Free Essay. Fiscal Divergence or Convergence in Asian Countries: A Panel Approach

The concept of divergence and convergence among countries in terms of GDP per capita is currently a controversial issue as well as a recurrent question of economic thinking. It is often presumed that regardless of the difference in the initial per capita income of economies, richer and poorer countries may eventually converge or diverge in terms of economic growth and development. This controversy of income convergence and divergence has drawn the attention of many empirical researchers and policymakers. According to these research studies, the main idea regarding convergence is viewed as the approximation of qualitative and quantitative attributes of countries based upon the neoclassical growth model developed by Solow (Guerrini, 2006). Every state in this hypothesis is considered to be part of a trade group and has a unique growth path in which they converge. Essentially, even if all countries have different levels of initial per capita income but share the same predilections such as the rate of population growth, the investment ratio or technology, they should converge to the same growth path.

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However, this convergence hypothesis has become a subject of intense controversy generally due to the variations in different analyses; with other researcher supporting the idea while others are refuting it. As a result, this debate has led to the development of the second wave of economists who constantly oppose the concept of trade liberalization among countries on the grounds that it continues to increase disparities between richer and poorer countries. Indeed, in contrast to the idea of convergence, liberalization of trade among countries may reinforce disparities in that when tariff barriers are eliminated between two economies, it can strengthen the economic activities of richer countries which could lead to unequal growth and polarization, and hence extreme divergence. This study documents the convergence and divergence phenomena on the selected Asian nations as well as the main debates based on the empirical and the theoretical studies on the subject.

Literature Review

The convergence hypothesis has currently become a dominant topic because many people question the living standards of those in underdeveloped countries, whether it has improved due to trade liberalization, has increased extensively compared to that of the richer nations, or whether their live standards keep deteriorating while their rich counterparts continue to get richer. The neoclassical growth model extensively supports the main idea of convergence among nations. According to Egger & Pfaffermayr (2006), although the poor nations often start at a disadvantaged position, both their economies and their rich counterparts will one day converge to one growth path or a steady state. The authors conducted empirical research studies using different data, methodology, and countries based on the 1956's Solow Growth Model. Their findings indicate that as nations continue to trade with one another with lenient tariff barriers between them, they tend to consolidate the economic activities between them which in turn promotes the economic growth in the poorer countries. Since then, many empirical studies have been conducted with different variables which have all predicted economic growth among nations. For instance, as Madsen (2007) states, openness promotes the movement of capital between countries, which in turn stimulates the growth of the countries involved. In this case, convergence is ensured by certain factors such as technology, factor mobility, and goods.

Since different methodologies often produce different results, the impact of globalization on growth and inequality in poor countries has become a crucial focus of the debate. Much of this idea is inspired by Baddeley (2006), who examined the impacts of globalization on cross-country comparative patterns of growth and development. Emphasizing on key factors such as capital flows, computerization, and trade, the author conducted her analysis using club convergence model. The results show that globalization, as in the past, promoted financial flows and trade towards poor and underdeveloped countries. Additionally, the results indicate that globalization has improved information flow, which is critical when it comes to economic and financial linkages. This is in line with Madsen's claim that since the beginning of the 21st century, some developing countries have converged towards the European per-capita income (2007). However, Baddeley (2006) study also reveals that presently, globalization is associated with inequalities rather than the convergence in the economic outcome.

The rate and the speed of convergence have also been the focus point for many empirical economists. For instance, in their investigation for the unconditional and the conditional income convergence in various provinces in Canada, Ralhan & Dayanandan (2005) concluded that the rate of convergence is about 6 percent. The authors applied the first-differenced GMM estimation technique using data between 1981 and 2001, and 10 provinces in Canada. The results found in this empirical study were analyzed against other panel data approaches, including random and fixed approaches. Similarly, Badinger, Muller, & Tondl (2004) conducted a research study on the convergence in the European Union between 1985 and 1999 and found that the rate of convergence stands at 7 percent using the GMM approach. They included a sample of 196 regions and assessed the speed of their income convergence.

