How valid is the claim that the twentieth century experience of economic development was ‘Divergence: Big Time’?

John Stuart Mill wrote of late nineteenth century capitalism that “[h]itherto it is questionable if all the mechanical inventions yet made have lightened the day’s toil of any human being.” As Brad DeLong (2008) explains, as late as 1871 (the last edition of Political Economy issued in Mill’s lifetime) Mill still did not think it accurate to substitute “hitherto” for “formerly.” The same cannot be said of the economic development of the twentieth century; the toil of the poorest human beings has been lightened considerably and, although there remains ambiguities, by many measures the poor world has converged on, not diverged from, the rich world.

Economic development is a term which can be defined in many ways. The most common, and straightforward, of which is a simple measurement of Gross Domestic Product GDP per capita. The historical GDP data used by Lant Pritcett (1997) led him to conclude that the growth rates of poor countries have not kept up with, nor converged on, the growth rates of rich countries over the last century leading to “Divergence, Big Time” in per capita income. Using Pritchett’s figures it is hard to argue that the world did not seen divergence in economic development in the twentieth century. With a theoretical lower bound on income at around $250 at purchasing power parity and the distribution of per capita income today, income and growth rates must have diverged across the last 150 years. From 1870 to 1990 the average absolute gap in incomes of all countries from the leader had grown from $1,286 to $12,662, an order of magnitude (Pritchett, 1997, pp 9-12).

However, the data used by Pritchett is not definitive; although both inequality within countries and inequalities between countries have increased it does not logically follow that inequality between all individuals has increased, because the first claim refers to individuals and the second refers to the per capita income of countries (Sala-I-Martin, 2006, pp 382-383). Even if the wealthiest have increased their income most quickly in India and China, by taking into account the increases in income at the bottom of the scale in these countries the “Divergence, Big Time” identified by Pritchett in the latter half of the twentieth century disappears, rather we have “Convergence, period!” (Sala-I-Martin, 2006, pg 392). Over the whole of the twentieth century, income inequality, as measured by the Gini coefficient, remained somewhat higher in 2000, at 0.637 (Sala-I-Martin 2006, pg 384), than it was at the end of the nineteenth century, between 0.588 and 0.610 (Bourguignon and Morrisson 2002, pg 731). There are problems comparing Gini coefficients constructed from two different data sets but the rough agreement between Pritchett and the data from Bourguignon and Morrisson (2002) and Sala-I-Martin (2006) reinforce the finding.

Although there is evidence that the world has seen some convergence in per capita income in the latter half of the twentieth century, the results necessarily remain ambiguous because large amounts of data are of uncertain quality. However, other measures of economic development show distinct and unequivocal signs of convergence. The most important of these is not per capita income but the poverty rates of the rich and poor world. By this measure the 20th Century has been a massive success, particularly in China and India, the worlds’ two most populous countries. Bourguignon and Morrisson offer an estimate for global poverty rates in 1890 of 71.7% and for 1910 of 65.6% (2002, pg 731).[1] Although development has been unequal throughout the twentieth century the reduction in poverty in the last century has been truly transformative for billions of people. Even in the later part of this century the decline in absolute poverty continues, by Chen and Ravaillon’s calculations from 1981 to 2001 “[e]xpressed as a proportion of world population the decline is from 33% to 18%” (2004, pg 151).

In fact, this may be an underestimate for the progress made in eliminating poverty as Sala-I-Martin argues that by properly aggregating the data by taking into account the population size of poor countries the “poverty rate [of $1 a day] in 2000 was 7 percent.” In fact, despite a near quadrupling of world population in the twentieth century, extreme poverty fell in by both relative and absolute measures from 1,127.7 million people (Bourguignon and Morrisson 2002, pg 731) to 1089 million people (Chen and Ravaillon 2004 pg 153) or 322 million people (Sala-I-Martin 2006, pg 374). Even if you find Sala-I-Martin’s data somewhat overcooked, the trend is undeniable, economic development in the twentieth century has seen massive convergence, not divergence, for one of the most important measures.

Other measures also lend credence to the idea that the twentieth century was one of convergence in economic development, not divergence. The most high profile of these complementary measures is the Human Development Index which measures income, life expectancy and educational standards. HDI has shown significant convergence since 1950 (Crafts, 2004, pg 6) between all regions, even those which have experienced strong divergence in per capita income, like sub Saharan Africa. HDI is not the only non-monetary measure of wellbeing which can be quantified and compared. A range of other indices such as health, mortality and even Beer production (Kenny, 2005, pg 8) strongly suggest a convergence in wellbeing across the world. The most basic measures of wellbeing such as life expectancy and child mortality (which combine with other measures for the composite HDI measure) show convergence. In the middle of the 20th Century infant mortality began to decline in the developing world with this change was a concomitant increase in life expectancy (Deaton 2004, pg 28).

