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N U MBER 6 ECONOMICPOLICY Public Disclosure Authorized Canbackward subnational regions catchup withadvanced ones? Thereare big differencesbetween the per capita incomesof backwardand advancedregions in developingcountries-and little reasonto believethat these differenceswill disappearvery quickly.Addressing poverty may requiredirect policyinterventions that encouragethe fasterdevelopment of poorerregions.

Public Disclosure Authorized The World Bank faces increasing demand observed for any industrial country. (It for advice on how economic development should be noted, however, that the sample Directinterventions can be accelerated in the poorer regions used is rather small.) The largest dispari- of developing countries. Although tradi- ties are usually in large developing coun- may be neededto tionally a lender to national governments, tries where transport costs are important, the Bank is ready to support subnational such as Argentina, Brazil, Indonesia, and ensurethat poorer governments with project and adjustment South Africa. But this is not always the loans. case, as disparities are relatively low in regionsshare in the One central question is, do backward India and high in Thailand (where large areas really need special treatment? Or will income differentials persist between benefitsof faster factor mobility and trade within countries Bangkok and the rest of the country). quickly equalize per capita incomes across Size seems to be less of a factor among national growth

Public Disclosure Authorized regions? If such tendencies toward equal- industrial countries. Regional disparities ization-or, as it is more commonly called are low in Australia and Canada and in the literature, convergence-are higher in smaller countries such as France, strong, then policy should ensure only that Germany, Italy, and Japan. barriers to internal factor mobility and trade are removed. But if convergence is Evidence on convergence slow or nonexistent, direct interventions Traditional growth theory predicts that in may be needed to ensure that poorer a country with low barriers to goods and regions share in the benefits of faster factor mobility,, there should be a trend national growth. toward convergence in per capita income across regions. In addition, many coun- Subnational disparities in tries and economic unions of countries per capitaincomes have adopted regional development poli- Despite a widespread absence of internal cies aimed at effecting such convergence.

Public Disclosure Authorized barriers to trade or factor mobility, average Since the mid-1950s disparities in per capita incomes vary considerably regional per capita incomes have fallen in across subnational regions-especially in nearly every industrial country. The only developing countries (figure 1). The low- exceptions are Australia (where regional est coefficient of variation calculated for disparities were initially relatively low) and any developing country is higher than that Germany (where disparities increased sub-

FROM THE DEVELOPMENT ECONOMICS VICE PRESIDENCY AND POVERTY REDUCTION AND ECONOMIC MANAGEMENT NETWORK Figurei. Disparities in stantially after reunification in 1991). The tuate with national growth rates or macro- subnational'income evidence suggests a definite trend toward economic regimes, but again the experi- incomehave become convergence in industrial countries, ence varies. The sharp drop in inequality less pronounced though it is rather slow. in Brazil during the late 1970s may be Coefficient Changes over time are less clear for linked to the country's Second National of variation developing countries. For example, only Development Plan and its massive wave of 0.6 Brazil, China, and Indonesia showed con- government-directed import substitution. 0.5 tinuous reductions in interregional Center-state grants in India may have . inequality from the 1970s to the early reduced subnational income inequality, 0.4 1990s. In Colombia and Mexico disparities but they did not seem to spur faster growth narrowed in the first half of that period, in backward regions. In Mexico periods of 0.3 then widened in the second half. And over fast convergence coincided with periods of 1950s the same period India saw an increase in strong national growth. During periods of 0.2 199l _0s interregional inequality. low or negative growth, however, there was

0.1 Some studies test for convergence by divergence in regional per capita incomes. seeing whether regions with initially lower O _ ' v_ pg than average per capita incomes tend to Doesinternal migration facilitate Industrial Developing countries countries grow more quickly-the 3 convergence convergence? criterion (box 1). These studies consis- Internal geographic labor mobility is one Note:Calculations are for 10 tently find evidence of subnational con- of the main processes that economists developingcountries. vergence within industrial countries. But expect to iron out per capita income dif- Source:Williamson 1965; the average rate of convergence is surpris- ferences between subnational regions. World Bank staff. ingly slow, at about 1.8 percent a year, with Strictly speaking, migration should tend to a half-life of about 38 years. equalize welfare levels between regions, Beta convergence estimates for devel- which means that factors other than real oping countries vary more than those for wages-such as physical security and the industrial countries. In China they range innate attractiveness of regions as places to from no change during the central plan- live-are also likely to influence the pat- ning period to divergence during the tern of interregional migration flows. But Cultural Revolution. By contrast, during it is usually assumed that subnational real 1960-89 Colombia saw a high rate of con- wage differences are sufficiently large to vergence-3.2 percent a year. Empirical ensure that migration flows will predomi- exercises find that convergence rates fluc- nantly occur from lower- to higher-wage

