The Catch-Up Effect Definition and Theory of Convergence

What Is the Catch-Up Effect?

The catch-up effect is a theory that the per capita incomes of all economies will eventually converge.

This theory is based on the observation that underdeveloped economies tend to grow more rapidly than wealthier economies. As a result, the less wealthy economies literally catch up to the more robust economies.

The catch-up effect is also referred to as the theory of convergence.

Understanding the Catch-Up Effect

The catch-up effect, or theory of convergence, is predicated on several key ideas.

1. One is the law of diminishing marginal returns. This is the idea that, as a country invests and profits, the amount gained from the investment will eventually decline as the level of investment rises.

Each time a country invests, it benefits slightly less from that investment. So, returns on capital investments in capital-rich countries are not as large as they would be in developing countries.

2. This is backed up by the empirical observation that more developed economies tend to grow at a slower, though more stable, rate than less developed countries.

According to the World Bank, high-income countries averaged 2.8% gross domestic product (GDP) growth in 2022, versus 3.6% for middle-income countries and 3.4% for low-income countries.

3. Developing and underdeveloped countries may also be able to experience more rapid growth because they can replicate the production methods, technologies, policies, and institutions of developed countries.

This is also known as a second-mover advantage. When developing markets have access to the technological know-how of the advanced nations, they can experience rapid rates of growth.

Limitations to the Catch-Up Effect

Lack of Capital

Although developing countries can see faster economic growth than more economically advanced countries, the limitations posed by a lack of capital can greatly reduce a developing country's ability to catch up.

Historically, some developing countries have been very successful in managing resources and securing capital to efficiently increase economic productivity. However, this has not become the norm on a global scale.

Lack of Social Capabilities

Economist Moses Abramowitz wrote that in order for countries to benefit from the catch-up effect, they need to develop and leverage what he called "social capabilities."

These include the ability to absorb new technology, attract capital, and participate in global markets. This means that if technology is not freely traded, or is prohibitively expensive, then the catch-up effect won't occur.

Lack of Open Trade

The adoption of open trade policies, especially with respect to international trade, also plays a role. According to a longitudinal study by economists Jeffrey Sachs and Andrew Warner, national economic policies of free trade and openness are associated with more rapid growth.

Studying 111 countries from 1970 to 1989, the researchers found that industrialized nations had a growth rate of 2.3% per year per capita. Developing countries with open trade policies had a rate of 4.5%. And developing countries with more protectionist and closed economy policies had a growth rate of only 2%.

Population Growth

Another major obstacle for the catch-up effect is that per capita income is not just a function of GDP, but also of a country's population growth. Less developed countries tend to have higher population growth than developed economies. The greater the number of people, the less the per capita income.

According to the World Bank figures for 2022, more developed countries (OECD members) experienced 0.3% average population growth, while the UN-classified least developed countries had an average 2.3% population growth rate.

Example of the Catch-Up Effect

During the period between 1911 to 1940, Japan was the fastest-growing economy in the world. It colonized and invested heavily in its neighbors South Korea and Taiwan, contributing to their economic growth as well. After the Second World War, however, Japan's economy lay in tatters.

The country rebuilt a sustainable environment for economic growth during the 1950s and began importing machinery and technology from the United States. It clocked incredible growth rates in the period from 1960 to the early 1980s.

As Japan's economy powered forward, the U.S. economy, which was a source for much of Japan's infrastructural and industrial underpinnings, hummed along. Then by the late 1970s, when the Japanese economy ranked among the world's top five, its growth rate had slowed down.

The economies of the Asian Tigers, a moniker used to describe the rapid growth of economies in Southeast Asia, have seen a similar trajectory, displaying rapid economic growth during the initial years of their development, followed by a more moderate (and declining) growth rate as they transitioned from a developing stage to that of developed.

The Bottom Line

The catch-up effect refers to a theory that holds that the per capita incomes of emerging and developing nations will eventually converge with the per capita incomes of more developed, wealthier countries.

The effect can be hampered by certain circumstances, such as the lack of capital and open trade policies, and the inability to attract investments.