Posts Tagged ‘Eastern Europe’

The theory of “economic convergence” is based on the notion that poor nations should grow faster than rich nations and eventually achieve the same level of development.

This theory is quite reasonable, but I’ve pointed out that decent public policy (i.e., free markets and small government) is a necessary condition for convergence to occur.

The link between good policy and convergence explains why Hong Kong and Singapore, for instance, have caught up to the United States.

And the adverse effect of bad policy is a big reason why Europe continues to lag.

Moreover, it also explains why some nations with awful policy are de-converging.

Today, let’s look at convergence between Western Europe and Eastern Europe.

Here are some excerpts from a new study published by the European Central Bank.

This paper analyses real income convergence in central, eastern and south-eastern Europe (CESEE) to the most advanced EU economies between 2000 and 2016. …The paper establishes stylised facts of convergence, analyses the drivers of economic growth and identifies factors that might explain the differences between fast- and slow-converging economies in the region. The results show that the most successful CESEE economies in terms of the pace of convergence share common characteristics such as, inter alia, a strong improvement in institutional quality and human capital, more outward-oriented economic policies, favourable demographic developments and the quick reallocation of labour from agriculture into other sectors. Looking ahead, accelerating and sustaining convergence in the region will require further efforts to enhance institutional quality and innovation, reinvigorate investment, and address the adverse impact of population ageing.

The study is filled with fascinating data (at least if you’re a policy wonk).

This chart, for example, shows how many nations are converging (the dots above the diagonal line) and how many nations are falling behind (the dots below the diagonal line).

The yellow dots are Eastern European nations, so it’s good news that all of them are experiencing some degree of convergence.

But the above graphic doesn’t provide any details.

So let’s look at another chart from the study. The blue bar shows per-capita GDP in selected Eastern European nations as a share of the EU average. The yellow dot shows where the countries were in 2008 and the orange dot shows where they were in 2000.

The good news, at least relatively speaking, is that all nations are catching up to Western Europe.

But the report notes that some are catching up faster than others.

The developments were…heterogeneous within CESEE countries that are EU Member States. Some of them (the Baltic States, Bulgaria, Poland, Romania and Slovakia) experienced particularly fast convergence in the period analysed. At the same time, other CESEE EU Member States found it hard to converge… In fact, GDP per capita in Croatia and Slovenia diverged from the EU average after 2008… Given these heterogeneous developments, it appears that while in some CESEE countries the middle-income trap hypothesis could be dismissed (at least given their experience so far), in others the signs of a slowdown in convergence after reaching a certain level of economic development are visible.

My one gripe with the ECB study is that there’s a missing piece of analysis.

The report does a great job of documenting relative levels of prosperity over time. And it also has a thorough discussion of the characteristics that are found in fast-converging countries.

But there’s not nearly enough attention paid to the policies that promote and enable convergence. Why, for instance, has there been so much convergence in Estonia and so little convergence in Slovenia?

So I’ve tinkered with the above chart by adding each nation’s ranking for Economic Freedom of the World.

Lo and behold, a quick glance shows that higher-ranked nations (blue numbers indicate a nation is in the “most free” category) have enjoyed the greatest degree of convergence.

Here are some specific observations.

  • The Baltic nations are the biggest success stories of the post-communist world. Thanks to pro-market reforms, they have enjoyed the most convergence.
  • Romania and Slovakia also experienced big income gains. Romania is in the “most free” group of nations and Slovakia was in the “most free” group until a few years ago.
  • Poland has enjoyed the most convergence since 2008. Not coincidentally, that’s a period during which Poland’s economic freedom score climbed from 7.00 to 7.27.
  • Bulgaria also merits a positive mention for a big improvement, doubtlessly driven by a huge improvement (from 5.55 to 7.41) in economic freedom since 2000.
  • Sadly, Slovenia and Croatia have not experienced much convergence, which presumably is caused in part by their comparatively low rankings for economic liberty.

To be sure, there’s not an ironclad relationship between a nation’s annual score and yearly growth rates.

