Convergence and divergence – emerging markets, global value chains and industrial policy

Containers are loaded onto a container ship at a shipping terminal in the harbour in Hamburg

According to a recent piece in The Economist, economic convergence with the US among so-called emerging markets has slowed in the ten years since the great recession. The difference in the growth rate of GDP per capita has slipped since the 2000s from an average of over six percent in emerging Asia to about four percent. Emerging Europe has slowed less, but from a lower rate, while Latin America, North Africa, Sub-Saharan Africa and the Middle East are now beginning to fall behind again, at least on average.

This is disappointing for champions of economic theories of convergence resting on the globalisation of the world economy. It is also bad news for those still living in poverty in the countries slipping back. Of course, slowing convergence need not mean that absolute poverty is no longer falling. But it does mean that the prospects for reducing inequality between rich and poor nations and more widely-shared prosperity are for now receding. Given that the US has not grown particularly fast since it emerged from recession, it means that only emerging Asia continues to be a truly dynamic region in economic terms. And even this mantle may be under threat as growth slows in China, affecting supply chains throughout Asia.

Economists have long debated the causes of convergence in living standards between countries, or the lack of it. From the neoclassical and endogenous growth theories of the mainstream, to the ‘combined and uneven development’ of Marxist political economy, there are a range of approaches which attempt to explain patterns of economic growth.

Divergence, convergence and the great unbundling

One recent contribution to the debate is Richard Baldwin’s The Great Convergence, which explores the relationship of the revolution in information and communications technology (ICT) to global value chains (GVCs) and globalisation and their impact on global growth and the distribution of income and wealth.

According to Baldwin, the world has experienced two significant periods of globalisation since the emergence of capitalism, each driven by what he terms a ‘great unbundling’ of production and consumption. First came falls in the cost of transporting goods during the 19th and 20th centuries which led to the first unbundling. This was followed by falls in the costs of communications from the late 20th century onwards which led to the second unbundling.

Baldwin’s first unbundling of production and consumption was key to the first wave of globalisation. Cheaper and improved transportation led to falls in the costs of moving goods so that industrial production and consumption no longer needed to be in the same place. Although all the successful industrialising nations used protectionist industrial policies to nurture emerging sectors, there was a gradual but uneven trend towards expanding international trade. As the opportunities for the latter expanded, this led to a great divergence as a number of nations in the ‘North’ industrialised, concentrating global incomes and wealth in what was to eventually become the G7.

With the ICT revolution came dramatic falls in the cost of communications and the international flow of information and knowledge. This produced a second unbundling of production and consumption and a new wave of globalisation which Baldwin argues took off in the 1990s. Combined with the advent of containerisation, this promoted the rise of GVCs. With ever cheaper and faster flows of information, opportunities arose for large multinational corporations (MNCs) to divide and spread their supply chains across different countries. Global trade in intermediate goods grew much faster than trade in final goods, as MNCs exploited some of the much cheaper labour costs of production in the global ‘South’, coordinated and managed using the new technologies.

This second unbundling has created a trend towards industrialisation in some developing countries, dominated by what Baldwin terms the I6, and deindustrialisation in the G7 and advanced Northern economies more generally. The I6 consists of China, India, Indonesia, South Korea, Poland and Thailand which, as their populations make up around half the global total, are part of the author’s ‘Great Convergence’. Thus know-how from the global North has combined with low wages in the global South to produce this trend.

The industrial growth unleashed by this second unbundling also led to a boom in the demand for commodities used as raw materials in production which boosted exports and growth in commodity-rich nations such as Brazil and Australia.

Despite the dramatic changes this has brought about, geography still matters for trade, since the cost of moving people remains relatively high and has not fallen anything like as much as that of transport or communications. Baldwin incorporates these three factors into his ‘Three-Cascading Constraints’ view of globalisation. The constraints are the costs of moving, respectively, goods, information and people. The fall in the first two led to two distinct waves of globalisation. He engages in a bit of futurism by predicting that the fall in the cost of the third constraint and a new wave of globalisation may be on the way, when it will not be so much the people that become cheaper to move, but their skills, as further advances in ICT and robotics allow remote work. As an example, a surgeon based in the US could operate on a patient in India using remote control, to substitute for travelling there.

Returning to the second unbundling, there is no doubt that the consequences of the development of GVCs have been transformative and disruptive, particularly with the deindustrialisation of many economies in the global North. This has contributed to a polarisation of the workforce and rising inequality within nations, as many middle-income jobs in manufacturing have been lost, while jobs growth at the bottom of the distribution has expanded, and pay for those at the very top has soared.

The Great Convergence has also changed the nature of successful industrial policy for emerging capitalist economies. For much of the 20th century, the handful of poor economies that managed to grow fast and catch up with the richest relied on a mixture of protectionism for infant industries to encourage or enable firms and sectors to ‘grow up’ and support for exports onto the world market. Successful late developers created and supported complete supply chains, all within one country. This partly state-led industrialisation was sometimes called a ‘big push’. Many more countries tried this strategy and met with mixed results or eventual failure. With the advent of GVCs driven by MNCs, a different set of opportunities arose. Instead of trying to develop a whole supply chain domestically, countries can join part of one by creating favourable conditions for foreign direct investment (FDI) to locate there and produce for exporting.

