27 Apr 2018

Convergence in the European Union

Inside and outside the euro

Daniel Gros

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CEPS Director Daniel Gros was invited by the Bulgarian Presidency of the European Council to contribute a paper on convergence for discussion at the Informal Meeting of Economic and Financial Affairs Ministers, in Sofia, 27-28 April 2018. The file below contains his thoughts and calculations.

Main findings. The convergence process in Europe has bifurcated: the new member states (NMSs) from Central and Eastern Europe are catching up in terms of income per capita, as one would expect, with the initially poorer ones growing generally at a faster pace. Within the euro area, however, the North has diverged from the South since the start of the financial crisis. This pattern, reflecting East-West convergence but also North-South divergence within the euro area, can be observed for a number of indicators, such as real wages, investment and consumption.

There is no indication that euro area membership has had a negative impact on convergence. On the contrary, each of the 11 new Central and Eastern European member states, which joined the euro after 2004, have been converging at a slightly faster rate than one would have expected given their starting level of income per capita. Moreover, the available projections for the next few years suggest that East-West convergence will continue, and that some North-South convergence might re-start. Moreover, several of the countries severely affected by the euro crisis are now returning to above-average growth, whereas some ‘non-euro Northern’ EU member states are also not growing faster than the euro area.

All in all, it appears that the lack of convergence North-South has roots other than the euro.

Our findings do not answer the question whether the East-West catch-up process will lead to ‘full’ convergence. It is often argued that further catching-up would require a change in the growth model. Catch-up growth can rely on importing foreign capital and know-how via massive amounts of foreign direct investment, but after a certain level, more domestic innovation is required to maintain growth. Reorienting the growth model towards more domestic innovation may pose the key challenge for the NMSs.