International Review of Applied Economics, Vol. 20, No.

3, 391410, July 2006

Convergence or Divergence? The Impacts of Globalisation on Growth and Inequality in Less Developed Countries

MICHELLE BADDELEY
Gonville & Caius College and Faculty of Economics, Cambridge, UK
International 10.1080/02692170600736250 CIRA_A_173589.sgm 0269-2171 Original Taylor 2006 0 3 20 Dr mb150@econ.cam.ac.uk 00000July MichelleBaddeley and & Article Francis (print)/1465-3486 Francis 2006 Review Ltd of Applied (online) Economics

ABSTRACT This paper assesses the impacts of globalisation on the cross-country comparative patterns of growth and development. In the theoretical section, some of the key linkages between growth, development and globalisation are explored including the positive and negative impacts of globalisation and the constraints on effective development in a globalised world. Some of the key factors emphasised include trade and capital flows as well as computerisation. These issues are then analysed empirically using and club convergence models, estimated using panel techniques. The empirical evidence presented indicates that globalisation has been associated with increasing trade and financial flows to less developed countries. It has also coincided with increasing penetration of the Internet suggesting that increases in informational flows have complemented economic and financial linkages, but the empirical evidence also shows that the current era of globalisation has not been associated with convergence in economic outcomes; instead less-developed countries have suffered from increases in international income inequality. In the final section, conclusions and policy implications are presented including a discussion of how international and national development policies could be designed properly to ameliorate tendencies towards growing international disparities in economic growth.

KEY WORDS: Globalisation, growth, development, convergence. JEL CLASSIFICATION: F02, O1, O3

Introduction The pace of globalisation has accelerated in the last 20 years and most economies in the world are now strongly linked together by flows of trade, finance and factors of production and by transport, communication and informational links.1 However, the forces of globalisation are largely unregulated; for example the magnitude, speed and volatility of financial flows has increased with moves
Correspondence Address: Michelle Baddeley, Gonville and Caius College, Trinity Street, Cambridge CB2 1TA, UK. Email: mb150@cam.ac.uk
ISSN 0269-2171 print; ISSN 1465-3486 online/06/030391-20 2006 Taylor & Francis DOI: 10.1080/02692170600736250

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towards financial deregulation in many OECD countries. Similar institutional changes have been transferred to developing economies, particularly as IMF conditionality and World Bank assistance have created pressure for developing countries to liberalise their economies and financial systems and to remove barriers to trade. This paper aims to assess the impact of globalisation on developing economies: if the gains emerging from increasing trade and financial flows have balanced out the dampening effects of financial instability, then globalisation will have had positive impacts. However, if trade linkages have developed to favour the economic interests of core OECD nations and if financial deregulation has increased global financial instability, then developing economies are likely to have suffered accordingly. The paper begins with an analysis of the links between globalisation, growth and development and a discussion of how globalisation has affected the global economic and financial system in general and the less developed countries in particular. The links between globalisation, growth and development are assessed via an analysis of the extent of international convergence in gross national income (GNI) per capita. Key models of convergence are presented, followed by the econometric estimation of convergence models using fixed effects two stage least squares (2SLS) panel estimation techniques. The impacts of globalisation and other conditioning variables are then incorporated using a conditional convergence modelling strategy. The empirical results show that globalisation, as measured by trade and capital flows, has increased international inequality over the period 1976 to 2003. The paper concludes with a discussion of policy implications and conclusions. Globalisation, Growth and Development Globalisation implies increasing flows of trade, finance and factors of production as international transport, communication and informational linkages develop. Globalisation is associated with the attenuation of nation states and the creation of a global village. With globalisation, international linkages develop not just between specific groups of countries but across a wide global network in which factors of production can move freely.2 Globalisation is prone to ebbs and flows; the first era of globalisation during the 19th century slowed in the first part of the 20th century (Dowrick & DeLong, 2003). The second era of globalisation that we are now experiencing has come as a consequence of a range of factors, not just because of technological advance in the form of computerisation (which has allowed the rapid flows of enormous volumes of information) but also because of profound changes in institutional environments. As the economic ideology of the 1970s promoted moves towards financial liberalisation and deregulation within a large number of OECD countries during the 1980s and 1990s, the policy approaches of the Bretton Woods institutions were also modifiedwith the Washington Consensus being built upon the promotion of fiscal austerity, privatisation and liberalisation (Stiglitz, 2002; Gualerzi, 2005). This deregulation has allowed freer movement of finance and factors of production across national boundaries, contributing to the globalisation process. There is little agreement about the real impacts of globalisation on global inequality and growth in less developed countries; the debate is divided into two camps. As discussed below, one camp focuses on the gains from trade and openness and the other focuses on the constraints and inequalities generated from globalisation.3

