Sources of Divergence and Policies and Long-Run Growth

Sources of Divergence:

The principal cause of extraordinary variation in output per worker between countries today are differences in their corresponding steady-state capital-output ratios. Two secondary causes are, first is openness to creating and adapting the technologies which improve the efficiency of labor as measured by levels of development two generations ago and second is the level of education today.

Productivity of two generations ago is a good indicator of the level of technological knowledge that had been attained as of half a century ago. The level of education today captures country's ability to invent and obtain further technological expertise today. Inventing new and adopting foreign-born technological knowledge is simply not possible without education,

Together these factors-- determinants of capital-output ratios and two determinants of access to technology--together account for the bulk of differences between nations in their relative productivity levels.

The determinants of steady-state balanced-growth capital-output ratio play a very dominant role. A higher share of investment in national product is strongly correlated with relative levels of output per worker. No nation with an investment rate of less than 10% has an output per worker level even 20% of the U.S. No country with an investment share of less than 20% has an output per worker level greater than 75% of the United States level.

A high level of labor force growth is correlated--even though less powerfully--with a low level of output per worker. The average nation with a labor force growth rate of more than 3 percent per year has an output per worker level less than 20 percent of the U.S. Average variable with a lab or force growth rate of less than 1% has an output per worker level greater than 60 percent of the U.S. level.

Together these determinants of steady-state capital-output ratio can statistically account for up to half of variation in national economies’ levels of productivity per worker in the world today.

Differences in the efficiency of labor are as significant as differences in steady-state capital-output ratios. Differences in efficiency of labor arise from differential ability of workers to handle and utilities modern technologies.

Efficiency of labor is high in those places where educational levels are high—sothat workers can use modern technologies they are exposed to—and where economic contact with industrial core is high—sothat managers and workers are exposed to the modern technologies invented in world’s R&D laboratories.

Schooling is the variable which has the strongest correlation with output per worker. Nations that have an average of 4-6 years of schooling have output per worker levels that average 20% of the United States’ Countries with an average level of schooling of greater than 10 years have output per worker levels of 65% of the U.S. level.

Policies and Long-Run Growth:

In many concerns it is decidedly odd that world distribution of output per worker is as unequal as it is. Migration, World trade and flows of capital must all work to take resources and consumption goods from where they are cheap to where they are dear. As they travel with increasing volume and increasing speed as communication and transportation costs fall, these commodity and factor-of-production flows must erode differences in productivity and living standards between national economies. Furthermore most of the edge in productivity and standards of living levels held by the industrial core is no one’s private property however instead the common intellectual and scientific heritage of humankind. Therefore every poor economy has an excellent opportunity to catch up with the rich by adopting and adapting from this open storehouse of modern machine technology.

We can view this certain glass either as half empty or as half full. Half full is that much of world that has already made the transition to sustained economic growth. Most people today live in economies that, while far poorer than leading-edge post-industrial nations of world’s economic core, have successfully climbed onto escalator of economic growth and so the escalator to modernity. Economic transformation of most of the world is less than a century behind economic transformation of leading-edge economies—just an eye blink behind from the perspective of the six millennia since the spread of agriculture out of Middle East's Fertile Crescent.

Furthermore perhaps we can look forward to a future in that convergence of relative income levels will finally begin to occur. The bulk of humanity is now achieving material standards of living at which demographic transition takes control. As population growth rates in developing countries fall then their capital-output ratios will begin to rise rapidly. And--with tolerable government, better ways of achieving an education and reasonable security of property --their material standards of living and output per worker levels will converge to world's leading edge.

Half empty is that we live today in most unequal--in terms of divergence in the life prospects of children born into various economies--age that world has ever seen. Today one and a half billion people live in economies that haven’t made the transition to intensive economic growth and haven’t climbed onto the escalator to modernity. It is very hard to argue that median inhabitant of Africa is any better off in material terms than his or her counterpart of a generation before.

Savings and Investment:

Policies to make sure that savers get reasonable rates of return on their savings have the potential to boost savings rate. Comparing systems of economic governance in that profits are diverted into the hands of political powerful through restrictions on entrepreneurship will tend over time to diminish savings as will economic policies that divert real returns to savings into the hands of financiers or government through inflation. Government discrepancies also have the potential to decrease the savings rate: unless investors and consumers are far-sighted enough to recognize that a government deficit now means a tax increase later, a government which spends more than it raises in revenue should borrow--and this amount borrowed isn’t a contribution to total national savings since it isn’t available to fund investment.

Some potential policies work to boost investment for a given amount of savings. Policies which welcome foreign investors' money have the potential to cut a decade or a generation off of the time to industrialize--if foreign funded capital is used wisely. Free-trade policies which allow businesses to freely earn and spend the foreign exchange they need to purchase new generations of equipment and machinery are an effective way of boosting investment. Policies which carry out heavy tariffs or need scarce import licenses in order to purchase foreign-made capital equipment are a sure sign that a country won’t get its money's worth out of a given nominal savings share however will instead find that real investment remains low. Certainly many of the most successful developmental states have done the opposite. They have provided large subsidies to fund investment and expansion by businesses which have demonstrated their productivity and competence by successfully exporting and therefore competing on the world market.


