1. Convergence in the European Union
BSSB.BE ceps.eu 04.05.2018
Balkans Danubiam France Germany The Baltics Poland
* The convergence process in Europe has bifurcated: the new member states (NMSs) from Central and Eastern Europe are catching up in terms of income per capita, as one would expect, with the initially poorer ones growing generally at a faster pace.
Within the euro area, however, the North has diverged from the South since the start of the financial crisis. This pattern, reflecting East-West convergence but also North-South divergence within the euro area, can be observed for a number of indicators, such as real wages, investment and consumption. There is no indication that euro area membership has had a negative impact on convergence.
On the contrary, each of the 11 new Central and Eastern European member states, which joined the euro after 2004, have been converging at a slightly faster rate than one would have expected given their starting level of income per capita. Moreover, the available projections for the next few years suggest that EastWest convergence will continue, and that some North-South convergence might re-start.
Moreover, several of the countries severely affected by the euro crisis are now returning to above-average growth, whereas some ‘non-euro Northern’ EU member states are also not growing faster than the euro area. All in all, it appears that the lack of convergence North-South has roots other than the euro.
Our findings do not answer the question whether the East-West catch-up process will lead to ‘full’ convergence. It is often argued that further catching-up would require a change in the growth model. Catch-up growth can rely on importing foreign capital and know-how via massive amounts of foreign direct investment, but after a certain level, more domestic innovation is required to maintain growth. Reorienting the growth model towards more domestic innovation may pose the key challenge for the NMSs.
One of the key promises made by the European Union to its member states was, and remains, shared prosperity. The combination of the internal market (for goods, services, people and capital) with EU cohesion policies was supposed to drive convergence, by allowing the poorer member states to grow faster and catch up with the richer ones.
Similarly, it was thought that the common currency would accelerate the process through lower interest rates for the peripheral countries and through capital flows towards lower-income member states exhibiting lower capital-to-output ratios.
However, these expectations have been met only partially or temporarily. Within the original EA121 , the poorest member states are the ones that are struggling with the aftermath of a devastating financial crisis. The distance between the richest and the poorest EA12 member states today is higher than when the euro was introduced, even taking into account the high growth period before the crisis.
By contrast, the new member states (NMSs) (both euro area ‘ins’ and ‘outs’) from Central and Eastern Europe seem to have performed better. Almost all of them have diminished the distance to the EU average, if one averages out the boom-bust episodes by considering the change in their position today relative to the beginning of the century.
Moreover, even the countries hit hardest by the financial crisis have resumed catch-up growth after very deep, relatively short recessions, indicating greater resilience. These developments raise some key questions.
- First, does the euro hinder convergence? The link between euro area membership and convergence has been extensively analysed.
- The most recent contributions are major studies from the ECB (Diaz del Hoyo et al., 2017) and the IMF (Franks et al., 2018), which also emphasise the distinction between nominal and real convergence.
- The European Commission has a regular report on convergence and has analysed convergence within the euro area in more detail in the last Quarterly Report on the Euro Area of 2017. The key argument why euro area membership might endanger convergence is that this could lead to excessive capital inflows, which lead to boom-bust cycles and a misallocation of resources.
- The experience of some of the Southern European countries illustrates the pattern as illustrated by both of these studies. The key argument why euro area membership might foster convergence is that it should facilitate capital mobility and market integration.
- Here the experience of the NMSs is instructive. Those that have joined the euro (the Baltics, Slovenia and Slovakia) are continuing to catch up, indicating that it is not their membership in the euro area that presents an obstacle to catching up. On the contrary, there is some evidence that these countries are catching up somewhat more quickly than the others.
We show below that these countries are not different from the other NMSs in terms of investment rates, education and other indicators. The only evidence we could find for the idea that euro area membership leads to more instability is that the growth rates of the euro area members among the NMSs are somewhat more variable.
Given that their average growth rates are also higher, however, it turns out that the variability relative to the average growth rate is about the same for all NMSs, across both groups: euro and non-euro area members.
The projections suggest that the asymmetry from the past is likely to persist, albeit in a more moderate form: convergence seems set remain stronger East-West than North-South. This study investigates this phenomenon more in depth by analysing the role of factors such as education, foreign direct investment (FDI), the size of manufacturing and the initial level of income.
- The publication is not an editorial. It reflects solely the point of view and argumentation of the author. The publication is presented in the presentation. Start in the previous issue. The original is available at: ceps.eu