It is safe to argue that we have seen a convergence of many non-GDP measures of economic development. However, this aggregate convergence clouds a lot of regional differences. Even within one continent we see massive disparities in performance. Sub Saharan Africa has been ravaged by the AIDS epidemic and some have seen their life expectancy reduced to levels last seen in the 1950s (Deaton, 2004, pp 30-31). In contrast North Africa has seen rapid increases in life expectancy. The latest World Development Report (2010) highlights that Algeria, Tunisia and Morocco were some of the most successful states for improving their HDI scores, despite both relatively low GDP growth and the health disaster to their immediate south. Were “Divergence, Big Time” to be really true, it could perhaps better be used as a description for differences between poor countries than for differences between rich and poor countries.

In conclusion, while the penalties for getting institutions and policies wrong has been very high in the twentieth century in terms of accelerating GDP growth (Crafts, 2004, pg 7), other indicators have been broadly positive for economic convergence throughout the last century. The divergent average growth rates developing economies enjoyed (or suffered) between 1960 and 1990 highlights the high stakes of getting economic policy right or wrong; the worst states shrunk by an average of 2.7% per annum, while the best grew by 6.9% per annum (1997, pg 14).

However, by the end of the century, very fast growth in two very large and very poor countries, India and China, had gone some way to reversing this divergence in growth (Sala-I-Martin 2006). Although it is unclear to what extent total per capita income had diverged by the end of the twentieth century, it is fair to conclude that a claim of “Divergence, Big Time” is difficult to substantiate for anything but a very narrow reading of the term “economic development.” In fact, the latest figures from the IMF’s World Economic Outlook support this view. GDP growth at the end of the last century was roughly similar in both developing and developed worlds, 2.8% and 3.8% respectively. The last decade has seen significantly stronger growth in the developing world and this trend is predicted to continue, with growth of 2.7% predicted for 2011 for the developed world and 7.1% for the developing (IMF, 2010, pg 177).

From the outset GDP was never intended as the sole criterion of economic development, even Simon Kuznets said of his measure that “the welfare of a nation can scarcely be inferred from a measurement of national income”. The data on life expectancy, infant mortality and educational achievement all corroborate Kuznets’ 70 year old caveat. As well as the above indicators, the most important measure of economic convergence we have, extreme poverty, has been converging for most of the twentieth century. Whether we use Sala-I-Martin’s (2006) optimistic data or Chen and Ravaillon’s more modest calculations (2004), it is clear a smaller proportion of the earth’s population than ever before is living in extreme poverty. Although economic development still remains patchy and uneven across the different regions of the globe it is fairer than ever to conclude that the world has seen anything but “Divergence, Big Time.”

Were later industrialisations systematically different from earlier?

The splitting industrialisations into “late” and “early” varieties owes a lot to Alexander Gerschenkron (1962). He argued that industrialisation would not occur spontaneously or quickly  in backwards countries, thus later industrialisations would be different to earlier ones. To overcome these deficiencies he argued that i) institutional substitutes would have to be created and that ii) later industrialisers would need qualitatively different substitutes to earlier industrialisers. In contrast, Jones (1988) argues that growth occurs naturally on the removal of restraints; hence, later industrialisers would appear similar, in that they would industrialise once their poor institutions are removed. Of course, industrialisation cannot be thought of too broadly otherwise our question becomes useless. That China now makes iPods and Germany then made railway tracks should not lead us to argue that their industrialisations are therefore irreconcilably different. Technology changes through time and sets an upper limit on a society’s potential wealth (North, 1996, part II), it is the convergence on a contemporary upper limit which we should examine. Institutions play a dominant role in prescribing the incentives affecting how individuals and organisations behave (North, 1996), the structure of these institutions in industrialising countries must be the focus of our study.

Arguably, the first state to begin to industrialise was Sung China (Jones, 1988, ch 4). This is somewhat problematic for Gerschenkron’s theories on late industrialisation, as it exposes the limits of his linear pattern for industrialisation. An alternative theory suggests that the removal of obstacles to growth, for example the removal of self reinforcing rent seeking (Murphy et al, 1993), may offer a better schematic for successful industrialisations. While some of Gerschenkron’s work on Europe has been questioned by the later historiography his general approach “still seems a fruitful way of approaching the problem of European industrialisation” (1991, 24).

Gerschenkron argued that there are a number of identifiable trends in the institutions of late industrialisers which set their experience apart from earlier industrialisers (1962, 353-354). Institutional substitutes appear to have operated in a number of developing countries. Active industrial policies in Germany (Chang, 2002, pp 32-35) and America (Chang, 2002, pp 24-32) have been credited some with their industrial success in catching up and overtaking England in the 19th Century. Amsden (1988, pp 143-144), citing data from East Asia, argues further that industrial policy has been different depending on the context of industrialisation.

