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Real convergence of the Czech Republic based on the
Solow model of economic growth**
Věra Tunkrová*
The importance of the economic and social cohesion
has been evident since the 1980s not only among
EU member states and for this reason, the member
states of this integration group started to cooperate
in this field. The Czech Republic, as well as some
EU member states, has to cope with considerable
regional disparities. According to this fact, it is
obvious, that the regional policy has had a
permanent substantial role and it is one of the most
important areas among common interest of the EU
member states. Regional policy helps EU member
states to increase their economic level. It is clear,
that the economic levels of the EU member states
differ. The question is: how are poorer countries able
to catch up with the advanced level of richer
countries and which factors affect them?
The main objective of this paper is to confirm or
disprove the hypothesis of absolute / conditional
convergence of the Czech Republic to the average
level of the EU member states according to the
Solow model of economic growth. At first, the Solow
model and its main assumptions are described.
Furthermore, the paper is devoted to the economic
level of the EU member states and especially to the
real convergence of the Czech Republic to the
average level of this integration group. At the end,
factors that influence the economic growth of the
country will be described, based on the specific
conditions of the Czech Republic.
JEL Codes: O11, 047
______________
*Ing. Věra Tunkrová, Department of World Economy, Faculty of International Relations, University of
Economics, Prague. Email: [email protected]
** This article was created under the solving the IGA project “Politics of the European Union: plans and
changes in the background of the Lisbon Treaty” No. F2/24/2010.
1. Introduction:
The importance of the economic and social cohesion has been evident since the
1980s not only among EU member states and for this reason, the member states of
this integration group started to cooperate in this field. The Czech Republic, as well
as some EU member states, has to cope with considerable regional disparities.
According to this fact, it is obvious, that the regional policy has had a permanent
substantial role and it is one of the most important areas among common interest of
the EU member states. The EU member states are committed to adopt a common
currency Euro and it is only a matter of time, before this promise will be fulfilled. The
important aspect in this area is the need to achieve a certain level of real
convergence to the former and richer member states. It is clear, that the economic
levels of the EU member states differ. Regional policy helps EU member states to
increase their economic level. The question is: how are poorer countries able to catch
up with the advanced level of richer countries and which factors affect them?
The main objective of this paper is to confirm or disprove the hypothesis of absolute /
conditional convergence of the Czech Republic to the average level of the EU
member states according to the Solow model of economic growth. At first, the Solow
model and its main assumptions are described. Furthermore, the paper is devoted to
the economic level of the EU member states and especially to the real convergence
of the Czech Republic to the average level of this integration group. At the end,
factors that influence the economic growth of the country will be described, based on
the specific conditions of the Czech Republic.
2. Literature Review:
This paper deals with the hypotheses of absolute and conditional convergence
according to the paper of R. Solow (Solow, 1956) and its application in
macroeconomic literature (Soukup, et al., 2007). Several theories of regional
development deal with a similar issue. For example the New growth theory (Barro,
Sala-i-Martin, 1992). The authors differentiate three types of convergence. The first
type is the absolute beta – convergence. This is a situation, when underdeveloped
regions grow faster than mature ones. The second type is the so called delta –
convergence, when it comes to the decrease of variability between regions (e.g. GDP
per capita). The authors follow the neoclassic theory and claim that each economy
(and also region) reaches another equilibrium or as they call this the “stable state”.
This is defined as the conditional beta – convergence (the third type of convergence).
According to the authors, it comes to the convergence rather at a regional level than
at an international level. This is caused by similar social, institutional, structural and
technological parameters of geographically closed regions. The conditional beta –
convergence is the process, when the pace of economic growth (of the whole
economy or region) shows a positive correlation with the distance of equilibrium.
3. The Methodology and Model:
The starting point of this paper will define the Solow model of economic growth and
its main assumptions. Without such characteristics, it would be very difficult to
understand the other context. As it was already mentioned in the Introduction of this
paper, the economic level of relatively poorer EU member states always converges to
the average of all EU member states. We can examine the real convergence, in this
sense, through the Solow model of economic growth (Solow, 1956).
This model is based on the assumption of a closed economy, in which we consider
the existence of only two sectors – households and firms. The basis for the Solow
model is the following production function: Y*=A f (C,L), where Y* stands for the
potential product, A for the technological progress, C for capital and L for labour. We
consider changes in the amount of capital, labour and technological progress for the
factors of economic growth. The production factors of capital and labour can be freely
changed. Furthermore we consider full employment. We consider the technological
progress for an exogenous variable, as its development is independent of the
economic cycle, but it also affects the size of the product. The population growth rate
is also considered to be an exogenous variable, as it is also not dependent on the
development of the economy.
