Policy Documentation Center

Melchior, Arne

      1/2008                             January   
 Europe’s recent transition: growth,
convergence and regional disparities
by Arne Melchior 
	
CASE	Network	E-briefs
 
www.case-research.eu
Since the fall of the iron curtain, Europe has undergone dramatic reforms 
and changes, most notably East-West integration, expansion of the Euro-
pean Union (EU) internal market and monetary integration. Two decades 
after the initiation of reforms we now have data to assess whether they 
have caused dramatic changes to the economic landscape of Europe. 
Specifically, has European integration contributed to regional conver-
gence or greater income disparities? Using data from 1995-2005, recent 
findings from the ENEPO (Eastern Neighbourhood: Economic Potential 
and Future Development) project show that economic integration has re-
sulted in greater EU-wide convergence, but also that regional inequality 
has increased considerably in Central and Eastern Europe (CEE); in new 
member states as well as outside the EU.
A V-shaped pattern of growth
While it is well known that within Europe, economic growth was recently 
(before the financial crisis) higher in the new EU member states, it is less 
known that growth was also higher in the most western parts of Europe. 
The lowest growth was observed in a central area stretching from Den-
mark through Germany, Switzerland and Italy; with higher growth to the 
west and east of this area. Along this east-west axis, there was a V-sha-
ped pattern of growth passing through Germany. Using both regional data 
and growth rate averages at each longitude between 1995 and 2005, the 
following pattern emerged (see Figure 1 below). 
Figure 1: Per capita income growth rate averages
2
3
4
5
6
7
-10 -5 0 5 10 15 20 25 30
Longitude
A
ve
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 a
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 ra
te
 (%
)
After 2000, growth had been faster to the east of the minimum longitude 
but there was still a distinct V-shaped pattern.
Taking averages of income per capita levels at each longitude, the 
ENEPO studies found an inverse U-shaped east-west distribution, with 
highest average income where growth was lowest. Hence on average, 
the poorest countries grew faster and resulted in greater income conver-
gence in Europe.
Increased regional disparities in Central and Eastern European 
countries
Growth was accompanied by a significant increase in regional disparities 
in CEE countries. Figure 2 shows changes in (population-weighted) Gini 
coefficients for regional inequality in per capita GDP (PPP) during 1995-
2005. The Gini is a standard measure of inequality. In the figure, darker 
areas indicate increasing inequality.
Trend change i n Gi ni  coef f i ci ent s dur i ng 1995-2005
change -0. 92 -  0. 18 0. 45 -  2. 17 2. 39 -  3. 15 3. 52 -  5. 49 6. 01 -  13. 82
AT
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While the increase in regional inequality has been considerable in CEE, 
the levels are varying and on average, still not exceptionally high. Howe-
ver some countries such as Russia, Ukraine and Latvia are approaching 
levels of regional inequality that are exceptionally high, especially when 
taken in a global comparative perspective.
The increase in regional inequality is related to growth. There was lit-
tle change in regional inequality in low-growth areas of Germany and 
Italy, but increasing regional inequality in faster-growing CEE countries. 
This correspondence is also statistically supported; economic growth and 
changes in regional inequality are positively related. The match is not 
unambiguous, since e.g. Spain had relatively fast growth and falling re-
gional inequality. This observation is in line with a hypothesis suggesting 
that growth and regional inequality are positively related at lower income 
levels, but this relationship may be reversed when countries become ri-
cher.
European convergence in spite of more regional inequality
During the 1970s and 1980s, faster growth in relatively less prosperous 
countries of  the EU-15 caused convergence in Western Europe; howe-
ver, regional disparities inside countries did not change significantly. The-
refore, the period 1995-2005 represents a major shift due to the rising 
regional gaps in CEE. For the EU-27, the conclusion is unambiguous 
– income convergence across countries is quantitatively much more im-
portant than divergence across regions within countries. Therefore on the 
whole, there was clearly income convergence in wider Europe – driven by 
convergence across countries. 
Why was there convergence? Three potential explanations are often sug-
gested:
1.According to the standard “neoclassical” growth hypothesis, countries 
with a lower capital-labour ratio grow faster due to the higher marginal 
returns to capital. 
2.A second possibility is technology catch-up; countries with a lower tech-
nology level grew faster as they climb the technology ladder.
3.A third possibility is the “economic geography” perspective, in which 
income changes are related to differences in location and market access. 
For example; east-west integration could raise income levels in Central 
Europe due to improved market access.
 
