This is a repository copy of Real convergence in Europe: a cluster analysis.

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1 This is a repository copy of Real convergence in Europe: a cluster analysis. White Rose Research Online URL for this paper: Monograph: Cuestas, J.C., Monfort, M. and Ordóñez, J. (2012) Real convergence in Europe: a cluster analysis. Working Paper. Department of Economics, University of Sheffield Reuse Unless indicated otherwise, fulltext items are protected by copyright with all rights reserved. The copyright exception in section 29 of the Copyright, Designs and Patents Act 1988 allows the making of a single copy solely for the purpose of non-commercial research or private study within the limits of fair dealing. The publisher or other rights-holder may allow further reproduction and re-use of this version - refer to the White Rose Research Online record for this item. Where records identify the publisher as the copyright holder, users can verify any specific terms of use on the publisher s website. Takedown If you consider content in White Rose Research Online to be in breach of UK law, please notify us by ing eprints@whiterose.ac.uk including the URL of the record and the reason for the withdrawal request. eprints@whiterose.ac.uk

2 Sheffield Economic Research Paper Series SERP Number: ISSN Juan Carlos Cuestas Mercedes Monfort Javier Ordóñez Real Convergence in Europe: A Cluster Analysis September 2012 Department of Economics University of Sheffield 9 Mappin Street Sheffield S1 4DT United Kingdom

3 RealconvergenceinEurope:aclusteranalysis JuanCarlosCuestasMercedesMonfortJavierOrdóñez UniversityofSheffieldJaumeIUniversityUniversityofBath Abstract InthispaperweanalyserealconvergenceinGDPperworkerintheEUmemberstates. The aim is to test whether there is evidence of club convergence in the EU, i.e. divergenceingdpperworker.evidenceinfavourofclusterorclubconvergencemay beanindicationofsignificantproductivitydivergencesbetweencountries,whichmay also explain the current turmoil in the euro zone. The results show evidence of different economic growth rates within Europe, which also converge to different steadystates,implyingdivergenceintheeu14.withintheeu14memberstateswe observetwoconvergenceclubs,whicharenotrelatedtothefactthatsomecountries belongtotheeuroarea.furthermore,easterneuropeancountriesarealsodividedin twoclubs,withamoredirecteffectofbelongingtotheeurozoneinthecompositionof theclubs. Keywords:cluster,realconvergence,economicintegration,euro. JELclassification:C32,C33,O47 Acknowledgments:TheauthorsgratefullyacknowledgeMustafaCaglayanandPeterWright forvaluablecommentsonanearlierdraft.theusualdisclaimerapplies.thefinancialsupport ofthemicinn(ministeriodecienciaeinnovación,spain)researchgranteco c03 01isalsoacknowledged. 1

4 1. Introduction TheexistenceofrealconvergencewithintheEuropeanUnion(EU)member statesisofparamountimportanceintheprocessofeconomicintegration,providinga mechanismtoachieveeconomicandsocialcohesionamongstcountries.infact,the reductionofincomeinequalityacrossitsmembershaslongbeenadeclaredobjective oftheeu,andpoliciesaimedtopromoteeconomicconvergenceweresetoutin1975 throughthestructuralfunds,andin1993throughthecohesionfunds.theideathat Europeanintegrationthroughmacroeconomicpolicyconvergenceandgreatercapital mobilitywillcauseconvergenceinincomegrowthratesmotivatedtheimplementation ofthosepoliciesaimedtopromotecohesion. BoldrinandCanova(2001)suggestthatEUregionalandstructuralpolicies havemostlyredistributedincomeandhavehadlittleeffectinfosteringeconomic growthandthedesiredconvergenceofincomelevelsacrosscountries. This divergenceviewstandsatoddswiththeneoclassicalgrowththeory(solow,1956; Mankiwetal.,1992).Accordingtothistheory,thegrowthrateofcapitalperworkerof countrieswithalowerinitialcapitalendowmenttendstobegreaterthancountries withaninitialhighercapitalstock.thus,countrieswithdifferentinitialcapitalstocks tendtoconvergeintermsofincomeperworker,overtime.thishypothesisisknown asabsoluteconvergence.theempiricalevidenceontheabsoluteconvergencehypothesis ismixed.baumol(1986)andtheworldbank(1993),amongstothers,pointtothefact thatthisprocessishardlyobservedinpractice.incontrast,barroandsalaimartin (1991) concluded in favour of absolute but slow convergence in Europe. There is generally more evidence in favour of the convergence hypothesis when country 2