But, over time, poor nations that want convergence almost certainly won’t get the necessary levels of sustained strong growth without high scores for economic liberty.

P.S. Here’s some related research on this topic from 2017. And here’s a column on the evolution of economic liberty (or lack thereof) in Europe.

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Changing demographics is one of the most powerful arguments for genuine entitlement reform.

When programs such as Social Security and Medicare (and equivalent systems in other nations) were first created, there were lots of young people and comparatively few old people.

And so long as a “population pyramid” was the norm, reasonably sized welfare states were sustainable (though still not desirable because of the impact on labor supply, savings rates, tax policy, etc).

In most parts of the world, however, demographic profiles have changed. Because of longer life expectancy and falling birth rates, population pyramids are turning into population cylinders.

This is one of the reasons why there is a fiscal crisis in Southern European nations such as Greece. And there’s little reason for optimism since the budgetary outlook will get worse in those countries as their versions of baby-boom generations move into full retirement.

But while Southern Europe already has been hit, and while the long-run challenge in Northern European nations such as France has received a lot of attention, there’s been inadequate focus on the problem in Eastern Europe.

The fact that there’s a major problem surprises some people. After all, isn’t the welfare state smaller in these countries? Haven’t many of them adopted pro-growth reforms such as the flat tax? Isn’t Eastern Europe a success story considering that the region was enslaved by communism for many decades?

To some degree, the answer to those questions is yes. But there are two big challenges for the region.

First, while the fiscal burden of government may not be as high in some Eastern European countries as it is elsewhere on the continent (damning with faint praise), those nations tend to rank lower for other factors that determine overall economic freedom, such as regulation and the rule of law.

Looking at the most-recent edition of Economic Freedom of the World, there are nine Western European nations among the top 30 countries: Switzerland (#4), Ireland (#8), United Kingdom (#10), Finland (#19), Denmark (#22), Luxembourg (#27), Norway (#27), Germany (#29), and the Netherlands (#30).

For Eastern Europe, by contrast, the only representatives are Romania (#17), Lithuania (#19), and Estonia (#22).

Second, Eastern Europe has a giant demographic challenge.

Here’s what was recently reported by the Financial Times.

Eastern Europe‚Äôs population is shrinking like no other regional population in modern history. …a population drop throughout a whole region and over decades has never been observed in the world since the 1950s with the exception of…Eastern Europe over the last 25 consecutive years.

Here’s the chart that accompanied the article. It shows the population change over five-year periods, starting in 1955. Eastern Europe (circled in the lower right) is suffering a population hemorrhage.

By the way, it’s not like the trend is about to change.

If you look at global fertility data, these nations all rank near the bottom. And they also suffer from brain drain since a very smart person, even from fast-growing, low-tax Estonia, generally can enjoy more after-tax income by moving to an already-rich nation such as Switzerland or the United Kingdom.

So what’s the moral of the story? What lessons can be learned?

There are actually three answers, only two of which are practical.

  • First, Eastern European nations can somehow boost birthrates. But nobody knows how to coerce or bribe people to have more children.
  • Second, Eastern European nations can engage in more reform to improve overall economic liberty and thus boost growth rates.
  • Third, Eastern European nations can copy Hong Kong and Singapore (both very near the bottom for fertility) by setting up private retirement systems.

The second option obviously is good, and presumably would reduce – and perhaps ultimately reverse – the brain drain.

But the third option is the one that’s absolutely required.

The good news is that there’s been some movement in that direction. But the bad news is that reform has taken place only in some nations, and usually only partial privatization, and in some cases (like Poland and Hungary) the reforms have been reversed.

And even if full pension reform is adopted, there’s still the harder-to-solve issue of government-run healthcare.

Eastern Europe has a very grim future.

P.S. I’m a great fan of the reforms that have been adopted in some of the nations in Eastern Europe, but none of them are small-government jurisdictions. Yes, the welfare state in Eastern European countries is generally smaller than in Western European nations, but it’s worth noting that every Eastern European nation in the OECD (Czech Republic, Estonia, Hungary, Poland, Slovakia, and Slovenia) has a larger burden of government spending than the United States.

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