THE MACROECONOMICS OF CONVERGENCE
2 The macroeconomics of convergence The fundamental political and economic goal of national economies is to create and increase social welfare, which requires stable economic growth. One important question is what the main driving forces of development are. Economies that have already had successful growth periods in the past can serve as empirical examples for emerging economies. Development is important not only in terms of economic considerations, but also for the individual. Development, rising standards of living and ‘living as well as possible’ are basic human needs and goals. Comparison with developed economies is important as they are the real examples of an attainable high standard of living. In the history of economics, various growth models were created to examine growth. The common goal of these tools is to describe convergence processes and help understand them. As with any model, these growth models also have strengths and weaknesses. At the same time, the models have often provided a consistent conceptual framework for economists to answer a specific question. The objective of all models is to examine the growth of economies and to explore, analyse and understand the underlying driving forces. Following World War II, by the 1950s, stable economic growth was observed in the world in general and a wealth of data was available for the wider analysis of growth. This period saw the creation and spread of the neoclassical growth theory, which primarily concentrated on the relationship between the factors of production and output of economies, focusing on how much a certain economy was able to potentially produce. This, in turn, depended on the factors of production, without being influenced by aggregate demand. Their main relationship is the so-called production function, which was applied as a general production function for the economy, and which described how much output was achievable from the various combinations of the different factors. As time passed, the models continuously expanded along various concepts. One of them was that, in addition to the traditional capital and labour as factors of production, human capital was also directly included in the production function. The importance of human capital is unquestionable nowadays; most economic progress, innovation and development is ultimately provided by knowledge, and increasing knowledge means sustained economic growth. One key question of growth theory is whether the differences between poor, middle-income and rich countries will ever cease to exist. Based on this approach, two basic types of convergence (absolute and conditional) are distinguished. According to absolute convergence, income disparities between countries will disappear sooner or later. Irrespective of any other factors (e.g. production possibilities, economic policy), economies are heading towards the same level of development in the long run. Based on data from past decades, this theoretical approach cannot be corroborated at all. According to conditional convergence, not every economy is automatically heading towards the same level of development, only ones with similar characteristics. This is exactly what neoclassical growth models claim: over the long term, economies with identical fundamentals will reach the same level of development, irrespective of where they started from. It is important to note here that at the same time the so-called endogenous models do not contain convergence to the developed economies, as there is no mechanism in the model that would decelerate a developed economy. This means that the ceasing of initial income disparities is not guaranteed on the basis of these models. According to our opinion, a more balanced approach describes the convergence characteristics. In this case, not only consider the basic fundamentals of the economy, but also the current level of development. In this type of path dependency, different stable situations arise at different levels of development. If an economy starts from a lower level of GDP per capita, but its growth gradually cools off, it becomes trapped. What state it arrives at also depends strongly on the initial income level. In the case of lower-income economies, it may even mean getting stuck in the poverty trap. In their case, it is important to set up an adequate institutional system, integrate into global trade and adopt more developed foreign technologies. In the case of Hungary, it is more important to compare the middle-income trap and the state of equilibrium of developed economies, which is discussed in more detail in this chapter. A middle-income economy can transition over to another convergence path towards developed economies with significant technological advances, innovation and substantial human capital development.
GROWTH REPORT • 2018
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