The Hindu Business Line : Convergence and divergence of growth

Myriad are the mysteries that surround a country's productivity and growth, and author Elhanan Helpman explores the `forces of convergence' that gave countries entry into the rich club, and `forces of divergence' that allowed prosperous nations to go on the fast track. D. Murali terms this effort a coming together of vast research for a broad audience.

ECONOMICS is hardly a thriller. But Elhanan Helpman's The Mystery of Economic Growth, from Academic Foundation (www.academicfoundation.com) seems inviting. For one, its title reminds one of The Mystery of the 99 Steps in the Nancy Drew series, and Hernando de Soto's The Mystery of Capital. And, second, the book runs to less than 150 pages, not counting the glossary and notes.

Yet, notes are where I start, to see a reference to Angus Maddison about how in the year 1000, levels of real GDP per capita in Africa and Asia were higher than in Western Europe, though by slender margins. By 2000, however, Africa's GDP per capita was about one-thirteenth of Western Europe's; and one-twentieth of what `Western offshoots' such as Australia, New Zealand, Canada, and the US enjoyed. "What makes some countries rich and others poor?" you ask, and that's the question chapter 1 begins with. This is a poser that has eluded an answer, says Helpman.

The dwindling middle

To measure how well off people are, we use real income per capita, but it is only a rough measure, says the author. People do care for things other than money — "such as political freedom, education, health, the environment, and the degree of inequality in their societies". But these variables are tough to measure. The UN's HDI or Human Development Index factors in health, education, and income, equally weighted. "The way in which the measure of income is constructed, however, causes it to rise less than proportionally with actual income," observes Helpman.

To add to the world's woes, there are fewer middle-income countries than earlier. "We have now two polarised economic clubs: one rich, the other poor," says the author. He cites the work of Steven N. Durlauf and Danny T. Quah, who found that there was a high probability of both high-income and low-income countries retaining their high and low category status. "A middle-income country, however, has a higher probability of becoming a low-income or high-income country than of remaining a middle-income country"; that perhaps explains the dwindle in the middle.

Growth rate, or the rate of change of real income per capita, makes a lot of difference. For instance if the annual growth rate is 1 per cent per annum, it will take 70 years for the country's standard of living to double. At 3 per cent, the jump can happen every 23 years! "It follows that prolonged differences in growth rates produce dramatic differences in living standards," writes Helpman. Oil crisis of 1973 impacted worldwide economic growth adversely. "None of the rich countries experienced a prolonged period of declining income per capita," points out the author with the help of charts that also show how "the story was different for the poor countries". In crisply named chapters such as accumulation, productivity, innovation, interdependence, inequality, and institutions, the author sets about to explore `forces of convergence' that helped countries to catch up with the rich club, and `forces of divergence' that allowed rich countries to pursue a fast track.

To explain the effects of capital accumulation, Helpman begins with Robert M. Solow's neoclassical growth model, and lays on the x-axis `capital intensity', that is, `the ratio of capital to effective labour'. Ratio of saving to effective labour and the ratio of the replacement requirement to effective labour are shown on the vertical axis, the point of their intersection being the equilibrium. One-liners that you may remember about accumulation-driven growth are that "growth rate of income per capita converges to the rate of technological progress", and that "countries with higher capital intensity grow more slowly".

The book refers to the work of Robert E. Lucas, comparing the US and India. In 1985, the US had an income per capital that was 15 times higher than in India, he'd said. "Had this difference been the result of differences in capital intensity only, the rate of return on capital in India should have been 58 times higher than in the US," he calculated. Such a high rate of return would have made investors move funds to India en masse, but that didn't happen. After making adjustments to account for labour productivity differences, "the corrected rate of return to capital in India was only 5 times higher than in the US." A smaller gap, but still large enough to trigger major capital flows, which didn't happen though, points out Helpman, on another puzzle.

Total factor productivity

Move on then to `productivity' chapter, using as measure "a coefficient that converts labour hours into effective labour units". Aggregation of working hours into a single measure of labour input is flawed, points out the author, emphasising the need to correct that number for `education and experience' to create `a measure of human capital'. You'd learn about `growth accounting' that decomposes output growth into components, and TFP (total factor productivity) that measures "the joint effectiveness of all inputs combined in producing output".

A depressing chart draws data from Nazrul Islam's work and shows 1960-1985 average TFP levels relative to Somalia, that lies at the far left with the smallest bar, dwarfed by Hong Kong (`forty times more productive'), but with India as the immediate neighbour. Differences in TFP explain about 90 per cent of the variation in the growth rate of income per worker across countries, says the author, and probes how technological change impacts TFP in a separate chapter titled `innovation'. GPT or general purpose technologies can produce a cycle in the value of stock market value relative to GDP, shows a graph, drawing upon results of other research studies. To understand what causes productivity growth, there is help in the `interdependence' chapter, because "countries' income levels are interdependent". Terms of trade movements provide an important mechanism for the international transmission of growth effects, says the book. Also to be considered are `diffusion of knowledge' and `speed of learning', to explain differences in productivity. "The way trade policy affects an economy's growth rate depends on the economy's characteristics, such as the type of products it trades on foreign markets or the human-capital intensity of its import-competing sectors," notes Helpman to caution against broad generalisations. Using data from his work along with Tamim Bayoumi and David T. Coe, the author depicts on a chart "the long-run outcome, which takes 80 years to attain, of a coordinated permanent expansion of R&D investment by half per cent of GDP in each one of 21 industrial countries".

An encouraging finding is that LDCs (less developed countries) benefit from R&D in the industrial countries; these manifest as larger consumption rather than GDP owing to improvements in terms of trade, says Helpman. A discouraging finding, though, is that "investment in innovation widens the gap between rich and poor countries" because the output gains of industrial countries surpass those of the LDCs. `Inequality' is the focus of another chapter that zeroes in on two main questions: "Does the distribution of income within a country affect its growth rate? And does economic growth affect the distribution of income?" There are innumerable measures of inequality — "such as the ratio of the income of the top decile to the income of the bottom decile, the Gini coefficient and the Theil index", but what are the sources of inequality? A host of forces, including economic growth, Helpman explains. "Even when growth changes the distribution of income, the ways in which it affects the distribution depend on the sources of growth."

Statistics to show that economic growth reduced poverty in general are that between 1970 and 1998, the number of people who lived on less than $2 a day declined by 350 million; and the number of people in extreme poverty, at less than $1 a day, declined by 201 million, even as population grew rapidly. To find if growth achieved equitable distribution, there is the last chapter, `institutions and politics'.

Politics, we know; but what are institutions? The author quotes Douglass C. North's view — that `institutions are the rules of the game, while organisations are the players', and a broader definition of Avner Greif, emphasising `a regularity of behaviour' and context-specificity. There is also a reference to the work of Jeffrey D. Sachs about the role of geography in economic success; he says that temperate zones and coastal regions have a higher income per capita.

According to modernisation theory, economic development leads to democratisation. "But larger inequality makes democracy more costly to the rich and makes repression more attractive to them." Democratisation is unlikely when inequality is small or large, opines Helpman. Does that explain the hung Houses we often have? "Institutions that are good for one period are not necessarily good for another," states the author, when emphasising the need to evolve them in tandem with technology. The mismatch between institutions and technology is severe when rapid GPT developments take place, points out the author. Helpman's engaging `tale of growth economics' brings together the vast research for `a broad audience', as he promises in the preface. Useful read, because "the subject is not only important; it is also intellectually fascinating and absorbing".

Economics@TheHindu.co.in

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