How Human Capital and Financial Systems Accelerate Convergence in Global Economies

The working paper “What is Needed for Convergence? The Role of Capital and Finance”, authored by Bryan Hardy from the Bank for International Settlements and Can Sever from the International Monetary Fund, investigates the mechanisms through which poorer countries can catch up to their wealthier counterparts in terms of productivity and income. Drawing on four decades of cross-country and cross-industry data, the study sheds new light on the role of human capital, physical capital, and financial development in shaping convergence trajectories, with particular emphasis on the manufacturing sector. Through rigorous empirical analysis, the authors confirm that convergence is indeed happening, but its pace and consistency depend heavily on the composition of economic activity and the maturity of financial institutions.

Human Capital Drives Manufacturing Convergence

A central takeaway from the paper is that convergence in labor productivity is strongest in manufacturing industries that depend heavily on human capital. These include sectors such as machinery, communication equipment, and precision instruments, where workers tend to have higher levels of education. The authors measure human capital intensity as the proportion of employees in an industry with at least a high school diploma. Industries in the top quartile of human capital intensity consistently display faster productivity growth than those at the bottom. For instance, the machinery industry, when starting at the 25th percentile of productivity distribution, experiences a convergence-induced annual growth boost nearly 0.8 percentage points higher than that of a low human capital industry like wood products.

The results suggest that human capital is not merely a complementary input but a decisive factor in enabling productivity catch-up. Even after controlling for industry size, country-specific effects, and exchange rate fluctuations, the relationship between human capital intensity and productivity convergence remains robust. This reinforces the view that education policy and workforce skill development are not just social priorities but crucial levers for national economic advancement.

Physical Capital Requires Financial Depth

While human capital stands out as a primary driver of convergence, the story becomes more complex for physical capital. Industries that are capital-intensive, such as basic metals or non-metallic minerals, do not show consistent convergence unless they are embedded within well-developed financial systems. The researchers use the IMF’s Financial Development Index, which captures the depth, access, and efficiency of both financial institutions and markets, to assess this link. Their findings indicate that physical capital-intensive industries actually diverge in low-finance environments but begin to converge only once financial development exceeds a threshold score of 0.61.

This result is consistent with theories that emphasize the role of finance in enabling investment and reducing misallocation of resources. Without sufficient financial infrastructure, businesses in capital-heavy sectors may face credit constraints, which limit their ability to invest in machinery, infrastructure, and innovation. Conversely, in countries where financial markets are well-functioning and accessible, firms can leverage external finance to modernize and scale their operations, allowing them to close the productivity gap with global leaders. The implication is clear: financial development is not optional for convergence; it is essential, particularly in economies seeking to industrialize through capital-deepening sectors.

Aggregate Convergence Tied to Structural Transformation

Beyond the manufacturing sector, the paper broadens its focus to examine GDP per capita convergence at the national level. It finds that countries with a higher share of non-agricultural activities, namely industry and services, converge faster than those still reliant on agriculture. This reflects the fact that services and industrial sectors typically require more skilled labor and offer greater productivity potential. As such, the sectoral composition of an economy becomes a critical determinant of its growth path.

The study documents a compelling trend: poorer countries that began the 1980s with high agricultural shares in GDP have been shifting more rapidly toward industry and services than their richer counterparts. This transition, often described as a structural transformation, has accelerated in successive decades and appears to be a major engine of convergence. Not only does this shift reallocate resources toward more productive uses, but it also creates demand for human capital, reinforcing the positive feedback loop between education, industrialization, and growth.

Financial Development Boosts National Income Growth

In tandem with structural transformation, financial development at the country level significantly enhances convergence in income levels. Countries with more advanced financial systems experience nearly double the convergence boost in per capita GDP growth compared to those with less developed systems. For example, a country at the 75th percentile of financial development sees a convergence-driven growth increase of 2.3 percentage points annually relative to a peer with higher initial income. This effect drops to just 1.1 percentage points for a country at the 25th percentile of financial development.

These findings echo the industry-level results and underscore the systemic importance of financial infrastructure. When households and firms have access to credit, savings instruments, and capital markets, economies are better equipped to mobilize investment, manage risk, and allocate resources efficiently. In this context, policies aimed at expanding banking coverage, deepening capital markets, and improving financial inclusion can have direct and substantial macroeconomic payoffs.

Aligning Policy with Convergence Goals

The research by the Bank for International Settlements and the International Monetary Fund carries important implications for policymakers in developing economies. First, investing in education is paramount, not only to elevate individual well-being but also to support the growth of industries that can capitalize on skilled labor. Second, fostering sectors with high human capital intensity, particularly within manufacturing, can lead to faster productivity gains and spillovers. Third, efforts to deepen domestic financial markets are vital, especially for capital-intensive industries that otherwise struggle to grow. Finally, supporting structural transformation through infrastructure, urbanization, and targeted incentives can accelerate the transition toward more productive economic models.

Taken together, the study presents a hopeful yet realistic view of economic convergence. While poor countries can catch up, doing so requires strategic investments in people, institutions, and productive sectors. With the right mix of education, financial development, and industrial policy, convergence is not just a theoretical promise but an attainable objective for many nations.