Convergence or Divergence? 393 The Positive Impacts of Globalisation In terms of the prospects for developing economies, it is argued by some that globalisation, by promoting trade and allowing easy access to international capital markets, promotes infrastructure development and export led growth in developing economies. Das (2005) extends this idea by developing a theoretical model to capture the impacts of marginal trade liberalisation on the NorthSouth divide and concludes that inequality decreases with the liberalisation that accompanies globalisation. Bhagwati (2004) and Loungani (2005) argue that globalisation has encouraged competition, has allowed countries to exploit economies of scale, has encouraged macroeconomic stability and has promoted foreign direct investment (FDI)all of which have benefited less developed countries. Bhagwati presents evidence to show that the consequent impact of increasing trade flows in enhancing economic growth has translated into reduced international poverty. There are a number of problems with the positive view of globalisation. These emerge from two angles. Some authors argue that globalisation has the potential to help developing nations but rigidities limit the spreading of benefits; others develop a core-periphery analysis in arguing that globalisation has had a negative impact because it has served the interests of rich countries in the North necessarily at the expense of the South.

Constraints on Globalisation Dreher (2003) presents evidence from panel estimations to show that globalisation promotes growth but, in contrast to Bhagwati, argues that the benefits do not necessarily trickle down to alleviate poverty. Krugman & Venables (1995) assert that globalisation has the potential to benefit less-developed nations but that the relationship between globalisation and convergence is non-linear, with globalisation initially exacerbating world inequality but then reducing it. For exampleas transport costs fall below a threshold, peripheral nations suffer real income declines. Falling transport costs allow core nations to exploit greater economies of scale in manufacturing to the detriment of manufacturing sectors in peripheral nations. Labour demand will fall in peripheral nations and rise in core nations as a consequence. However, once a critical level of integration has been reached, further falls in transport costs will outweigh the costs of being remote. Peripheral nations will industrialise and will be able to gain from further falls in transport costs and increases in trade, encouraging global economic convergence. Stiglitz (2002) identifies a number of institutional rigidities, monopolistic tendencies and other problems (e.g. moral hazard and adverse selection) that have limited the spreading of benefits from globalisation. He advocates reform of the Bretton Woods institutions to allow a greater role for well-deigned structural adjustment programmes and government policy co-ordination. Stulz (2005) argues that the spreading of benefits from financial globalisation has been limited by twin agency problems emerging because of ownership concentration. Obstfeld (1998) focuses on the potential benefits of liberalising international capital markets but argues that risk aversion and asymmetric information have left unexploited opportunities for diversification and loose regulation has left less-developed countries vulnerable to financial crisis. Obstfeld also argues that the IMF faces a policy dilemma in its role as emergency lender in balancing the need to alleviate

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economic suffering without encouraging problems of moral hazard in international borrowing. Some authors argue that differences between countries can be explained in terms of the links between technological potential and stagnationfor example, see Howitt (2000) and Howitt & Mayer-Foulkes (2005) for an analysis of the technological forces encouraging divergence in per capita income in the context of Schumpeterian growth theory. They argue that in the context of technological change, adoption of new technologies in open economies will be unevenly distributed and while technological leaders will converge to one steady state the least advanced countries will be trapped. Countries with high minimum skill levels will converge onto an advanced research and development (R&D) steady state. Countries with the human skills and appropriate institutions to enable technology transfer will converge to another steady state: the implementation steady state, but the poorest countries will form a stagnation group, growing at a slower rate. Income inequality between the R&D and implementation group will increase only in the short-run; but between the stagnation group and the other groups, inequality will increase in the long runwith relative incomes in the stagnation group falling asymptotically towards zero. Other authors also explore links between technology, globalisation and growth. Bernard & Jones (1996) show that there is little evidence for convergence of manufacturing technologies and find substantial technology gaps across OECD countries during the most recent era of globalisation. Abramovitz (1986) argues that productivity differences across countries have the potential to encourage subsequent convergence as long as less developed countries have the potential to absorb new technologies. The Negative Impacts of Globalisation Milanovic (2003) completely rejects the view of globalisation as a benign force, presenting evidence that, since 1870, globalisation has exacerbated international inequality with particularly pronounced increases in inequality during the 1978 1998 globalisation era. He argues that the impacts on less developed countries have been severe: per capita GDP has not increased in Africa; a number of lessdeveloped countries have suffered the impacts of financial crisis and many transition economies are facing historically unprecedented levels of debt. Cornwall & Cornwall (2001) and Setterfield (2003) argue that globalisation will exacerbate distributional conflicts. Whilst the moves towards financial liberalisation mentioned above contributed to the easy flow of capital across national boundaries, Singh (2003) presents empirical evidence showing that capital account liberalisation has made banks more vulnerable to external shocks and economies more susceptible to financial crisis. So the social and economic costs of financial crisis have been exacerbated by the inter-connectedness of nations. In terms of labour market outcomes, Wood (1998) shows that there have been widening gaps between skilled and unskilled labour both in terms of wages and in terms of unemployment rates and argues that globalisation is the most likely explanation for this rising inequality. Feenstra (1998) introduces outsourcing into the analysis to show that the impacts of globalisation on employment and wages will be similar to the impacts of skills-biased technological innovation; the demand for skilled labour in less developed countries will rise but the demand for unskilled labour will fall contributing to wage inequality. So while globalisation

