What is the Catch-Up Effect?

The catch-up effect is a theory speculating that poorer economies tend to grow more rapidly than wealthier economies, and so all economies will eventually converge in terms of per capita income. 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.

Key Takeaways

  • The catch-up effect refers to a theory speculating that poorer economies will grow more rapidly than wealthier economies, leading to a convergence in terms of per capita income.
  • It is based on, among other things, the law of diminishing marginal returns, which states that a country's returns on its investment tend towards becoming less than the investment itself as it becomes more developed.
  • Developing nations can enhance their catch-up effect by opening up their economy to free trade and developing "social capabilities," or the ability to absorb new technology, attract capital, and participate in global markets.

Understanding 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 be worth less than the initial investment itself. Each time a country invests, they benefit slightly less from that investment. So, returns on capital investments in capital-rich countries are not as strong as they would be in developing countries.

Poorer countries are also at an advantage because they can replicate the production methods, technologies, and institutions of developed countries. 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

However, 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.

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. 

According to a longitudinal study by economist Jeffrey Sachs and Andrew Warner, national economic policies on free trade and openness play a role in the catch-up effect's manifesting. 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%.

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.

Example of 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.

For example, the Japanese economy's growth rate between 1960 and 1978 was 9.4%, while the U.S. and U.K. had growth rates of 3.1% and 2.4%, respectively. By the late 1970s, when the Japanese economy ranked among the world's top five, its growth rate had slowed down to between 2% to 2.7%.

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 and followed by a more conservative (and declining) growth rate as the economy transitions from a developing stage to that of being developed.