Universal education--particularly universal education of girls--pays a two-fold benefit. Investments are more likely to be productive with a better-educated workforce to draw on; therefore investments are more likely to be made. Educated women are likely to want as a minimum as much education for their children and to have relatively attractive opportunities outside the home--and so birth rate is likely to fall.

It is indeed the case that developing countries of the world appear, for the most part, to be going through demographic transition faster than economies of today's industrial core did in the past 3 centuries. Therefore current estimates of the world's population in 2050 are markedly lower than estimates of a decade ago. A decade ago projected global population in 2050 was 16 billion or more; today it is 12 billion or less. This is in part at least because of rapid expansions in educational attainment in today's developing economies.

A high level of educational attainment also raises the efficiency of labor both by teaching skills directly and by making it easier to advance general level of technological expertise. A leading-edge economy with a higher level of educational attainment is likely to make more inventions. A follower economy with a higher level of educational attainment is likely to have a more successful time at adapting to local conditions innovations and inventions from the industrial core of the world economy. How large these effects are at macroeconomic level is uncertain. That they are there nobody doubts.

East Asian economies particularly provide illustrations of how uncorrupt and well-managed developmental states can follow macroeconomic policies which accelerate economic growth and convergence. These economies which have provided incentives to accelerate demographic transition and boost savings and investment have managed to close the gap concerning the world economy’s industrial core faster than anyone would ex ante have believed possible.

Policies for Technological Advance:

Without better technology, increases in capital stock generated by investment rapidly run into diminishing returns. And without improvements in ‘technologies’ of government, organization and education, productivity stagnates.

Somewhat unexpectedly, economists have relatively little to say about what governs technological progress. Why did better technology raise living standards by 2% yearly a generation before though by less than 1% today? Why did technology progress by only 0.25% per year in the early 1800s? Improving literacy, research, and communications and development can help explain faster progress since than before industrial revolution and faster progress in twentieth than in the nineteenth century. Yet as significant a feature of recent economic history as the post-1973 productivity slowdown remains largely a mystery.

Will Governments Follow Good Policies?

That governments can assist in development and growth doesn’t mean that governments will. The broad experience of growth in developing economies--outside of East Asian Pacific Rim, outside of OECD--has been that governments often won’t. Over the past 2 decades many have argued that typical systems of regulation in developing countries have retarded development by:

a) Embarking on ‘prestige’ industrialization programs which keep resources from shifting to activities in that the country had a long-run comparative advantage.

b) Inducing entrepreneurs and firms to devote their energies to seeking rents by lobbying governments in place of seeking profits by lowering costs.

c) Creating systems of regulation as well a project approval which have degenerated into extortion machines for manufacturing bribes for bureaucrats.

Many governments--mainly unelected governments—aren’t that interested in economic development. Giving valuable industrial franchises to nephews of dictator; making sure that members of your ethnic group are in key places to extort bribes; or taking foreign exchange which would have been spent importing productive machinery and equipment and using it in place of buy more modern weapons for the army--these can seem more attractive options. In absence of political democracy checks on a government that doesn’t seek economic development are few.

Furthermore checks on government that do exist may not be helpful. In a non-democracy--or a shaky semi-democracy--there are two probable sources of pressure on government: riots in the capital and coups by the soldiers. Even a government which seeks only the best for its people in terms of economic growth would have to deal with these sources of pressure and will have to avoid coups by soldiers and riots in capital.

Coups by the soldiers are best avoided by spending money on military. Riots in capital are best avoided by making sure that price of food is low and that influential opinion leaders in capital are relatively happy with their material standards of living. So governments find themselves driven to policies which redistribute income from the farms to cities, from exporting businesses to urban customers of imported goods, from those who have power to invest and make economy grow to those who have power to overthrow the government.

If the rulers have the worst of motives then government degenerates into kleptocracy: rule by thieves. If government has the best of motives, it’s still hard to avoid policies that diminish saving and retard the ability to translate saving into productive investment. W.W. Rostov recounts a visit by President Kennedy to Indonesia in the early 1960s; Kennedy talked about economic development and a South Asian Development Bank to provide capital for Indonesia’s economic growth. Indonesia's then-dictator Sukarno's response? “Mr. President, development takes too long. Give me West Irian [province, the western half of island of New Guinea, to annex] instead."

Taken as a group the poor countries of the world have not closed any of the gap relative to the world’s industrial leaders since World War II.


So much thinking about the proper role of government in economic growth over the past 2 decades has tends to conclusions which are today known as neo-liberal. The government has a sphere of core competencies-- maintenance of macroeconomic stability, administration of justice, avoidance of deep recessions, provision of social insurance, some infrastructure development --at which it’s effective. Though there is a large area of potential activities in which governments--or, at least governments that don’t have the bureaucratic honesty and efficiency required for a successful developmental state--are more likely to be destructive than constructive. Thus the neo-liberal recommendation which governments attempt to shrink their role back to their core competencies and thus to deregulate industries and privatize public enterprises. Whether such policies would in fact lead to convergence instead of continued divergence is still an open question.

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