ROMANIA AND BULGARIA LESSONS OF FIRST DECADE IN EU AND MID-RUN CHALLENGES. Andrei RADULESCU, PhD 1

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1 ROMANIA AND BULGARIA LESSONS OF FIRST DECADE IN EU AND MID-RUN CHALLENGES Absrac Andrei RADULESCU, PhD 1 The EU inegraion process was he main caalys of real European economic convergence in Romania and Bulgaria over he pas decades. However, boh counries coninue o be he laggards in erms of developmen in 2017, in a period wih unprecedened challenges for he EU. In his paper we analyze he convergence of hese economies owards he Euro Area (he core of he European Union) during he firs decade of EU membership. The resuls show ha Romania and Bulgaria need an improvemen of he policy-mix, wih focus on srucural reforms in order o accelerae he economic convergence and developmen processes in mid-run. These reforms and he implemenaion of a balanced policy-mix in he fuure are imperaive, especially in he scenario of muli-speed Europe. Keywords: EU inegraion, producion funcion, economic convergence JEL Classificaion: E23, E32, F15 Inroducion The European economic inegraion was he main caalys of growh and developmen for boh Bulgaria and Romania over he pas wo decades. The negoiaions, he implemenaion of he acquis communauaire and he enry ino he European Union conribued o he improvemen of he invesors confidence in hese economies, leading o significan capial inflows. As can easily be noiced from he Figure 1 he GDP/capia (one of he mos used indicaors for he analysis of he real economic convergence) grew by a pace more han five imes he Euro Area average during in Romania and Bulgaria, a period including he negoiaions, he signaure of he EU Treay and he firs year as a full member of he European Union for hese counries. This evoluion was mainly deermined by he massive capial inflows wih spill-over effecs for he labor facor. However, he oal facor produciviy did no presen posiive evoluions in ha inerval (especially in Bulgaria), given he disconinuiy of he srucural reforms. 1 Senior Economis, Banca Transilvania, Researcher, Insiue for World Economy, Romanian Academy, andrei.radulescu@brl.ro; iemradulescu@gmail.com 9

2 Bulgaria and Romania: Counry Members of he EU, Par of he Global Economy 12% 10% The dynamics of he GDP/capia (real, YoY) Figure 1 8% 6% 4% 2% 0% -2% % -6% Bulgaria Romania Euro Area -8% Source: AMECO, Eurosa Boh counries were caugh by he Grea Recession in an overheaing sance in, wih he curren accoun defici of 11.8% of GDP in Romania and 22.1% of GDP in Bulgaria, according o he IMF daabase. This macroeconomic disequilibrium corroboraed wih he dependence on he foreign capial flows deermined he launch of a very severe macroeconomic adjusmen process in hese economies, saring 2009, as can be noiced from Figure 1. The fixed invesmens conraced severely in 2009 and in hese counries, wih negaive impac for he dynamics of he poenial GDP. A presen Bulgaria and Romania are in he pos-crisis economic cycle, boh economies having already finished he adjusmen process, wih macroeconomic disequilibria under conrol and wih he poenial GDP gradually converging o he pre-crisis levels. However, boh counries presen imporan challenges for he susainable developmen, especially in erms of he coninuiy of he srucural reforms. In his conex, he esablishmen of a credible sraegy for he enry in he Euro Area may be anoher imporan caalys for he developmen of hese counries 10

3 ROMANIA AND BULGARIA LESSONS OF FIRST DECADE IN EU AND MID-RUN CHALLENGES in he mid-run. The aim of his paper is o analyze he real economic convergence process of Romania and Bulgaria owards he Euro Area average during he firs decade of EU membership by implemening a Cobb Douglas producion funcion. This analysis may be seen as coninuiy o he paper of Radulescu (). The res of he paper has his srucure: he mehodology is briefly described in he nex chaper; he resuls are presened in he following chaper; he las chaper underlines he main conclusions of he analysis. Mehodology This paper employs a Cobb-Douglas producion funcion in order o esimae he poenial oupu and he oupu gap for Romania, Bulgaria and Euro Area. Aferwards, we compue he sandard deviaion in order o analyze he convergence of he srucural and cyclical componens of he GDP of hese counries owards he Euro Area, he core of he European Union. The Cobb Douglas producion funcion is expressed in he following relaion: Y = α x L + (1 - α) x K + TFP (1) where Y is he real GDP (%, YoY), L represens he labor facor (%, YoY), K is he capial sock (%, YoY), TFP represens he oal produciviy facor and α is he oupu elasiciy of labor. The poenial GDP can be easily derived from he relaion (1), as can be noiced in he following relaion: Y * = α x L * + (1 - α) x K + TFP * (2) where Y * is he poenial GDP (%, YoY), L * represens he poenial labor facor (%, YoY), K is he capial sock (%, YoY), TFP * represens he poenial oal produciviy facor and α is he oupu elasiciy of labor. In his paper we divide all he elemens from he relaions (1) and (2) by he capia facor, as he GDP/capia is one of he mos used economic indicaors in he analysis of he real economic convergence. As regards he labor facor (L) i was esimaed saring from he following relaion: 11