5/2009 May
      1/2008                         January    
 
www.case-research.eu
These three explanations are often perceived as competing but it is quite 
possible that they are actually complementary. The ENEPO project pur-
sued the economic geography track, without ruling out a role for the other 
explanations.
According to the economic geography hypothesis, a common theme is 
that Central European regions close to the EU should benefit more from 
integration due to their proximity to western European markets. This, ho-
wever, is not so self-evident since such regions may also be exposed to 
fiercer competition. In order to derive consistent hypotheses about the 
impact of integration, large-scale numerical simulation models with many 
countries and regions were used in the ENEPO project. These models 
suggest that:
1.Wider European integration and WTO-type trade liberalisation has a 
particularly positive impact in Central Europe, by eliminating the former 
trade discrimination they faced as “outsiders” to the EU.
2.Reduction in transport costs or other distance-related trade costs have 
a decentralising impact in Europe, by eroding the advantage of regions 
that are centrally located. 
3.European integration casts an “agglomeration shadow” on non-mem-
bers and eastward extension of European integration should move this 
shadow further east.
These and other hypotheses from the numerical simulations provide a 
conceptual framework and an extensive set of predictions that may be 
used for further empirical work. The specific predictions vary across sce-
narios; e.g. wider European integration has an impact that differs from 
WTO liberalisation or reduction in distance-related trade costs. Conse-
quently, there are no universal laws about agglomeration in Europe and 
one has to examine the specific reforms in question.
Faster growth in Central Europe is in line with the economic geography 
hypothesis, but it could also be caused by standard neoclassical con-
vergence. As an attempt to distinguish between the two, ENEPO went 
one step further and tested empirically the economic geography predic-
tions about regional disparities inside countries. For example, if regions 
in Western Poland grow faster than other Polish regions, it may support 
the economic geography predictions. Running regressions for regions in 
Poland as well as 23 other countries achieved results that were distinct for 
Western and Central and Eastern Europe. These results are presented 
below.
Western Europe: The world becoming smaller
Is the V-shaped pattern of growth (in Figure 1 above) driven by cross-
country differences only, or is it also reflected in regional growth differen-
ces inside countries? Figure 3 shows east-west growth differences inside 
each country, based on country-level regression analysis.
Based on regressi on anal ysi s f or  each count ry
East -west Hi gher growt h i n west Hi gher  growt h t o t he east
Not  si gni f i cant
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Figure 3 confirms that for Western Europe, the V-shape is also reflec-
ted in growth patterns inside countries. In Germany and Italy (and even 
the Czech Republic), growth was higher in eastern parts of the country. 
For the Netherlands, France and Spain, the western regions grew faster. 
These east-west patterns of growth in Western Europe are in line with the 
“spatial liberalisation” hypothesis which states that reduced geographi-
cal trade costs (i.e. trade costs that depend on distance) undermine the 
advantage of central regions and create decentralisation. This creates 
a U- or V-shaped growth pattern that applies across countries and – for 
Western Europe – also inside them.
In Central and Eastern Europe, we find no evidence of faster growth in 
the western regions of Poland, Hungary, Ukraine and Bulgaria. An excep-
tion is Romania. A closer examination reveals that the faster per capita 
income growth in the west was mainly driven by faster population decline 
in Western Romania, and this is hardly in line with the “proximity-to-mar-
kets” hypothesis for Central or Eastern Europe. This hypothesis therefore 
obtains little empirical support. 
Between 1995 and 2005, Western Europe underwent very important re-
forms; particularly strengthening the EU internal market and enhanced 
monetary integration. The results suggest that these reforms have redu-
ced the costs related to distance and actually “made Europe smaller”. 
Central and Eastern Europe: The empire of capitals
While few east-west or north-south differences in regional economic gro-
wth are found in CEE, a persistent finding in the ENEPO project was that 
growth was higher in capital regions and their surrounding areas. 
Based on regressi on anal ysi s f or  each count ry
Capi t al Hi gher  growt h around capi t al Hi gher  growt h away f rom capi t al
Not  si gni f i cant
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The project found “capital effects” in all CEE countries under analysis. 
It is generally the case that larger regional inequality corresponds with 
higher income in the capital region. The analysis confirmed the signifi-
cance of this phenomenon in CEE. It is not fully clear whether this is a 
“development phenomenon” or whether it is a “transition
phenomenon” linked to the particular institutional features of the former 
communist countries. Using the economic geography framework, “capital 
effects” may be explained by “hub-and-spoke” patterns whereby periphe-
ral regions have to use the capital city infrastructure when they trade. For 
example, if western regions in Poland have to use banks and services 
located in Warsaw when they trade with Western Europe, they are not 
able to exploit their favourable geographic location. 
Eastern Europe and Eurasia: No agglomeration shadows in sight
According to the “agglomeration shadow” hypothesis, economic develop-
ment should be weaker in regions outside but close to an integrating bloc. 
Thus western regions in Eastern European countries outside the EU sho-
uld be worse off due to the eastward extension of European integration.
5/20 9 May
The views in this publication are solely those of the author, and do not necessarily reflect the views of  
CASE - Center for Social and Economic Research or any of its partner organizations in the CASE Network.
      1/2008                         January    
 
