Mitchell: With good policy, poor nations can succeed

Daniel J. Mitchell

 

The theory of “economic convergence” is based on the notion that poor nations should grow faster than rich nations and eventually achieve the same level of development.

This theory is quite reasonable, but I’ve pointed out that decent public policy (i.e., free markets and small government) is a necessary condition for convergence to occur.

The link between good policy and convergence explains why Hong Kong and Singapore, for instance, have caught up to the United States. And the adverse effect of bad policy is a big reason why Europe continues to lag.

Moreover, it also explains why some nations with awful policy are de-converging.

Today, let’s look at convergence between Western Europe and Eastern Europe.

A new study of income convergence in central, eastern and south-eastern Europe published by the European Central Bank finds common characteristics in fast-converging economies in that region. They include: “strong improvement in institutional quality and human capital, more outward-oriented economic policies, favourable demographic developments and the quick reallocation of labour from agriculture into other sectors.”

The study is filled with fascinating data (at least if you are a policy wonk). The good news, at least relatively speaking, is that all nations are catching up to Western Europe.

But the report notes that some are catching up faster than others. The authors write:

“The developments were … heterogeneous within CESEE countries that are EU Member States. Some of them (the Baltic States, Bulgaria, Poland, Romania and Slovakia) experienced particularly fast convergence in the period analysed. At the same time, other CESEE EU Member States found it hard to converge … In fact, GDP per capita in Croatia and Slovenia diverged from the EU average after 2008 … Given these heterogeneous developments, it appears that while in some CESEE countries the middle-income trap hypothesis could be dismissed (at least given their experience so far), in others the signs of a slowdown in convergence after reaching a certain level of economic development are visible.”

The report does a great job of documenting relative levels of prosperity over time. And it also has a thorough discussion of the characteristics that are found in fast-converging countries.

But there’s not nearly enough attention paid to the policies that promote and enable convergence. Why, for instance, has there been so much convergence in Estonia and so little convergence in Slovenia?

So I’ve tinkered with their analysis by adding each nation’s ranking for Economic Freedom of the World. Lo and behold, a quick glance shows that higher-ranked nations have enjoyed the greatest degree of convergence.

Here are some specific observations.

The Baltic nations are the biggest success stories of the post-communist world. Thanks to pro-market reforms, they have enjoyed the most convergence.

Romania and Slovakia also experienced big income gains. Romania is in the “most free” group of nations and Slovakia was in the “most free” group until a few years ago.

Poland has enjoyed the most convergence since 2008. Not coincidentally, that is a period during which Poland’s economic freedom score climbed from 7.00 to 7.27.

Bulgaria also merits a positive mention for a big improvement, doubtlessly driven by a huge improvement (from 5.55 to 7.41) in economic freedom since 2000,.

Sadly, Slovenia and Croatia have not experienced much convergence, which presumably is caused in part by their comparatively low rankings for economic liberty.

To be sure, there’s not an ironclad relationship between a nation’s annual score and yearly growth rates.

But, over time, poor nations that want convergence almost certainly will not get the necessary levels of sustained strong growth without high scores for economic liberty.

Daniel J. Mitchell, chairman of the Center for Freedom and Prosperity, is on the Editorial Board of the Cayman Financial Review.

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