Catch-Up Growth and What It Means for Nepal

A question that has always plagued economic discourse is how poor economies can accelerate their growth rate and escape low-income status. In the quest to answer this, economists have conducted decades of research and observation, identifying interesting phenomena in some countries that managed to break out of poverty traps. In the 1960s, Clark Kerr popularized the “Theory of convergence” to explain this pattern of growth. Also commonly known as the “Catch-Up Effect”, this theory suggests that poorer or developing economies tend to grow faster than wealthier ones, thereby gradually reaching similar levels of per capita income. Over time, this can lead to a global convergence of income levels, as long as the right conditions are met.

High-Performing Asian Economies and Newly Industrializing Economies

Several countries have demonstrated remarkable growth, supporting the theory of convergence. From 1965 to 1990, 23 economies in East Asia grew faster than all other regions in the world. Much of this success was driven by just eight economies: Japan, the Four Tigers (Hong Kong, South Korea, Singapore, and Taiwan), and the three newly industrializing Southeast Asian economies (NIEs): Indonesia, Malaysia, and Thailand. Also called High-Performing Asian Economies (HPAE), these countries grew more than twice as fast as the rest of East Asia, roughly three times as fast as Latin America and South Asia, and five times faster than Sub-Saharan Africa. They far outpaced the rest of the world in terms of economic growth. For instance, between 1960 and 1985, per capita income more than quadrupled in Japan and the Four Tigers and more than doubled in Southeast Asian NIEs. Additionally, life expectancy in the developing HPAES increased from 56 years in 1960 to 71 years in 1990. Similarly, the proportion of people living in absolute poverty, lacking necessities such as clean water, food, and shelter, dropped from 58% in 1960 to 17% in 1990 in Indonesia, and from 37% to less than 5% in Malaysia during the same period. A host of other social and economic indicators, from education to appliance ownership, have also improved rapidly in the HPAEs and now are at levels that sometimes surpass those in industrial economies.

How Do Countries Catch Up?

Economies that have demonstrated remarkable growth often share common patterns. Below are some of the key factors behind this growth.

1. Growth from a Low Base

Among the main drivers of the catch-up process are high growth rates resulting from a low starting base. According to the theory of convergence, developing economies possess greater growth potential due to their underutilized resources. This potential is further enhanced by increasing returns to capital. However, as countries catch up, growth slows due to diminishing returns over time.

2. Technology Transfer and FDI

A central feature of catch-up growth is the ability to adopt and utilize existing technologies from more advanced economies. Poor countries grow by importing knowledge rather than innovating. Because of this, developing countries can bypass the costly research and development (R&D) process by absorbing knowledge and technologies through foreign direct investment (FDI) and international trade. For instance, in 2000, China attracted over 40% of all FDI flowing into developing countries. Additionally, lagging countries close the productivity gap with richer nations through the outsourcing of labor and production in cheaper markets of developing countries.

3. Structural Transformation

A vital aspect of economic transformation involves shifting labor and resources from low-productivity agriculture to higher-productivity sectors like manufacturing and services. In China, the share of industry in GDP increased from about 40% to over 50% during its catch-up phase, reflecting rapid structural transformation from agriculture. Similarly, countries with higher education levels and stable institutions also absorb foreign technologies more effectively, supporting structural transformation. This pattern of learning and growth is apparent in Japan, South Korea, and China.

4. Global Integration

Structural transformation is further supported by integration into global markets, which provides access to capital, technology, and export opportunities. In Poland, trade as a share of GDP doubled in the 1990s due to liberalization and EU integration. China is another example of strategic openness, which capitalized FDI and trade to build domestic capacity while retaining control over key sectors. Between 1990 and 2000, China and Poland achieved average annual GDP growth rates of 7–10%.

