Catch-Up Effect

What is the 'Catch-Up Effect'

The catch-up effect is a theory speculating that poorer economies will tend to grow more rapidly than wealthier economies, and so all economies in time will 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.

BREAKING DOWN 'Catch-Up Effect'

The catch-up effect, or theory of convergence is predicated on a couple 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.