Convergence or Divergence? 395 has encouraged factor price equalisation, it has been at the expense of lower relative incomes for low-skilled workers. Williamson (1998) shows that factor-price convergence in earlier eras of globalisation led to improving conditions for unskilled workers in Europe but deteriorating conditions for poor unskilled workers in the New World. He explains this finding in terms of mass migration. An Empirical Analysis of Convergence/Divergence4 Empirically, the record of globalisation can be assessed by analysing the extent to which globalisation has been accompanied by international economic convergence. Abramovitz (1986), in his analyses of globalisation eras between 1870 to 1979, finds that there was strong evidence of convergence only during the period following the Second World Wari.e. when the Bretton Woods system of fixed exchange rates and capital controls was limiting the extent of globalisation. Dowrick & DeLong (2003), Dreher (2003) and Jones (2003) present empirical analyses of the links between globalisation and international convergence. Dowrick and DeLong present clear evidence that globalisation does not imply global convergence. Periods of expansion are associated with club convergence for richer nations but the poorer nations do not necessarily benefit, though Dowrick and DeLong identify India and China as possible exceptions. Generally, however, they argue that demographic constraints and the expense of access to innovative new technologies mean that developing countries do not have the resources to escape their poverty traps. In this section we analyse some data to capture patterns of internationalisation, globalisation and convergence/divergence, where convergence/divergence are interpreted in terms of income equality/inequalityas will be explained below. Where data availability allows, the empirical analyses start in the early 1970s to coincide with the beginning of the move away from the fixed exchange rate, regulated global financial environment of the Bretton Woods era. Empirical Patterns What have been the empirical trends in globalisation? The magnitude and volatility of financial flows have been increasing. In terms of financial flows, Figure 1 captures the trend increase in the magnitude of real capital outflows from the OECD, peaking in 2000 but falling off from 2001. This was matched by a corresponding trend increase in the volatility of flowsa symptom of the widespread move towards financial liberalisation from the 1980s onwards, with the consequent loosening of controls on capital flows contributing to the globalisation of financial capital. What have been the specific patterns for less-developed countries in terms of trade and debt? Figure 2 shows that in terms of trade benefits, exports as a percentage of GDP have been rising steadily throughout the period. Figure 3 shows that international debt has fluctuated: rising levels of international debt in the early 1980s were followed by a levelling-off in the late 1980s and a trend fall in debt levels from 1990, with a brief upward blip around the time of the 1997 financial crisis.
Figure 1. Source: OECD Real capital outflows from the OECD Figure 2. Source: Earthtrends Goods and services exports from developing countries Figure 3. Source: Earthtrends External debt of developing countries

Convergence/Divergence and Income Equality Figures 13 capture the trend increases in capital flows, trade flows and debt that have accompanying globalisation. Have there been corresponding changes in the

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1200 Constant US$ (billions) 1000 800 600 400 200 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Figure 1.

Real capital outflows from the OECD (Source: OECD)

patterns of income inequality across nations? Figure 4 shows the spread of GNI per capita measured in purchasing power parity (PPP) terms across 107 countries (developed and less-developed) over the period 1975 to 2003. For countries with the lowest levels of GNI per capita, not much has changed since 1975. By contrast the initially richer countries have experienced pronounced growth in GNI per capita over the same period. Overall, this suggests either that there has been limited convergence and limited equalisation in the distribution of international income and/or that population growth has been too high. Some of these increases may reflect nominal rather than real changes and so, in Figure 5, the coefficient of variation (standard deviation divided by the mean and therefore unit free) is plotted and also provides clear evidence that the international spread of income per capita has been increasing over time, suggesting increasing international income inequality.
Figure 4. Source: Earthtrends GNI (PPP) per capita by country Figure 5. Source: Earthtrends Coefficient of variation, GNI (PPP) per capita

40 35 % of GDP 30 25 20 15
19 70 19 73 19 76 19 79 19 82 19 85 19 88 19 91 19 94 19 97 20 00

Figure 2.

Goods and services exports from developing countries (Source: Earthtrends)

Convergence or Divergence? 397

45% 40% % of GDP 35% 30% 25% 20% 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001

Figure 3.