4 Bulgaria and Romania: Counry Members of he EU, Par of he Global Economy L labor force * paricipaion rae * (1-unemploymen rae) * average number of hours worked (3) The capial sock (K) was esimaed by applying he perpeual invenory mehod and a depreciaion raio of 5%. The capial sock for he saring year (1995) was considered he level esimaed by he paper of Derbyshire e al. (). In his paper we applied a level of he parameer α of 0.65, as also employed by he paper of he European Commission, signed by D Auria e al. (). The srucural componen of he GDP/capia was esimaed by implemening he Hodrick-Presco economeric filer, which is based on he following mahemaic expression: T 2 * ) Min ( Y Y + λ = = 1 T 1 2 (( Y * * * + Y ) ( Y * 1 1 Y )) 2 (4) A he end, we compued he sandard deviaion for he cyclical and srucural componens of he GDP/capia for Bulgaria and Romania in relaion o he levels in he Euro Area. In his paper we used he economeric sofware E-Views and he Eurosa and Ameco daabases, wih annual daa for he period Inerpreaion of he resuls As can be easily noiced from he Figure 2 he firs decade of European Union membership was similar for Romania and Bulgaria in erms of he dynamics of he srucural componen of he GDP/capia. On he one hand, he YoY dynamics of his indicaor hi record high YoY levels during 2007-, he firs years of EU inegraion and before he incidence of he Grea Recession. The EU enry had an imporan posiive impac for he fixed invesmens and for he capial sock, especially due o he increase of he foreign invesmens. For insance in Bulgaria he srucural componen of he GDP/capia rose by 5.9% YoY in 2007 and by 6.2% YoY in. In Romania his indicaor climbed by 7.8% YoY in 2007 and by 7.6% YoY in. This evoluion was mainly deermined by he increase of he capial sock componen, in Bulgaria by a double digi pace during - (on average by 13.3% YoY), as in his counry he credibiliy in erms of economic policy was higher, due o he peg o he EUR. In Romania he capial sock climbed by 12.5% YoY during -, a period including he negoiaions process and he firs wo years of EU membership. 12

5 ROMANIA AND BULGARIA LESSONS OF FIRST DECADE IN EU AND MID-RUN CHALLENGES 9,0% 8,0% The dynamics of he srucural componen of GDP/capia (YoY) Bulgaria Romania Euro Area Figure 2 7,0% 6,0% 5,0% 4,0% 3,0% 2,0% 1,0% 0,0% -1,0% Source: he resuls of he mehodology applied by using daa from Eurosa and AMECO A he same ime, as can be noiced from he Figure 2 he speed of real economic convergence of Bulgaria and Romania o he Euro Area average was higher before he incidence of he Grea Recession: he differenial in erms of he dynamics of he poenail GDP/capia beween hese counries and he Euro Area hi record high levels during -. However, he dynamics of he poenial GDP/capia during he pre-crisis period was no susainable, eiher in Romania, or in Bulgaria, as boh economies accumulaed imporan macroeconomic disequilibria, as refleced by he Figure 3 (which presens he Invesmens Savings differenial, as a % of GDP). During he differenial Invesmens Savings was around 7.8% of GDP per year in Romania and 10.3% of GDP per year in Bulgaria, according o he IMF daabase. These macroeconomic disequilibria were financed mainly by he foreign capial flows. 13

6 Bulgaria and Romania: Counry Members of he EU, Par of he Global Economy 30 The Invesmens Savings differenial (% GDP) Figure Romania Bulgaria Source: Inernaional Moneary Fund daabase, Spring 2017 Afer he incidence of he Grea Recession hese economies adjused he macroeconomic disequilibria, in a conex of massive foreign capial ouflows. In erms of he producion funcion his macroeconomic adjusmen deermined he improvemen of he conribuion of he oal produciviy facor/capia o he poenial GDP/capia in hese economies saring 2011, as can be easily noiced from Figure 4. The curren accoun disequilibrium was higher in Bulgaria han in Romania before he crisis. However, in Romania he domesic disequilibrium (public finance defici) was higher han in Bulgaria, which had a more disciplined policy-mix, given he peg of he leva o he euro. A presen, boh counries presen low levels of deficis, bu here can be noiced a rend of divergence saring, wih Romania accumulaing disequilibria and Bulgaria regisering surpluses (boh domesic and foreign) las year. 14

7 ROMANIA AND BULGARIA LESSONS OF FIRST DECADE IN EU AND MID-RUN CHALLENGES 3 The conribuion of he oal produciviy facor/capia o he poenial GDP/capia (pp) Figure Bulgaria Romania Euro Area -6 Source: esimaes based on he mehodology described above, using Eurosa and AMECO daabases As can be noiced from Figure 4 he Romanian economy presened a beer performance in erms of he conribuion of he oal produciviy facor per capia o he poenial GDP per capia during he firs decade of EU membership. This evoluion was deermined by several facors: he increasing role of he IT secor, he high level of he foreign direc invesmens, he reforms implemened under he financing agreemens wih he inernaional insiuions (saring 2009). Overall, from he Figure 4 one can noice ha, a presen, he dynamics of he conribuion of he oal produciviy facor per capia o he poenial GDP per capia presens record high levels in boh counries, which is a posiive sign for he shor-erm evoluion of Romania and Bulgaria. However, imporan differences persis beween Bulgaria and Romania in erms of he conribuion of he labor per capia o he poenial GDP per capia, as can be easily noiced from Figure 5. On he one hand, from he poin of view of his indicaor Bulgaria was converging owards he Euro Area over he pas decade. On he oher hand, Romania presened a more divergen evoluion compared wih he 15