Box1 Measuringconvergence There are two types of convergence: a con- lapsing. Tests of a convergence are usually vergence and D convergence. Sigma coII- obtained from estimation of the following vergence means declining cross-sectional equation: dispersion of per capita income across units, as measured by the coefficient of variation or 1 other measures of dispersion. - log a + ,Blog(yit-,T) + u Beta convergence relates to the relation- T LYi,I ship between initial income levels and sub- sequent growth rates. This relationship is where y is the per capita income of region i usually inferred from regressions of growth at time t, and u is a random error term. If rates on initial income levels. A negative rela- we interpret this as the transition toward a tionship implies that poorer regions grow at uniform steady state or steady state growth faster rates and catch up to initially richer rate, then P measures the speed of conver- areas. Beta convergence is a necessary but gence-the fraction of the gap between cur- insufficient condition for the inference that rent per capita income and the long-run dispersion in income across regions is col- value that is reduced each period. areas. A consequent decrease in labor sup- population reporthavingmovedwithin the Figure 2. Migration does plyin backward areas relative to more pros- past 10 years-about 3 percent a year. But not contribul-e much perous areas will then encourage a most migration is within states, and even to convergenice narrowing of wage differences and per between poor and rich states there are Convergence capita incomes. invariably flows in both directions, which coeffidcent Recent research suggests that internal means that net flows are often much 0.025 migration has only a minor effect on con- smaller than gross flows. As a result net vergence (figure 2). These results must be annual migration in India in 1981-90 0.020 treated with caution, however, as the data ranged from -0.30 to 0.43 percent of the used are highly aggregated. The basic 1981 population across states. 0.015 method used to evaluate the role of migra- Second, in some countries migration is tion is to estimate the convergence equa- impeded by institutional obstacles. In China 0.010 tion both with and without a net migration and the former Soviet Union, for example, term. Adding the migration term should the absence of housing markets acts as a 0.005 reduce the convergence coefficient (1) if major brake on geographic mobility, while migration plays a significant role in the con- Chinese migration into urban areas is still 0 With ou vergence process. Since there is a danger of subject to legal restrictions. A recent study migration migration simultaneity bias in this equation, as one on migration in Russia finds that oblasts Note: Calculations are for a sample might expect higher per capita growth to with higher rates of apartment privatization of eight countries. induce more net migration, simultaneous are more likely to be chosen by immigrants Source:Subnational Regional Economics Knowledge equation estimating techniques are used. but are also more likely to experience sig- Management System. Most studies have found evidence that nificant emigration. It has also been sug- migration affects convergence, but this evi- gested that differences in housing dence is unimpressive. In the United opportunities may partly explain why inter- States, for example, without standardizing nal mobility is higher in Australia, Canada, for migration the estimated convergence New Zealand, and the United States than in coefficient for 1920-90 is 0.0196. That is, a Western Europe andJapan. Countries with 1 percent increase in a U.S. state's initial a long history of immigration may also have per capita income will take about 0.0196 of a culture that facilitates internal mobility. a percentage point from its subsequent Third, the effect of migration may be growth rate. But when the effect of migra- concealed by the aggregate nature of the tion is excluded, the convergence coeffi- data used in convergence studies. Apart cient only falls to 0.0174, implying that from the fact that populations rather than migration makes a trivial contribution. labor movements are being measured, Average convergence coefficients for the there is also the concern that the effect of eight countries in which similar studies migration flows of skilled and unskilled have been carried out are 0.0219 (with labor could be very different. Suppose that migration) and 0.0214 (without)-again, a backward regions have high relative trivial difference. In some countries, such endowments of unskilled labor but low rel- as the United Kingdom, studies suggest ative endowments of skilled labor. that migration actually seems to create Equilibrating flows would then take the slight divergence. form of migration of unskilled labor from There are a number of reasons migra- backward to more developed regions and tion seems to play a limited role in pro- of skilled labor in the opposite direction. moting convergence between subnational Using net migration flows without distin- regions. First, despite the fact that mobility guishing unskilled from skilled labor may be large in the sense that significant would generate a very misleading analysis portions of populations move annually, net of migration's effect on convergence. migration between sizable areas (such as Finally, if labor markets are insuffi- states and provinces) is quite small. In ciently flexible, migration may do little India, for example, about 30 percent of the more than move open or disguised unem- ployment from one state to another. This is private demand. The marketplace ap- possible in developing countries because proach encouraged by advocates of unskilled labor is often in surplus in both clustering may help guide public backward and more developed regions. investment decisions if public agencies participate. Policyconclusions Third, there is also not much evidence The results so far suggest that income dis- that strategic investments in a leading sec- parities across subnational regions in tor or industry will do the trick. Such invest- developing countries are likely to remain ments are often capital-intensive and prove substantial for some time. Relying on mar- costly mistakes (as in Brazil and India). Thereis no) ket forces alone to remove subnational Fourth, equalizing fiscal transfers inequality is not enough, yet long exp- between the national government and easyway to iron erience with regional policy in industrial subnational regions, while possibly justi- countries suggests that there is no easy way fied on equity grounds, do not seem to out subnaLional to iron out subnational differences. generate economic growth in backward Nevertheless, some lessons have emerged. regions. Fiscal equalization has had a differences First, countries that have displayed sig- strong appeal in a number of countries nificant subnational convergence (France, and federal systems (India, Italy, the the United Kingdom, the United States) European Union), and has doubtless encouraged private sector development in raised per capita incomes in poorer backward regions, although the relative regions on a one-off basis. There is no evi- merits of the various instruments used- dence, however, that such transfers gener- investment and employment incentives, ate economic dynamism, and poorer industrial estates, local development cor- regions may become permanently depen- porations-remain a matter of debate. dent on the central government. The currently popular approach, of bring- ing together the private sector and other Furtherreading actors to develop an informal marketplace Barro, RJ., and X. Sala-I-Martin. 1995. to encourage appropriate clusters, seems Economic Growth.New York: McGraw-Hill. to offer considerable promise. Williamson, J.G. 1965. "Regional Inequal- Second, there is little evidence that ity and the Process of National large public infrastructure investments in Development: A Description of the subnational regions can be used to create Patterns." Economic Development and growth poles. Countries that have tried this Cultural Change 13. (Brazil, Italy) have had little success and experienced slow subnational converg- This note was uwitten ly PeterFallon (Principal ence. Cross-regional investments in major Economist, Economic Policy Group, PREM Net- highways run the risk of making it easier work) and Camille Lampart (Young Pro- for firms to relocate in developed centers fessional, Economic Policy Group, PREM and supply more backward areas from Network). It draws on material prepared by the there. Public investment seems most authorsfortheSubnationalRegionalEconomics appropriate when it is led and justified by Knowledge Management System.

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