Divergence in Europe: what measure, what for?

In a recent post, David Milleker discussed the results of Phillip d’Arvisenet on convergence in Europe which point to an increasing cyclical convergence (measured by strong correlation coeffocients) but an increasing divergence in trend growth rates. Milleker points to the high degree of divergence of economic sentiment and monetary indicators — both indicate high cyclical divergence according to his view. He claims that asymmetric shocks — financial sector distress, oil price shock intensity and the exposure to foreign (outside EMU) shocks.

The discussion on convergence, however, has to distinguish three aspects:

  1. Level convergence versus growth rate convergence: these concepts are very different. Giving a high dispersion in income or productivity levels, trend growth rates should differ for a while. Quite often it is argued that then at the end the growth rates should convergence — which in principle is right. However convergence can happen by increasing relative income levels of catching-up countries but in principle high-income countries can stagnate as well — both is in line with convergence or a mixture. Therefore one has to be careful when using a dispersion in trend growth as an indication of non-convergence.
  2. Cyclical convergence: in itself the absence of strong cyclical convergence should not pose a problem in itself. In fact, the cyclical downturn in the U.S. affects the states quite differently as a view into local unemployment figures reveals.
  3. The interaction of level convergence processes, cyclical divergences and the setting of fiscal and monetary policy in the Euro area: I think this is the relevant point. As Sebastian Dullien and I often argued, cyclical divergences can be lasting and lead to “structural” kind of problems — take the house price bubble argument — especially if the institutions of financial and labor markets show certain features (insufficient regulation, efficiency wages, insider-outsider problems). This institutional setting leads to a shaky and slow adjustment to shocks — a path which can either be dampened of accelerated by policy. Unfortunately the European “policy-mix” does not seem to promote high degrees of anti-cyclicality, in fact, the opposite is true. The asymmetry does not not need to come from shocks alone but more likely from inappropriate institutions to deal with these shocks.

The lessons which which different economists might drawn from this evidence might quite different — see my recent post. You can either argue that institutional setting in labor and financial markets must be changed to make adjustment work smoothly. At the same time, there are good arguments to to think about a different policy mix — as institutions are the outcome of decisions of rationally behaved citoyens.

2 Responses to "Divergence in Europe: what measure, what for?"

  1. interested reader   April 17, 2008 at 4:16 pm

    The cyclical response of fiscal policies in the euro area. Why do results of empirical research differ so strongly? (March 2008)http://www.bancaditalia.it/pubblicazioni/econo/temidi/td08/td654_08/td654/en_tema_654.pdffrom the abstract:"Whether discretionary fiscal policies in industrialized countries act counter- orpro-cyclically and whether their reaction is symmetric or asymmetric over the cycle are stilllargely unsettled questions. This uncertainty remains even when attention is restricted to euroareacountries, where these questions have important implications for the debate on Europeanfiscal rules. We review the recent empirical literature to explain why the results of the variousstudies differ so greatly. We find that differences are driven partly by the choices made inmodelling fiscal behaviour and in the related notions of fiscal policy cyclicality. Results arealso affected by data source and vintage (ex post or real-time). The time period chosen isrelatively less important. We conclude that the notion of pro-cyclical fiscal policies oftenupheld in the debate is not justified by the data."

  2. Ulrich Fritsche   April 18, 2008 at 9:25 am

    Thank you very much for pointing our attention to the new paper. Indeed, econometric evaluation is quite difficult (in my impression to some extent due to the differing cycle extraction methodologies and therefore differing structural/cyclical balances…). But indeed, an interesting paper. In the conclusion it is argued that the degree of counter-cyclicality is slightly falling which — I would argue — goes in our direction. Automatic stabilizers are still at work but often governments are forced to intervene and counteract the full scope of possible stabilzation gains due to the restraints of SGP.