1. OUTPUT CONVERGENCE IN EU AND ACCESSION COUNTRIES Author: MSc Catalina Constantinescu Supervisor: Moisa Altar ACADEMY OF ECONOMIC STUDIES DOCTORAL SCHOOL OF FINANCE AND BANKING

2. Convergence aspects in European Union Nominal convergence – Maastricht Convergence Criteria (for EMU) Real convergence – restructuring the old economic system – catching up with the productivity and per capita income levels of mature market economies

3. Literature review Convergence: Countries with high output per capita must grow less then countries with low output per capita. Romer (1986), Lucas (1998) - predictions of dynamic equilibrium models for long-term behavior Baumol (1986), Barro (1991), Barro and Sala-i-Martin (1991, 1992, 1995), Mankiw, Romer and Weil (1992) – negative cross-section correlation between initial income and growth rates → convergence Problems for cross-section methodology: - using production function with diminishing marginal product of capital - null hypothesis: no countries are converging Bernard and Durlauf (1991, 1995), Quah (1996), De la Fuente (2000), St.Aubyn (1999), Lim and McAleer (2000), Estrin and Urga (1997) – time series methods for testing convergence

4. Definitions for convergence in time series framework Bernard and Durlauf (1991) Condition: Output series contain stochastic trend Definition 1. Convergence in output Countries i and j converge if the long-term forecast of output for both countries are equal at fixed time t: Definition 2. Common trends in output Countries i and j contain a common trend if the long-term forecast of output are proportional at a fixed time t:

5. Implications : Convergence for a group of countries → identical long-run trends, either stochastic or deterministic. Common trends → proportionality of the stochastic elements. Zero mean stationary processes.

6. Econometric methodology Verspagen (1994) W i,t = y i,t – y* t where: y i,t log real GDP per capita for country i at time t y* t average log real GDP per capita for the countries in the sample W changes according to the following process: W i,t+1 = Ψ*W i,t Ψ > 1→ per capita income in country i diverges from the sample group; Ψ < 1→ convergence of income takes place.

7. Convergence tests for pairs of countries “Achieved convergence” The Augmented Dickey-Fuller test Variables: differences between logarithm of GDP per capita series of two countries Cointegration test (Johansen methodology) Variables: logarithm of GDP per capita series for two countries - [1,-1] cointegrating vector → convergence - [1,-α] cointegrating vector → common trend

8. “Ongoing convergence” Kalman filter method (St. Aubyn 1999) (1) (2) (3) H 0 : Φ=1 against H 1 : Φ<1

9. Empirical Analysis Data - Annual GDP per capita in PPP (USD) - World Bank Data Base - Countries from EU: Denmark, Belgium, Netherlands, Germany, France, United Kingdom and Italy (1975-2000). - EU periphery countries: Spain, Portugal and Greece (1975-2000). - 10 accession countries: - Cyprus, Malta, Hungary, Latvia (1975-2000) - Slovak Republic (1984-2000) - Estonia (1987-2000 ) - Poland and Lithuania (1990-2000) - 2 more accession countries: Romania and Bulgaria (1980-2000)

11. Empirical results CountryΨAdjusted R squared Denmark0.980320.756885 Belgium0.9989760.109907 Netherlands0.9138310.858455 Germany0.8845920.502831 France1.0168550.773264 United Kingdom0.9814330.497414 Italy0.9432080.920861 Verspagen test

12. CountryΨAdjusted R squared Denmark0.9839140.752599 Netherlands0.8887140.861127 Germany0.960350.491654 France0.9307390.764081 United Kingdom0.97820.542527 Italy0.926590.908997 CountryΨ Adjusted R squared Spain0.9829110.803116 Portugal0.9223730.965001 Greece0.9508010.949905

13. Convergence test resultsBelgiumNetherlandsGermanyFrance United KingdomItaly Denmark ADFI(1) I(0) I(1) Cointegration [1,-1] 0.8470.0270.9450.0360.3040.313 Kalman filter -3.023-0.353-2.483-0.132-0.892-3.023 Belgium ADF I(1)I(0)I(1) Cointegration [1,-1] 0.2180.120.1790.0010.003 Kalman filter -0.368-2.487-1.946-2.820.007 Netherlands ADF I(0)I(1) I(0) Cointegration [1,-1] 0..000.00 Kalman filter -0.431-2.937-1.907-2.363 Germany ADF I(0)I(1)I(0) Cointegration [1,-1] 0.001 1 0.0020.308 Kalman filter -6.5024.208-4.946 France ADF I(0) Cointegration [1,-1] 0.000.921 Kalman filter -0.117-6.527 United Kingdom ADF I(1) Cointegration [1,-1] 0.027 Kalman filter -3.845

14. Convergence test resultsPortugalGreeceGermanyFranceItaly Spain ADFI(0)I(1) Cointegration [1,-1] 0.9240.000 Kalman filter -3.117-5.708-2.001-0.248-2.033 Portugal ADF I(0)I(1)I(0)I(1) Cointegration [1,-1] 0.004 Non cointegrated0.907 Non cointegrated Kalman filter -3.57-0.652-0.0180.0361 Greece ADF I(1) Cointegration [1,-1] 0.0340.7170.044 Kalman filter -1.619-2.579-2.429

