Academic journal article The European Journal of Comparative Economics

Real Convergence in the New Member States of the European Union (Shorter and Longer Term Prospects)

Academic journal article The European Journal of Comparative Economics

Real Convergence in the New Member States of the European Union (Shorter and Longer Term Prospects)

Article excerpt

Abstract

The success of the integration process of the new EU Member States is reflected by their nominal and real convergence performance. These tendencies are of special importance considering further enlargement of the Eurozone. The financial and economic crisis of 2008 has resulted, however, in a fundamentally new situation as regards these issues.

The paper considers the experiences gained in real convergence, the catch-up processes and their future prospects. As for nominal convergence, only those factors were analysed which affect real convergence directly. In particular, the analysis focuses on the sustainability of the convergence processes.

The possible trends of longer term growth and convergence processes are presented based on a qualitative analysis representing the supply side approach.3 The analysis is aimed at revealing potential - not insignificant - risks and threats.

JEL Classification: F43, F47, F15, E60, O11, O47

Keywords: European Union, real convergence, convergence crisis, potential growth, catch-up

(ProQuest: ... denotes formula omitted.)

1. Real and nominal convergence

1.1. New challenges of convergence during the crisis

The potential advantages of adopting the euro are of great importance for new Member States (NMSs). Euro adoption can contribute positively to long term growth and stability. It has an impact on economic performance through several macro- and microeconomic channels: the stability-oriented macroeconomic framework, access to liquid markets, more trade and foreign direct investment, lower transaction costs and increased competition.

Indeed, Eurozone membership has to be assessed in a broader context when considering it from the point of view of economic policy. The static view on the state of nominal convergence is not enough (Angeloni, Flad and Mongelli (2007)). In order to take full advantage of the single currency - taking into consideration the restrictions of the common monetary policy and irrevocably fixed exchange rate - the economic policy needs to ensure the proper functioning of the internal adjustment mechanism safeguarding stability. Adequate labour- and product market flexibility, as well as sufficient fiscal buffers were identified as the preconditions of successful euro adoption (Rybinski (2007), Darvas and Szapáry (2008)). Closer economic integration with the Eurozone might contribute to mitigating vulnerability against asymmetric shocks.

Considering the special conditions of the NMSs, special attention needs to be paid to the risks related to convergence. Countries accumulating huge internal and external deficit are very vulnerable under the conditions of the present crisis. At the same time there has been a progressive price level convergence and real equilibrium appreciation as part of the process. On the other hand the catching up process of the NMSs is effected by globalization and financial integration. The NMSs are highly sensitive against shock impacts due to their relatively small size, high level of openness and greater need for external financing. These risks have become apparent during the current crisis. The retreat from risk and the search for liquidity by investors might contribute to heavy pressures on the financial markets of the NMSs.

1.2. Price level and real convergence

The majority of the NMSs achieved remarkable convergence (taking into account the advancement of macroeconomic stability and the supply side reforms related to EUaccession). Nevertheless, a broad difference among certain member states remained. The new MSs have to face a shortfall caused by the crisis and sharp decline in growth (often accompanied by a decrease in GDP). Certain countries, which had a significant catch-up growth during the past years (e.g. the Baltic States) entered into a recession. Growth in the region has slowed down permanently. Therefore real convergence - within and outside the Eurozone - remains a determinant factor shaping the economic policy strategy for most NMSs in the medium term. …

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