Gediminas Šimkus: Central Europe's convergence
Introductory remarks by Mr Gediminas Šimkus, Chairman of the Board of the Bank of
Lithuania, at the10th National Bank of Poland Annual Flagship Conference on the
Future of the European Economy (CoFEE), Session II "Drivers of growth and
convergence of Central European economies", Warsaw, 21 October 2022.
* * *
Good afternoon, dear Governors, Colleagues, and Guests,
First and foremost, let me express my joy of being here in Warsaw today for this 10th
annual Narodowy Bank Polski flagship conference on the future of the European
economy.
The Future of Europe and Europe's convergence are topics that are crucially important
for our region, especially in today's context.
Economic convergence is a complex theoretical issue, but also poses practical
challenges on various macroeconomic, political, and financial levels. Varying speeds of
convergence and economic growth among European countries, uncertainty and
instability in current international markets, and the threat of a worldwide recession in the
wake of russia's unprovoked invasion of Ukraine all make the discussions in which we
are about to engage in not only desirable but essential.
To set the stage for our discussion, let me share a few of my thoughts.
1
I consider Zeno's paradox , a philosophical fable, to be fitting when discussing
convergence. This fable tells of the swift Achilles racing against a slow-moving tortoise.
The paradox is that if the tortoise is given a head start in the race, Achilles will never
catch him, no matter how fast he runs. The argument for this paradox is rather
straightforward: Achilles must first reach the point where the tortoise was when Achilles
started, but by that time, the tortoise will have moved further ahead.
This story of different speeds and different starting points in time, in my opinion, is
analogous to different speeds of convergence. Countries differ in their rates of
synchronization and growth, their response to exogenous shocks or fragmentation
risks, and the macroeconomic adjustment policies they adopt. Furthermore, each
country in Central Europe is distinct in its economic, political, social, and even cultural
institutions, and the countries' historical context has determined where they each
started out on their convergence paths. The collision of all these variables gives rise to
theoretical and practical challenges. And that is why we are here.
Allow me to illustrate my point with this chart depicting convergence trajectories of total
factor productivities (TFPs) of 23 EU economies since 1998.
Countries in Europe grow at different speeds. They also appear to belong to different
2
convergence clubs . Even among Central European economies, more than one
convergence club could be discerned.
For example, Hungary and the Czech Republic appear to belong to one club, while
Poland, Lithuania, and Latvia belong to another; the members of the two clubs are
converging to different points of TFP if they continue their current trajectories.
Furthermore, Lietuvos bankas, in its 2020 study on convergence, estimated that
Lithuania would have needed a TFP of more than 30% higher over the past 20 years to
catch up with the TFP levels of the original EU member states of Germany, France, or
Belgium, who belong to a club of their own.
This challenges the convergence measurement itself because convergence in terms of
TFP is not straightforward. Countries belonging to different convergence clubs appear
to be experiencing convergence at the level of their club - a concept that is not
equivalent to the overall convergence within the EU.
What is puzzling is that when we focus solely on convergence in terms of GDP, we find
evidence that such convergence is happening. For example, over the past decade
Lithuania's GDP per capita rose to 87% of the EU average. The other two Baltic States
also boasted robust convergence rates in terms of GDP convergence. But when we
look at productivity - and, in my view, productivity is the key driver of growth - the
picture changes.
Data shows substantial productivity variation within Europe. Labour productivity growth
is uneven, and we can see evidence that the Central European Region was growing
considerably faster in the first decade of the 21st century than in the following decade.
This is a gravely worrisome trend, especially when discussing convergence.
The productivity debate usually ends with prescriptions like "increase investments" and
"implement structural reforms". Today, however, I hope that panelists will share their
thoughts on the economic model of Central Europe in general. Have we reached the
limit of what can be achieved without undergoing a fundamental transformation of how
we do things? Will automation and immigration provide the impetus for this region to
grow and prosper?
With all this in mind, I would like to move to the institutional side and its effects on
convergence.
Institutions undoubtedly play a significant role in determining countries' overall
economic success. The question remains as to which institutions have the greatest
impact on convergence and through what causal mechanisms can they lead to both
growth and convergence at the same time?
My last slide depicts the linear relationship between the quality of institutions and gross
domestic product (GDP). Countries with higher-quality institutions tend to have higher
GDP per capita levels. But is there more to the story than appears at first glance?
Evidence is emerging that the relationship between income and democracy is
nonlinear. Similarly, crises and shocks appear to impact similar institutions in different
countries differently.
Indeed, there is a powerful narrative that every crisis is an opportunity for better
adjustments. But changing course is not easy, and path-dependency obstacles arise.
It is obvious that the European economy is constantly being hit by macro shocks; the
war in Ukraine and the energy crisis we are currently experiencing are just two of them.
We are now witnessing growing risks of monetary, fiscal, and financial policy
miscalibration, and it looks like these disturbances are here to stay.
In sum, I invite you to contemplate how Central European economies could utilize these
shocks as spurs to sustainable action that would accelerate overall convergence.
1
From the treatise "The Physics" by Aristotle.
2
Definition of convergence clubs comes from Phillips and Sul (2009).