www.case-research.eu
In contrast, the ENEPO studies did not find evidence confirming the pre-
sence of such an adverse impact of integration. In Turkey, income gro-
wth was higher in regions to the north and east. In Russia and Ukraine, 
there were distinct patterns of population change. For instance, popula-
tion decline in Russia was stronger in regions to the north and east. This 
is likely to be a transition effect that has little to do with the repercus-
sions of wider European integration. On the whole, the results for these 
three countries are mixed and at least for Russia and Ukraine they are 
interpreted as having forces of transition still stronger than the forces of 
international market access and economic geography.
Policy implications
The results of the ENEPO project support the view that wider European 
integration has indeed contributed to economic convergence in Europe. 
On the other hand growth in CEE is disproportionately concentrated in 
capital cities, resulting in a pronounced increase in regional inequality. 
Therefore, one policy objective should be to promote a more equitable 
pattern of growth in these countries. In order to achieve this, it is impor-
tant to obtain more insight about the main drivers that create and sustain 
the dominating role of capital regions. 
The results also provide tentative support for the view that increased 
integration in Western Europe has finally reduced the cost of distan-
ce and “made Europe smaller”. In Western Europe, this seems to be a 
decentralising force that strengthens peripheral regions and contribu-
tes to convergence. The policy implication is that integration in Western 
Europe had a positive impact on regional disparities. This conclusion 
rests on a macro-analysis of regional income levels only, and so further 
micro-based research is needed to verify that the cost of distance has 
actually been reduced. 
This ebrief is based on results from the European research project ENE-
PO (EU Eastern Neighbourhood: Economic Potential and Future Deve-
lopment). For more information and publications, see CASE Network 
Studies and Analyses series No. 374, 378, 379 and 383 at www.case.
com.pl, or Working Papers No. 348, 349 and 350 at www.nupi.no. Finan-
cial support from the EU 6th Framework Programme and the Norwegian 
Research Council is gratefully acknowledged.
I	
Arne Melchior is a Senior Research Fellow at the 
Norwegian Institute of International Affairs, Oslo, 
Norway. He earned his Ph.D. in international 
economics from the University of Oslo.  Previously, 
he has worked with international trade negotiations 
for the Norwegian Government and has broad 
experience teaching at various universities. His 
main research interests include international trade, 
economic geography and income distribution.
1)
  In Germany we find higher growth further away from the capital. This 
may possibly be due to the special historical situation due to the change 
of capital city.
E-Brief Series Editor: Ewa Błaszczyńska ewa.blaszczynska@case-research.eu
5/2009 M y