5 heterogeneityistakenintoaccountand,inparticular,whentheassumptionofsimilar parametersbetweencountriesisrelaxed,implyingdifferentsteadystates(barroand SalaiMartin,1995).Onlyaftercontrollingfordifferenteconomicconditions,canone observethenegativerelationshipbetweeninitialincomeperworkerandeconomic growth.thishypothesisisknownasconditionalconvergence. TheconsensusattheintroductionoftheeurowasthattheinternalEUmarket withfreemobilityofgoods,capital,andlabourwouldensuresustainablegrowthand economic convergence in the euro area, even though crosscountry structural differencesprevailedatthebeginning.thisviewalsosuggestedthatundereconomic andmonetaryintegration,thepreconditionsfortheconvergencetheoriesaremore likelytobemet.anumberofstudieshaveanalysedtheexistenceofconvergenceinthe EUandtheeurozone.Theresultstodatearefarfromconclusive.DelaFuente(2003) findsonlymildevidenceinfavourofconvergence,duetothedifferentlabourmarket institutionsandinvestmentratios,whereassalinasjiménezetal.(2006)findsome evidence in favour of convergence trends, due to human and physical capital accumulation.inarecentcontribution,crespocuaresmaetal.(2008)pointtothefact thatbeingaeumemberstateincreasesintegrationandhaspositiveandlastingeffects oneconomicconvergence. AsthenewandfutureEUmembersaremuchpoorerthantheoldmembers,the prospectoffurtherenlargementoftheeumayjeopardisetheachievementofreal convergence.itisalsoworthmentioningthattheprocessofconvergenceofeastern EuropeancountrieswithWesternEuropeancountrieshasspecialfeatureswhichare differentfromotherprocessofeconomicandpoliticalintegration:first,alleastern 3

6 Europeancountrieshavebeenintransitionfromplannedtomarketeconomies,atthe sametimeasanintenseprocessofintegrationwiththewest;second,thisgroupof countriesbelongtothecommoneuropeanmarketand,accordingtotheneoclassical modelofeconomicgrowth,theprocessofeconomicintegrationmayhaveaccelerated realconvergencewiththewest.thisisduetotheeliminationofbarrierstothemobility ofproductionfactors.thelatterelimination,arguably,wouldhelptoequalisethose productionfactors productivities. OneoftheconsequencesoftheprocessofeconomicintegrationisthatEastern EuropeancountrieshaveadoptedtheEUstandardsintermsofeconomicpolicies, institutionsandeconomicgovernance.forinstance,thesecountrieshavehadtoadopt multilateral agreements, such as Stability and Growth Pact, which establishes a number of fiscal policy rules. Thus, PadoaShioppa (2003) highlights the fact that EasternEuropeancountrieshavehadtokeeptwoprocessofconvergence;realincome andstructuralconvergence.theseprocessesareofcourserelated. Additionally,bymeansofparticipatingintheprocessofEuropeaneconomic integration,thisgroupofcountries,soonerorlater,willjointheeurozone,oncethe Maastrichtcriteriaarefulfilled(ECB,2003).Thissituationimplies,then,thatnotonly thecountriesinvolvedwillhavetofacetheprocessofrealconvergence,butalsothose countrieswhichareeumemberstates,willhavetofulfilnominalconvergence.leinet al. (2008) have analysed whether real convergence has been driving nominal convergenceintheneweumemberstates.theseauthorsconcludedthatopennesshas hadanegativeimpactandproductivityapositiveoneonpricelevelconvergencewith respecttotheeuroarea. 4

