1. 1 Life after the hangover: Economic growth in the new EU member states between accession boom and adjustment bust Life after the hangover: Economic growth in the new EU member states between accession boom and adjustment bust Uwe Böwer Alessandro Turrini European Commission DG Economic and Financial Affairs 25 June 2009

2. 2 Agenda Motivation: Accession boom and adjustment bust Motivation: Accession boom and adjustment bust The EU growth effect in the literature The EU growth effect in the literature Assessing the accession boom Assessing the accession boom –Growth regressions –Cross-country variation in model predictions Growth implications of external adjustment Growth implications of external adjustment –Competitiveness developments –Currency misalignment and growth regressions Conclusion Conclusion

3. 3 GDP growth from boom to bust

4. 4 Beta and sigma convergence

5. 5 Investment and trade

6. 6 Quality of the legal system

7. 7 The EU growth effect in the literature Crespo-Cuaresma et al. (2002) Crespo-Cuaresma et al. (2002) –Pre-2004 enlargements –Length of EU membership positive and significant Schadler et al. (2006) Schadler et al. (2006) –Growth determinants of transition countries –Importance of institutional quality Cihak and Fonteyne (2009) Cihak and Fonteyne (2009) –Regression over 10 years –“EU membership growth dividend” ~ 1-2.5%

8. 8 Assessing the accession boom Panel dataset Panel dataset –62 advanced and emerging economies –Annual data 1960-2009, 5-year averages Standard growth determinants Standard growth determinants –Real per-capita GDP growth –Initial real GDP (PPP) –Gross fixed capital formation –Population growth –Openness, terms-of-trade growth –Human capital formation Control dummies (time periods, country groups) Control dummies (time periods, country groups)

9. 9 Enlargement-specific variables Institutional indices Institutional indices –Quality of the legal system –Freedom of trade –Quality of regulation NMS dummy NMS dummy Time/region interaction dummies Time/region interaction dummies –Difference-in-difference approach –Reference: EU-15 during 1995-1999 –Interacting NMS*(1990-94), NMS*(2000-2004), NMS*(post-2005)

10. 10 Regression results (1)

11. 11 Regression results (2)

12. 12 Actual and predicted growth rates

13. 13 Competitiveness developments

14. 14 Current account imbalances

15. 15 Misalignment and growth literature Rodrik (2008) Rodrik (2008) –Undervaluation stimulating growth –Effect driven by developing countries –Institutional weakness harming the tradable sector in poor countries  undervaluation as second-best –PPP-based misalignment measure Freund and Pierola (2008) Freund and Pierola (2008) –Misalignment effect on export competitiveness –Export surges in developing countries preceded by significant undervaluations –Resource allocation: depreciation leadas more firms to expand product and market space for exports

16. 16 Real exchange rate misalignment PPP versus current-account based misalignment PPP versus current-account based misalignment Current account norms approach Current account norms approach –Equilibrium REER: internal and external balance –Actual current account, adjusted for the cycle –Estimating a benchmark CA Panel regressions of CA determinants Panel regressions of CA determinants In-sample fitted values as CA norm In-sample fitted values as CA norm  Misalignment: required change in the REER to close the current account gap

17. 17 CA regression results

18. 18 Misalignment and growth results

19. 19 Implications of misalignment results Overvaluation indicating less productive sectoral allocation (non-tradables) Overvaluation indicating less productive sectoral allocation (non-tradables) Undervaluation promoting growth (tradables) as a second-best option in the presence of institutional weaknesses (Rodrik) Undervaluation promoting growth (tradables) as a second-best option in the presence of institutional weaknesses (Rodrik) From adjustment bust to boom? From adjustment bust to boom? –Negative growth impact in the short run –Benefits from sectoral reallocation in the longer term

20. 20 From accession boom to adjustment bust, and then what? Catching up: beta and sigma convergence Catching up: beta and sigma convergence Significant impact of EU accession period, on top of variety of control variables Significant impact of EU accession period, on top of variety of control variables Actual growth rates exceeding, then undercutting model predictions Actual growth rates exceeding, then undercutting model predictions Substantial external imbalances and misalignments Substantial external imbalances and misalignments Misalignment based on current account norms indicates Misalignment based on current account norms indicates –Negative effect of overvaluation, mostly for open, poor and transition countries –Positive adjustment effect in the longer term  Implications for NMS: rebalancing current accounts will imply reduced investment financing in short-to-medium run but could be beneficial to stronger growth in longer run as the tradable sector expands