External debt of developing countries (Source: Earthtrends)

To assess first, whether or not these patterns are clear evidence of divergence and second, whether or not globalisation can form part of an explanation for these patternsin the following section the extent of convergence/divergence is assessed using convergence models. Modelling Convergence Mainstream analyses of convergence develop the neoclassical growth theories of Solow (1956) and Swan (1956) in which convergence, whether absolute or conditional, is towards some steady state. Endogenous growth theory predicts that convergence will not occur because of importance differences in physical and human capitaldifferences in technology and increasing returns generate multiple equilibriums limiting the potential for convergence (Romer, 1986; Lucas, 1988). In testing these theories and analysing the data on globalisation and convergence, it is important to distinguish between different forms of convergence including

50000 40000 US$ per capita 30000 20000 10000 0 -10000 -20000

Figure 4.

GNI (PPP) per capita by country (Source: Earthtrends)

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1.15 1.1 1.05 1 0.95 0.9 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003

Figure 5.

Coefficient of variation, GNI (PPP) per capita (Source: Earthtrends)

(weak) convergence; (strong) convergence and club convergence. Weak convergence implies mean reversion and a significant negative relationship between growth rates and initial levels, e.g. of real per capita income (Abramovitz, 1986; Barro, 1991; Barro & Sala-I-Martin, 1992, 1995; Baumol, 1986; Jones, 2003; Quah, 1996a,b; Sala-I-Martin, 1996a,b). Even if there is mean reversion, if the dispersion of GDP is increasing across countries then convergence will not be completea difficulty that can be resolved with the use of strong convergence models, as explained below. However, convergence models suffer from a number of limitations. To attribute mean reversion to some underlying causal convergence mechanism is to commit Galtons regression fallacy (Hotelling, 1933; Friedman, 1992).5 Mean reversion does not necessarily reflect any causal mechanism ensuring convergence: probability dictates that extreme outcomes will be followed by more average outcomes just because extreme outcomes are unlikely and therefore are unlikely to be repeated (Bliss, 1999).6 So if convergence is explained, as it is in neoclassical growth theory, in terms of the equilibrating and equalising power of free markets under perfect competition, then policy will be misinformed accordingly, with serious implications for countries trying properly to design policies to alleviate poverty and promote growth and development. The theoretical foundations of convergence models can be attacked on the grounds that convergence is only of interest if all countries within the analysis have a common steady state; otherwise changes will just reflect initial conditions (Lee et al., 1997). More fundamentally, even for countries with comparable structural characteristics, convergence concepts that emerge from theories based around aggregate production functions are prone to various substantive theoretical and empirical weaknesses. These reflect the limitations of using aggregate production function as a building block in macroeconomic theory, emerging because of the problems in measuring and defining capital and in the mathematical assumptions required to aggregate from micro-foundations to a well-defined aggregate production function (e.g. see Felipe & Fisher, 2003; Fisher, 1969a,b, 1993; Harcourt, 1972). In addition, Felipe & McCombie (2005) argue that the empirical evidence seemingly supporting the widespread belief in the concept of an aggregate production

Convergence or Divergence? 399 function is in fact tautological, reflecting arithmetic relationships (i.e. the national income identities) rather than real causal mechanisms. The criticism applies to endogenous growth models as well because whilst they predict divergence and multiple equilibriums in a world of increasing returns, they nonetheless suffer from similar problems as the SwanSolow growth model because they are based around an aggregate production function too. Felipe and McCombie show that the specifications of Solows (1956) neo-classical growth model and the extensions of endogenous growth theory of Mankiw et al. (1992) can be derived from the national income identities without any need to rely on methodologically problematic constructions of aggregate production functions from microeconomic axioms.7

Convergence and Club Convergence

In more sophisticated analyses of convergence, a number of models have been influential.8 They are based around an analysis of the evolution of a regions per capita income gap away from the leaderGi,T for each region i in period T. This gap in income is defined as: Gi ,T = YL ,T Yi ,T (1)

Where YL,T is the per capita income in period T for the leader country L and Yi,T is the per capita income in period T for the ith region. When the gaps are stable over time then Gi,T will be a function of lags of itself, i.e. Gi ,T = f ( Gi ,T n ) ( 2)

where n is the length of the lag. When the current gap has a strong linear correlation with past gaps, then this suggests persistence, i.e. per capita income differentials are not dispersing.9 When gaps are increasing over time then this suggests divergence. However, if gaps are decreasing over time, then there is convergence. Applying this idea to international income inequality: shrinking gaps are associated with strong convergence and diminishing income inequality; increasing gaps are associated with divergence and increasing inequality; and stable gaps are associated with persistent inequality. Concepts of convergence can be separated further. Quah (1996a,b) and Kumar & Russell (2002) identify a bipolarisation of outcomes across countries. Durlauf & Johnson (1992) develop models to distinguish between local vs global convergence, with local convergence occurring for countries with similar economic conditions. These insights are consistent with an extension of the convergence methodology in which, rather than postulating a linear relationship between current gaps and lagged gaps (as in convergence models), a non-linear relationship between current and lagged gaps allows club convergence. Following this approach, Chatterji (1992), Chatterji & Dewhurst (1996) and Galor (1996) develop convergence models that are an extension of equations (1) and (2) but with the lag length set to 1 (i.e. n=1). In this way, various types of convergence can be captured by this specification: Gi ,T = k Gik,T 1 = 1Gi ,T 1 + 2 (Gi ,T 1 )2 + 3 (Gi ,T 1 )3
k =1 3