Some economists who support the divergence hypothesis believe that the current existence of huge disparities between the poor and the rich nations can be attributed to trade liberalization. All the criticism of conditional convergence from these researchers is backed by both statistical, methodological, and conceptual evidence. For instance, using non-stationary panel techniques in their study of regional divergence in China, Pedroni & Yao (2006) found that, although openness often leads to convergence among nations, long term economic openness ultimately encourages rapid growth while increasingly diverging regional income inequality. Similarly, after studying the effect and the evolution of inequality in different countries, Wahiba (2015) argues that trade liberalization often leads to divergence. To the author, the majority of the countries participating in a trade group remain the same. However, countries characterized as an intermediate divide to join either the richer or, the poorer nations. Hallett & Piscitelli (2002) also while analyzing the conditions of onset of convergence phenomenon claim that underdeveloped countries which are poorly integrated into the global market actually converge, however, most nations that are integrated effectively in the global market and are more stable often diverge in the end.

Data and Methodology

Ordinary Least Squares (OLS) have always been used to estimate most of the divergence and convergence studies; however, many researchers believe that the method often leads to biased results in which regressors are correlated with the error term. In response to this criticism, many have proposed that the analyses be done within a panel framework to include individual specific effects such as a nation's characteristics. According to Hsiao (2014), a panel approach as a research method is a longitudinal quantitative survey. It generally involves collecting particular data repeatedly from a sample representing a given target group. In this case, the data from the target group can be collected in different ways from observations, interviews to code readers.

As the first step, members of the panel were recruited through questionnaires sent to Asian countries officials willing to take part in the study. The sample period of this study included in the questionnaire covers a period of 2000 and 2018 of 5 Asian countries. The sample period was chosen based on the availability of data for all the nations to be included in the study. The idea was to recruit participants with real-life experiences, especially in the economic sector and with sufficient knowledge, particularly in international trade. The questionnaire included questions on the income convergence or divergence during the chosen study period, the changes in the individual country's GDP during that period, the living standards of citizens of various countries, the average growth rates of each country and the rate of economic activities in each country. One purpose of the questionnaire was to identify which countries are actively involved with one another in the regions and the ones that are not. The questionnaire was also intended to identify which countries started at a disadvantage based on the simple idea that convergence implies that poor nations grow faster than richer nations in terms of their per-capita income.

Five discussion groups, composed of 50 participants all from different countries, including China, Singapore, Philippine, Cambodia, and Myanmar, were chosen. Each group consisted of nine to eleven members each from a different nation. Each group was given a discussion question based on per capita income of their various countries during the period chosen, the GDP transformation, the standards of living, the average growth rate in each country and general economic activities.

Results

The discussions revealed different countries had had different experiences when it comes to convergence and the divergence phenomena. For instance, while some countries such as China began trade liberalization with incomes already fairly affluent, some countries did not. In the beginning, the poor nations experienced extensive changes in the per capita income due to increased economic activities. The convergence was experienced in poor countries than the rich countries, and there was a belief that over time, they will catch up in terms of their level of income. However, with time, the process started to reverse as there was a consolidation in these countries' economic activities making richer countries to grow faster. This resulted in the income divergence witnessed today in Asian countries.

The discussions also revealed that convergence in GDP per capita did occur during the first wave of Asian globalization due to massive international immigration and an increase in international trade. The poor countries, such as Philippine, Cambodia, and Myanmar, experienced increased economic activities, which in turn increased their overall national output. This was also expected to improve in the long-run; however, the trend was not witnessed in the second wave of globalization. Since 2000 to date, inequality has risen with countries like Singapore keeps improving its GDP growth while other countries like Cambodia remain poor. This new trend can be attributed to liberal economic policy regimes and the way in which these countries have carried out their economic reform policies.

The living standard of poor nations over this period as disclosed in the discussions have deteriorated mostly due to consolidation, which has strengthened the phenomena of polarization and unequal growth. Essentially, during globalization, labor markets in richer nations become more polarized with employment opportunities increasing in high and low wage jobs but all these at the expense of the mid-wage jobs. This indicates an inverted U-shaped relationship between poverty and globalization, particularly in poor countries in which at low (higher) levels of globalization tends to increase (reduce) poverty.