7 InthispaperweanalysetheprocessofrealeconomicconvergenceinEurope, focusingontherealeconomy,usingasaproxythegrossdomesticproductperworker. In contrast to Lein et al. (2008) the aim is to test whether there has been club convergence.thatis,ourprimaryquestionis:areeucountriesconvergingtoasingle steadystateoraretheyclusteringarounddifferentstates?thepossibilityofclub convergencewithintheeumayraiseissuesintermsofdifferencesincompetitiveness, linkedtothelackofstructuralreforms,whichmayyieldsignificantinstabilitieswithin theeu.theseinstabilitiesmayalsoaffectthestabilityoftheeurocurrency,aswehave seeninthe financialandsovereigndebtcrisis. Theremainderofthepaperisorganisedasfollows;thenextsectionpresents theclustermethodologyproposedbyphillipsandsul(2007,2009)totestforclub convergence within the EU14. Section 3 discusses the empirical results. The last sectionconcludes. 2. Methodology:convergenceandclustertests The hypothesis of conditional convergence implies that real convergence dependsupontheeconomicconditionsofthecountry,butitdoesnotdependupon initialincomeperworker.nevertheless,theinitialincomeperworkermayhavean effectonthecountry seconomicgrowthpath.thus,regardlessofthefactthattwo countries might share similar evolutions of fundamental variables and long term growthrate,theymaynotconvergetothesamesteadystateiftheydonothavesimilar initialincomesperworker.thisisknownastheclubconvergencehypothesis.according 5

8 tothelatter,iftwocountriesstarttheprocessofeconomicconvergencewithdifferent incomesperworker,theywillhitdifferentsteadystates.inorderwords,givena threshold of income per worker, countries with an income per worker below the thresholdwillconvergencetoadifferentsteadystatethanthosecountrieswithan income per worker above the threshold. This hypothesis, then, implies that those countrieswithlowerincomeperworkerwillformaclubwithalowerlongterm incomepercapitathanthosecountrieswithhigherinitialincomeperworker. Thisdoesnotcontradictthefactthatcountrieswithdifferentinitialincomeper worker may converge to the same steady state as richer countries, if the former countriesgetinvolvedinstructuralreforms.inthecaseoftheeu,clubconvergence refers to the possibility that Southern and Eastern European countries may have sluggisheconomicgrowth,diminishingtheirpossibilitiesofcatchingupwiththerest ofthecountries,thelatterachievingahighersteadystate. Thetimeseriesapproachtoconvergencestudycanbefoundintheseminal papers by Carlino and Mills (1993) and Bernard and Durlauf (1995, 1996). These authors have developed the concept of stochastic convergence, based upon the stationarity properties of the variables under analysis. Thus, two nonstationary variables converge if there is a cointegrating relationship between them. In other words,twononstationaryseriesconvergenceiftheysharethesamestochastictrend. Thisdefinitionofconvergencecanbeempiricallytestedbymeansoftimeseries econometrictechniques.however,aspointedoutbyphillipsandsul(2009),traditional convergencetestsareinadequatewhentechnologyisheterogeneousacrosscountries andthespeedofconvergenceistimevarying.toaccountfortemporaltransitional 6

9 heterogeneity,phillipsandsul(2007,2009)introducedcrosssectionalandtimeseries heterogeneityintheparametersofaneoclassicalgrowthmodel.thestartingpointof thetestisasimplefactormodel: X it i t it (1) where i measurestheidiosyncraticdistancebetweensomecommonfactor t andthe systematic part of X it. This model seeks to capture the evolution on the country specific X it inrelationto t bymeansofitstwoidiosyncraticelements,thatis,the systematicelement i andtheerror it.phillipsandsul(2007)modifiedthisinitial modelbyallowingthesystematicidiosyncraticelementtoevolveovertime,thereby accommodatingheterogeneousagentbehaviourandevolutionwithinthatbehaviour bymeansofatimevaryingfactorloadingcoefficient, it.furthermore,theyallow it to have a random component, which absorbs it in (1) and allows for possible convergencebehaviourin it overtimeinrelationtothecommonfactor t.thenew modelhasthefollowingtimevaryingrepresentation: X it it t (2) Thetimevaryingrepresentationin(2)canbeusedtoseparatecommonfrom idiosyncraticcomponentsinthetraditionaldecompositionofpaneldata: X it g it a it (3) where g it embodies systematic components, including permanent components that giverisetocrosssectiondependence,and a it representstransitorycomponent.the transformationof(3)totheformof(2)isgivenby: X it g a it it t it t (4) t 7