( 3)

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Equation (3) shows that Gi,Tthe per capita income gap away from the leader for the ith region in period T, is a cubic function of Gi,T1the gap away from the leader for the ith region in period T1. The extent of influence of the linear, quadratic and cubic terms captured by the parameters 1, 2, 3 respectively. Following Chatterji (1992) the different patterns of convergence can be explained intuitively using equation (3) as follows: No convergence takes place when 10 and 20 and 30 because of a complex non-linear relationship between current and past per capita income gaps. Strong convergence emerges when |1|<1 and 2=3=0. When this is true then the squared gap (Gi,T1)2 and cubed gap (Gi,T1)3 drop out leaving only the relationship between the current gap (Gi,T) and the lagged gap (Gi,T1). If 1<1 then the current gap will be smaller than the lagged gap, i.e. the gaps are diminishing and strong convergence is taking place. Club convergence emerges when 10 and 20 but 3=0. When this is true, gaps will be magnified for countries that start with a relatively large gap; but gaps will diminish for countries that start with a small gap. In the latter case, these countries will converge into a convergence club. To illustrate with a numerical example and assuming that 1=2=0.5 for simplicity: if the lagged gap for a given country is relatively large, e.g. Gi,T1=2, then Gi,T=(0.52)+(0.522)=3. The gap has grown from 2 to 3 and the country is moving further and further away from the leader country. On the other hand, if another countrys lagged gap is relatively small, e.g. if Gi,T1=0.4, then Gi,T=(0.50.4)+(0.50.42)=0.28. The gap has shrunk from 0.4 to 0.28 and the country is moving towards the leader country. For this example, the two groups of countries will be defined by whether their gaps fall above or below 1.0. When Gi,T1<1.0, i.e. when the gap is relatively small, then the gaps will be diminishing, but if Gi,T1>1.0, then the current gap will be larger than the lagged gap and so countries with relatively large gaps will be moving further and further away from the leader. The first group will form an exclusive convergence club; the second group will be moving further and further away from the convergence club and countries in this group will be getting ever poorer in relative terms. Chatterji & Dewhurst (1996) extend their analytical approach to an international context from 1960 to 1985 to show that there are two mutually exclusive convergence clubs: one including the rich countries and another including the poor countries. Baumol & Wolff (1988) use a rudimentary version of club convergence models in analysing international convergence and find that there had been some convergence amongst developed economies since the 1960s though larger samples including developing economies did not show the same degree of convergence. Conditional vs Absolute Convergence Club convergence models show the conditions determining whether or not different countries will club into particular groups, but it is also important to identify the factors that explain why a particular country is converging or diverging away from others or away from a club. Estimating a club convergence model will identify which countries fall into each club but conditional convergence models will identify the factors that determine the membership of each club. When different economies or subsets of economies are converging onto different steady states

Convergence or Divergence? 401 reflecting inherent economic differences, then convergence is conditional upon the fundamental variables that define a given steady state (Temple, 1999). In this vein, Berthelemy & Varoudakis (1996) use an extension of Durlauf & Johnson (1992) to show that the stability of convergence can be captured using different sorting criteria and they incorporate Chow tests for stability to assess the extent of convergence across these sorting criteria. They argue that the existence of poverty traps may reflect limitations on financial development (e.g. in the banking sector) and they identify the different multiple endogenous growth equilibriums reflecting financial backwardness and human capital and education, with possible endogeneity between the two if financial constraints limit access to education. Howitt (2000) and Howitt & Mayer-Foulkes (2005) explain the clubs on technological grounds adapting Schumpeterian growth theory to show convergence into clubs according to technological characteristics (see above). In the econometric analysis that follows, these theoretical ideas are applied to a cross-section of countries for which the USA is identified as the global economic leader. For the ith country a small per capita income gap away from the USA implies that a country is relatively rich; a large per capita income gap implies that it is relatively poor. We retain a concept of conditional convergence and steady states but understood in terms of convergence towards equality rather than towards a SwanSolow type steady state. We extend the and club convergence methodology to a conditional convergence context by controlling for the factors that may determine a specific countrys steady state to give the following equation: Gi ,T = Gi ,T 1 + j X j ,i + m Zm ,i + i ( 4)