CASE Network E-briefs
No. 05/2009 Europe's recent transition: growth, convergence and regional disparities

Mykhailychenko, Kostyantyn

Unfriendly steps of a friendly country

Pieklo, Jan

English

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Lubloy, Agnes

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Sonin, Konstantin

  
This Crisis Isn't So Bad After All 
15 January 2009  
The most common way of formulating an economic forecast is to compare current events to similar
cases in the past, analyze how those historical events unfolded and then base the prediction on that
model. All of today's economic forecasts are constructed in this way. 
The question of how the U.S. recession will progress is important to answer because Russia, like all
developing economies, will probably not experience economic growth until it picks up in developed
economies. The answer to that question depends on which past U.S. event we base our
comparisons. If we take as our model the economic panic of 1907, when the stock market and
production fell at a pace that is similar to current declines, then the economy will recover in about
one year. But if we conclude that a closer match with today's crisis, given its severe credit
shortages, is the Great Depression, the recovery might take a few years. 
We can also draw lessons from comparisons with other recessions. The 1970s recessions in
developed nations taught us that aggressive monetary policies could lead to growth coupled with
inflation or inflation without growth. Recessions of the 1980s demonstrated that running a fiscal
deficit is not a problem as long as the economy is growing. And Japan's recession in the 1990s
showed that an economy might stop growing when a government allows banks not to write off their
bad assets. 
 
Russia's history of capitalism is very short -- a little less than 20 years. The catastrophic decline that
began in the first six months of 1990, which ultimately brought down the Soviet Union, occurred
under a centralized, planned economy. Privatization of state enterprises, despite all of the fanfare,
was just one step leading to a market economy. Lessons can be learned from the attempt at
macroeconomic stabilization from 1995 to 1998, the reaction by the economy and the government
to the Asian crisis of 1997 and the collapse of the fixed exchange rate in August 1998.
 
In fact, if you compare the current economic crisis to the one in 1998, this could be a cause for
optimism. True, the drop in industrial output was worse last November (and December as well, if the
preliminary data is correct) than during fall 1998, but it is important to put this into perspective: The
2008 declines were from a far greater height after nine years of growth, while the 1998 crisis hit the
country after eight preceding years of declining production (with a brief period of low growth in
1997). 
 
Furthermore, production declines in late 2008 were worse than in the catastrophic year of 1990, but
manufacturing constituted a far greater percentage of the gross domestic product during the Soviet
era than it does now. Against these backdrops, the recent decrease in the industrial production and
a dramatic drop in the GDP growth rate does not look quite so alarming. 
 
But the main cause for optimism today lies in comparing contemporary businesses and employees
with those of 10 and 20 years ago. Today's firms and workers are more energetic and better able to
ride out rapidly changing market conditions. In fact, the widespread layoffs in certain industries and
salary cuts instituted in the third and fourth quarters of 2008, which were of a much larger scale than
a typical economics textbook would have predicted under similar circumstances, actually testify to
the resilience of today's businesses. Even with all of the handwringing currently going on, Russia's
companies and work force today are much healthier than they were in 1990 and 1998. Now isn't
that a reason to be optimistic? 
 
 
Konstantin Sonin, a professor at the New Economic School/CEFIR, is a columnist for Vedomosti.  
 
 
© Copyright 2007. The Moscow Times. All rights reserved.  
 
