Economic Integration and Income Convergence: Not Such a Strong Link?

We would expect that the process of globalization between 1870 and 1914 and subsequent disintegration of the world economy during the interwar period would have led first to income convergence and then to income divergence between the participating countries. But in fact we find stronger evidence for income convergence during the interwar period than during the first globalization. Similarly, the average level of import protection in the world cannot be shown to have either helped or hampered convergence. The evidence for trade-induced convergence is therefore weak. I. Economic Integration and Income Convergence ONE of the main arguments in favor of economic integration is that, in addition to the fact that it raises incomes of all the participants, it helps the poorer ones proportionally more. This is the view that has informed much of the recent literature on income convergence— whether of the conditional or of the unconditional variety. It is a view that has a long and distinguished pedigree in economic theory, and is supported by a fair amount of contemporary evidence. In theory, increased trade raises real incomes of all participating countries. But access of a poor country to superior technology embodied in goods or capital, or simply through intellectual exchange allows greater productivity gains in the poor country, that is further away from the production possibility frontier. Free capital flows will also help the poor country more, by bringing in new technology and by allowing it to tap into the larger savings pool of a rich country. Finally, migration too should contribute to convergence in incomes, as people from poor countries migrate to the rich. Thus, greater integration— reflected in closer sharing of information and technology (knowledge spillover), more trade, greater capital flows, and labor migration—should help reduce the gap between the poor and the rich. This view is behind a score of empirical papers on income convergence. The earliest papers on the convergence among industrialized countries over the period of a century beginning in 1870 were by Baumol (1986) and Baumol and Wolff (1988). The convergence literature continued with papers on convergence among OECD countries (Barro and Sala-i-Martin, 1992) among European Community members (Ben-David, 1993), among individual U.S. states (Barro and Sala-i-Martin, 1992), among European regions (for example, Cannon & Duck, 2000, p. 418), among Spanish provinces (Goerlich & Mas, 2001), and so forth.1 In all such cases, greater economic integration among units (countries or regions or states) was shown to have resulted in income convergence—as we would expect from economic theory. More recently, somewhat greater attention was paid to the historical process of income divergence (Maddison, 1995, 2001; Pritchett, 1997), but that fact did not detract from the mainstream belief in a strong causal link between economic integration and income convergence. This is because the Great Divergence (so named by Kenneth Pomeranz) was due to the discrete technological breakthroughs of the Industrial Revolution, while the fact of income divergence among the countries of the world over the last 20 years (see Milanovic, 2005, chapter 4; Kanbur and Lustig, 1999, table 2) was explained away by the claim that the slow-growing (or declining) countries were precisely those that did not integrate.2 The only shadow was cast by those who did not regard the Great Divergence as something that occurred— for whatever institutional or geographical reasons—in one part the world (the North) and then (slowly) spread to the rest, but held that the growth and industrialization in the North were linked with the decline and deindustrialization in the South. Under the latter hypothesis, it is clearly integration that is the cause of the South’s decline and therefore of the divergence of incomes.3 That view is expressed in Krugman (1991), and was recently summarized by Baldwin and Martin (1999, p. 7): At a time before the Industrial Revolution, they write, “regions are initially identical, so the question which region takes off is a matter of happenstance. Whichever region edges ahead initially, call it North, finds itself in a virtuous circle. Higher incomes lead to a larger local market in the North and this in turn attracts relatively more investment to the North. Of course, the higher investment rate leads to a growing market-size gap and the cycle restarts. . . . As the North experiences this stylized industrial revolution, Southern industry rapidly disappears in the face of competition from Northern exports. In a self-generating process, the North specializes in industry and the South in primary goods.” Received for publication December 12, 2003. Revision accepted for publication September 13, 2005. * Development Research Group, World Bank and Carnegie Endowment for International Peace. I am grateful to Prem Sangraula for excellent research assistance. I am grateful to Michele Alacevich, Joe Ferrie, Mansoob Murshed, Martin Ravallion, Maurice Schiff, Thomas Pogge, Bernard Wasow, two anonymous referees, and participants at Northwestern University Economic History seminar for very helpful comments. The views expressed in the paper are author’s own, and should not be attributed to the World Bank, Carnegie Endowment, or its affiliated organizations. 1 See also the review of findings in Barro and Sala-i-Martin (1995). 2 For the most recent manifestation of such a view see the World Bank’s report on globalization (2002). 3 Even if the South’s decline (see Bairoch, 1997, vol. 2, pp. 549, 576, 648; also Bairoch, 1989, p. 238) may not be viewed as the cause of the Northern success. On a more radical note, Frank (1998) argues that the South’s decline helped the North’s advance. The Review of Economics and Statistics, November 2006, 88(4): 659–670 © 2006 by the President and Fellows of Harvard College and the Massachusetts Institute of Technology So, we see that it is at least possible for economic integration to lead to a decline in incomes in a part of the world and/or to divergence. The introduction of increasing returns to scale in the context of neoclassical or endogenous growth models (for a review see Easterly & Levine, 2001) makes this a more realistic possibility. A similar point is made by Rodriguez and Rodrik (2000), who, based on numerous empirical evidence and reruns of equations originally estimated by various authors, argue that economic integration and convergence are orthogonal, and find that convergence among the future European Community countries continued during the interwar period. However, this possibility is not very seriously contemplated by many economists. The finding of income convergence among the club of rich countries (western Europe and its offshoots—to use Maddison’s terminology) during the earlier period of globalization 1870–1913 provides empirical support for the mainstream view.4 The well-documented post–World War II convergence in incomes among the OECD countries [Barro and Sala-i-Martin (1992, p. 244) and, more recently, Maudos, Pastor, and Serrano (2000), Li and Papell (1999), de La Fuente (1998), and Tsangarides (2001)] presents a further corroboration of the hypothesis. Then, following these results and theoretical predictions, we would expect the period 1919–1939—the period of retreat from globalization—to be characterized by increasing income gaps between the countries. And indeed, Lindert and Williamson (2001, p. 13) write: “Real wages and living standards [my emphasis] converged among the currently industrialized countries between 1850 and World War I,” and then, for the interwar period, “. . . there was no period when divergence between countries was more ‘big time.’ We do not yet know how much of this should be attributed to the great depression, two world wars, anti-global policies and other forces” (p. 19).5 Lindert and Williamson neatly summarize their results in a table where the period 1914– 1950 is described as the period of retreat from globalization, which widened (notice the causality) the gaps between nations. Foreman-Peck (1998, p. xxiii), in the introduction to an excellent compendium of texts on historical foundation of globalization, summarizes the interwar period of deglobalization: “[b]etween the wars, trade migration and currency movement impediments became far more serious, setting in train deglobalisation and divergence.” Williamson (1996, p. 278) also writes, “I will by inference also suggest that convergence stopped between 1914 and 1950 because of deglobalization and implosion into autarchy,” and “an anticonvergence regime intervened, which stopped convergence between 1914 and 1950” (p. 281). But, if we look at the data, was this really the case? II. What Happened to Income Convergence between