where Gi,T=YUS,TYi,T and Xj represents j exogenous explanatory variables and Zm represents the m endogenous explanatory variables. Econometric Analysis The econometric analysis proceeds in three main stages: first the absolute convergence models are estimated to test for and club convergence patterns. Then conditional convergence versions are estimated. The models are estimated using EViews 5.0. Temple (1999) argues that it can be difficult to disentangle convergence from other aspects of growth because of problems of with simultaneity, endogeneity and measurement error. So in the econometric analysis we have used 2SLS estimation to ameliorate these problems. Also, Lee et al. (1997) emphasise the importance of allowing for heterogeneity of growth rates to get consistent estimates of speed of convergencesee also Temple (1999) and Durlauf et al. (2004). Given the importance of allowing for unit roots, heterogeneity and fixed effects, panel estimation techniques have been used here. Given the possibility of nonspherical disturbances emerging as a consequence of heterogeneity bias, a generalised least squares (GLS) procedure for panel data was adopted, incorporating Whites (1997) corrective procedure to enhance the efficiency of the estimations. Non-stationarity across the temporal dimension creates another potential source of bias and inconsistency in panel estimations. Conventional time-series testing procedures should therefore be modified for use with panel data and so panel unit root tests are conducted following Levin et al. (2002). The results from these tests are reported in Table 1. Each variable was included in its I(0) form.

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M. Baddeley Table 1. Panel unit root tests (Levin et al., 2002)

H0: unit root (assumes common unit root process)

G LY LY1 FDI Exports D*IT(logged)a birth rate HDI Savings rate 5.361 11.39 19.87 3.923 4. 014 2.736 5.895 9.046 5.782

p value 0.000 0.000 0.000 0.000 0.000 0.003 0.000 0.000 0.000

a D*IT is an interactive dummyto capture technical progress in IT, which is assumed to start taking hold from 1990 onwards so the unit root test on the IT variable (number of households with Internet access) was conducted from 1990 onwards.

Absolute Convergence The results from the estimation of the absolute convergence models are reported in Table 2. The results show that, on initial inspection, there is evidence of some convergencethe regression of income growth on lagged income delivers a significant negative parameter on lagged income. By contrast the results from the convergence models show that there is an almost one-to-one correspondence between current gaps and lagged gaps suggesting persistence rather than converTable 2. Absolute convergence models
convergence
Dependent variable Constant Coefficient t ratio p value Coefficient t ratio p value Coefficient t ratio p value Coefficient t ratio p value Coefficient t ratio p value LY 0.454** 10.046 0.000 0.051** 9.204 0.000 0.590 80.284 1.522

convergence
G 0.171** 6.363 0.000 0.915** 67.075 0.000 0.999 0.406 1.630

Club convergence G 0.234** 7.351 0.000

LY1

G 1

G 12

G 13

Adjusted R-squared J statistic DurbinWatson statistic *Significant at 10%; ** significant at 5%

0.812** 28.091 0.000 0.038** 2.461 0.014 0.004 1.511 0.131 0.999 0.627 1.616

Convergence or Divergence? 403 gence. These anomalous results can be explained in terms of Galtons fallacy, i.e. that mean reversion occurs not because of some causal mechanism but because extreme outcomes are more unlikely and therefore unlikely to be repeated (as discussed above). In addition, the results from the club convergence models are estimated and these reveal that whilst there is weak convergence into convergence clubs there is no evidence of strong convergence. Globalisation and Club Convergence The initial analyses identified the existence of convergence clubs, confirming previous empirical analyses. But in the context of convergence/divergence in a globalised economy, what determines whether or not a country will converge into a rich club? Hobijn & Franses (2000), Bernard & Durlauf (1995) adopt a cointegration methodology to identify club members. Carrado et al. (2005) use a cluster methodology to identify regional clubs or clusters in the European Union by testing for pairwise stationarity. Carrado et al. point out that the Hobijn and Franses technique does not include conditioning variables and so the interpretation of findings is difficult. In this analysis, we are interested in identifying some potential explanations about the processes that contribute to convergence whether strong convergence by all countries or weak convergence into specific clubs, as explained above. In the following section we assess this question by incorporating conditioning variables into the convergence models. In estimating conditional convergence models, the impacts of globalisation on income differentials are captured using globalisation variables. Dutt & Mukhopadhyay (2005) assess the relationship between globalisation and international inequality by estimating conditional -convergence models within a vector autoregressive (VAR) framework, using trade (the ratio of trade to GDP) and capital flows (as captured by current account data) as conditioning variables to capture globalisation. They also test for the direction of causality using Granger causality tests. They find that the trade globalisation variable Granger-causes inequality though the direction of Granger causality is unclear in the case of their capital flows variable. Both variables are positively related to international inequality and they conclude that globalisation has contributed to an increase in international inequality over the period 1977 to 1998. A similar approach is used here with the impacts of globalisation. For the conditional convergence models, the impact of globalisation on convergence is assessed by introducing variables to capture the impacts of increasing international linkages on trade (exports as a percentage of GDP) and on finance by incorporating foreign direct investment (FDI) as a percentage of GDP. In addition, given the likely impact of computerisation on globalisation, the impacts of technical change in the form of computerisation are captured using data on the number of households with access to the Internet. This also addresses Temples (1999) assertion that the level of technology should be included in growth regressions if bias is to be avoided. To ensure a correctly specified model additional conditioning variables were included to control for other determinants of a countrys relative income gap. We control for factors that might affect the evolution of divergences from US GDP per capita for each country including the Human Development Index (HDI) (which captures literacy, life expectancy and average income), changes in the crude birth rate (to capture population growth), and savings rates (to capture the