As Baldwin admits, while it can be ‘easier’ for a developing country to find and develop comparative advantage by joining part of a supply chain than developing a whole chain as was necessary in the past, industrialisation has become less meaningful and industrial policy for developing countries in a world of GVCs remains challenging and in need of further research. Old problems of development remain: how to fund and develop skills, physical and legal infrastructure, the role of politics etc.

International trade has shifted towards trade in tasks and away from ‘lumpy’, complex industry requiring a big push. There is also the problem of how to integrate into the GVC in the first place and then to enable industrial upgrading within the value chain in order to sustain growth in productivity. A national innovation system, including a key role for the state, still matters in order to avoid ‘immiserising specialisation’ in a niche captured by large MNCs who prevent upgrading and innovation. There is thus a need for nations to integrate strategically into GVCs, if possible. The balance of power between states and MNCs can be crucial in this regard.

Or is it divergence?

Other studies of global development have drawn more attention to the uneven nature of convergence, or the lack of it. In Growth Divergences, a number of heterodox economists, writing in 2007, argue that there has been a divergence in the levels of income per capita, both between the North and the South, and between economies in the South, since the 1960s, particularly since the beginning of the era of neoliberal globalisation. If one removes China and India from the data, global inequality has actually been rising.

Among developing countries, growth spurts and collapses, as well as periods of stagnation, seem to be the norm, apart from a few economies that have been growing rapidly and catching up with the rich world. But these success stories do not support the policy prescriptions of neoliberal economists. It is not simply openness to trade and capital flows that have driven growth in the presence of substantial gaps in income. These have only supported rapid growth if they have been associated with increases in capital investment, taking advantage of supportive infrastructure, industrialisation, skills, and developmentalist institutions and governance capabilities which drive technology acquisition and learning-by-doing.

The most successful converging economies were for a time helped by supportive global governance which gave them space to enact interventionist development policies, including access to Western markets even while they protected their own. In addition, history, culture and the initial conditions all matter for subsequent development, or the lack of it.

Tellingly, among emerging market economies, an increase in the share of global exports may not be associated with an increase in the share of global value added. It is quite possible for inflows of FDI to result in production enclaves for exporting which rely on imported components, but which do not develop linkages with the rest of the economy and thus prevent broad-based development from occurring.

In order to benefit fully from FDI, there is a need to foster domestic linkages and for absorptive capacity. Globally, much of it has tended to flow to economies with higher incomes, larger markets and better infrastructure. Low wages on their own are not sufficient to launch rapid growth and development, even with the free flow of know-how.

Heterodox development economists have also argued that development is associated with a rising technological content of output, continued product diversification and structural change away from agriculture and towards industry and sophisticated services. It is export ‘quality’ that matters, not just quantity. Excessive specialisation patterns can make economies more vulnerable to external shocks such as a fall in the terms of trade. If exports are not very diversified and differentiated from regional neighbours, there is a risk of the economy falling victim to fallacies of composition: one economy can benefit for a time from rapid growth in demand for a particular product, but if too many specialise in the same area, market saturation and sudden falls in demand can occur, hindering growth.

Governance for catch-up

Finally, governance capabilities which support growth and development, rather than simply attempting to make markets work more efficiently, have historically proven to be vital. Periods of market liberalisation can lead to growth spurts, building on existing capabilities in production, but if they do not promote learning-by-doing processes and actual increases in technological and organisational capabilities over the longer term, such growth is unlikely to last. Thus institutions such as the World Bank are right that governance matters, but it is growth-enhancing rather than market-enhancing governance that is key. Political and institutional reform may be necessary to try and build the conditions necessary to create sustained periods of successful development promoted by state intervention. This contrasts with simply giving up on intervention and liberalising markets.

On this reading, growth in emerging markets which promotes convergence with the rich world relies on an evolving interaction between internal and external conditions, shaped not only by markets and technology but also by the role of the state and political and institutional conditions.

Responding to the changing nature of GVCs is part of this picture. According to a survey in The Economist, they are becoming shorter, smarter and faster with the advent of new technologies such as artificial intelligence, robotics and digitisation. Rising protectionism and the prospect of a technological cold war are also having an impact, as is the growth of more sophisticated services which provide inputs for, or make use of, manufacturing activity. Industry is still an ‘engine of growth’, but the way we define the engine is broadening.

Convergence then is far from automatic, and successful periods of catching up by poorer countries need a conducive global environment and effective and responsive domestic policy-making as well as a little luck.

References

Baldwin, R. (2016), The Great Convergence, Harvard University Press

Ocampo, J. A., Jomo, K. S. and R. Vos (eds) (2007), Growth Divergences, Zed Books

Szirmai, A., W. Naudé, and L. Alcorta (eds) (2013), Pathways to Industrialization in the Twenty-First Century, Oxford University Press

“The world is not flat” – Special Report: Global Supply Chains (2019), The Economist, July 13th

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2 thoughts on “Convergence and divergence – emerging markets, global value chains and industrial policy

  1. Thank you for this superb synopsis which is valuable to anyone who wishes to learn (more) about and keep abreast of developments in the important and vast area covered in this post.

    To me, you are doing an excellent job in pointing out the multidimensional requirements of successful development. The discernment, the balance and the lucidity in your incisive writing is refreshing, admirable, and, again, helpful in informing open minds and keeping them updated.

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