Focus on European Economic Integration Q3/18

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• Focus on European Economic Integration Q3/18 (PDF, 4.5 MB) September 2018

Studies and Analyses

• Restarting real economic convergence in CESEE (PDF, 1 MB) Ritzberger-Grünwald, Schreiner. Economic transition, European integration and EU membership have spurred an unprecedented process of social, political and economic modernization in Central, Eastern and Southeastern Europe (CESEE). Economic catching-up, however, has slowed since the Great Recession of 2008. Potential growth rates moderated notably and have not yet returned to the dynamism
  of the early 2000s. After providing a short overview of the status quo of transition in the 11 CESEE EU Member States2, this study elaborates on the reasons for weakening potential growth by focusing on the contributions of labor, capital and productivity to potential output. At the same time, we try to identify the most suitable policy options to reaccelerate economic dynamics in CESEE in the medium term. en Central, Eastern and Southeastern Europe, convergence, potential growth, demography, J11, J21, O11, O30, O40, O57 Sep 12, 2018, 12:00:00 AM

• Sustainable and equitable convergence and integration in Central, Eastern and Southeastern Europe (PDF, 609 kB) Székely. The transformation of Central, Eastern and Southeastern European (CESEE) economies from centrally planned toward open market economies has been inherently linked with their Integration into the European Union. The widely held desire to join the EU was a major Driver of economic reform. Such reforms not only improved the efficiency of resource allocation but
  also made EU membership a plausible outcome, which in turn attracted FDI and accelerated integration. EU accession crowned this process and unleashed historically unprecedented private and public capital flows. The positive climate that such rapid growth and convergence created temporarily masked the deep-seated problems that weak institutions and slow social
  learning had created, while the excessive capital inflow led to resource misallocation in the economy. The financial and economic crisis that hit the CESEE region in 2008 thus revealed deeply rooted problems, which these countries now need to face during their journey toward the frontier of development. Reform reversals have become widespread, in some cases
  touching the very foundations of a modern market economy. This article argues that the speed, sustainability and equity of future convergence in the region will crucially depend on renewed reform efforts. Reforms will also allow these countries to fully benefit from the continued deepening of European integration, further accelerating convergence. en EU integration, convergence, reform reversals P3, F5, F6, O5 Sep 12, 2018, 12:00:00 AM

• Digitalization and higher R&D readiness – way to foster income convergence in CESEE (PDF, 527 kB) Arokszallasi, Kotian, Rzentarzewska. After the fall of socialism and a short transition period, Central, Eastern and Southeastern Europe (CESEE2) has been outperforming the growth of Western Europe and thus helped reduce the relative gap vis-à-vis the EU-15 in GDP per capita (purchasing power standard) by one-third. The Great Recession has visibly slowed down the pace of convergence, however. The
  current growth model, which is based mostly on capital accumulation, has thus been challenged, calling for CESEE economies to become more innovative and knowledge oriented. Focusing on returns from different types of investments on total factor productivity (TFP), our panel data analysis suggests that the same amount of money invested in the information and
  communication technology (ICT) sector tends to have a higher immediate spillover effect on TFP growth than investment in infrastructure or machineries. Although capital accumulation is likely to remain an important growth factor in CESEE in the years to come, a sufficient Level of computer skills and Internet usage support knowledge-based investments, yielding relatively high returns. Thus, CESEE economies could potentially benefit from going digital and spending more on research and development (R&D), but on condition that complementary factors are in place. en income convergence, CESEE region, digital economy E22, O30 Sep 12, 2018, 12:00:00 AM

• Enlargement of the euro area toward CESEE: progress and perspectives (PDF, 285 kB) Backé, Dvorsky. This article reviews the enlargement of the euro area toward CESEE EU Member States since 2010. It covers the Baltic countries’ accession to monetary union and summarizes the present state of convergence of non-euro area CESEE EU Member States, with a focus on the economic
  convergence criteria. Furthermore, it depicts the current views of these countries on future euro area accession. We show how convergence assessments have developed since the onset of the crisis and examine the impact of the deepening of Economic and Monetary Union on the monetary integration process. Looking ahead, the article argues for an even-handed
  application of the principle of equal treatment in an advancing environment, which combines continuity with a careful and well-grounded integration of the lessons from the past and the institutional reforms that have resulted as a consequence, for the mutual benefit of all stakeholders in the process. en European Union, euro area, monetary integration, Central, Eastern and Southeastern Europe E42, E52, E58, N14 Sep 12, 2018, 12:00:00 AM

• External actors and European integration in the Western Balkans (PDF, 237 kB) Freund, Petritsch. The Western Balkans region has returned to the center of European policymakers’ attention amidst increased concerns over geopolitical competition and inherent instability. The present study examines the major external players and their goals and policy tools in the region and –
  in spite of the EU’s less than stellar performance at the Sofia Summit of May 2018 – calls for a consistent and committed approach to the integration of the Western Balkans into the EU. en international relations, European Union, Western Balkans F51, F55, O52 Sep 12, 2018, 12:00:00 AM

