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European Policy Committee 29 th October 2007 R EAL C ONVERGENCE

Explore trade impact, FDI trends, and convergence measures in European economies. Analyze the pace of convergence, alternative growth metrics, and macroeconomic sustainability factors.

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European Policy Committee 29 th October 2007 R EAL C ONVERGENCE

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  1. European Policy Committee29th October 2007REAL CONVERGENCE • Jiří Palán • Ministry of Finance of the Czech Republic

  2. Outline • • Trade and catching up • • FDI and catching-up • • Recent convergence pace • • Alternative measures of real convergence • Nominal vs. real convergence • Macroeconomic sustainability • Convergence drivers, need for structural reforms • Summary

  3. Trade and Catching up • High weight of trade in GDP, dynamic development • Strong links between trade and FDI Exports of Goods % GDP SK EE CZ HU SI LT LV EU15 PT PL Source: Eurostat

  4. FDI and Catching-up Trade and FDI inflows in percentage of GDP (2000 - 2006) •High FDI inflows support trade, growth and convergence •CZ: ¼ of gross value added (GDP) creation, 60% of gross value addedgrowth due FDI dominated manufacturing MT IE BE EE SK HU CZ NL BG SI Exports and Imports in percent of GDP (2000 - 2006) LT LV CY AT DK SE RO FI PL DE PT IT UK ES IT FR Source: Eurostat FDI inflows in percent of GDP (2000 - 2006)

  5. Recent Pace of Convergence •Convergence is a prevailing process within the EU GDP at current prices: Percentage of EU27 (based on PPS per inhabitant) % Source: Eurostat

  6. Recent Pace of Convergence •β convergence • Conditional (macro stability, structural reforms) GDP at currentprices: (EU 27 = 100%) % SI PT CZ HU SK LT PL LV EE Source: Eurostat

  7. Alternative Measures of Real Convergence •Real Gross Domestic Income (RGDI),RealGross National Income (RGNI), • GDP adjusted for terms of trade and income balance RGDP, RGDI, RGNI Average Growth Rates 2000-2006 (in percent per capita) Source: Ministry of Finance of the Czech Republic

  8. Nominal vs. Real Convergence DK SE IE FI UK FR BE IT NL DE AT Price level of GDP (EU27=100; 2006) ES GR PT SI EE CZ PL HU SK RO LT BG GDP in PPP (EU27=100; 2006) Source: Eurostat

  9. Nominal vs. Real Convergence – Case of CZ 2007 Price level of GDP (EA12=100;1993 - 2006) 1993 GDP in PPP (EA12=100; 1993 - 2006) Source: Ministry of Finance of the Czech Republic

  10. Nominal vs. Real Convergence • Relation between GDP(in PPP) and REER • Non linear • Competitiveness development • Two channels of CPL adjustment • CPLt = χt+ πt CPL = comparative price level, χ = FX movement, π = level of inflation • FX fixers – convergence channelled through higher inflation • Inflation targeters - convergence channelled through inflation and nominal FX appreciation • Different challenges for macroeconomic policies • FX fixers (BG, EE, LT, LV) – CA deficits • Inflation targeters (CZ, HU, PL, SK, RO) – fiscal deficits

  11. Macroeconomic sustainability • Small open economies, dispersion of CA has trend up • Use of foreign savings for economic development Current Account Positions and FDI Inflows (Percent of GDP) Source: IMF - World Economic Outlook; Eurostat

  12. Macroeconomic Sustainability •CA structure matters for double deficit assessment • Composition of deficit (transfers vs. investment) Government Deficit (Percent of GDP) Source: Eurostat

  13. Macroeconomic sustainability •Small open economies, high weight of trade, export oriented FDI • Structure of CA deficit (life cycle of FDI) Balance of Trade in Goods and Services, Income Balance (Billions €) Source: Eurostat

  14. Convergence Drivers, Need for Structural Reforms • Main convergence drivers • TFP as main growth driver • Capital accumulation precedes • Labour utilisation increases only recently • Challenges for structural reforms • Competition enhancement especially in non traded goods and services • Prudential policies to avoid assets prices boom and bust • Creation of knowledge based economy (education, R&D, innovation) • Improvement of business environment • Infrastructure investment • Successful catch-up needs flexible economy

  15. Summary • Conclusions mostly relevant for the Czech economy, • Trade (often based on FDI) is fostering catch-up, • Convergence is prevailing among EU NMS, • RGDI and RGNI are important alternative measures for small open economies with high weight of trade and FDI in their GDP, • Relation between nominal and real convergence is often non linear, • Challenges for macroeconomic policies are different among EU NMS, • Mix of structural policies is often very similar.

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