Catch-Up Effect in Economics

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After World War II, it took only a couple of decades for once-devastated countries like Japan and West Germany to emerge as economic powerhouses. A theory that was used to explain this was the catch-up effect, which literally means that poorer economies can quickly catch up with richer ones.

Central to the catch-up effect is the law of diminishing marginal returns. This is something that applies to a single business and a national economy just the same: an initial investment of capital can have a large effect on profit and productivity, however, the more you invest the less the result will be.

TL;DR (Too Long; Didn't Read)

Catch-up effect definition (Economics): A theory that states that poorer developing economies can grow faster compared to richer economies and that their income levels per person will eventually converge. As such, this is also known as the theory of convergence.

Catch-Up Effect Economics: Contributing Factors

Poorer nations have the ability to reproduce the production methods that were developed by richer nations. They can also take advantage of policies, technologies and institutions that were tested, tried and refined by their richer neighbors. A manufacturer, for example, doesn't have to reinvent the modern assembly line or reinvent robotics. It merely needs to adopt what other companies have already perfected.

Another factor in this theory is the role of international trade. If a developing nation opens itself to free trade agreements with other countries, it has access to the same global markets that developed countries do.

Similarly, the human capital effect can help a poorer nation accelerate its economic growth. Essentially, this means that investing in education increases the production of a workforce, something that today can be done much more easily than in previous decades due to online education and the vast amount of knowledge accessible online.

An Example of the Catch-Up Effect

Even a small influx of capital in a developing economy can make a huge difference. Consider how much capital an American manufacturing company may need to increase revenue by just 10%. This could involve millions of dollars in new equipment, new facilities and new hires.

Compare this scenario to an entrepreneur in a village in a developing nation, walking five miles to the market each day to sell milk and walking to get water for her family and livestock. An investment of $200 for a bicycle would give her an enormous leg up. In fact, according to World Bicycle Relief, this would increase her carrying capacity by 500%, increase her milk deliveries by 25% and increase her revenue by 23%, all from a single bicycle.

The Role of Technology in Developing Economies

Another large part of the catch-up effect theory has been the role of technology. Essentially, the theory states that a poorer economy with businesses that invest in new technology can leapfrog over industrialized nations that use older technology.

One would be hard-pressed to find a real-life example where this has been the case. There are few, if any, examples of a richer country not having the resources to invest in the newer technology that would be available to a poorer country. If anything, richer nations have access to new technology before poorer nations do. This has been the case with computers, internet access and even more recent tech, like 5G wireless.

All told, there has been a great deal of debate in recent years regarding convergence theory. Certainly, a developing economy can increase faster than one that is already established. However, how fast a poorer nation could catch up to, let alone exceed, the per-capita income of a developed nation is still under question.