5. Urbanization and Human Capital Growth

Urban growth and infrastructure development also supported the shift to high-productivity sectors. In HPAEs, high domestic savings and investment rates, rapidly growing human capital, effective public administration, and policy interventions all played key roles. High levels of domestic financial savings sustained the HPAEs’ high investment levels. Agriculture, while declining in relative importance, also experienced rapid growth and productivity improvement.

And some of these economies also got a head start because they had a better-educated labor force, a more effective system of public administration, and superior accumulation of physical and human capital. Evolving consumption patterns, reduced labor time for essentials, and technological progress all contribute to the broader catch-up phenomenon.

6. Policy and Priority Sectors

Sound development policy was also a major ingredient in achieving rapid growth. In most of the catch-up economies, the government intervened, in one form or another, to foster development, and in some cases, the development of specific industries. Governments intervened to develop specific industries through targeted credit, protection of domestic markets, export promotion, and public investments in applied research. These selective interventions were closely associated with high productivity and private investment rates. Strategies of selective promotion were closely associated with high rates of private investment and, in the fastest-growing economies, high rates of productivity growth. This is regarded as a major strategy that has significantly contributed to South Korea’s rapid development.

Nepal’s Growth Prospects

This theory is particularly relevant for Nepal, as the country also possesses many of the conditions that position it as a strong candidate for catch-up growth. Moreover, Nepal has already demonstrated a promising growth performance in the last few decades. The average annual GDP growth rate of Nepal from 2014 to 2023 was approximately 4.3%. The economy grew by 3.1% in 2024, surpassing the global growth rate of 2.9% and the U.S. rate of 2.8%. Meanwhile, the highest GDP growth rate in Nepal was recorded to be 8.98% in 2017, and Nepal is projected to grow by 4.5% in 2025 and 5.4% annually for 2026-2027. These figures suggest that while Nepal’s economic growth has faced occasional setbacks, its overall performance has been steady.

Despite this, the country still holds several untapped opportunities for accelerating growth. Its strategic location between India and China, two of the world’s largest and fastest-growing economies, provides unique advantages in accessing regional markets and participating in cross-border infrastructure projects. Another resource that Nepal can tap into is the demographic dividend. Nepal can leverage either the outsourcing of work from developed countries or the export of its labor force to drive economic growth.  At the same time, Nepal’s vast water resources position it as a future leader in clean energy, particularly hydropower, which could become a cornerstone of its export economy.

Furthermore, global trade patterns are evolving in ways that may benefit Nepal. According to UNCTAD’s Trade and Development Report 2024, trade in services grew by 5% in real terms in 2023. With services already contributing over half of total output in developing countries, Nepal has the opportunity to expand its service sector as a key growth driver.

Barriers to Growth

The theory of convergence offers a compelling framework, but only conditional on sound policies and institutions. Empirical evidence suggests that while some developing economies have been able to effectively tap the available advantages to grow faster and catch up with robust economies, this has not been true for a large part of the developing world. Countries, such as Russia or Argentina, failed to catch up due to poor governance, macroeconomic mismanagement, or premature liberalization.

The benefits of global integration can only be realized when certain conditions are met. These include macroeconomic stability, strong governance, and institutional strength. Successful technology absorption also depends on domestic factors such as education systems, infrastructure, governance, and the strength of public institutions.

In Nepal’s case, while the country has the potential to benefit from its geographic location between two economic giants (India and China), and sectors like hydropower, tourism, and digital entrepreneurship, the extent to which the country can capitalize on the opportunities depends heavily on its internal readiness. Persistent structural challenges, such as weak institutions, political instability, underinvestment in education, poor infrastructure, and heavy reliance on remittances, have significantly constrained its ability to harness foreign direct investment and technological diffusion. Corruption and mismatched skill development further hamper productivity and innovation.

It is therefore not enough to identify which specific policies have worked elsewhere; what truly matters is understanding the institutional and economic environments that made those policies viable. Without strengthening these domestic foundations, Nepal will struggle to convert external opportunities into long-term, sustainable growth.