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European Integration, Productivity Growth and Real Convergence

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European Integration, Productivity Growth and Real Convergence Taner M. Yigita Bilkent University and Ali M. Kutanb Southern Illinois University, Edwardsville; ZEI, Bonn; and WDI, Michigan. Abstract This paper derives a stochastic endogenous growth model that investigates the impact of European Union integration on convergence and productivity growth. We deviate from the general strand of literature by not only deriving a theoretical model for the effects of integration on the rate of economic growth, but also by using more flexible estimation techniques. The outcome of a series of panel and structural break tests examining the accession process of five recent members to the Union generally show improved rates of productivity growth and convergence to EU standards. We then draw from the experience of these recent members to derive implications for the first-round EU candidate countries. Subsequent tests on the first-round candidate countries find a high level of heterogeneity in growth rates, and a fast-paced convergence to EU standards. JEL Codes: F02, O47, O52, C22, C23 Keywords: Integration, Growth, European Union _________________________________________________________________________________________________________________ aCorresponding author: Department of Economics, Bilkent University, Bilkent, 06800 Ankara-Turkey. Tel: +90 (312) 2901898, Fax: +90 (312) 2665140, E-mail: [email protected] bEconomics and Finance Department, School of Business, Southern Illinois University Edwardsville, IL 62026-1102, The Center for European Integration Studies (ZEI), Bonn, and The William Davidson Institute (WDI), Michigan. E-mail: [email protected] 1. Introduction♣ In an age where many former communist countries strive to become a member of the European Union (EU) and policy circles discuss how best to synchronize the policies so that the existing members “all” benefit, it is natural to ask whether the EU membership pays off and eliminates the divergence of EU’s incumbents over time. To answer this question, we formulate and test a stochastic endogenous growth model that investigates the impact of EU integration on convergence and productivity growth. We achieve this by combining the ideas in Rivera-Batiz & Romer (hereafter, RB-R, 1991) and Lee, Pesaran & Smith (LPS, 1997), complemented later on by a battery of structural break and panel data tests. This paper contributes to the literature in more than one way. First, we extend the stochastic neoclassical growth model of LPS by implementing the ‘integration parameter’ of RB-R to analyze the effects of accession into the Union. We assume that integration to a wider body of knowledge that comes with (prospective) membership into the EU leads to higher returns to scale by enhancing the effectiveness of capital, hence speeding up the convergence process. Second, we test the findings of our theoretical model by utilizing the methodology by LPS, which provides a sound framework regarding the variables that should be included in the estimation1. The use of this technique especially fits our analysis since it corrects for the false inference in convergence when technological progress or sufficient heterogeneity are not adequately accounted for. Third, we complement the LPS tests with a series of structural break tests to validate the implications of the theoretical model regarding changes in the parameters of the growth process. Finally, we apply our modified theoretical model to the case of real convergence of the candidate transition economies to gain insight on ♣ We thank Jesus Crespo-Cuaresma, Kostas Drakos, Balázs Egert, Lucjan T. Orlowski, Erinc Yeldan, the participants of the 7th International ERC, and the participants of the 49th East Jour Fixe for their valuable comments on the earlier versions of this paper. 1 Earlier studies use rather ad hoc specifications with many control variables to test for convergence, developing models that have very little reliance on growth theory.3the prospects of their integration to the EU by drawing from the experience of recent EU members during pre- and post-membership periods. To our best knowledge, our work is the first research that brings theory and empirics together to analyze the impact of integration on convergence and productivity growth. There are some related studies that complement ours. Henrekson, Thorstensson & Thorstensson (1997) examine the role of trade and institutional integration on economic growth, using a purely empirical approach on European Community (EC) and European Free Trade Area (EFTA) countries along with a sample of OECD countries. Using a cross-sectional and pooled OLS study, their study finds that joining the EU or EFTA enhances growth. Crespo-Cuaresma, Ritzberger-Grünwald, and Silgoner (2002) examine the impact of European integration on economic growth of current EU members, using a panel regression. They find that the length of EU membership has a significant and positive effect on growth, and it is higher for poorer countries, suggesting an asymmetric impact of EU membership. These studies solely focus on a regression analysis of the relation between membership and growth without providing an underlying theoretical framework or projections for the candidate economies. Martin and Velázquez (2001), Wagner and Hlouskova (2002) and Boldrin and Canova (2003) provide a descriptive analysis of how different experiences of convergence of the recent EU members affected economic growth after joining the EU and derive lessons from these countries’ experience for the candidate countries. Employing different growth scenarios, they examine the beneficial effects of the EU membership and how long it would take for the candidate countries to fully complete the convergence process. They emphasize the importance of national policies to achieve a sustained period of significant growth above EU averages and hence real convergence towards the EU standards. Our paper extends the analysis in these papers by providing not only an in depth theoretical foundation on the effects of integration, but also empirically testing for its4implications on the specific aspects of growth, namely productivity and convergence. We also contribute to the literature by using a variety of estimation techniques that have less room for false inference due to impositions of homogeneity or neglecting of productivity growth. In addition, like in Martin and Velázquez


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