Factors that influence convergence.
Interwar period: 19181939
Postwar period: After WWII
• Background to the story:
o Focus: 18701914
• We talked about last time: Theme through the year: economic policy matters,
institutions, interwar period.
• Trade liberalization seemed to be good for economic growth and consistently
o What distinguishes interwar period to postwar period.
• Competition is good. Everything that gets into the way of competition seems to
have negative effects on economic growth.
• As much as possible, reliance on the market as an allocated mechanism seems to
have a positive effect on economic growth and welfare.
• Globalization in 18701914
o This period seems to have been a period of very rapid globalization
(growth of international trade, huge movements of people and capital,
equal to the post WW2 period).
o Dramatic international interdependence.
o Why people have been looking at this is because there is some belief that
their lessons in the past that we can learn to help inform the present.
• Issue of convergence
o In the Atlantic economy: The economy of Western Europe which overlaps
into the Eastern and to Southern Europe.
o New world: Focus on America and Canada. (Countries that promote
• We are going to look at migration, international trade, international capital flows
and technology transfer. (Forces that cause convergence)
• What is convergence
o Generally, economists mean the tendency for GDP per capita in the group
that you are focusing on (Atlantic economy) to converge towards the same
o If you have 2 economies, one has GDP per capital lower than the other and
they are both expanding through time, the notion is that the poorer (lower
GDP/capita) will at some point for some period of time expand/grow more
rapidly than the wealthier economy so that the poorer catches up with the
wealthier. Everything else being equal, theoretically this is true.
o Real wage convergence has the same argument and the theoretical
foundation of the argument is the same as GDP per capita but the
measurement is different. • Conditions under which this convergence in the Atlantic economy would take
o Neoclassical growth model: Key is growth. Looking at change over time.
(don’t have to worry about this) Q = Af(K,L) or q = Af(k)
(everything divided by labor, easy way to handle this equation, no
• Output is related to two inputs and scalar (vector) of
technology that influences the way in which we combine
our inputs to produce our outputs.
• Pretty much describes everything we need to know about
how output is determined.
• A: Technology, productivity.
Growth depends on the rate of population expansion, savings and
investment rate, and technology. (key to growth)
Labor (L): In its crudest form, what’s going to determine the size
of your labor force? Population growth.
K (capital stock): What influences the change in our capital stock?
The amount of investment and savings in some very crude way, the
size of our capital stock.
The efficiency of productivity of labor force combined with capital
stock will be influenced by technology.
• Back to the convergence story
o Roughly speaking, you can identify groups of economies with the same
population growth, saving rate and have access to utilize technology. You
should expect, over time, to achieve convergence. The real wage should
converge. (The story that lies behind a work of H. Williamson.)
• L: labor. Somehow we want to think of labors as educated or what economists call
human capital. Education is an important feature in turning labor input to
something sophisticated. Education is not some exogenous feature.
• Learning by doing has to do with this Neoclassical model: The more you do
something, the better you get at it, the more rapid you make growth.
• Time is missing in the model. How long does all this convergence take? When
should you expect convergence to take place?
• Why are there differences in different economies? Starting at 1870, there are some
countries/economies that are clearly richer than others. Why? How do we get to
that situation? The professor can tell stories but can’t answer.
• We are going to take as given that there are differences in these economies.
• Economies that have a larger k (capital to labor ratio), where workers have more
capital resources to work with, tended to be richer, have a higher real wage,
higher GDP per capita. Vice versa.
o If that’s true and we live in a world of diminishing marginal returns, would
it also be true that the greater return on capital on a new investment (introduction to new capital) will be higher in the poor country than in the
richer country? Yes.
o Why is it that the case that capital doesn’t always seem to flow from the
richer country to the poorer country? We need to introduce risk
assessment. In the poorer countries the risk is higher so the capital doesn’t
always flow to the poorer country even though there is a greater return on
o Putting patents to one side, technology is one of those almost public
goods. It doesn’t take too long to figure technology out and use it. It
travels fast as long as you have an economy that is able to adapt.
o Propositional statements: (significant consequences to growth of Atlantic
By and large, capital (risk adjusted) will tend to flow towards the
relatively capital scarce areas because the return is higher.
Labor will tend to flow from the areas where the wage rate is
relatively low to areas where the wage rate is relatively high.
• What other input would matter in this period? Land/Resources. Agriculture in the
new world was a hugely important sector and has influenced everything that
• You would almost want to combine capital and land but it’s not a perfect
• Capital flow story
o Problem: In a world, where at least in short run, there are diminishing
marginal returns to a factor. In the long run, you can change the size of
factory and stuff.
o Take two economies. One has a lot of labors and resources, not much
capital. The other has a reasonable amount of resources, labors and lots of
capital. At any moment in time, it makes sense that the return on a unit of
capital (call it, financial capital) invested in a country that doesn’t have
much capital will yield a larger capital return than one that has a lot of
o If that’s true, why doesn’t capital flow like mad from the rich country to
the poor country?
o Ex. You have some savings you have accumulated. Two choices:
becoming a part owner of BMO (7% return on investment long term,
including dividends, capital gains) or Bank of Congo, lots of resources and
labors in the jungle. (50% or 60% return