My most recent post tried to warn against what I consider a wrong belief, namely that poorer countries invariably will catch up with richer ones. It is also a dangerous belief since it might lead to complacency among policy makers – much as I think one could, at least partly, characterize the situation during the boom years where some seemed to believe that income convergence was just a question of time.
Allow me here just three examples of a) why convergence is not automatic and b) why it may not happen at all.
First example. Many of us will believe that spending on research and development (R&D) is crucial for a rich society. Unfortunately, as Figure 1 shows, Latvia has an awful record in terms of this indicator.
Figure 1: Spending on research and development (R&D), euro per inhabitant, 2011
Note: Greece is missing (no number available since 2006)
Just a casual glance reveals how R&D spending is highly correlated with GDP per capita. OK, spend more on R&D, you might say but one thing is the spending, another is whether the country has a big enough stock of researchers, actual and potential, to transform R&D spending into useful inventions etc. I would also be interested in why Estonia, although way behind the Nordic countries is so far ahead of Latvia.
This may be partly explained by my second example. Most of us would believe that the more innovative a nation is, the better it is for GDP per capita. In that case Latvia does not look too good as the EU’s innovation scoreboard for 2013 tells us. Whereas a (simple) solution to low R&D spending is to increase that spending it is not so obvious a) how one increases Latvian innovation capacity or b) why it is so low. Is the education system to blame? Most likely it is one of the reasons, but what exactly is then wrong?
My third example is corruption. Here the economic reasoning would be that more corruption leads to poorer resource allocation, deters investment etc. and thereby has a negative impact on GDP per capita.
Data seems to suggest that this is correct. In Figure 2 I plot the score from Transparency International’s Corruption Perceptions Index (the higher the score, the less corrupt a country is perceived to be) against GDP per capita and a positive correlation is clearly present.
Figure 2: Corruption perception index score against GDP per capita, 2012, European Union. Latvia is the red dot.
Source: Eurostat and Transparency International
Note: Luxemburg excluded for the usual reason (inflated GDP figure due to many non-residents working in Luxemburg).
Latvia has improved quite substantially over the years (the two countries with really poor scores are Greece and Italy by the way) but there is a long way to the top scorers (the Nordic countries). Is it even realistic that such a gap can be closed? Here many argue that the Nordic countries have a culture of very little corruption, a culture that cannot easily be adopted, if at all, and this gives them a significant advantage forever. Where one can point at ways to reduce corruption in Latvia (having KNAB is a simple but very good example) it is most likely very difficult if not impossible to really root out a culture of corruption.
Altogether, as mentioned in the beginning, just three examples of why it is naïve at best to believe that income convergence will ‘just’ happen. But also examples of that policy making has a very important role to play in improving this situation.
Morten Hansen is Head of Economics Department at Stockholm School of Economics in Riga