 


This crisis isn't so bad after all

Kolesnichenko, Anna

  
 CASE Network E-briefs 
 6/2009  June 2009 
Gazprom's New Weakness Offers Opportunity 
By Anders Åslund  
Gazprom has gone from being a great commercial hope 
to an ailing giant. Gazprom's owners need to face up to 
the crisis and institute reforms.  
A year ago, Gazprom was the third‐most valuable 
company in the world with a market capitalization of 
over $350 billion. Today, it has shrunk by two‐thirds to 
about $120 billion, declining to become the world's 
40th‐largest company, even though it still accounts for 
about 20 percent of Russia's market capitalization and 
roughly 10 percent of its gross domestic product. 
In the first quarter, the country's gas exports plunged by 
56 percent from last year, compelling Gazprom to cut its 
production ever more. During the first 10 days of May, it 
plummeted by 34 percent. Even in the fourth quarter of 
2008 ‐‐ when production, exports and prices were still 
strong ‐‐ Gazprom's profit shrank to $1.4 billion. As a 
result, the company is expected to suffer a multibillion‐
dollar loss this year. 
Gazprom has persistently been poorly managed, but its 
problems reached a peak when it turned off the spigot 
to 20 European countries for two weeks in January. It 
has cut off supplies to former Soviet republics several 
times before, even affecting customers in eight 
European countries back in 2006. This time, however, 
Gazprom truly established its reputation as an 
unreliable supplier. Its European clients are not likely to 
come back any time soon. In the present economic 
recession, in which energy supplies are ample, other 
alternatives look more attractive than Gazprom. 
Unfortunately, Gazprom is a state corporation with few 
commercial advantages. Independent gas producers, 
notably Novatek, produce gas far cheaper, and they 
manage to sell increased amounts on the domestic 
market, unlike Gazprom. With its unwieldy bureaucracy, 
Gazprom can only produce from giant fields, leaving 
most secondary and tertiary fields undeveloped, since it 
prohibits more agile independent companies to do so. 
Gazprom also lacks a comparative advantage in the 
transportation of gas. No other company has so many 
explosions on major pipelines. Moreover, Gazprom is 
notorious for including shady intermediaries, which 
later prompt the company to shut off its deliveries. 
Finally, few companies procure at more excessive 
prices. When Gazprom built Blue Stream, Hermitage 
Capital Management showed that Gazprom's cost per 
kilometer of pipeline was three times greater than on 
the Turkish side. This seems to be a standard excess cost 
for Gazprom. 
Gazprom's only comparative advantage is its control of 
one‐quarter of the world's gas reserves, but these 
reserves do not actually belong to the company. They 
are only licenses granted by the government. In reality, 
government protection is its only true strength 
In their excellent book, "Putin and Gazprom," former 
Deputy Prime Minister Boris Nemtsov and former 
Deputy Energy Minister Vladimir Milov clarify the real 
purpose of Gazprom: to transfer assets out of the 
company to government officials. 
The current recession exposes Gazprom's weakness and 
offers an excellent opportunity to reform it. In a rational 
market economy, such a company would not exist. The 
Natural Resources and Environment Ministry would 
deprive it of neglected or mothballed licenses. 
Independent gas producers would quickly outcompete 
Gazprom in production. Its share of Russia's gas output 
has actually fallen to 75 percent in May 2009 from 83 
percent in May 2008. The gas pipeline system should be 
separated from production and be opened on equal 
pricing conditions to independent producers. 
The arguments for a profound reform of the country's 
gas sector have never been stronger. How long is the 
Kremlin prepared to tolerate Gazprom's massive waste 
of resources? 
  www.case‐research.eu 
  
