Convergence Aspect of Capital Formation: A Study on Major Countries

Convergence Aspect of Capital Formation: A Study on Major Countries

Kamal Ray (Katwa College, India), Ramesh Chandra Das (Vidyasagar University, India) and Utpal Das (Katwa College, India)
DOI: 10.4018/978-1-5225-0215-9.ch003


Empirical evidences on convergence or divergence of a group of economies or regions in most instances are based upon per capita income as the only determinant for discussion. As time goes on, there has been a lot of studies on the convergence or divergence of certain variables which are proxy to the income variable. The present chapter attempts to examine whether there is convergence or divergence in per capita gross capital formation across 37 countries for the period 1980-2013. The study observes that there is significant absolute ß and s convergence for the cross section of all the economies for the entire period. By segregating the entire data into the categories of developed and developing country, the study further observes significant s convergence in both the cases with no absolute ß convergence in either of the country categories.
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Prevailing massive inequality in per capita income across the nations or continents in the global economy is a benchmark today as we often talk about the virtual aspect of human rights. On the one hand, struggling for bare minimum subsistence in the South and roll in luxury in the North on the other contradict the holistic economic theories and their applications under globalization in new millennium. The output of mammoth growth that taken place in some regions, reforms policies so far realized in different corners, evolution in respective fields in different nations during the last 100 years is being funneled into global output that does not conform to the rights to human beings today-human suffering in large scale continues. We are really worried, but with a hope. There is a hope in the face of neoclassical growth models developed in1960s, absolute convergence among the world economies due to the diminishing marginal productivity of capital is not impossible event in 50 or 100 years ahead. All the countries might converge to a common level of per capita income and growth, if capital matters much. The countries might differ or diverge, but it could be explained by the theory of conditional convergence. Sala-i-Martin (1990) as a follower of Solow (1956) introduced terminology of β convergence and σ convergence, and then conditional β convergence in 1991.The removal or minimization of disparities of per capita income across the nations depends on the speed of convergence that could be tested empirically by clubbing group of concerned nations. How much time would be allowable for sustainability so far as rampant poverty in the developing countries is concerned?

Land, labor and capital are assumed to be basic inputs of production, if technology is taken as a secondary factor of production. Land of the concerned nation is supposed to be exogenously given and cross-border movement of land is next to impossible even in the era of globalization whereas technology as a public good is transferable across the nations as per assumption of neoclassical growth theory of Solow (1956) and Swan (1956). Inward- oriented economies seem to grow slower than outward-looking ones. The rate of convergence also tends to be higher if we allow for the flow of technological advances from rich to poor economies. Solow and Swan have given conceptual ideas that derive standard neoclassical growth theory and famous neoclassical growth model. Labor and capital are also transferable from one nation to other because of the differences of factor payments; but it is subjected to the governance policy of the concerned nation. Solow justified that production of output depends on labor, capital and technology and he assumed that technological progress is absent in the short run period; constant returns to scale and inada conditions prevail. Accordingly, per capita output of a nation is directly proportional to capital labor ratio and both marginal productivities of labor and capital are positive but both are falling over the time horizon. The change in capital stock is simply a difference between investment and depreciation rate when population growth rate is being bracketed into depreciation. As Dynamic Equalization between the investment and depreciation rate plus population growth rate results in zero incremental capital stock, the economy would come to a halt. Solow defines it steady state of growth as all the variables grow at a same rate and hence per capita quantities do not grow; it is a steady and stable equilibrium point because of strong force of diminishing marginal productivity of capital. Our model does not allow any departure from equilibrium point towards any transitional phase because of the variations of marginal productivity of capital. The smaller initial values of per head capital are associated with larger values of marginal productivities of capital and vice versa. Consequently, the economies with lower per capita capital tend to grow faster in per capita terms. It was argued that capital would have a tendency to move from low-rent region to high-rent region and the process continues until factor returns are equalized. Low income group countries would catch up with the high income nations because of convergence process.

Key Terms in this Chapter

Developed Countries: The status of development of a country is mostly judged by income per capita. A country with high gross domestic product per capita can be described as developed. Another economic criterion is industrialization; a country in which the growth and share of tertiary sectors dominate can also be described as developed. Besides, the important social variable for which a country is considered as developed is high human development index that covers literacy rates, women empowerment, falling mortality rates, and good governance, among others.

Gross Capital Formation: According to the Word Bank, gross capital formation or the gross domestic investment consists of outlays on additions to the fixed assets of the economy plus net changes in the level of inventories. Fixed assets include land improvements, plants, machineries, and equipment purchases; and the construction of roads, railways, etc. including schools, offices, hospitals, private residential dwellings, and commercial and industrial buildings. Inventories are stocks of goods held by firms to meet temporary or unexpected fluctuations in production or sales, and work in progress.

Absolute ß Convergence: By this definition of convergence, the countries with low base values of the concerned variable, e.g. per capita income, should grow at higher rates than the country with higher base values of the variable (with homogeneous characters in other structural variables) and as time goes on the former countries will catch the latter countries in a common steady state value of the variable. This common steady state may be treated as the unification of the countries in the long run. For detail, see the methodology section.

Per Capita Gross Capital Formation: It is the gross capita formation per head of population of the country. It is derived by dividing the gross capital formation at current prices by the existing population of the country. A high value of per capita gross capital formation means the country is relatively richer than the country with low value of per capita gross capita formation. Thus, it is an important indicator of industrial as well as overall development of a country.

Conditional ß Convergence: Absolute ß convergence works when the economies are homogeneous in other respects except the differences in the variable under consideration. It is a highly restricted condition on the ground that all the economies will be homogeneous in all fundamental/structural variables; rather there may be differences or heterogeneities across the economies in this respect. The countries converging in conditional sense mean that, even if the base values are identical, the countries can converge to its own steady state. Other structural variables that create the difference may be the level of education, levels of FDI, position in the human development index ranking, etc.

Developing Countries: A developing country, also called an emerging or transitional economy, is a nation with an underdeveloped industrial base, and low Human Development Index (HDI) relative to other countries and poor quality of governance. According to the UN, a developing country is a country with a relatively low standard of living, undeveloped industrial base, and moderate to low Human Development Index (HDI).

s Convergence: This is the sufficient approach of convergence. By it, convergence across the economies will occur if the trend of dispersion will be falling over time in a significant manner. The magnitude of dispersion is usually measured by the coefficient of variation. Detail is available in the methodology section.

Regression: It is a method of projection or forecasting of a dependent variable (say Y) for a specific value of an independent variable (say X). If the dependent and independent variables are set with y* and x* as their respective mean values then the equation (y-y*) = b yx (x-x*) is called Regression Equation of Y on X, where b yx is known as regression coefficient determined by variances of Y and X and correlation coefficient. On the other hand the regression equation of X on Y will be (x-x*) = b xy (y-y*), where b xy stands for the regression coefficient of X on Y.

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