The Cicero Foundation Paris, 14 October 2004

1. "Prospects of Economic Integration: Are the New Member States Ready to Catch-Up in the Wider EU?"Patrick Lenain, OECD(patrick.lenain@oecd.org)Alexandra Janovskaia, OECD(a.janovskaia-alumni@lse.ac.uk) The Cicero FoundationParis, 14 October 2004 The views expressed in this presentation are those of the authors and should not be construed as those of the OECD.

2. Three issues • Has the EU achieved its goal of cohesion? • How fast will the “New Member States” catch-up? • What prospects for EU Eastern neighbours?

3. First issue Has the EU achieved its goal of cohesion?

4. The EU goal of cohesion “The Community shall aim at reducing disparities between the levels of development of the various regions and the backwardness of the least favoured regions…” (Article 158 of the Treaty).

5. Advantages Free trade of goods Free trade in services Free movement of people Free movement of capital Company legislation Structural funds What Has EU to Offer:Acquis Communautaire

6. Measuring cohesion with “σ-convergence” Reduced cross-country dispersion of income-per-capita measured by standard deviation.

7. Cohesion countries have “σ-converged” … 1980 GDP per capita (PPP), EU15 =100 Standard deviation = 19.6 + 25% of EU average - 25% of EU average

8. … but slowly 2002 GDP per capita (PPP), EU15=100 Standard deviation = 17.2 + 25% of EU average - 25% of EU average

9. Measuring cohesion with “β-convergence” Negative relation between growth rate and level of GDP per capita

10. Countries have slowly β-converged towards the leader

11. EU membership has helped Average GDP/Capita growth rate 1986-2002 Cohesion countries: Ireland, Greece, Portugal & Spain. Control group: Antigua, Argentina, Barbados, Cyprus, Israel, Korea, Malta, Macao & Singapore (GDP per capita between 5000$ and 15000$ in 1986).

12. But other “conditions” also matter (Number of years to close income gap with EU from 2002 based on average growth rates of GDP/capita during 1993-2003) Years Average growth rates calculated using HP-smoothed time series.

13. In summary • EU countries are converging slowly • Membership in the EU helps to catch-up • But convergence is not automatic in the EU: other forces (institutions / policies) are at work.

14. Second issue How fast will the “New Member States” catch-up?

15. The new member states have income per capita of 40% to 60% of EU

16. Convergence is a distant prospect at present pace Number of years to converge from 2003* 80 years 97 years Based on average growth during 1995-2003.

17. Faster growth rate would make a difference Assuming annual growth of 2% in EU

18. Gaps in living standards reflecttwo factors GDP per capita can be decomposed between: Labour productivity Labour utilisation

19. Labour utilisation Labour productivity Share of employment in total population, 2003, deviation from EU15 GDP per employed (PPP) in 2003, deviation from EU15

20. Convergence needs both labour productivity and utilisation

21. How does labour productivity catch up? • Capital deepening (increase in the ratio of capital to labour) • Diffusion of technology through international spillover, education and R&D spending. • Reallocation of labour towards high-productivity sectors

22. Most new member states invest strongly GFCF in % of GDP, 2003

23. Labour productivity benefits from international integration, including FDI 1995-2003 average, regression without outliers (CZE and SVK)

24. FDI has helped technology spillovers Share of high medium-tech manufactures in total value-added

25. Growth could benefit from faster reallocation of labour towards high-productivity industries Source and methodology: See Lenain et Rawdonowicz (2004)

26. How does labour utilisation increase? • Higher participation rates (incentives for older workers to work rather than retire, incentives for female workers to enter the labour market). • Higher labour demand (lower tax wedge, easier Employment Protection Legislation). • Higher regional mobility (housing-rental market deregulation). • Removal of disincentives to join “official economy”.

27. Participation is particularly low among older workers Labour-force participation rate of workers age 55-64 EU-15

28. Without higher labour-force participation, population ageing will prevent convergence Projected decline in labour force during… 2000-25 2025-50 Source: Burniaux et al. (2004)

29. Labour-market policies hinders participationSomeexamples: • Poland • Minimum wage high relative to average wage • Tax wedge among highest in OECD • High share of persons with disability pension • Slovak Republic • Employment Protection Legislation very strict (being eased) • Low regional mobility • Czech Republic • Employment Protection Legislation very strict (being eased) • High tax wedge on low-skilled labour • Regulations impede functioning of housing market

30. In sum… • New member states have started to converge, but at different speeds. Baltic states & Slovenia have better convergence prospects than Central Europe. • In most (but not all) countries, labour productivity has risen fast thanks to, inter alia, strong investment, FDI and technology spill-overs. • Weak labour utilisation impedes convergence, especially in Central Europe. Low participation of older workers and negative demographic trends will hinder convergence, unless labour markets are reformed.

31. Third issue What prospects at the “new” EU Eastern borders? A few issues for discussion

32. Growth “premium” from being an accession country

33. Will candidate countries benefit from accession boom? Romania (Since 2000) Real GDP Bulgaria (Since 1998) New EU members (Since 1995)

34. Two Turkish challenges: how to raise labour utilisation and improve resilience? Labour utilisation relative to EU-15 (left scale) Change in labour utilisation (right scale) Real GDP growth

35. What economic strategy to sustain growth in non-candidate Eastern neighbours? Ukraine Russia

36. Thank you for your attention !