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demand-side).10 The results from the estimations of the conditional convergence models are reported in Table 3. The conditional version of the convergence model exhibits some signs of misspecification reflected in a relatively low DurbinWatson statisticunsurprising given the drawbacks of these models as outlined above. The conditional convergence model shows strong persistence, with the trade and savings variables correlated with increasing income differentials. This suggests that increasing trade and increasing savings rates are correlated with growing divergence and increases in relative inequality, i.e. increased savings and increased trade seem somehow to exacerbate international differences in per capita income. The conditional club convergence models show that once key economic variables have been incorporated, there is no longer significant evidence for club convergence in the unrestricted model (the parameter on the quadratic term is insignificantly different from zero), suggesting that the essential economic characteristics of each club have been captured in conditional convergence models. The parameter on the lagged gap is insignificantly different from unity suggesting strong forces towards persistence and limited convergence. The parameter estimates on FDI and exports are positive and significant. These results suggest that the impacts of globalisation on trade/financial flows has been associated with increasing international income disparities. These findings are consistent with critiques of export led growth strategies, for example Blecker (2002), who identifies a fallacy of composition in export-led growth strategies; if many less developed countries are competing against each other in the same export markets then export incomes will decline, introducing balance of payments pressures and increasing susceptibility to financial crisis. By contrast, the sign on the Internet penetration variables in the conditional club convergence model is negative, suggesting that technological change in the form of computerisation has moderated income international differentials perhaps by facilitating the flow of global information. The other significant variable is the savings ratewhich is positively correlated with income differentials: greater savings rates are associated with great income deviations away from the USA. This result suggests that Keyness paradox of thrift may operate at an international level with the savings leakages from the circular flow of current income exacerbating income inequality by pulling economies further away from full employment output. For the insignificant variables, the birth rate variable and the HDI are insignificant in most regressions. Initially this seems to be a surprising result but may be explained by the fact that this paper is assessing convergence/divergence in income per capita rather than more broadly defined measures of development. Further research could focus on identifying the extent of convergence in development outcomes more broadly defined. Policy Implications and Conclusions In this paper, the linkages between globalisation and convergence/divergence in income growth have been analysed showing that recent trends towards convergence into clubs has paralleled globalisation of trade and capital flows. This globalisation has taken place with the context of financial liberalisation and deregulation. In terms of assessing the impacts of globalisation, the empirical evidence suggests that globalisation has had an impact: trade and financial flows have

Table 3. Conditional convergence models

convergence
Club convergence Dependent variable: LY G Restricted Unrestricted Restricted Unrestricted G Restricted Unrestricted

convergence

Constant

LY1

G 1

G 1 2

G 1 3

FDI

Exports (% GDP)

Convergence or Divergence? 405

IT penetration (logged)

Coefficient t ratio p value Coefficient t ratio p value Coefficient t ratio p value Coefficient t ratio p value Coefficient t ratio p value Coefficient t ratio p value Coefficient t ratio p value Coefficient t ratio p value

0.577** 10.264 0.000 0.080** 4.138 0.000 0.001** 2.716 0.007 0.001** 4.154 0.000 0.003* 1.849 0.065

0.576** 11.729 0.000 0.086** 8.760 0.000 0.001** 3.190 0.001 0.001** 5.800 0.000 0.003** 3.028 0.003

0.073 0.452 0.651 0.919** 45.714 0.000 0.000 1.226 0.220 0.001** 3.984 0.000 0.001 0.562 0.574

0.204** 5.775 0.000 0.914** 60.274 0.000 0.001** 2.712 0.007

0.186 1.347 0.178 0.831** 17.500 0.000 0.018 1.009 0.313 0.000 0.060 0.952 0.001* 1.736 0.083 0.001** 3.805 0.000 0.001 0.879 0.380

0.255** 7.493 0.000 0.850** 36.264 0.000 0.015** 4.364 0.000 0.001** 2.767 0.006 0.001** 3.855 0.000 0.002* 1.709 0.088

Table 3. (continued)
convergence
Club convergence Dependent variable: LY G Restricted Unrestricted Restricted Unrestricted G Restricted Unrestricted

406

convergence

M. Baddeley

birth rate

HDI

Savings rate

Coefficient t ratio p value Coefficient t ratio p value Coefficient t ratio p value

Adjusted R-squared J test DurbinWatson statistic

0.003 0.179 0.858 0.111 0.483 0.629 0.001** 4.675 0.000 0.602 35.253 1.620

0.181** 2.177 0.030 0.001** 4.960 0.000 0.638 36.620 1.602

0.021 0.883 0.377 0.199 0.916 0.360 0.001** 2.602 0.009 0.998 3.060 1.948

0.001** 3.691 0.000 0.999 31.342 1.696

0.015 0.824 0.410 0.144 0.780 0.436 0.001** 2.969 0.003 0.998 2.711 1.885

0.001** 3.536 0.000 0.999 7.288 1.683

*Significant at 10%; **Significant at 5%.

