Lecture on Economic Growth (WS 15/16) Speed of Convergence

4. Speed of convergence: theory and measure-

ment

4.1 Speed of convergence

The movement of an economy towards its steady state path is called

convergence. The speed of convergence is measured by either the rate of
convergence or the half life of convergence.

Let d := log(y/y ) denote the relative distance from steady state in

terms of income per capita. For example, d = 0.2 means that y/y =
exp(0.2) = 0.82, that in other words y falls short of the steady state level
by close to 20%. d declines at an approximately constant rate, meaning
d , and hence
d(t) d(t0 ) exp[(t t0 )].

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Lecture on Economic Growth (WS 15/16) Speed of Convergence

is the rate of convergence. = 0.02 p.a., say, means that the relative
distance from steady state declines by 2% per year. The half life h is the
time needed for d to half, thus
d(t0 + h) 1
= ,
d(t0 ) 2
thus
exp(h) = 1/2,
thus
log(1/2) 0.7
h= .

If the convergence rate is given in % p.a., then
half life of convergence 70/ rate of convergence.

Dr. Stephen Sacht CAU/IfR Kiel 84

Lecture on Economic Growth (WS 15/16) Speed of Convergence

Dr. Stephen Sacht CAU/IfR Kiel 85

Lecture on Economic Growth (WS 15/16) Speed of Convergence

4.2. The exact rate of convergence for K/Y

A CD function
Y = aK (EL)
implies
K/Y = a1 K 1 (EL)1 = a1 k1.

Write z := K/Y , for short, then z = (1 )

k, and therefore, by (17):

k = sf (k)/k ( + x + n) = sY /K ( + x + n)
we get
z = (1 )[s/z ( + x + n)].

Multiplying by z gives a non-homogeneous linear ODE with fixed coeffi-

cients in z:
z = (1 )[s z( + x + n)].

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Lecture on Economic Growth (WS 15/16) Speed of Convergence

Its stationary point (i.e. z such that z = 0) is

z = s/( + x + n).

Define v := z z , thus v = z,
then
v = (1 )[s (v + z )( + x + n)]
| {z }
z
= (1 )[s {v + s/( + x + n)}( + x + n)]
= (1 )( + x + n)(v), (18)
and therefore
v = with rate of convergence
= (1 )( + x + n). (19)

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Lecture on Economic Growth (WS 15/16) Speed of Convergence

Given long term observations = 0.3, = 0.05 p.a., x = 0.02 p.a.,

n = 0.01 p.a. one gets = 0.7 (0.05 + 0.02 + 0.01) = 0.056 p.a. Another
approach is to use (under consideration of z = 0):
(1 )s (1 )sY
= = .
z K

For West Germany one observes 1 0.71, s 0.22 and Y /K 0.37

p.a. Assuming West Germany to move along its steady state path one
obtains 0.058 p.a. The half life is therefore (70/5.6) years or (70/5.8)
years for the former or latter method, respectively, that is roughly 12 years.

Dr. Stephen Sacht CAU/IfR Kiel 88

Lecture on Economic Growth (WS 15/16) Speed of Convergence

Dr. Stephen Sacht CAU/IfR Kiel 89

Lecture on Economic Growth (WS 15/16) Speed of Convergence

Dr. Stephen Sacht CAU/IfR Kiel 90

Lecture on Economic Growth (WS 15/16) Speed of Convergence

4.3 Asymptotic rate of convergence

For an ODE z = g(z) let z denotes a stable stationary point, i.e. g(z ) = 0
and g (z ) < 0. g (z ) is called the asymptotic rate of convergence,
because, in the neighbourhood of z ,
z (z z )g (z ),
and hence
v vg (z )
for v := z z . Thus
v = g (z ).

Dr. Stephen Sacht CAU/IfR Kiel 91

Lecture on Economic Growth (WS 15/16) Speed of Convergence

For any neoclassical production function (not necessarily CD), as in

formula (19) is the asymptotic rate of convergence of k, if is the steady
state capital share.