“An important conclusion that follows from the Solow model is, the claim of process of
gradual convergence of the economic level (that means the product per capita) of the
states” (Soukup, et al., 2007). We assume that countries have the same aggregate
production function, as they are open economies and the technological progress is
available to all. The only thing, which differs with these countries, is their stock of
labour and capital. According to the Solow model it’s true, that a relatively poorer
country will show higher economic growth, so it will catch up to other countries and all
will reach a common stable state and have similar economic growth. We call this fact
the hypothesis of the absolute convergence. In practice this hypothesis is not too
common, poorer countries often have lower economic growth than wealthier ones.
This is explained through the hypothesis of the conditional convergence that
argues with exogenous variables. Countries can have different rates of savings, and
the assumption of the same stock of labour and capital is also not true. The economic
growth of countries is influenced by many other factors that are not accounted for in
the production function of this model.
4. The Findings:
In this part of the paper, I will consider the exogenous variables (the rate of savings,
the rate of population growth and technological progress) as variable.
The rate of savings significantly influences the rate of investments and this influences
the stock of capital in the economy. I will therefore examine the change of rate of
savings, hence the impact of the changes of capital in the economic growth.
According to the Solow model, the economy in a stable state shows zero economic
growth. “If the economy shows a higher rate of savings, it will show higher
investments and then also higher stock of capital and higher rate of product per
capita” (Soukup, et al., 2007). If it comes to the increase of savings, it will temporarily
increase the economic growth of the country. This increase will only have a
temporary character, as the economy will come to a new stable state and the rate of
economic growth will again turn back to its original level.
Graph No. 1 Relationship between the share of investments and level of product per
capita among countries of the EU eastern enlargement
17000
15000
GDP per capita (EUR)
13000
11000
9000
7000
5000
3000
1000
-1000 0
20
40
60
80
Share of investment in GDP (%)
Source: EUROSTAT and own calculations.
According to this graph, it is clear that in conditions of countries of the EU east
enlargement, the claim of the Solow model in regards to the relationship of the rate of
savings (rate of investments) and the rate of product per capita was confirmed. I
came to the conclusion through the regression analysis of the countries of the EU
eastern enlargement, that between these two variables exists a relatively close
relationship – GDP per capita in PPP depends on a share of investment of 74.5%.
This claim is obvious, as the investments represent a relatively large portion of
produced GDP of these countries. According to the economist Petr Sedlacek
investments significantly contribute to the shaping of the economic cycle and it is very
important to support a healthy investment climate to the economy (Sedlacek, 2006).
In graph No. 2 the results are shown from the regression analysis for the rate of
savings (investments) and the pace of economic growth among countries of the EU
eastern enlargement. In this case, I came to the opposite conclusion that the pace of
economic growth depends on the rate of investments in conditions of countries of EU
eastern enlargement of 18.7%. According to Petr Kral the middle and eastern region
did not belong to significant areas of FDI flows in recent years (Kral, 2004). It is
obvious, that I came to the right conclusion for the selected sample of countries. If we
considered this relationship for other countries of the world, then the investments
(savings) would represent an important factor of economic growth. The conclusion
would also be different for the group of advanced economies of the world, where the
investments represent the engine of economic growth.
Graph No. 2 Relationship between the share of investments and the pace of
economic growth among the countries of EU eastern enlargement
5
Pace of economic growth (%)
0
0
20
40
60
80
-5
-10
-15
-20
Share of investment in GDP (%)
Source: EUROSTAT and own calculations.
Furthermore, I will consider the rate of population growth as an inconsistent variable.
If we presume the increase of the rate of population growth and the rate of
investments remains unchanged, the average capital – labour stock will decrease.
However, the economy reaches a new stable state, with lower capital – labour stock
and also lower product per capita. According to the Solow model, we can assume
two conclusions – countries with a higher rate of population growth will have a lower
product per capita and furthermore, due to population growth, there is growth of
capital volume and constant economic growth of the whole product (Soukup, et al.,
2007).
In graph No. 3, there is the regression analysis of the EU eastern enlargement
countries, specifically in relationship to the GDP per capita and the population
growth. In case of these specific groups of countries I came to a conclusion that the
GDP per capita is quite strongly dependent on the population growth – 76.1%.
According to the chosen sample of countries I came to a different conclusion than
that of Soukup – with a higher rate of population growth the product per capita also
increases. This conclusion of the regression analysis is strongly influenced by higher
living standards of Slovenia, Cyprus and Malta. The conclusion would be different, if I
were to consider another group of countries.
