Convergence in Per Capita Income Levels, Productivity Dynamics and Real Exchange Rates in the Candidate Countries on the Way to EU Accession

Dobrinsky, R. (2001). Convergence in Per Capita Income Levels, Productivity Dynamics and Real Exchange Rates in the Candidate Countries on the Way to EU Accession. IIASA Interim Report. IIASA, Laxenburg, Austria: IR-01-038

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Abstract

One of the greatest challenges of the present round of eastern enlargement of the EU is the unprecedented gap in per capita incomes between incumbents and candidate countries and even under favorable future growth assumptions, the candidate countries still face a long process of catching up. During a catch up process there emerges an essential and fundamental economic link between nominal and real variables and hence real convergence cannot be de-coupled from nominal convergence. The link between the two surfaces in the dynamics of the real exchange rate through the "Balassa-Samuelson effect".

This paper analyzes convergence in per capita income levels between present EU-member states and candidate countries and some of the implications of this process for the candidate countries addressing three main groups of issues. The first one is related to the empirical measurement of a catching precess and convergence between candidate countries and EU-member states and the paper provides some broad measures of these income gaps and their dynamics during the past decade. The second group of issues is that of the sources and economic fundamentals of a catch up process. It is argued that for a catch up process to be self-sustained, it must be based on differential productivity growth in which productivity in the candidate countries grows faster than that in the incumbent EU-member states. The third group of issues is related to the dynamics of the real exchange rate during a productivity catch up process and the implications of the Balassa-Samuelson effect. The paper analyzes the dynamics of the real exchange rates in the candidate countries and attempts to test empirically the Balassa-Samuelson effect in these countries. The paper concludes with a discussion of some of the policy implications of the dichotomy "real-empirically the Balassa-Samuelson effect in these countries. The paper concludes with a discussion of some of the policy implications of the dichotomy "real-cum-nominal convergence" and of the emerging "catch up inflation" for the candidate countries on the way to EU accession.

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