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Is the European integration speeding up the economic convergence process of the Central and South-Eastern European countries? A shock perspective

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Abstract

In the current context of continuous reassessment of the sustainability of the single currency and gradual enlargement of the euro area during the last decade, the objective of this research is to obtain new insights into the factors that determine the synchronisation of shocks in the Central and South-Eastern European countries vis-à-vis the euro area. The research contributes to the previous work by making a novel use of error correction model in a dynamic panel context which is extended by adding several important omitted variables related to the trade structure and policy coordination. We find that an increase in trade intensity, intra-industry trade and financial integration leads to less frequent asymmetric shocks. On the other hand, divergent fiscal policies are estimated in some model specifications to increase the shock divergence process, although the estimated impact is rather small to counteract the positive effects associated with trade and financial integration. The identified relationships in this research are affected by the significant trade and growth slowdown in the crisis period; while the global economic turmoil has boosted a demand shock convergence, its impact on the supply shocks is in the opposite (diverging) direction.

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Notes

  1. Kalman filter was developed by Rudolph E. Kalman in 1960. See Harvey (1989, 1993) and Hamilton (Hamilton 1994) for a mathematical explanation of the algorithm.

  2. The variable for output composition is not included explicitly in the model due to two main reasons. First, its effects are expected to be reflected by the trade structure. Lee et al. (2004) estimate that if both a variable for trade structure and a variable for output composition are included together in the model, only a variable for trade structure is statistically significant in explaining synchronization of business cycles. Clark and van Wincoop (2001) and Otto et al. (2003) find that output composition has significant effects, but it is dominated by the trade structure. Second, there are no available quarterly data for output structure of substantial number of countries in our sample.

  3. Slovenia was the first country from the CSEE joining the euro area in 2007, followed by Cyprus and Malta in 2008, Slovakia in 2009 and Estonia and 2011.

  4. From an econometric point of view, Greene (2008, p. 469) offers forcible arguments for the importance of modelling dynamics, as: ‘adding dynamics to a model […] creates a major change in the interpretation of the equation. With the lagged variable, we now have in the equation the entire history of the right-hand-side variables, so that any measured influence is conditional on this history; in this case, any impact of the independent variables represents the effect of new information’.

  5. Data sample starts in q1:1996 for Malta, q1:1997 for Bulgaria, Croatia, Macedonia and Serbia, and q1:1998 for Romania.

  6. The results obtained from ADF tests are not presented here due to space limitation but are available upon request to the authors.

  7. This approach was followed by Dibooglu and Horvath (1997) as well.

  8. On theoretical grounds, the horizontal intra-industry trade is assumed to be more consistent with the modern theories of trade and relevant to trade among developed countries, whereas vertical intra-industry trade is expected to be more related to traditional theories of comparative advantage and to dominate the trade among countries with different income levels (so called North–South trade models). As Greenaway et al. (1995) demonstrate a failure to separate the two components can seriously undermine the interpretation of the empirical results. Not only horizontal and vertical intra-industry trade are driven by different factors, but also the adjustment implications of a given trade expansion differ between the two.

  9. The unit values for exports and imports are obtained by dividing the values of exports and imports by their quantity.

  10. Fontagné and Freudenberg (1997) estimate the share of intra-EU trade flows according to the degree of overlap (the minority flow as a percentage of the majority flow) and find that the highest value is for a threshold of 10 % (almost one-third of all intra-EU trade). Regarding the share of intra-EU trade flows according to the unit value ratios of bilateral trade flows (measured by dividing the larger unit value by the smaller one), the highest value is for the threshold of 15 % (more than a quarter of total intra-EU trade).

  11. The difference in change of cyclically adjusted government budget balance (surplus or deficit) measured as a percentage of country’s GDP, between the CSEEC and the euro area is used as a robustness check.

  12. Sources of the data employed in the analysis include Eurostat (data for budget balances and foreign direct investments), Eurostat Comext database (data for intra-industry trade), IMF’s International financial statistics (data for prices, output, interest rates and real effective exchange rates), IMF’s Direction of Trade statistics (data for trade intensity) and the statistics agencies and central banks of the respective countries for data that were not available from previous sources.

  13. Due to statistical insignificance of the monetary policy coordination proxy and a dummy for the euro area membership in the core model regressions, these variables are omitted and we rely on more parsimonious specifications in the robustness checks. Nevertheless, the obtained results are consistent if these variables are included and are available upon request to the authors.

  14. The variables for supply and demand shocks are also re-estimated only for the quarterly observations in the pre-crisis period (q2:1997–q2:2008).

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Acknowledgments

This research was supported by a grant from the Center for Economic Research & Graduate Education-Economics Institute (CERGE-EI) under a program of the Global Development Network (GDN). All opinions expressed are those of the authors and have not been endorsed by CERGE-EI or the GDN. The views expressed herein do not necessarily reflect the views of the National Bank of the Republic of Macedonia, the University American College Skopje and the Ss. Cyril and Methodius University. The authors would like to thank the reviewers and participants at the conference in Prague organized by CERGE-EI in 2012 and Branimir Jovanović for helpful comments and discussions.

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Authors and Affiliations

  1. National Bank of the Republic of Macedonia, Kuzman Josifovski Pitu 1, 1000, Skopje, Republic of Macedonia

    Igor Veličkovski

  2. University American College Skopje, Treta Makedonska Brigada 60, 1000, Skopje, Republic of Macedonia

    Igor Veličkovski

  3. Ss. Cyril and Methodius University, Blvd. Krste Misirkov b.b., 1000, Skopje, Republic of Macedonia

    Aleksandar Stojkov

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  1. Igor Veličkovski
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Correspondence to Igor Veličkovski.

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Veličkovski, I., Stojkov, A. Is the European integration speeding up the economic convergence process of the Central and South-Eastern European countries? A shock perspective. Empirica 41, 287–321 (2014). https://doi.org/10.1007/s10663-014-9247-1

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