5.2. LESSONS FROM THE USA FOR THE EUROPEAN ECONOMIC CONVERGENCE



I. INTRODUCTION

One of the great economic objectives of the European Union is to achieve real convergence among its member states. By that it is meant to bring poorer countries (measured in terms of gross domestic product per capita) into the European average.

For such a purpose the European Commission in Brussels (the equivalent to the federal government in the USA) has for the last two decades invested year after year considerable amounts into the economy of four poorer European countries: Spain, Ireland, Greece and Portugal.

These investments have come under different forms: costs sharing of major public work programs; financing of education; subsidising private companies under special programs.

Also, the values of these transfers into poorer countries have been significant. Both for the European budget where they represent 33% of the total budget and in terms of each country’s economy: at 2004 prices (between 2000-2006) what Portugal, Greece, Spain and Ireland (the four poorer European countries when they joined) received in transfers represent respectively 2,2%, 1,6%, 1,3% and 0,33% of their gross domestic product.


II. THE PROBLEM

 

Nevertheless, progress among poorest European countries has been relatively slow.

Portugal joined the European Union in 1986. At that time its GDP per capita was 53,1% of Europe’s average. In 2016 it is 71,3%. Thus a progress of (71,3% - 53,1%) 18,2% in 30 years, for an annual convergence rate of 1%. At this trend Portugal will reach European GDP average only after 35 years; in 2051 (see figure one). And the European Union will need to keep on pumping funds at the present rate (2,2% of Portugal’s GDP).

Greece has been diverging. Greece joined the European club in 1981. At that time its GDP per capita was 88,3% of Europe’s average. Thirty five years later it is at 63,7%. A decrease of 24,6% in 35 years: -1% per year. At this rhythm Greece will never reach the European GDP average (see figure one).

Spain joined in 1986. At that time its GDP per capita was 71,8% of Europe’s. Thirty years later, in 2016, it is at 85,4%. A progress of 13,6% in 30 years, that is 0,6% per year. If the trend is kept, another 28 years, will pass by before Spain reaches the European average (figure one).

Ireland is the only previously poor country (when it joined the European Union) that has achieved fast convergence. It joined in 1973 with GDP per capita of 62,4%. In 1998, twenty-five years later its GDP per capita reached Europe’s average. In 2016 it is 62% above that average.

So what is the outcome of the European Union process of economic convergence? At best, a mixed outcome. Ireland achieved a fast convergence. But for Portugal and Spain convergence was slow: another 35 years will be needed before Portugal reach the European average. In spite of the fact that all countries received in central transfers over one per cent of their GDP, year after year (except Ireland).

Should this come as a surprise? In part. We knew from economic theory that there are forces in favour and against economic convergence (figure two).

 




In general, in favour of convergence of a poor region there are three variables:


1. transfers from the central government
2. lower salaries; and
3. it is not necessary to innovate, only to imitate (the so called Krugman effect).


Then, against convergence, that is in favour of more developed regions, there are two factors:


1. More money, therefore a larger market making possible greater specialization and company scale economies, without the onus of transport costs; and
2. greater dynamism, thus more opportunities (the rhythm of a chain, is the rhythm of its slowest link).





So, we knew from economic theory that there were factors for and against economic convergence.

However, it was thought that in the long run, forces in favour would outweigh those against. That this is not the case, comes somewhat as a surprise. But that should not be so if one had looked at the example of the United States.


III. THE EXAMPLE FROM THE UNITED STATES


The U.S.A. is an economic union (no internal trade tariffs) for more than 200 years (Europe started, slowly in 1957). It has been a monetary union for long, too (single currency). And has a federal budget over sixteen times larger than Europe’s. And what is the result? What economic convergence has been achieved by the U.S.A.?
The answer is: much lower than could be expected. There are two ways of seeing this. The first is by looking at the difference in the standard of living among the fifty-one U.S.A. states. The other is by comparing the level of that difference with the difference among the fifteen countries of the European Union.
Indeed, among the fifty-one U.S.A. states there are great differences. The average GDP per capital (PPP) (1) in 2010 (2) of the U.S.A. was 47.131dollars (see figure three). But the state of Mississippi is 30,5% below (GDP per capita equal to 70% of the average of the U.S.A). West Virginia is 28,4% below. And South Carolina 25,7%.
There are the riches states: District of Columbia is 257% above the average; Alaska is 50% above; and Delaware 48%.
Comparing the richer states with the poorer, the differences are enormous. In relation to the average of the three poorest states (South Carolina, Mississippi and West Virginia) the GDP per capita of the District of Columbia (capital Washington) is 400% times superior, Alaska is 109% superior and Delaware 106% superior.
So, there is a large economic divergence. There are a few states very much above the average. And others well below. After two hundred years of an economic and monetary union. This is illustrated in figure three.

This happens despite the existence of a large number of states with a GDP per capita close to the average, forming a solid nucleus of convergence: Texas, Nebraska, Hawaii, Oregon, Louisiana, Iowa, etc. But afterwards there are extreme cases. Of richness. And of poorness. Here, apart from the above mentioned three states (South Carolina, Mississippi and West Virginia), there are other poor states: Idaho (23,4% below the average of U.S.A.), Alabama (23,6% inferior), Montana (23,8% below) and Arkansas (25,4% below). Among others.






Then, there is a major surprise. When one compares how similar they are among themselves, all fifty-one U.S.A. states with, how similar are all fifteen European countries, in terms of GDP per capita, one reaches the conclusion that European countries are more similar (have greater convergence) than U.S.A. states!

Two measures indicate that much. The Gini Index and the GDP per capita variance divided by its mean.

As figure 4.1 shows the Gini Index is greater for the U.S.A. (0,22) than for Europe (0,16) (3). Thus the economic divergence is greater in the U.S.A. Convergence is larger in Europe. There is a six per cent difference.

That is represented in figure 4.2 where the U.S.A. Lorenz curve (the geometric representation of the Gini Index) is below that of Europe.

Indeed, the higher the economic divergence is, the flatter over the horizontal axis the curve would be. On the contrary, in the case of no divergence whatsoever (total convergence), the curve would be equal to the straight line linking the southwest and northeast corners.

Another indication that U.S.A. economic divergence is higher than Europe’s is provided by the GDP per capita variance divided by its average. The fifteen European countries rate here far below the fifty-one U.S.A. states: 4,6 against 7,7 (see figure 4.3). Indicating that variability is far greater in the U.S.A. (1,7 times ) than in Europe.





IV. CONCLUSION


The example of the U.S.A. indicates that it should come as no surprise that the economic convergence of some poorer European countries has been slow in some cases (Portugal) and practically non-existent in others (Greece).

Two hundred years of economic, monetary and political union were not able to achieve that convergence in the U.S.A.: South Carolina, Mississippi and West Virginia stand out as the most important non-convergence cases.

However, what is most surprising is that, at present, economic divergence is greater in the U.S.A. than in Europe (figure four).

That indicates that contrary to the wide spread belief, time and transfers of central funds will not do it all.

Thus the conclusion that the sole way of achieving and speeding up the process of economic convergence, is through structural reforms in the economy of each state or country. Without them, all regions may equally benefit from the transfer of central funds, but in the end, some will be more equal than others.

(1) Purchasing Power Parity.
(2) Most recent data available for international comparisons.
(3) The Gini Index ranges from zero (total economic convergence, that is, no difference in GDP per capita) to one (total economic divergence, very large GDP per capita differences among states or countries). So, the higher the value of the index, the greater the difference in GDP per capita.