10 foralliandt.inthisway, X it isdecomposedinasinglecommoncomponent t anda idiosyncraticone it,bothofwhicharetimevarying. Thesimpleeconometricrepresentationin(2)canbeusedtoanalyzegrowth convergence by testing whether the factor loadings it converge. Phillips and Sul (2009)proposedamodificationoftheneoclassicalgrowthmodelsothattechnological growthratesdifferacrossandovertimeandareendogenouslydetermined.toaccount fortemporalandtransitionalheterogeneity,phillipsandsul(2009)introducedtime heterogeneoustechnologybyallowingtechnologicalprogress, A it,tofollowapathof the form A it A i0 exp(x it t). Under this heterogeneous technology the individual transitionpathoflogpercapitarealincome,log y it,evolvesas: logy it logy * * i log A i0 log y i0 log y i e it t x it (5) wherelog y i0 andlog y * i denoteinitialandsteadystatelevelsofeffectivelogpercapita realincomeand it isatimevaryingspeedofadjustment. Equation(5)canbeexpressedintheform(2): log y it log y * * i log A i0 log y i0 log y i e it t x it a it x it it t (6) where x it ispresumedtohavesomeelementsthatarecommonacrosscountriessothat countries share a common growth component, t. This common component can representcommonlyavailableworldtechnologysuchastheindustrialandscientific revolutions and internet technology. Thus, the dynamic factor formulation it t involvesthegrowthcomponent t thatiscommonacrosscountriesandindividual transitionfactors it whichmeasuresthetransitionpathofaneconomytoacommon steadystate growth path determined by t. During transition, it depends on the speedofconvergenceparameter it,therateoftechnologicalprogressparameter x it 8

11 andtheinitialtechnicalendowmentandsteadystatelevelsthroughtheparameter a it (PhillipsandSul,2009,p.1158). PhillipsandSul(2007)proposedmodellingthetransitionelements it bythe constructionofarelativemeasureofthetransitioncoefficients: h it 1 N X it N X it i1 1 N it N it i1 (7) Thismeasurestheloadingcoefficient it inrelationtothepanel.thevariable h it is calledtherelativetransitionpath,andtracesoutanindividualtrajectoryforeachi relativetothepanelaverage.so, h it measuresregioni srelativedeparturefromthe commonsteadystategrowthpath t.whenthereisacommonlimitingtransition behaviouracrossregions,wehave h it h t acrossi,andwhenthereisultimategrowth convergencethen h it 1forallias t. Next, Phillips and Sul (2007) construct the crosssectional mean square transitiondifferential H 1 H t where: H t 1 N N i1 h ˆ it 1 2 (8) andmeasuresthedistanceofthepanelfromthecommonlimit. Toformulateanullhypothesisofgrowthconvergence,theauthorsproposeda semiparametricmodelforthetimevaryingbehaviourof it asfollows: it i i it L(t) 1 t (9) where i isfixed, i 0, it isi.i.d(0,1)acrossibutweaklydependentont 1,andL(t) isaslowlyvaryingfunctionforwhichl(t)tendstoinfinityastalsogoestoinfinity. 1 Theseconditionsimplythatthestochasticcomponentdeclinesasymptoticallysothatthe trendvanishesandeachcoefficientconvergesto i. 9

12 FollowingPhillipsandSul(2007)theL(t)functionisassumedtobelogt. it introduces timevaryingandregionspecificcomponentstothemodel.thesizeofdetermines the behaviour (convergence or divergence) of it. This formulation ensures convergenceoftheparameterofinterestforall 0,whichisthenullhypothesisof interestsince it i as t.furthermore,ifthishypothesisholdsand i j for i j,thespecificationin(9)stillallowsfortransitionalperiodsinwhich it jt, therebyincorporatingtheinterestingpossibilityoftransitionalheterogeneityoreven transitional divergence acrossi.thus, the null hypothesis of convergence can be writtenas: H 0 : it and 0 (10) andthealternative: H A : it for all i with 0 (11) or H : (12) A it Thealternativehypothesisincludesdivergence,asin(11)and(12),butcanalso consider club convergence. For example, if there are two convergent clubs, the alternativeis: H A : it and 0, if i G and 0, if i G 2 (13) wheregstandforaspecificclub. 10

