Convergence Prospects for CEE Countries

1. ACADEMY OF ECONMIC STUDIES DOCTORAL SCHOOL OF FINANCE AND BANKING Convergence Prospects for CEE Countries Mihaescu Flaviu M. Sc. Dissertation Paper Coordinator: Professor Moisa Altar

2. Convergence:Hypotheses • Poor countries catch-up with the rich ones. • The farther the initial level of (per capita) output from the steady state, the faster the growth. • Equation:

3. Convergence:Major drawbacks • “Steady states”: different countries have different steady states • Unconditioned convergence holds only for some countries / regions • E.g.: U.S. states, Japanese prefectures and OECD regions • They have the same steady states

4. Conditional Convergence • Conditional convergence accounts for different steady states • Conditioning variables may be: • Government consumption • Domestic savings • Domestic investments

5. Conditional Convergence • Equation: • Empirical evidence: • Barro and Sala-i-Martin (1991), • Mankiw, Romer and Weil (1990), • Sachs and Warner (1995)

6. Unconditional Convergence: CEEC11 • Premises for convergence: • the same pattern of output growth • EU accession candidates and proximity • converging structure of the economies • legislative and institutional approximation • openness of trade

7. Unconditional Convergence: CEEC11 Average Growth Vs. Initial Level of GNP per capita, PPP, 1992 - 2000 Average Growth Initial Level

8. Conditional Convergence:Accounting for Different Steady-States • Split the 11 countries group by EU - Accession criteria: 1998 Group: Poland, Czech Republic, Estonia, Hungary and Slovenia 2000 Group: Bulgaria, Lithuania, Latvia, Romania, Slovak Republic plus Croatia

9. Conditional Convergence:Accounting for Different Steady-States • The 1998 Group will have the per capita income level of Spain as steady state (about 80% of EU level) • The 2000 Group will have the per capita income level of Greece as steady state (about 60% of EU level)

10. Conditional Convergence:Accounting for Different Steady-States The highlighted countries are those from the 1998 group and their per-capita GNP was divided by Spain’s. The rest – not highlighted – are the 2000 group countries plus Croatia and they have Greece as steady state.

11. Conditional Convergence Average Growth Vs. Initial Level of relative GNP per capita, PPP, 1992 - 2000 Average Growth Initial Level

12. Unconditional Convergence in Expanded Sample 24 countries sample, CEEC11 + CIS countries + Turkey Average Growth Vs. Initial Level of GNP per capita at PPP in expanded sample, 1992 - 1999

13. Unconditional Convergence in Expanded Sample Regression output (CIS is a dummy variable for CIS countries):

14. Conditional Convergence:Conditioning Variables

15. Conditional Convergence:Conditioning Variables With a = -0.06 β = -0.089 γ1 = 0.068 γ2 = 0.0025 [0.005] [0.017] [0.019] [0.037] R - sqr. = 0.803 F-stat. = 9.539 [0.007] Adj. R - sqr. = 0.719

16. Conditional Convergence:Conditioning Variables • “Institutional Quality” comprises voice and accountability, politically instability and violence, government effectiveness, regulatory burden, rule of law and graft. • “Trade” is the sum of imports and exports divided by GDP, all at PPP, and it is often taken as a measure of openness.

17. Timing Convergence • The 1998 group (Czech Republic, Estonia, Hungary, Poland and Slovenia) will reach Spain or approximately 80 percent of EU average per capita income in 16 – 18 years • The 2000 group (Bulgaria, Latvia, Lithuania, Slovak Republic, Romania plus Croatia) will reach Greece or approximately 60 percent of EU average income also in 16 – 18 years.

18. Scenario Analysis • Assumptions: • “Trade” will increase with one Standard Deviation • “Institutional Quality”: the 1998 Group will improve their institutional quality with 2 points, while the 2000 Group will improve with 4 points. • “Optimistic” scenario assumes a 9% speed of convergence, the “pessimistic” one a 2.4%, while the “intermediate” one assumes 6%.

19. Scenario Analysis

20. Scenario Analysis

21. Convergence of “Cohesion”Countries to EU Average Vs. Initial levels of per –capita income, EU-14, 1975-1998

22. Convergence of “Cohesion”Countries to EU Conditioning variables: a = -0.37 β = -0.281 γ1 = 0.051 γ2 = 0.082 γ3 = -0.021 [0.006] [0.077] [0.013] [0.003] R - sqr. = 0.809 Adj. R - sqr. = 0.777

23. Scenario Analysis Scenario 1: Theoretical assumptions - GC = 10% and DI = 30% Scenario 2: Average values of GC and DI for CEECs, 1994 - 1999 Scenario 3: Average values of GC and DI for Greece, Spain and Portugal, 1991 - 1999 Scenario 4: Average values of GC and DI for Ireland, 1991 - 1999

24. Scenario Analysis

25. Scenario Analysis

26. σ - Convergence • Output gap between the group members decline over time • σ - convergence does dot imply β - convergence, nor conversely • “catch-up at the top and downward convergence at the bottom” (Ben- David, 1997)

27. σ - Convergence

28. σ - Convergence Variance trend for restricted sample, 1992 - 1999 Var(Group1998) = 0.347 - 0.0078 * trend [0.00] [0.02] R – sqr = 0.56 Var(Group 2000) = 0.156 + 0.0138 * trend [0.00] [0.00] R – sqr = 0.88

29. Ergodic Distribution • Follows Quah (1997) • Considers the entire income distribution • Transition probabilities matrix of moving from one income group to another. The diagonal probabilities show the probability of staying in the same income group, while the off-diagonal probabilities are the probabilities of moving from one income group to the subsequent one (up or down).

30. Ergodic Distribution • The ergodic distribution is: Where P is the transition probabilities matrix. • The ergodic distribution can be obtained as the left eigenvector corresponding to the unit eigenvalue.(Because each row of the matrix sums to one)

31. Ergodic Distribution Number of observations per income group ( as a % of EU average)

32. Ergodic Distribution

33. Ergodic Distribution Initial and ergodic distribution

34. Conclusions • β - convergence is achieved after controlling for different steady states • σ - convergence shows that there is rather divergence among 2000 Group countries, while 1998 Group countries do also exhibit σ - convergence • The ergodic distribution shows that there is convergence among CEEC 11 countries, namely the 2000 Group will converge in per capita income to the 1998 Group.