However, the importance of avoiding rent seeking remained central in the experience of all industrialisers, whether late or early. For example, while the institutions of South Korea certainly seem more activist than those of early modern England, one thing which unites the two is the importance of evading rent seeking activities. While rent-seeking in Latin America helped the continent fall behind the rest of the world (North et al, 2000), the South Korean government remained “cold-blooded” in allowing poorly managed firms to fail where necessary. Furthermore, some of the evidence from industrialising Europe suggests that there is continuity between many different industrialisations. In Imperial Russia, before the 1850s, the state’s policy sought to “impede rather than promote economic development,” (Gregory, 1991, pg 77), a pattern closely matching Jones’ own description of a state of “greed and lethargy… sufficient to smother the prospects of re-growth” (1988, pg 146).

Once again, in this case the impetus to growth rests more on the elimination of rent-seeking growth impeding institutions than on the creation of Gerschenkronian institutional substitutes. One of the reasons that there is a continuity in the institutions of industrialising countries is the damage done by rent seeking, and the improvement in growth prospects that results in rent seeking’s elimination. Murphy et al. explain that rent seeking can put “a severe tax on innovative activities and thereby move resources into established production or the public rent-seeking sector. The result would be a sharp reduction in economic growth.” (1993, pg 413) There are are therefore large returns to the elimination of rent-seeking.

However, there are a number of differences identifiable in the institutions of later industrialisers than in the earlier industrialisers of the North Atlantic. Alice Amsden argues that there are unique institutions adopted in South Korea (and other East Asian “Tiger” economies) which aided its industrialisation. In her words, “Korea is evidence for the proposition that if and when late industrialization arrives, the driving force behind it is a strong interventionist state.“ (1988, pg 55) Furthermore, she argues that this modern, or post-war, interventionist state has behaved in a qualitatively different manner to states in the past.

“The First Industrial Revolution was built on laissez-faire, the Second on infant industry protection. In late industrialization, the foundation is the subsidy—which includes both protection and financial incentives. “ (1988, pp 143-144)

Amsden may have resorted to hyperbole in the above quotation in order to downplay the continuity in the success of industrialising states in adopting institutions which avoid rent-seeking, however the pattern of industrialisation does appear to roughly match her sentiment. Similarly, Wade approvingly cites Krugman and Stiglitz expressing similar sentiments to Gerschenkron that the financial system best suited to industrialising countries does not conform to an ideal type, but rather needs to be suited to the country’s individual circumstances (2003, pg 368). There do appear to be notably differences in the institutions adopted by later industrialisers even if there remain significant continuities also.

While the institutions which foster (or fail to stifle) growth may appear somewhat similar through time as examined above, there remains debate on the extent to which later industrialisers rely on past technological advancement compared with earlier industrialisers. Amsden has argued that South Korea’s industrialisation proceeded through a process of “Industrializing through Learning.” In this process imported technologies allow a country to industrialise by leapfrogging on the achievements of the already developed. She claims that the “First Industrial Revolution in Britain… [had] the distinction of generating new products and processes,” whereas the Korean did not, at least initially (Amsden, 1988, pg 3). In fact, as Mokyr argues, the British Industrial Revolution relied a great deal on imported technology (1993, pp 36-37). The experience of industrialisation often, if not always, involves the adoption of best practice techniques from abroad, the technological “trade deficit” may have been greater in South Korea than in England, but both relied on external invention and innovations to varying degrees.

While institutions and technology remain important, geography play a very real role in shaping economic performance (see Kruman 1991; Diamond 1997; Harman, 1999 esp. part 1) . As Sachs (2003) argues, even under conditions where either Jones’s “bad” institutions have been removed, or where Gerschenkron’s enlightened state has created the “good” institutions, there may still be large barriers to economic development. This geographic constraint is one reason to argue firmly that “late” industrialisers will always be different, from past industrialisations and from one another. Likewise, South Korea’s industrialisation took place despite its domestic paucity of natural resources (Amsden, 1989, pg 11), England may not have industrialised were it not for abundant supplies of coal (Allen, 2009).

With a world as geographically varied as our own and with the swift technological progress of the last two centuries there will always be differences in economic experience across space and time. However, as Karl Polanyi (2001 [1944]) argues, all industrialisation constitute a “Great Transformation” for the societies and people involved; in this broad way all “late” and “early” industrialisations are, in fact, very similar. There is evidence that this similarity extends deeper, the institutions adopted in different countries during industrialisation bare striking similarities given the disparate locations, cultures and technologies involved. The removal of institutions which encourage rent-seeking or actively seek to discourage growth, such as those followed in Imperial Russia, seem vital for industrialisation. For example, even where institutions appear different to those in earlier industrialises, compare South Korea’s industrial policy with Germany’s, the importance of avoiding rent seeking remains paramount. However, the focus on removing bad institutions should not lead us to ignore the very real institutional differences which appeared in later institutions. The financial arrangements present in England, Germany and South Korea certainly differed in significant respects. However as Acemoglu and Johnson (2003) argue secure property rights have far stronger positive effects on growth than do the different forms of financial intermediation practised in each country. Therefore, although it is possible to identify significant differences in later industrialisers I do not think it is necessary to label these differences systematic.

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