13 PhillipsandSul(2007)showthatthesehypothesescanbestatisticallytestedby meansofthefollowing logt regressionmodel: log(h 1 H t ) 2log(log(t)) a blogt u t (14) fort=[rt],[rt]+1,,twithsomer>0.phillipsandsul(2007)suggestr=0.3basedon theirsimulationexperiments. Thekeyparameteroftheconvergencetest,b,isrelatedwith.Indeed,Phillips andsul(2007)showedthatthefittedvalueoflogtis ˆ b 2 ˆ where ˆ istheestimated valueofunderthenull.inthismethod,rejectionofthenullforthewholepaneldoes notimplythatthereisnotconvergence,sinceitispossibletotest,bymeansofan algorithm,whetherthereareclubs/clustersofconvergence.hence,itispossibletotest the hypothesis of convergence for different group of countries, and identify commonalitieswithinapanelofcountries. Theregressiontestofconvergencein(14)ismadeupofthreestages(Phillips andsul,2007,p.1788).inthefirststep,thecrosssectionalvariance(h 1 H t )ratiois constructed,andtheninthesecondsteptheconventionalrobust t statistic, t ˆ b,forthe coefficient ˆ b iscomputedusing(14).finally,inthethirdstep,anautocorrelationand heteroskedasticity robust onesidet test of the inequality null hypothesis 0 is appliedusingtheestimatedcoefficient ˆ b andhacstandarderrors.atthe5percent level, the null hypothesis of convergence is rejected if the statistic has a value below1.65. However,thenovelaspectofthisapproachisthatconvergencepatternswithin groups can be examined using the logt regressions, i.e. the existence of club convergenceandthenclustering.thisfactisparticularlyrelevantsincetherejectionof 11

14 thenullofconvergencedoesnotnecessarilyimplydivergence,sincedifferentscenarios canbemet,suchasseparatepointsofequilibriumorsteadystategrowthpaths,aswell asconvergenceclustersanddivergentregionsinthefullpanel. TheconvergenceapproachbyPhillipsandSul(2007)hasanumberofclear advantages.first,itisatestforrelativeconvergenceasitmeasuresconvergenceto somecrosssectionalaverageincontrasttotheconceptoflevelconvergenceanalyzed bybernardanddurlauf(1996).second,thisapproachoutperformsthestandardpanel unitroottestssinceinthelattercase X it X jt mayretainnonstationarycharacteristics eventhoughtheconvergenceconditionholds,i.e.panelunitroottestmayclassifythe difference between gradually converging series as nonstationary. As a further problem,amixtureofstationaryandnonstationaryseriesinthepanelmaybiasthe results.moreover,testresultsaresometimesnotparticularlyrobust.incontrast,the PhillipsandSul(2007)testdoesnotdependonparticularassumptionconcerningtrend stationarityorstochasticnonstationarityofthevariablestobetested. 3. Empiricalresults InthispaperweanalysetheconvergenceofGDPPPPadjustedin1990US dollarsperworkerconvergenceinthefollowingcountries;austria,belgium,bulgaria, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland,Italy,Latvia,Lithuania,Holland,Poland,Portugal,Romania,SlovakRepublic, Spain,SwedenandtheUnitedKingdom.Weuseannualdatafrom1980to2009for WesternEuropeandfrom1990to2009forEasternEurope.DatacomefromtheWorld Bank. 12

15 In order to analyse if the convergence process of our pool of countries is homogeneousor,onthecontrary,thecountriesformclubsofconvergence,weapply thephillipsandsul(2007,2009)methodology.accordingtothismethodology,groups ofcountriesmayconvergetoasteadystatewhichiscommontoallthecountriesofthe group but different to other groups of countries. As previously mentioned, this approachisbasedonanonlinearandtimevaryingfactormodel,whichincorporates the possibility of transitory heterogeneity and even transitory divergence. Furthermore,theorderofintegrationofthevariablesisnotrelevantinapplyingthis methodology.interestingly,thismethodalsoallowsustodistinguishconvergence clubs. Table1showstheresultsoftheclusteranalysisforthe24targetcountries,for thesample toobtaintheresultswehavefollowedphillipsandsul s(2007) algorithm.thisimpliesfoursteps.inthefirststeptheseriesinthepanelaresortedout accordingtotheamountofthelastthirdperiodincome. Thesecondstepconsistsofselectingthekhighestindividualsinthepaneltoformthe subgroupgkforsome2k<n.thelogtregressionisrunandtheconvergencetest statisticstk=t(gk)calculated.thecoregroupsizek*ischosenaccordingtothecriterion: k * argmax k t k subject to mint k 1.65 Inthethirdstepthedataissievedfornewclubmembers.Thisimpliestoadd onecountryatatimetocoreprimarygroupwithk*membersandrunthelogttest again. 13