• Sanctions and countersanctions − effects on economy, trade and finance (PDF, 423 kB) Korhonen, Simola, Solanko. In this paper we review the history and current state of sanctions imposed on Russian entities by the EU, the U.S.A. and others, as well as Russia’s countersanctions. We try to assess what kind of economic effects these measures have had, although any such analysis is bound to be
  confounded by the large drop in the price of oil that occurred in 2014 and 2015. We find that sanctions have had a clear, negative effect on the Russian economy, although the decline in the price of oil affected Russian GDP much more strongly in 2014−2016. The U.S. and EU sanctions have worked e.g. by restricting Russian banks’ access to capital. EU countries’ trade with Russia and their market share in Russia have declined, but this is partly a continuation of a long-term trend. Russia’s countersanctions have e.g. affected exports of foodstuffs from the EU, but macroeconomic effects in the EU are very small. en Russia, sanctions F51 Sep 12, 2018, 12:00:00 AM

• The EU’s Multiannual Financial Framework and some implications for CESEE countries (PDF, 353 kB) Darvas, Wolff. The European Union’s budget – which is fundamentally different from the budgets of federal countries and amounts to only about 1% of the EU’s gross national income – continues to be heavy on agricultural and cohesion spending. The literature shows that the EU’s common agricultural policy (accounting for 38% of EU spending from the current budget) provides good
  income support, especially for richer farmers, but is less effective for greening and biodiversity and is unevenly distributed. The EU’s cohesion policy (accounting for 34% of current EU spending) contributes to convergence, but it is unclear how strong and long-lasting the effects are. Spending on new priorities such as border control could require additional funds of at
  least EUR 100 billion in the 2021–2027 period, but there will be a EUR 94 billion Brexit-related hole in the EU budget for 2021–2027 if the EU loses the United Kingdom’s share of contributions and the EU’s work program as a share of gross national income remains unchanged. The European Commission’s May 2, 2018, proposal for the 2021–2027 budget
  makes several welcome steps in reforming the EU budget, e.g. by reorganizing spending commitments toward priorities which have gained more importance recently, while reducing the share of spending on agriculture and cohesion policies. But many details remain quite fuzzy
  and need to be spelled out further before a critical appraisal can be made. Moreover, the new draft budget for agriculture foresees larger cuts for rural development support – important for environment and biodiversity goals – than for direct subsidies to farmers. Also, we would argue that the European Commission needs to make a significantly stronger attempt at measuring
  the actual “European value added” of the various proposed initiatives. Therefore, while we regard the European Commission’s proposal a good basis for subsequent negotiations, we propose a number of significant changes. en multi-annual EU budget, common agricultural policy, cohesion policy E60, H11, H41 Sep 12, 2018, 12:00:00 AM

• Structural investment needs in CESEE and the use of EU funds (PDF, 470 kB) Bubbico, Kollar, Slacík. Investment recovery in Central, Eastern and Southeastern Europe (CESEE) as well as in Europe as a whole is gaining steam. Hence, despite measurement challenges, there seems to be a broad consensus that there is currently no cyclical quantitative investment gap that would need to be addressed. However, there is tangible evidence suggesting that there are significant
  structural investment needs, particularly with regard to the quality of capital. Against this background, the aim of the present paper is twofold. First, we shed some light on the thematic areas in which structural investment needs persist by collecting and exploring a large set of strategic indicators. Second, we compare these structural investment needs with the structure of the European Structural and Investment Funds (ESIF) in the 2007–2013 programming period. This gives us some insights into whether the ESIF were directed to areas with the greatest investment needs and offers some tentative suggestions regarding the impact the ESIF had on the respective structural areas and as to the efficient use of the ESIF. en European Structural and Investment Funds, investment gap, structural investment needs F33, F36, F42, F45, F55, O11 Sep 12, 2018, 12:00:00 AM

• What is the appropriate role of structural reforms in E(M)U deepening? (PDF, 303 kB) Bayer, Breitenfellner. Can flexibility-enhancing “structural” reforms at the national level substitute institutional reforms at the EU level, or are they rather complementary? In this article, we first look at more broadly defined structural reforms of both institutions and product and factor markets through the lens of economic theory – and also review empirical evidence. In particular, we discuss if and how reforms depend on macroeconomic conditions and policies. We then
  analyze the role that reforms play for the proper functioning of Economic and Monetary Union (EMU) and for fostering the well-being of EU citizens. In a nutshell, there is no one-size policy framework that fits all. The optimal set of structural policies for an economy depends on the quality of its institutions as well as its factor endowment, level of development and/or geographical location. We argue for extending the structural reform paradigm beyond “defensive” (flexibility-enhancing) toward “upgrading” (productivity-enhancing) instruments. Design, packaging, timing and sequencing will make or break such reforms. In general, reform ownership based on broad consensus is essential at the national level. EU involvement, however,
  would only be justified in the case of cross-border spillovers. en structural reform, economic growth, institutional reform, Economic and Monetary E24, F45, O43 Sep 12, 2018, 12:00:00 AM

