# **Table** **<u>6. Why is Emerging Europe Different? Financial Development versus Frictions</u>**

|_Growth regressions_<br>||Depe<br>Financial de|ndent variable isg<br>velopment|rowth|in GDPper|capita(PPP term<br>Institutional d<br>|s)<br>evelopment<br>||
|---|---|---|---|---|---|---|---|---|
|_Explanatory variable_|[1]|[2]|[3]||[4]|[5]|[6]||
|Log of initial GDP per<br>|-1.555|-1.460|-1.500||-1.738|-1.569|-1.635||
|capita<sup>[A]</sup>|[0.431]|*** [0.444]|***<br>[0.481]|***|<br>[0.742]|**<br>[0.526]|*** [0.598]|***|
|Educational attainment;|0.363|0.337|0.306||0.269|0.240|0.239||
|pop. above 25|[0.094]|*** [0.090]|***<br>[0.092]|***|<br>[0.146]|*<br>[0.161]|[0.139]|*|
|Population growth|-0.284|-0.322|-0.328||-0.275|-0.246|-0.281||
||[0.134]|** [0.129]|**<br>[0.126]|**|<br>[0.170]|[0.123]|** [0.147]|*|
|Relative price of|0.041|0.108|-0.066||-0.192|-0.331|-0.256||
|investment|[0.490]|[0.515]|[0.628]||[0.653]|[0.734]|[0.746]||
|Trade openness (in|0.005|0.005|0.005||0.001|-0.000|0.002||
|percent of GDP)|[0.003]|[0.004]|[0.004]||[0.007]|[0.006]|[0.006]||
|Current account balance (CAB)|0.032|0.028|0.029||0.019|0.031|0.016||
||[0.034]|[0.039]|[0.039]||[0.038]|[0.057]|[0.041]||
|EU10 and candidate countries times CAB|-0.164|-0.169|-0.169||-0.674|-0.735|-0.505||
||[0.051]|*** [0.057]|***<br>[0.057]|***|<br>[0.255]|**<br>[0.260]|*** [0.264]|*|
|EU neighborhood times CAB|0.488|0.477|0.477||0.498|0.429|0.499||
||[0.082]|*** [0.101]|***<br>[0.101]|***|<br>[0.086]|***<br>[0.095]|***[0.074]|***|
|CAB times dummy for financial<br>development; quartile 3 and above||0.006<br>[0.049]|||||||
|CAB times dummy for financial|||-0.025||||||
|development; quartile 4|||[0.077]||||||
|CAB times dummy for institutional<br>development; quartile 3 and above||||||0.027<br>[0.075]|||
|CAB times dummy for institutional|||||||-0.037||
|development; quartile 4|||||||[0.055]||
|Common intercept|14.418|13.779|14.825||17.958|16.586|17.378||
||[3.979]|*** [4.161]|***<br>[4.540]|***|<br>[6.663]|***<br>[4.831]|*** [5.259]|***|
|Number of observations|329|329|329||208|208|208||
|Number of countries|88|<br>88|88||59|59|<br>59||
|Number of instruments|37|46|46||37|46|<br>46||
|Hansen test for over-id. restrictions|0.305|0.567|0.269||0.511|0.598|0.720||
|Arellano-Bond AR(1) test (p-value)|0.000|0.000|0.000||0.002|0.001|0.002||
|Arellano-Bond AR(2)test(p-value)|0.741|0.836|0.976||0.315|0.268|0.290||

Notes: Other growth determinants included (but not reported) are population growth, educational attainment, trade openness, and the relative price of investment goods. Robust standard errors below each point estimate. ***, ** and * denote significance at the 1, 5 and 10 percent levels, respectively. All equations include time period and group-specific dummies. Data for the transition economies refer only from 1997 onwards. All equations include time period and group-specific dummies.

The estimations confirm our earlier results; see Table 7. In fact, the growth impact of foreign capital in the EU10 and EU candidate countries is even stronger; the magnitude of the coefficient is about three times larger than the previous estimates. Two hypotheses are worth putting forward. First, the impact on growth is not a statistical artifact of the high, but unsustainable, growth episodes of the pre-crisis period among European transition countries. Second, the excesses of the pre-crisis period were not as supportive of medium-term growth. A more detailed assessment, however, is hampered by the small sample size. Still, we believe the evidence is sufficiently clear in that prospective EU membership has been a sound impetus for institutional and economic reforms in the EU10 and the EU candidate economies, and this has made it possible for them to strengthen their capacity to absorb effectively foreign capital. Of course the pre-crisis excesses were also not as supportive of medium-term growth and thus there is much to learn from the case of emerging European countries with more sustainable growth experiences.

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