16 Table1 Clusteranalysis.Sample stclubanalysis bcoefficient tstatistic constant logt First cluster: Bulgaria, Estonia, Greece, Hungary, Latvia, Lithuania, Poland, Romania, Slovak Republic andslovenia Test to know whether the rest of countries form a cluster: bcoefficient tstatistic constant logt Sincethet<1.65theanalysisneedstoberepeated 2ndclubanalysis bcoefficient tstatistic constant logt Second cluster: Austria, Belgium, Czech Republic, Denmark, Finland, France, Germany, Italy, Ireland, Holland, Portugal, Spain, Sweden and the United Kingdom. Thenewcountryisincludedintheconvergenceclubiftheassociatedtstatistic isgreaterthenthecriterionc*.finally,inthefourthstepnewclusteraresearchedfor. Asecondgroupofcountriesisformedfromthoseforwhichthesieveconditionfailed instep3.thelogttestisruntoseeifthisgroupsatisfiestheconvergencetest.ifso,it ispossibletoconcludethattherearetwoconvergenceclubgroups.ifnot,steps1to3 arerepeatedtoseeifthesecondgroupcanitselfbesubdividedintoconvergenceclubs. Ifthereisnokinstep2forwhichtk>1.65,theremainingcountrieshavedivergent behaviour. 14

17 Accordingtotheresultsintable1,wefindafirstclusterconsistingofBulgaria, Estonia,Greece,Hungary,Latvia,Lithuania,Poland,Romania,SlovakRepublicand Slovenia.Thatis,allEasternEuropeancountriesplusGreece.Surprisingly,Greece s GDPperworkerconvergeswithEasternEuroperatherthanwiththeEU14.The second cluster is formed by the Western economies minus Greece. These results highlightthat,duringtheprocessofeconomicintegration,countriesfromeastern Europehaveconvergetotheirownsteadystate,whichisdifferentfromthatoftherest oftheeu.theseresultsgivesupporttotheideathat,despitenotableimprovements, gapsintermsofincomeperworkerrelativetotheeuroarearemainlargeinthe EasternEuropeancountries(Borys,etal.,2008).Thissuggeststhatthechallengesof realconvergencewillremainrelevantforthesecountrieseveninthemediumandlong term. PhillipsandSul s(2007)procedure,allowsusafirstclassificationofcountries withmorehomogenousfeaturesintermsconvergence.thisdoesnotpreventusfrom findingsubclusterswithinclusters,implyingdifferentsteadystatewithingroups.to dothis,wedividethepanelintwogroupsofcountries.thefirstoneconsistsof EasternEuropeancountries,andthesecondconsistsoftheremainder.Despitethefact thatgreeceappearsintheeasterneuropeancountriesinthepreviousanalysis,we haveincludethiscountriesinthewesterngroupsinceitisnotatransitioneconomy, andweareinterestedinanalysingitsbehaviourinrelationwiththerestofthemember states, andwith thosewith whom sharesthe euro. Also, we have left the Czech RepublicintheEasternEuropeangroupofcountries,giventhatGDPperworkerdata isnotavailablebefore

18 Table2 Clusteranalysis.Sample stclubanalysis bcoefficient tstatistic constant logt stcluster:Finland,Ireland,Italy,Portugal,Spainand Sweden Testfortheremaindercountriesformingaclub: bcoefficient tstatistic constant logt Sincet<1.65theprocessneedstoberepeated 2ndclubanalysis bcoefficient tstatistic constant logt nd cluster: Austria, Belgium, Denmark, France, Germany,HollandandtheUnitedKingdom Table2displaystheresultsoftheEU14clusteranalysis.Thesampleis Fromtheseresultsitispossibletohighlightthatthereisevidenceoftwogroups. However,theresultsdonotpinpointthetraditionaldivisionintoNorthernEuropeand SouthernEurope.AlthoughthefirstclusterincludesSouthernEuropeancountries,it alsoincludesnortherncountriessuchasfinlandandsweden.thesecondcluster consistsofgermany,franceandtheunitedkingdom,alongwiththosecountrieswith stronglinkswithgermany.inaddition,belongingtotheeurozonedoesnotdetermine theclusterandconvergencetoacommonsteadystate.forinstance,swedenbelongsto thefirstcluster,anddenmarkalongwiththeunitedkingdom,belongtothesecond. Rather,theseclustersseemtoberelatedwiththedivergenceincompetitivenesshas 16