• How did EU Eastern enlargement affect migrant labor supply in Austria? (PDF, 523 kB) Schmieder, Weber. In this paper, we study the employment of workers from Central, Eastern and Southeastern European (CESEE) EU Member States in Austria after the Eastern enlargement of the European Union. To prevent a sudden rush of immigrants into the labor market, Austria opted for a Transition period during which immigration remained restricted. We will show that these restrictions
  had the anticipated effect; while the stock of workers from the new CESEE Member States increased slowly in Austria during the transition period, the trend became markedly steeper after the introduction of free labor market access. Between 2003 and 2016, the stock of workers from CESEE EU Member States in Austria increased fourfold by about 185,000 individuals. The
  largest immigrant groups are from Hungary, Romania and Poland. A large share of migrant workers are employed in seasonal industries and in border regions closest to their home countries. en EU Eastern enlargement, free movement of labor, Austria J61, O52 Sep 12, 2018, 12:00:00 AM

• Demographic decline does not necessarily condemn CESEE EU countries to a low growth future (PDF, 589 kB) Grieveson. Labor markets in many EU countries in Central, Eastern and Southeastern Europe (CESEE EU) are increasingly tight, reflecting strong growth, emigration and demographic decline. This Situation will only get worse in the coming years, and represents an increasingly significant challenge to economic growth. Immigration from Ukraine is a partial short-term fix, but not a long-term solution. Significant returns of workers to the region after Brexit seem to be unlikely. For political reasons, large-scale immigration from outside Europe is impossible to imagine. As a result, there is a risk that – faced by persistent labor shortages and higher wage demands – firms will move production away from the region, and that the CESEE EU countries will be condemned to a low growth future. However, this is not inevitable. First, there are big incentives for capital owners to Keep production in CESEE EU countries despite strong wage increases, including proximity to Western
  markets and the quality of governance, institutions and infrastructure relative to other European or nearby emerging economies. Second, recent rises in productivity, and moves toward automation, indicate a possible long-term solution to demographic challenges. en demographics, productivity, automation, labor markets, migration E24, J11, J21, J23, J24, J31, J61, O30, O40 Sep 12, 2018, 12:00:00 AM

• The ESRB and macroprudential policy in the EU (PDF, 555 kB) Dierick, Mazzaferro. Since its establishment, the European Systemic Risk Board (ESRB) has undertaken important work in fostering a coherent macroprudential framework for the EU and in helping make it operational. The groundwork for such a framework was laid by setting up national macroprudential authorities in all EU Member States and spelling out their mandate and tasks. The
  next step consisted in making the concept of macroprudential supervision more precise by identifying intermediate objectives of macroprudential policy and designating macroprudential instruments. Initially, the ESRB focused on the banking sector but, over the past few years, considerable work has also been undertaken on nonbank financial sectors. One of the very
  first areas the ESRB dealt with was systemic risk resulting from lending in foreign currencies, an area particularly relevant for countries in Central, Eastern and Southeastern Europe (CESEE). Some CESEE Member States have also been most active in implementing macroprudential policies in the EU. en European Systemic Risk Board, financial stability, macroprudential policy G18, G28 Sep 12, 2018, 12:00:00 AM

• Has private sector credit in CESEE approached levels justified by fundamentals? A post-crisis assessment (PDF, 599 kB) Comunale, Eller, Lahnsteiner. We analyze private sector credit developments in CESEE EU countries by calculating the credit-to-GDP ratios that are in line with macroeconomic and financial fundamentals and by comparing them with actual levels. In contrast to previous work in this area, we add cross-border credit to domestic bank credit and take care of global factors and cross-country spillovers.
  We derive three main findings from our analysis: First, countries featuring positive credit gaps at the start of the global financial crisis (GFC) have managed to adjust their credit ratios downward toward levels justified by fundamentals, but the adjustment is apparently not yet complete in all countries. Second, in most countries characterized by credit levels close to
  or below the “fundamental” levels of credit at the start of the GFC, negative credit gaps have emerged or widened. Third, the inclusion of cross-border credit matters considerably for credit gap assessments as it results in larger gaps in most cases. As part of the policy discussion, we also relate our findings to recent efforts in setting countercyclical capital buffers depending on credit gaps. en private sector credit, fundamental level of credit, bank lending, global financial crisis, C33, E44, E51, G01, G21, O16 Sep 12, 2018, 12:00:00 AM