Graph No. 3 Relationship between the population growth and GDP per capita among
countries of the EU eastern enlargement
18000
16000
GDP per capita (EUR)
14000
12000
10000
8000
6000
4000
2000
0
-10
-5
0
5
10
Population growth (%)
Source: EUROSTAT and own calculations.
The last variable according to the Solow model that influences economic growth of
the country is the technological progress. Solow differentiates two types of
technological progress – a labour expanding technological changes and a neutral
technological progress. Generally we can say that the technological progress allows
an increase in labour efficiency. The higher the labour efficiency each country shows,
the higher the economic growth we can presume. This fact explains to us, why it
leads to constant growth of product per capita. From the state perspective it is
necessary to invest financial resources for science and research in order to reach the
highest degree of technological progress and higher labour efficiency. So in future
invested financial resources it will surely cause the multiplier effect and that country
will gain a comparative advantage over the other states that will ignore technological
changes.
5. Summary and Conclusions
The main conclusion of the Solow model is the hypotheses of the absolute and
conditional convergence. In this part, I will examine these hypotheses in concrete
conditions of the group of the EU eastern enlargement countries.
To assess the degree of real convergence of a state, we can use two
macroeconomic indicators – GDP per capita in PPP or the comparative price level. I
chose the indicator of GDP per capita in PPP for a comparison. In table No. 1 (See
Annex), there is a percentage increase of real GDP in the EU-27 countries in 2009. If
the hypothesis of the absolute convergence according to the Solow model should
have been proven, relatively poorer countries would show higher rates of economic
growth than wealthier countries. From this table and graph it is clear, that this
hypothesis was not proven. I will support this conclusion with a concrete example of
the Czech Republic. In 2009 The Czech Republic is 81% of the average level of EU27 countries and Slovenia is 88% (EUROSTAT). The Czech Republic, as a relatively
poorer country should show higher rates of economic growth during this period.
According to table No. 1 this is not true. Comparing the table and the graph, we also
come to this conclusion in other examples (Slovakia and Poland, Cyprus and Malta).
We can not presume that the hypothesis of absolute convergence is always true in
conditions of the EU eastern enlargement group of countries. The explanation gives
the hypothesis of conditional convergence which accounts for some exogenous
factors.
There are many approaches how to examine exogenous factors which influence the
economic growth of a country. Undoubtedly it depends on the specific conditions of a
country and its actual position in the economic cycle. Soukup defines several
exogenous factors, included among them the human capital of the country. Not one
of the countries disposes of the educational system of the same quality and with this
it’s related to the special qualification of labour. These factors influence the
production function of the country, which will be the country with quality human
capital at a higher level. Furthermore the exogenous factor is the political capital of
the country. It is clear, that among these countries there are differences in a political
and legislative environment that furthermore influences other areas such as business
conditions, foreign direct investments and so on. Economic growth also indirectly
depends on the infrastructure of the country. A qualitative road and railway net will be
an advantage for trade and services.
According to Sohn and Lee the economic growth is largely influenced by trade. They
examine the relationship between trade and economic growth and confirm the
assumption that a free trade area as an integration that supports economic growth.
This fact depends on the region where the integration group is located (Sohn; Lee,
2010). M. Castano examines the influence of socioeconomic factors of the economic
growth of a country. She comes to the conclusion that public capital has a negative
effect on economic growth, the social capital on the other hand supports economic
growth (Castano, 2007).
Now it is time to devote to the specific factors that influence the economic growth of
the Czech Republic. Firstly I must mention the dependence on the economy of our
neighbour – Germany as the bigger export partner. Especially at this time, when the
economies are recovering from the financial crisis, it is very important how Germany
is dealing with this situation and this will have a significant influence on the economic
growth of the Czech Republic. Furthermore a specific factor is the competitiveness of
the Czech Republic in the middle and eastern region. It is necessary to support the
awareness of the Czech Republic as a qualitative and innovative potential economy.
According to the analysis of meeting the Maastricht convergence criteria and the
degree of alignment of the Czech Republic and Eurozone the economic growth of the
Czech Republic was influenced by the rapid increase of food and energy prices, with
an increase of VAT from 5% to 9%. The Czech Republic furthermore introduced
ecological tax and medical fees and increased excise tax as well. An important
exogenous factor is the increase of petroleum prices (MF CR and CNB, 2010).