Gazprom's management ‐‐ which is to say the Russian 
government ‐‐ does not seem to understand the 
severity of the crisis. Instead of apologizing to their 
European customers for the supply cut and trying to 
woo them back, Gazprom is pursuing an aggressive, 
self‐defeating policy that further alienates customers. 
With sharply reduced gas exports to Europe, Russia has 
no immediate need for additional pipelines, such as the 
$15 billion Nord Stream (through the Baltic Sea to 
Germany) and $20 billion South Stream (through the 
Black Sea to Italy) projects. Gazprom, which is already 
heavily indebted, cannot afford such expensive 
pipelines. Moreover, the gas conflict in January 
demonstrated that the biggest problem is Gazprom and 
not gas transit. The existing transit pipelines through 
Ukraine and Belarus have ample excess capacity and are 
much cheaper. This eliminates the need for alternative 
pipelines. 
Even so, the Kremlin is trying to accelerate the 
construction of Nord Stream and South Stream. It also 
sharply criticized the March 23 EU‐Ukraine declaration 
on the gas transit system through Ukraine, which would 
solve the problems with its gas transit for a paltry 
investment of $3.5 billion. Such protests against 
improved governance are clearly not in Russia's national 
interest. 
Since Gazprom has been forced to reduce its output, it 
has neither the need nor financing for the expensive 
development of its new mammoth fields, Shtokman in 
the Barents Sea and Yamal in the far northern tip of 
Siberia. Even so, it is now proceeding with contracts for 
the development of the Shtokman filed for an initial $15 
billion. Its partners, France's Total and Norway's 
StatoilHydro, should call its bluff. 
In the current gas glut, Gazprom no longer needs 
Central Asian gas, which it has contracted at prices 
above the current market prices. The Turkmens were 
not surprised when the pipeline taking their gas through 
Russia blew up on Russian territory. After all, Moscow 
embargoed all of Turkmenistan's exports for 18 months 
in 1997 and 1998 until Ashgabat built a pipeline to Iran. 
For the European Union, Gazprom's new weakness 
offers a once‐in‐a‐lifetime opportunity for the gas trade 
with Russia to improve, and Gazprom's shareholders 
have an evident interest in going along with European 
gas reforms to recover the markets the company has 
lost. The two should come together and reform both 
the European and Russian gas sectors. The centerpiece 
should be pan‐European gas reform, with unbundling of 
transportation and gas production. 
Therefore, the Europeans should take up President 
Dmitry Medvedev's recent proposal for a new legal 
framework on energy cooperation. Medvedev wants to 
replace the Energy Charter of 1991, which nearly all 
other European countries have ratified. Both Russia and 
Europe need an agreed legal framework for global 
energy cooperation. 
Gazprom's acute crisis offers the best opportunity for 
Russian and European energy reform. In the current 
recession, Russia can no longer afford Gazprom 
management's egregious waste. 
 
 
 
 
 
 
 
 
 
Dr. Anders Aslund, a Senior Fellow 
at the Peterson Institute for 
International Economics, is co‐
author of the new book "The Russia 
Balance Sheet." He is also the 
Chairman of CASE Advisory 
  Council.  
 
 
 
 
 
  www.case‐research.eu 
    June 2009 
The opinions expressed in this publication are solely the author’s; they do not necessarily reflect the views of  
CASE ‐ Center for Social and Economic Research, nor any of its partner organizations in the CASE Network.  CASE E‐Brief Editor: Ewa Błaszczynska 


CASE Network E-briefs
No. 06/2009 Gazprom's new Wweakness offers opportunity

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CASE Network E-briefs No. 05/2009 Europe's recent transition: growth, convergence and regional disparities

Unfriendly steps of a friendly country

Russia today: neo-imperialism and crisis \u2013 the Polish perspective.

Operational disruption and the Hungarian real time gross settlement system (VIBER)

EU's Eastern Partnership: additional possibilities for European Integration of Ukraine

CASE Network Studies and Analyses No. 378 European integration and domestic regions: a numerical simulation analysis

Ensuring the language and cultural rights of ethnic Russians in Ukraine

Impact of the return of France to NATO military structures on Ukraine\u2019s European integration

This crisis isn't so bad after all

CASE Network E-briefs No. 06/2009 Gazprom's new Wweakness offers opportunity

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