if we could talk by e-mail.
Yours sincerely, Vinicius