16. CountryΨAdjusted R squared Cyprus1.0313240.941309 Malta0.9653480.952942 Hungary0.8600370.929309 Latvia1.0355030.924918 CountryΨAdjusted R squared Cyprus1.0319150.802815 Malta1.0157850.871978 Hungary0.5705560.191988 Latvia1.0366930.81199 Estonia1.0048350.687855 Slovak0.9280120.209155 Verspagen tests

17. CountryΨAdjusted R squared Cyprus1.0261080.130426 Malta1.0499140.368951 Hungary0.970821-0.09418 Latvia1.0269970.338245 Estonia0.9689530.200447 Slovak0.6363240.078729 Poland0.9012080.780803 Lithuania1.074640.725657

18. CountryΨ Adjusted R squared Cyprus1.0311780.213404 Malta1.0618960.505355 Hungary1.0235280.131505 Latvia0.9970750.291233 Estonia0.886920.427853 Slovak0.9788990.403625 Poland0.8454810.869723 Lithuania1.0377160.63805 Romania1.0590690.620672 Bulgaria1.044250.763662

19. Convergence test resultsMaltaHungaryLatviaSlovak R.EstoniaSpain Cyprus ADFI(1) I(0) Cointegration [1,-1] 0.000 Non cointegrated Non cointegrated 0.017 0.518 0.118 Kalman filter 0.268-2.4571.891-2.198-3.523-3.628 Malta ADF I(0)I(1) I(0) Cointegration [1,-1] 0.000 Non cointegrated Non cointegrated 0.000 Kalman filter -1.780.557-0.3-2.64-3.41 Hungary ADF I(1)I(0)I(1) Cointegration [1,-1] Non cointegrated 0.241 Non cointegrated 0.924 Kalman filter 0.6710.367-0.022-1.501 Latvia ADF I(1) Cointegration [1,-1] Non cointegrated Non cointegrated Non cointegrated Kalman filter -0.391-4.950.731 Slovak Rep ublik ADF I(1) Cointegration [1,-1] 0.030 Kalman filter -0.276

20. Convergence test resultsRomaniaBulgaria Cyprus ADFI(1) Cointegration [1,-1] 0.0000.003 Kalman filter 0.345 0.4 Malta ADF I(1) Cointegration [1,-1] 0.000 Kalman filter 0.522 Hungary ADFI(0)I(1) Cointegration [1,-1] 0.000 Non-cointegrated Kalman filter 1.072 --- Latvia ADF I(0) I(1) Cointegration [1,-1]Non-cointegrated 0.002 Kalman filter --- 0.581 Romania ADF I(0) Cointegration [1,-1] 0.000 Kalman filter 0.211

21. Conclusions Some evidence of convergence for European Union countries All EU countries have common trends EU periphery countries form an ongoing convergent group Accession countries form a heterogeneous group of economies Counteracts for inadequate real convergence: - wage flexibility in the accession countries, migration to the EU core countries and large fiscal transfers from the EU to the new Member States. - structural issues for the new members

22. References Barro, R.J. (1991), “Economic Growth in a Cross-Section of Countries”, Quarterly Journal of Economics, 106. Barro, R.J. and Sala-i-Martin (1991a), “Convergence Across States and Regions”, Brookings Papers on Economic Activity, 1. (1992b), “Convergence”, Journal of Political Economy, 100. (1995c), “Economic Growth”, McGraw-Hill, New-York. Baumol, W.J. (1986), “Productivity Growth, Convergence and Welfare: What the Long Run Data Show”, American Economic Review, 76. Bergs, Rolf (2001) “EU Regional and Cohesion Policy and Economic Integration of the Accession Countries”, Policy Research & Consultancy (Germany), Discussion Papers. Bernard, A.B. and S.N. Durlauf (1991a), “Convergence of International Output Movements”, NBER W.P.3717. (1995b), “Convergence in International Output”, Journal of Applied Econometrics, 10. (1996c), “Interpreting Tests of the Convergence Hypothesis”, Journal of Econometrics,71 Van Eden, Holger, Albert de Groot, Elisabeth Ledrut, Gerbert Romijn and Lucio Vinhas de Souza (1999) “EMU and Enlargement: A Review of Policy Issues”, European Parliament Economic Affairs Series ECON 117 EN 12/99). Enders, Walter (1995), “Applied Econometric Time Series”, John Wiley & Sons, Inc. Estrin, Saul and Giovanni Urga (1997), “Convergence in Output in Transitions Economies Central and Eastern Europe 1970-1995”, The Williamson Davidson Institute WP30. De la Fuente, Angel (2000), “Convergence Across Countries and Regions: Theory and Empirics”, Instituto de Analisis Economico WP 44700.

23. Hamilton, James D. (1994), “Time Series Analysis”, Princeton University Press. Lim, Lee Kian and Michael McAleer (2000), “Convergence and Catching Up in South East Asia: A Comparative Analysis”, University of Western Australia, Department of Economics. Lucas, R.J. (1988), “On the Mechanism of Economic Development”, Journal of Monetary Economics, 22. Mankiw, N.G., D. Romer and D. Weil (1992), “A Contribution to the Empirics of Economic Growth”, Quarterly Journal of Economics, V 107. Quah, D.T. (1996), “Empirics for Economic Growth and Convergence”, European Economic Review. Romer, P.M. (1986), “Increasing Returns and Long-Run Growth”, Journal of Political Economy, 94. St. Aubyn, M (1999), “Convergence Across Industrialized Countries (1890-1989). New Results using Time Series Methods”, Empirical Economics, 24. World Bank “2002 World Development Indicators” Data-Base.