Catching up in Europe

Europe's economic growth is driven by poorer countries and regions that are catching up to the wealthier areas.

"Economic growth in Europe is primarily driven by the newer EU countries in Central and Eastern Europe (CEE) catching up to the wealthier countries", says Professor Gernot Doppelhofer in the Department of Economics at NHH. These are countries like Poland, Hungary, Croatia, Estonia, Latvia and Lithuania, and others.

- For the more established EU countries in the West, we find the same dynamic within countries: poorer regions are growing faster than wealthier regions", says Doppelhofer.

1995-2005

Doppelhofer and international colleagues have studied 48 possible determinants of growth in 255 regions in the EU from 1995 to 2005. In Norway, each region would be equivalent to one county.

The study is remarkable not only because it establishes the factors that are essential for growth, but also because no one has previously tested so many possible growth factors against actual data. Various theories have been opposed each other and given different answers.

"With this broad study, we have been able to weed out theories that do not hold water in the face of the data," says Gernot Doppelhofer.

Completely agnostic

The co-author of the article, Professor Jesús Crespo Cuaresma of the Vienna University of Economics and Business, believes that this is one of the most important contributions the article makes.

"There are hundreds of different theoretical answers to the question of why some regions become wealthier than others. We decided to be completely agnostic and test the theories against real data", says Cuaresma.

One of the main findings is that there are surprisingly few factors that appear to play a role with any certainty. Of the 48 possible factors, only three remain as robust growth factors: the region's income level at the outset, the share of workers with higher education, and whether the capital city is located in the region or not.

Income and catching up

"The income level a region has at the start of the study is a robust growth factor, but with a negative effect. In other words, a wealthy region, for example in Switzerland, will grow slower than a poorer region, for example in Romania. The speed at which the poorer regions are catching up with the wealthier region is about two percent a year. This means that the gap will be halved in about 35 years", explains Doppelhofer.

This finding corresponds with the speed that others have found in other regions, such as in the USA or in Japan.

"The reason for this observation is that it is more difficult to create economic growth through for instance new technology than it is to start using something that already works. In that way, it is easier to catch up than to move the limits further", says Jesús Crespo Cuaresma.

The researchers find the same effect within the wealthy countries in the West, where poorer regions are growing faster than the wealthy regions. However, this does not apply to the countries in Central and Eastern Europe.

"In these CEE countries, it is more often the case that the growth regions, which often correspond with the capital cities, are speeding up and catching up with the rest of Europe. This explains the convergence between the countries. The poorer regions of Eastern Europe lag behind", says Doppelhofer.

The periphery is catching up

In the literature, this phenomenon is known as the "Williamson hypothesis". According to this theory, growth is strongest at its early stages and is often very concentrated, while peripheral regions lag behind. When the central areas have matured, the peripheries catch up.

"According to this theory, Eastern Europe is experiencing the same process as Western Europe, but is currently at an earlier stage", says Cuaresma.

Population movements also play a central role in this dynamic. EU has for a long time been criticised for mobility across national borders not being very good for workers, and that in practice there is no common labour market. However, within countries people move with greater ease, and the tendency to move from rural areas and to more urban areas fits with the above model.

Education

Another factor that remains robust and relevant is the share of workers with higher education.

"Our estimate here is that an increase of ten per cent more workers with higher education in the population leads to 0.6 percentage points higher annual growth. Increased education is in other words clearly a very promising way to go to enhance economic growth", says Doppelhofer.

The NHH Professor thinks that this should provide clear advice as to what politicians in countries with lower levels of average education ought to spend money on.

"Education is also tied to other factors, such as technology transfers from other countries. A region with more educated people will be able to start using new technology more easily", Cuaresma adds.

Capital city

A third robust factor characterising regions experiencing growth, is that the region is home to the capital city. In capital city regions, growth is on average one percentage point higher than in non-capital city regions.

"This is also true when we correct for the size of the city and other factors. That the city is the administrative centre appears to give it extra growth impulses", says Cuaresma.

"This is again most typical of the regions in Eastern Europe. However, that is to be expected, as that is where most of the growth is happening", says Doppelhofer.

He emphasises that the researchers are careful with drawing causal links. Nevertheless, he believes that the results indicate what may be underlying causal connections.

Two models get it right

The researchers highlight two theories of economic growth that are consistent with the findings of the study: neoclassical and endogenous growth theory.

"The neoclassical theory says that a poor region will have relatively less capital relative to labour. Then the most scarce resource - capital - will become more efficient and lead to a higher return then in richer regions. Thus, investors get an incentive to move capital from wealthy regions with low marginal productivity on capital to areas where the marginal productivity, and thus profits, are higher", says Doppelhofer.

The theory of endogenous growth also fits with the figures in the study. Here, findings about profits from knowledge and technology transfers and the clear effect of increased levels of education in the labour force fit well.

"In other words, there are still models that can be used", Cuaresma concludes.