The Czech Republic has been a part of the European Union since 2004 and not only
since this time, it is very important to examine its economic level in comparison to
other member states of this integration group. At this time, the Czech Republic has
81% of the economic average level of this group. Only Slovenia and Cyprus show a
better economic level from countries of the EU eastern enlargement. I came to the
conclusion, that in conditions of the EU eastern enlargement group of countries, the
main indicator, which influences the economic growth, is the share of investments
(74.5%) and population growth (76.1%). On the other hand, the pace of economic
growth that depends on the share of investments is very low (18.7%).
References:
Barro, R. and Sala-i-Martin, X. 1992. Convergence, The Journal of Political Economy,
vol. 100, no. 2. pp. 223-251.
Castano, M. S. 2007. The influence of socioeconomic factors on economic growth.
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_en.cfm>. ISBN 978-92-79-17800-9.
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vyhodnoceni_2010.pdf
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ČNB
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Appendix
Table No. 1 Annual increase of real GDP in the EU-27 countries (%)
Annual average growth rates of real gross domestic product – EU 27
PERIOD
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
ECONOMY
Austria
3,56
3,32
3,36
0,83
0,86
1,21
2,31
2,04
3,30
3,38
1,80
Belgium
1,68
3,42
3,74
0,79
1,51
0,99
2,97
1,67
2,85
2,71
1,10
Bulgaria
4,01
2,30
5,39
4,07
5,59
5,01
6,64
6,25
6,09
6,17
6,00
Cyprus
5,04
4,85
5,04
3,98
2,10
1,91
4,20
3,95
4,04
4,36
3,70
-0,76
1,34
3,65
2,46
1,90
3,60
4,48
6,37
6,36
5,80
3,50
Denmark
2,16
2,56
3,53
0,70
0,47
0,38
2,13
3,06
3,52
1,82
-1,10
Estonia
4,44
0,31
7,85
7,66
8,02
7,24
8,26
10,15
11,19
7,11
-3,60
Finland
5,19
3,89
5,01
2,64
1,64
1,77
3,73
2,92
5,01
4,40
0,90
France
3,50
3,30
3,91
1,85
1,03
1,09
2,47
1,71
1,99
1,90
0,70
Germany
2,03
2,01
3,21
1,24
0,00
-0,22
1,06
0,78
2,87
2,48
1,30
Greece
3,36
3,42
4,48
4,49
3,90
5,04
4,58
3,83
4,19
4,00
2,90
Hungary
4,86
4,15
5,20
4,07
4,37
4,18
4,81
4,13
3,88
1,33
0,50
Ireland
8,05
10,39
9,37
6,07
6,58
4,46
4,38
6,02
5,74
4,92
-2,30
Italy
1,44
1,93
3,58
1,80
0,34
0,04
1,20
0,09
1,87
1,46
-1,00
Latvia
4,73
3,28
6,91
8,04
6,47
7,20
8,68
10,60
12,24
10,31
-4,60
Lithuania
7,49
-1,47
4,09
6,65
6,92
10,32
7,32
7,94
7,66
8,78
3,20
Luxembourg
6,49
8,42
8,44
2,52
4,10
2,10
4,88
5,02
6,12
5,24
-0,90
Malta
5,13
4,72
5,03
-1,62
2,62
-0,31
0,21
3,29
3,38
3,92
2,30
Netherlands
3,92
4,68
3,94
1,93
0,08
0,34
2,24
1,51
3,01
3,46
2,00
Poland
4,98
4,52
4,25
1,21
1,44
3,87
5,34
3,62
6,13
6,52
4,80
Portugal
4,85
3,84
3,92
2,02
0,76
-0,81
1,52
0,74
1,20
2,22
0,00
Romania
-4,82
-1,15
2,15
5,75
5,12
5,22
8,46
4,18
7,86
5,97
7,10
Slovakia
3,69
0,32
0,72
3,23
4,12
4,16
5,42
6,04
8,27
8,70
6,30
Slovenia
3,59
5,33
4,13
3,10
3,66
2,81
4,44
4,15
5,72
6,07
3,50
Spain
4,47
4,75
5,05
3,65
2,70
3,10
3,27
3,62
3,86
3,83
1,20
Sweden
3,81
4,60
4,40
1,06
2,41
1,91
4,13
3,30
4,09
2,58
-0,20
UK
3,35
3,04
3,80
2,37
2,05
2,77
3,26
1,84
2,85
3,12
0,70
Czech Republic
Source: UNCTAD
Graph No. 1 GDP per capita in PPP in the EU-27 countries
Source: Eurostat, 2009