1. CATCHING UP AND THE EMU Péter Halmai Viktória Vásáry Institute of European Studies Szent István University, Hungary Economic and Monetary Union: 10 years of success? Mendel University, Brno, Czech Republic November 28, 2008

2. European integration Growth theory Convergence between economic development of certain countries and catch-up process of less developed countries EMU, preparation and attainment of the Euro-adoption exert significant impact on macroeconomic and institutional conditions of economic growth

3. Catching up Catching-up: the distance to be travelled Convergence: the measure of progress Negative/Positive catch up rate

4. Factors determining economic growth Supply side Labour Capital Total Factor Productivity growth accounting, production function Further factors Demand Trade and geographical situation Macroeconomic policies Institutional factors, etc.

5. Potential growth rate in the „old” convergence countries 0 2 4 6 8 10 1989199119931995199719992001200320052007 IrelandGreeceSpainPortugalOther countries in the Eurozone

6. Growth characteristics in the „old” convergence countries Significant increase in labour and capital input Impacts of labour market reforms in Spain (moderated real wages, growing employment) Remarkable TFP growth in Ireland (FDI, high- technology, intensive investment in human resource, etc.)

7. Potential growth and its factors 0,20,11,92,60,90,70,8 1999-2008 1,40,60,83,81,31,11,3 1989-1998 TFP 1,01,61,31,80,61,50,8 1999-2008 1,3 0,81,10,81,20,8 1989-1998 capital 0,72,00,61,90,31,60,5 1999-2008 0,31,00,41,30,10,80,2 1989-1998 labour potential growth factors 1,93,73,96,51,83,82,2 1999-2008 3,12,92,16,52,23,02,3 1989-1998 potential growth, as percentage per annum PTESELIEEU-8EU-4Eurozone

8. Growth characteristics in the „old” convergence countries Significant increase in labour and capital input Impacts of labour market reforms in Spain (moderated real wages, growing employment) Remarkable TFP growth in Ireland (FDI, high-technology, intensive investment in human resource, etc.) Impact of money market integration: – Decrease in risk premia, desinflation, reducing real interest rates – Decreasing capital costs – Growing gap between capital productivity and capital cost Fiscal consolidation EU-transfers - promotion of structural adaptation, 25-50% of public investments expectations, role of creditability

9. Development of cost of capital 0 2 4 6 8 10 12 14 19851990199520002005 IrelandGreeceSpainPortugal Other countries in the Eurozone

10. -7 -6 -5 -4 -3 -2 0 1 19971999200120032005200720092011 SP/CP 1998SP/CP 1999SP/CP 2001SP/CP 2003 SP/CP 2005SP/CP 2006SP/CP 2007actual Current account deficit commitment as percentage of GDP – Portugal

11. Average catch-up rates in NMSs (in % per annum) -9,54-3,90-3,64SI -7,35-1,45-2,08SK -2,57-0,48-2,55PL -5,21-2,95-1,21LT -5,65-2,40-2,56LV -0,24-4,59-0,86HU -7,82-4,28-2,44EE -6,51-1,970,71CZ -3,35-1,58-1,74EU-10 2004-20081999-20031995-1998

12. Potential GDP growth 1 2 3 4 5 6 7 8 9 19961997199819992000200120022003200420052006200720082009 CZEEHUPLROSKEU-15

13. Potential growth rate in the EU-25 The potential growth rate in the EU-25 is declining The decline is much higher in the EU-12 than in the EU- 15 in the long run Output in the EU-12 is growing faster than in the EU-15 The pace of convergence will slow down as time passes (it might stop in the long run) Significant difference between MSs (due to different productivity dynamics, demographic developments) Convergence process will continue

14. Potential GDP growth (annual average %) 2041 - 2050 2031 - 2040 2021 - 2030 2011 - 2020 2004 - 2010 0,61,22,53,54,7EU - 10 1,31,21,42,12,2EU - 15 1,2 1,52,22,4EU - 25

15. Advantages of Euro adoption Additional trade Reduction in risk premium Improving conditions of FDI Disappearance of exchange rate Financial integration, development of the financial sectors Fiscal discipline Microeconomic advantages

16. Real and nominal convergence Productivity gap

17. Sources of disparities in GDP per capita compared to EU-15 (2006) -48%-39%-69%-67% Romania -39%-29%-55%-40% Estonia -35%-32%-55%-53% Poland -32%-20%-45%-29% Czech Republic -28%-25%-45%-42% Hungary -30%-22%-45%-43% Slovakia -16% -29%-21% Slovenia TFP Capital intensity Hourly labour productivity GDP per capita Source: European Commission

18. Real and nominal convergence Productivity gap Price level convergence (BS-effect) Structural adaptation (structure, trade, integration) Higher but more volatile growth Relatively flexible labour market Improving fiscal positions, but different fiscal soundness and quality of the public finances Significant financial integration Monetary policy transmission – structural differences

19. Challenges during transition Significant capital inflows – Challenge to be faced by macroeconomic and financial stability Price level convergence process – Real equilibrium appreciation through higher domestic inflation and/or nominal appreciation „Old” cohesion countries: main shock was the monetary expansion related to the euro-adoption „New” MSs: structural factor might dominate

20. Increasing divergence, adoption constraint Increasing diversity of the Eurozone (More volatile inflation, asymmetric shocks, etc.) Economic policy reaction to decrease related risks, at the same time to promote potential growth and structural reforms contributing to real convergence Credit booms – in the case of rapid financial integration – might result in pressure on real exchange rate Lack of of adequate adoption – economic growth is supposed to stay at a low level in the long run; the process of the real convergence might get stuck or it can even change direction Sustaining monetary stability is essential + need for structural reforms

21. Concluding remarks The accession to the stability oriented EMU provides remarkable long term advantages for the NMSs. The fulfillment of the nominal convergence criteria per se is not enough to ensure a robust long term economic performance. Catch-up and convergence is based on the economic growth. –NMSs – transition path – but the pace of their catch up might dwindle/stop over time (stagnating convergence club)

22. Long-term convergence 0 50 100 150 200 250 200520082011201420172020202320262029203220352038 EU-15EU-10

23. Concluding remarks Abovementioned assume no changes in the policies – BUT: comprehensive, integrated structural refoms could provide an opportunity to overcome the adverse developments (Lisbon type reforms)

24. CATCHING UP AND THE EMU halmai.peter@gtk.szie.hu vásáry.viktoria@gtk.szie.hu Economic and Monetary Union: 10 years of success? Mendel University, Brno, Czech Republic November 28, 2008

25. Convergence trend (1999-2008) GDP per capita in 1999 (Eurozone=100) Per capita GDP growth Total (except LU)