8 Bulgaria and Romania: Counry Members of he EU, Par of he Global Economy Euro Area since he enry ino he European Union. These differences are based on he srucural facors of he labor markes, including he echnological progress and he migraion of he acive populaion. 3,0 The conribuion of he labour/capia o he poenial GDP/capia (pp) Figure 5 2,5 2,0 1,5 1,0 0,5 0,0-0, ,0-1,5-2,0 Bulgaria Romania Euro Area Source: esimaes based on he mehodology described above, using Eurosa and AMECO daabases Overall, if we compue he sandard deviaion for he dynamics of he cyclical and srucural componens of he GDP/capia for Romania and Bulgaria compared wih he Euro Area levels here can be noiced ha: 1. The convergence of he economic cycles of hese economies owards he Euro Area has improved over he pas quarers, reaching record high levels; As can be noiced from Figure 6, a presen he sandard deviaion for he cyclical componen of he GDP/capia (Bulgaria and Romania vs. he Euro Area) is very low. 2. There are signals of accumulaion of a gradual divergence in erms of he poenial GDP/capia, due o he differences in erms of srucural reforms. 16

9 ROMANIA AND BULGARIA LESSONS OF FIRST DECADE IN EU AND MID-RUN CHALLENGES Figure 6 The sandard deviaion for he cyclical componen of GDP/capia (Bulgaria 0,06 0,05 0,04 0,03 0,02 0,01 0, and Romania vs. he Euro Area) Source: esimaes based on he mehodology described above, using Eurosa and AMECO daabases Conclusions In his paper we analysed he evoluion of he real economic convergence process of Romania and Bulgaria owards he Euro Area over he pas decade. Overall, he resuls show ha afer a significan adjusmen process deermined by he incidence of he waves of he Grea Recession boh Easern Europe economies resumed he convergence process, bu differences persis in erms of srucural and cyclical componens. For insance, he economic cycles of hese counries seem more correlaed wih he Euro Area cycle a presen, wih he highes level of convergence in he recen hisory. However, differences persis in erms of he pace of srucural convergence, which presens a slower pace compared wih he pre-crisis period. These differences are deermined by he economic policy implemened in hese counries, 17

10 Bulgaria and Romania: Counry Members of he EU, Par of he Global Economy bu also by he ehcnological progress, foreign direc invesmens and labour migraion. In his conex we consider ha boh counries need o accelerae he implemenaion of srucural reforms in order o diminish he disance compared wih he Euro Area. A he same ime, his analysis is relevan for he policy-makers in boh economies, as hey have o implemen counercyclical measures in order o avoid he accumulaion of macroeconomic disequilibria in he fuure. In his respec boh counries can borrow each oher in erms of successful economic policy measures implemened over he pas decade. In he end we consider ha he implemenaion of measures in boh counries in order o inensify he regional economic inegraion would conribue o he acceleraion of he real economic convergence owards he Euro Area. Las, bu no leas, he esablishmen of a credible sraegy for he adopion of he euro ogeher wih he coninuiy of he srucural reforms (focus on Digial Revoluion, Research and Developmen) and he implemenaion of a proper policy-mix are facors ha would lead o he higher inegraion wih he Euro Area in he mid-run, in our view. References AMECO, 2017, available a: hp://ec.europa.eu/economy_finance/ameco/user/serie/selecserie.cfm Bloomberg daabase, 2017, available a: D Auria, F., e al.. The producion funcion mehodology for calculaing poenial growh raes and oupu gaps. European Commission Economic Papers, 420. ISSN available a: hp://ec.europa.eu/economy_finance/publicaions/economic_paper//ecp420_en.hm Derbyshire, J., B. Gardiner and S. Waighs.. Esimaing he capial sock for he NUTS2 regions of he EU-27. European Union Regional Policy, 1. available a: hp://ec.europa.eu/regional_policy/sources/docgener/work/2011_01_capial_sock.pdf Dobrescu, E Esimaing he Toal Facor Produciviy in Romanian Economy. Amfiearu Economic, 26, pp ISSN Eurosa, 2017, available a: hp://ec.europa.eu/eurosa Hodrick, R. and E.C. Presco Poswar U.S. Business Cycles: An Empirical Invesigaion. Journal of Money, Credi and Banking, 29 (1), pp ISSN Inernaional Moneary Fund, 2017, available a: Radulescu, A.. Romania and Bulgaria afer one decade in EU an assessmen of he economic performance. Economy and Business, volume 10, pp , ISSN World Bank, 2017, available a: 18