Catch-Up Effect

What Is the Catch-Up Effect?

The catch-up effect is a theory that all economies will eventually converge in terms of per capita income, due to the observation that poorer economies tend to grow more rapidly than wealthier economies. In other words, the poorer economies will 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 a couple of key ideas.

One is the law of diminishing marginal returns — 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, they benefit 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.

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 1.6% gross domestic product (GDP) growth in 2019, versus 3.6% for middle-income countries and 4.0% GDP growth in low-income countries.

Poorer countries may also be able to experience more rapid growth because they can replicate the production methods, technologies, and institutions of developed countries. This is also known as a second-mover advantage. Because developing markets have access to the technological know-how of the advanced nations, they often experienced rapid rates of growth.

Limitations to the Catch-Up Effect

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.

Economist Moses Abramowitz wrote about the limitations to the catch-up effect. He said that in order for countries to benefit from the catch-up effect, they would 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. 

The adoption of high-quality institutions, 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 on 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, while 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%.

Another major obstacle to 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. According to the World Bank figures for 2019, more developed countries (OECD members) experienced 0.5% 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 between 1960 to the early 1980s.

Even as Japan's economy powered forward, the United States' 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 followed a similar trajectory, displaying rapid economic growth during the initial years of their development, followed by a more moderate (and declining) growth rate as the economy transitions from a developing stage to that of being developed.