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.

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Three issues

1. Has the EU achieved its goal of cohesion?

2. How fast will the “New Member States” catch-up?

3. 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

What Has EU to Offer:Acquis Communautaire

Advantages Free trade of goods Free trade in services Free movement of people Free movement of capital Company legislation Structural funds

6

Measuring cohesion with

“σ-convergence”

Reduced cross-country dispersion

of income-per-capita

measured by standard deviation.

7

Cohesion countries have “σ-converged” …

40.0

60.0

80.0

100.0

120.0

140.0

1980 GDP per capita (PPP), EU15 =100

+ 25% of EU average

- 25% of EU average

Standard deviation = 19.6

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… but slowly2002 GDP per capita (PPP), EU15=100

Standard deviation = 17.2

40.0

60.0

80.0

100.0

120.0

140.0

- 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

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Countries have slowly β-converged towards the leader

UK

Sweden

SpainPortugal

Netherlands

Italy

Ireland

Greece

Germany

France

Finland

DanemarkBelgium

Austria

y = -0.0015x + 0.0443

R2 = 0.3628

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

9 11 13 15 17 19 21

Countries catching-up to leader

Countries diverging from leader

GDP per capita, average growth

1980-2003

GDP per capita in '000 dollars (PPP95) in 1980

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EU membership has helped

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).

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

Cohesion countries Control group EU

Average GDP/Capita growth rate 1986-2002

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)

Average growth rates calculated using HP-smoothed time series.

Years

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

90.0

Spain Greece Portugal

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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.

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How fast will the “New Member States” catch-up?

Second issue

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

0 10 20 30 40 50 60 70 80 90 100

Latvia

Poland

Lithuania

Estonia

Slovakia

Hungary

Czech Republic

Slovenia

Portugal

Greece

Spain

per cent

16

Convergence is a distant prospect at present pace Number of years to converge from 2003*

Based on average growth during 1995-2003.

80 years 97 years

0

5

10

15

20

25

30

35

40

45

50

Years

17

GDP per capita in % of EU

  70.0 80.0 90.0

Annual growth of GDP/capita

(%)

3.0 37 23 11

4.0 18 11 5

5.0 12 8 4

6.0 9 6 3

Faster growth rate would make a difference

Assuming annual growth of 2% in EU

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Gaps in living standards reflecttwo factors

POP

EMPx

EMP

GDP

POP

GDP

GDP per capita can be decomposed between:

Labour productivity Labour utilisation

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Labour productivity

Ireland

EU 15

Spain

Slovenia

Greece

Portugal

Czech R.

Hungary

Slovak R.

Estonia

Lithuania

Poland

Latvia

Russia

Bulgaria

Romania

Turkey

Ukraine

-100.0 -50.0 0.0 50.0

GDP per employed (PPP) in 2003, deviation from

EU15

Ireland

EU 15

Spain

Slovenia

Greece

Portugal

Czech R.

Hungary

Slovak R.

Estonia

Lithuania

Poland

Latvia

Russia

Bulgaria

Romania

Turkey

Ukraine

-100.0 -50.0 0.0 50.0

Labour utilisation

Share of employment in total population, 2003,

deviation from EU15

20

Convergence needs both labour productivity and utilisation

EU-15

Estonia

Latvia

Lithania

Slovenia

Bulgaria

Romania

Turkey

Czech R.

Hungary

Poland

Slovakia

Ireland (86)

Ireland (03)

Belgium

Finland

France

Germany

Greece

Italy

Netherlands

Portugal

Spain

SwedenUK

60

70

80

90

100

110

30 50 70 90 110 130

Labour productiv ity, 2003

Labour utilisation, 2003

Countries that need to increase both labour

productivity and utilisation

EU15=100

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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

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Most new member states invest strongly

10.0%

12.0%

14.0%

16.0%

18.0%

20.0%

22.0%

24.0%

26.0%

28.0%

30.0%

GFCF in % of GDP, 2003

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Labour productivity benefits from international integration, including FDI

Hungary

Poland

Ukraine

Russian Federation

Turkey

RomaniaBulgariaSlovenia

Lithuania

LatviaEstonia

0

1

2

3

4

5

6

7

8

0 1 2 3 4 5 6 7

FDI Inflows as % of GDP

La

bo

ur

pro

du

cit

ivty

gro

wth

1995-2003 average, regression without outliers (CZE and SVK)

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FDI has helped technology spillovers

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

20.00

Share of high medium-tech manufactures in total value-added

25

0

5

10

15

20

25

30

35

Czech Republic Hungary Poland Slovak Republic

Labour productivity growth

Intra-industry

Shift effect

Growth could benefit from faster reallocation of labour towards high-

productivity industries

Source and methodology: See Lenain et Rawdonowicz (2004)

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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”.

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Participation is particularly low among older workers

Labour-force participation rate of workers age 55-64

0

10

20

30

40

50

60

Estonia Lithuania Latvia Czech Republic Poland Hungary Slovak Republic Slovenia

In % of working age population

EU-15

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Without higher labour-force participation, population ageing will prevent convergence

Source: Burniaux et al. (2004)

Projected decline in labour force during…

-40-30-20-10

010

Czech Rep. Hungary Poland SlovakiaOECD

average

2000-25

2025-50

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Labour-market policies hinders participationSome examples:

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

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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.

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What prospects at the “new” EU Eastern borders?

A few issues for discussion

Third issue

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Growth “premium” from being an accession country

Estonia

Latvia

Lithuania

Slovenia

Bulgaria

Romania

Turkey

Russia

Ukraine Czech Republic

HungaryPoland

Slovak Republic

0

1

2

3

4

5

6

7

8

0 2 4 6 8 10 12 14

GDP per capita, in thousand USD, in constant 1995 prices and constant PPPs

Annual GDP per capita growth,

1995-2003, in per cent

New member states

Eastern neighbours

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Will candidate countries benefit from accession boom?

0

1

2

3

4

5

6

1 2 3 4 5 6 7 8 9

Years after recovery

Annual GDP growth

New EU members (Since 1995)

Bulgaria (Since 1998)

Romania (Since 2000)

Real GDP

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Two Turkish challenges: how to raise labour utilisation and improve resilience?

-10

-8

-6

-4

-2

0

2

4

6

8

10

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Change in labour utilisation (right scale)

Real GDP growth

Labour utilisation relative to EU-15 (left scale)

0102030405060708090

100

1996 1997 1998 1999 2000 2001 2002 2003

-5

-4

-3

-2

-1

0

1

2

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What economic strategy to sustain growth in non-candidate Eastern neighbours?

-15

-10

-5

0

5

10

15

1996 1997 1998 1999 2000 2001 2002 2003

Annual real GDP growth Russia

Ukraine

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Thank you for your attention !