Convergence or Divergence? 407 increased, and the increasing penetration of the Internet suggests that increases in informational flows have complemented these linkages. However, the impact of the globalisation of trade and finance has not been positive and has been associated with an increase in international income inequality. This finding would seem to support the assertions of analysts focussing on coreperiphery effects: globalisation has served the interests of rich countries in the North at the expense of the poorer nations in the South. This suggests that international policy co-ordination should focus on limiting the rapid and volatile flow of capital across national borders and also that dualistic allocation of international capital should be limited by providing more broadly based access to foreign direct investment, and/or by encouraging the development of micro-finance schemes to support new, small scale businesses in poor countries. In terms of trade patterns, with many less developed countries being dependent on the volatile export incomes from primary commodities, it is not surprising that increasing the volume of these exports has increased inequality. Encouraging the development of export industries that can deliver more stable income growth could also be achieved by developing micro-finance schemes and also by providing incentives to develop infrastructure. The impacts in terms of informational flows do however seem to be positive the empirical evidence reported here suggests that the increasing use of the Internet has been associated with diminishing international income differentials. However, it should be noted that identified correlation between internet use and increasing equality does not imply causation as it might be declining inequality that encourages internet penetration rather than vice versa. But if Howitt (2000) and Howitt & Mayer-Foulkes (2005) are correct, guaranteeing that benefits from increasing computerisation continue will involve developing education and skill levels in less-developed countries. This would maximise the potential for technological transfer and to minimise the risks of technological stagnation and increasing international income inequality. Overall, while free flows of capital and trade may have some positive impacts they have not ensured income equality. To ensure that globalisation does not limit the potential for growth and development in poorer countries, specific policies should be developed to moderate the inequality potentially generated by globalisation. The negative impacts of globalisation may be ameliorated if the international financial system is more carefully regulated and monitored to moderate the impacts of adverse selection and moral hazard on effective financial decision making. Notes
1. Though Rodrick (1998) argues that the extent of globalisation and integration has not been as profound as is sometimes argued. 2. It is important to distinguish between the terms globalisation and internationalisation. Internationalisation is the move away from autarky towards greater co-ordination of trade and finance within groups of nations, potentially conflicting with the economic and financial interests of nations outside the group. For example, increasing blocism implies internationalisation rather than globalisation. In contrast, globalisation is about increasing global interconnectedness, not necessarily just by developing trade and financial links with specific countries, but with all countries regardless of national boundaries. 3. Ravallion (2004) argues that these divergences in opinion about the record of globalisation can be explained in terms of different value judgements and different emphases in empirical assessments on hard quantitative analyses vs eclectic approaches. He concludes that a greater consistency in

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4. 5.

6. 7.

8. 9.

10.

approaches will enhance our understanding of the relationships between globalisation and inequality. Data used in the empirical section and for Figures 25 is from the EarthTrends databasehttp:// earthtrends.wri.org/. Though see Bliss (1999) for a discussion of the limitations of critiques based around the Galtons fallacy. Bliss also argues that convergence models suffer from econometric problems such as nonstationarity and misspecification bias. The implications of this problem for purely cross-sectional analyses are unclear though the critique would nonetheless hold within panel estimations. Issues of non-stationarity are addressed in the econometric estimations below. For further discussions of the statistical limitations of convergence modelling strategies see also Friedman (1992), Quah (1993, 1996a,b) and Bliss (1999). These theoretical problems with traditional SwanSolow growth convergence models will also undermine analyses of convergence and catch-up towards efficient stochastic production frontiers (e.g. Kneller & Stevens, 2003; Kumar & Russell, 2002; Kumbhakar & Wang, 2005). See Quah (1993, 1996a,b), Baddeley et al. (1998a), Barro & Sala-i-Martin (1995), Bentzen (2005), Quah (1993) and Sala-i-Martin (1996a,b) for surveys. A similar idea is developed by Bernard & Durlauf (1995) and Greasley & Oxley (1997) in a time series context: if an inter-country gap has a non-zero mean or a unit root, then convergence conditions are violated. Greasley and Oxley use this methodology to establish bivariate convergence between combinations of OECD countries. These tests for time series convergence do suffer from the classic problems of unit root tests in presence of structural breakssee Greasley & Oxley (1997) and Baddeley & Sala-i-Martin (1998b). Whilst the HDI is necessarily a reductionist measure of broadly based development, Ranis et al. (2005) have shown that HDI is a better proxy for more widely based development indicators than per capita income.

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