Long-term growth prospects

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Convergence at risk

In order to analyse the long-term growth prospects in transition economies, an empirical analysis was undertaken that relates investment, savings and productivity growth to countries’ institutional quality, levels of human capital, population structures, geography and openness to trade and finance (see Box 1.1).

Political institutions enter the analysis through a variable that measures constraints on the executive¹, while economic institutions are proxied by an index that captures the rule of law.² The analysis was used to generate forecasts for countries in the transition region and for western European comparator countries that predict the likely rate of income convergence over the next 20 years, based on different assumptions about political and economic reform. The baseline scenario assesses growth prospects in the event of continued reform stagnation. Political and economic institutions are assumed to remain at their current levels, with no anticipated reversals, but also no progress.

Chart 1.12 shows the predicted rate of convergence of GDP per worker for a group of relatively advanced transition economies.³ 12 Assuming an absence of reform, most countries would continue converging, but far more slowly than over the past decade (something that is also true for countries not shown in the chart). In 20 years’ time only the CEB countries would have incomes per working member of the population that were in excess of 60 per cent of the EU-15 average. This is not very impressive given that all CEB countries except Latvia already exceed the 60 per cent threshold. Only the Czech and Slovak Republics are projected to have incomes in excess of 80 per cent of the EU-15 average in the baseline scenario.

In some countries, including Croatia, Slovenia and Russia, the model predicts stagnation in income growth to roughly the same or slightly lower rates than the EU-15 average over the next decade or so. This means that, in the baseline scenario (which assumes an absence of reform), convergence is projected to stop entirely in these countries. In the case of Russia this would occur at a relative income level of just 55 per cent of the EU-15 average.

In order to gauge how political and economic reform might impact on growth in the transition region, we can look at an alternative scenario in which openness to trade, financial openness and political and economic institutions are assumed to converge to the highest level currently prevailing among advanced EU countries by 2035 (the end of the last forecasting period).

Charts 1.13 and 1.14 illustrate the impact on growth and convergence respectively. In new EU members this reform scenario would lead to increases of about 0.2 to 0.5 percentage point in the annual growth rate of output per worker in the most distant forecasting period (see Chart 1.13). This may seem modest, but it would be sufficient to restore convergence in all countries and propel several additional CEB countries (including Croatia, Estonia, Hungary and Slovenia) to income levels per worker of around 80 per cent of the EU-15 average in about 20 years (see Chart 1.14).

Non-EU countries where institutional and reform gaps are larger could expect a greater impact ‒ in the order of 1 to 1.5 percentage points in the most distant forecasting period, and more in some cases. While all the above variables positively affect growth, political institutions – as measured by constraints on the executive – are estimated to make the greatest contribution, as a determinant of both productivity and capital accumulation. For this reason the reform scenario has the highest impact on growth and convergence in countries where constraints on the executive are currently judged to be weak – for example, Kazakhstan, Russia and some southern and eastern Mediterranean (SEMED) countries.

1. 'Executive constraints' is a subcomponent of the Polity IV project's democratisation variable that is commonly used in the literature on growth and institutions. It captures checks and balances on those in power, and as such is also seen as a measure of the strength of property rights (see for example Acemoğlu and Johnson 2005). [back]
2. The analysis was based on a large sample of countries including those in the transition region and in the rest of the world. This precluded the use of the EBRD transition indicators as a measure of reform or market institutions. [back]
3. The analysis focuses on output per worker rather than aggregate GDP. Growth rates of output per worker will differ from aggregate growth rates as a result of demographic developments that are an important determinant of the output of countries in the long run (see Box 1.1), but are less directly influenced by economic and political institutions. [back]

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