For a proof, rewrite the fundamental equation (17) as

k = sf (k) k( + x + n). (20)

Thus
dk
= = sf (k) + ( + x + n).
dk

Using the definition of with

k
= f (k) ,
f (k)
and the fact that, at the steady state with
k = 0, equation (20) reduced
to
f (k)
s = + x + n,
k

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Lecture on Economic Growth (WS 15/16) Speed of Convergence

according to (20), we then obtain

f (k) k
sf = s f (k) = ( + x + n).
k f (k)

Thus
= ( + x + n) ( + x + n) = (1 )( + x + n).
| {z }
sf (k)

Any other endogenous variable of the model that continuously depends on

k with non-vanishing derivative at the steady state can be shown to have
the same rate of convergence as k, as shown by the following proposition:

If u = h(z) with twice continuously differentiable h, with h (z ) 6= 0, and

if z converges to z at rate , u converges to u = h(z ) at asymptotic
rate .

Dr. Stephen Sacht CAU/IfR Kiel 93

Lecture on Economic Growth (WS 15/16) Speed of Convergence

Proof: Take the derivative of u = h(z) with respect to t: u = h (z)g(z).

Taking the derivative of the right-hand side with respect to u at z yields
[h (z )g(z ) + h (z )g (z )]/h (z ) = g (z ).
q.e.d.
The variables Y /Y , y/y , w/w, k, their respective logs, as well as r and
are all functions of K/Y = k/f (k) (all twice continuously differentiable)
and therefore all converge at the same rate .

Dr. Stephen Sacht CAU/IfR Kiel 94

Lecture on Economic Growth (WS 15/16) Speed of Convergence

4.4 Convergence regression

The rate of convergence can be estimated empirically by the convergence

regression.

Assume we observe the GDP per capita for different countries j and at
different points in time, t and t + t, say.

To simplify notation, define j (t) = log yj (t) and j (t) = log yj (t). Let
dj (t) denote the log distance of of country js GDP per capita from its
respective steady state level, as in Section 4.1.

Hence, dj (t) = j (t) j (t). dj (t) converges to zero at asymptotic rate .

If we accept the asymptotic rate as a good approximation also at y 6= y ,
then
dj (t + t) = dj (t) exp(t).

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Lecture on Economic Growth (WS 15/16) Speed of Convergence

Subtracting dj (t) from both sides and dividing by t yields

dj (t + t) dj (t) exp(t) 1
= dj (t)
t t
j (t)
= d
with
1 exp(t)
= .
t

Inserting for d one finally gets

j (t + t) j (t) j (t + t) j (t)
j (t) + j (t) .
=
| t
{z } | t
{z } | {z }
x j (0)+xt
yj (tt+t)

The first left term is the average growth rate in the time span t to t + t
(denoted yj (t t + t)). The second left term is the steady state growth
rate x. We therefore can write
(j (0) + xt).
j (t) + x +
yj (t t + t) =

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Lecture on Economic Growth (WS 15/16) Speed of Convergence

Adding a random term ujt transforms this into a regression equation

j (t) + Aj + Bt + ujt
yj (t t + t) =
j (0) and B = x.
with Aj = x + This can be estimated. The parameters
to be estimated are , Aj and B. For small t (in the order of magnitude
< 0.1) the approximation holds.

The exact solution for is

log(1 t)
= .
t

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Lecture on Economic Growth (WS 15/16) Speed of Convergence

If we can assume all countries to converge to the same steady state, we

set Aj = A for all j. This case is called unconditional convergence. The
case with country specific levels of Aj is called conditional convergence.
For this case estimation requires either time series data for each country
or additional control variables that can explain country specific values of
Aj .

Another strategy can be applied, if data on Y and K are available. If we

assume , , x and n to be uniform across countries and time, a regression
equation can be derived from
z = (z z)
(see (18)).

Inserting observations for countries and points in time and adding a ran-
dom term yields
zjt = z zjt + ujt.

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Lecture on Economic Growth (WS 15/16) Speed of Convergence

z = (1 )s is the intercept; it is the same for all countries and all

points in time. The advantage of this regression is that the productivity
parameters aj are absent in the regression equation. They need not be
estimated, and misspecifications of their respective determinants cannot
bias the estimates. The regression estimates conditional convergence.
The disadvantage is that estimates of K are notoriously unreliable.

The unconditional rate of convergence in a sample of (almost) all coun-

tries in the world is virtually zero. For countries or regions in the developed
world it is about 2% p.a., one third of what the Solow model predicts.

Results on conditional convergence rates much depend on the regression

specification, but for the countries of the world 2% p.a. seems to be a
literature consensus.

For countries or regions in the developed world the rate of conditional

convergence is at least 6% p.a., that is what Solow model predicts, or
even higher.

Dr. Stephen Sacht CAU/IfR Kiel 99