19 suggestedbydegrauwe(2008).accordingtothisauthorsomecountriesasportugal, SpainandItalyamongstothershavesufferedanimportantlossofpricecompetiveness whichmaybelinkedtodifferentnationalpolicies.finally,greeceisnotineitherofthe twoclustersandthereforefollowsadivergencepath. Table3showstheresultsoftheclusteranalysisforEasternEuropefor Here we also find two clusters. The first one consists of Bulgaria, Latvia, Lithuania, Poland, Romania and Hungary. In the second one we find the Czech Republic,SlovakRepublic,SloveniaandEstonia.Itseemsthat,withthisgroupof countries,belongingtotheeurozonedeterminestheclusters.thethreecountries whicharepartoftheeurozoneappearinthesamecluster. Table3 Clusteranalysis.Sample stclubanalysis bcoefficient tstatistic constant logt First cluster: Bulgaria, Latvia, Lithuania, Poland, RomaniaandHungary Testfortheremaindercountriesformingaclub: 2ndclubanalysis bcoefficient tstatistic constant logt Since t > 1.65 the remaining countries form a convergenceclub 2ndcluster:CzechRepublic,Estonia,SlovakRepublic andslovenia 17

20 Figure1presentsthetransitioncurvestheforfourclusters. 2 Thesetransitioncurves depict the transitional dynamics of each cluster. Under theassumption of overall convergenceforthefullsampleofcountries,therelativetransitionparametersshould convergetoone.inthepresenceofclubconvergence,therelativetransitionparameters of each club converge to different constants. As is clear, the four cluster present differentsteadystatesintermsofpercapitaincome.thetransitioncurvesshowthat, from midnineties, countries in cluster two have slowly converged to the cluster formed by Germany, France and the United Kingdom (inter alia). However, this transitionwasbrokenin2008and,asaconsequenceofthefinancialturmoil,european countriesincluster1and2diverge.asregardseasterncountries(clusters3and4), thereisnoevidenceofconvergencewithineu14countries,neitherwithinthem.these resultshavetwoimportantimplications.first,convergencewithineu14isoverall modest.thislackofconvergencemayreflectmacroeconomicimbalanceswithinthese countriesthatmaypartlyexplainthecurrenteurocrisis.second,thefactthateastern European countries do not show any signal of convergence casts doubt on the sustainabilityofafutureenlargedcommoncurrencyareaincludinglessadvanced economiesaswellastheinabilityofmaastrichtcriteriatopromoterealconvergence. 2 Cluster1andcluster2correspondsrespectivelytocluster1and2inTable2.Cluster3and4 correspondsrespectivelytocluster1and2intable2. 18

21 Figure1:transition curves for the clusters 4. Conclusions Inthispaperwehaveanalysedthehypothesisofincomepercapitaconvergencewithin theeu.thisanalysisisofcrucialimportance,sincetheeunowconsistsofalarge numberofcountrieswithdifferentlevelsofproductivityandeconomicgrowth. Bymeansofapplyingclubconvergencetechniques,wefindthatthereare strongdivergencesintermsofincomepercapitawithintheeu;first,wehavethe CentralandEasternEuropeancountriesplusGreece,formingagroupofconvergence. Interestingly,Greeceappearstobehavemoresimilarlytotheeconomiesintransition group.second,afterrepeatingtheanalysisforwesternandeasterneucountries,we findthatthereisneitherclearsubdivisionbetweensouthernandnortherncountries, norbetweeneuroandnoneurocountries.inaddition,greeceappearsnottobelongto eitheroftheclusters,withinthewest.finally,foreasterneuropeancountries,itseems thatbelongingtotheeurozonedeterminestheclusterthatthesecountriesbelongto.it 19

22 seems that for Eastern European countries, the process of transition to market economies,alongwiththedesiretobelongtotheeuandeurozone,hashadthe anticipatedeffect. OurresultspointoutthenecessityofdeepstructuralreformswithintheEU,in ordertoincreasethelevelofconvergenceamongstitsmemberstates. 20

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