ECONOMIC DEVELOPMENT AND CONVERGENCE IN ROMANIA

Elena-Raluca, Moisescu (Duican)1

Abstract:
This paper presents the economic connection between nominal convergence, real convergence and
economic development in Romania. It is shown that fulfilling the nominal criteria is not enough to enter the
Economic Monetary Union. It needs to be accompanied by a sustainable economic development and an
increasing labour productivity.

Keywords: economic development, convergence, real convergence, nominal convergence

JEL Classification: F63, O47

1. Introduction
The integration of Romania in the eurozone requires a certain level of nominal and
real convergence with the countries in this area, and reducing disparities between our
country and the European Union average.
According to Raileanu and Marinescu (2010) empirical evidence shows that real
convergence process influences the nominal convergence through productivity growth and
openness of the economy.
Openness of an economy is one of the criteria the theory of optimum currency areas
and is a factor that indicates growth. The contribution of labor to gross domestic product
(GDP) can be measured by labor productivity growth. GDP growth rate highlights the
absolute and conditional convergence, based on the initial GDP/capita.
In order to strengthen the euro area, the European Union (EU) has taken steps such
as ,,Euro-Plus Pact that support a better coordination of economic policies in order to
increase the convergence and economic competitiveness. The main measures are referring
to sustainable public finances and strengthen economic stability supports Ni (2014).
The financial and economic recent crisis has brought in discussion three coordination
components for the economic policies affirms Ghizdeanu (2012):
- Structural reforms within Europe 2020 Strategy that reffer to the kind of desirable
economic growth, i.e. an intelligent, sustainable and socially inclusive one.
- The fiscal-budgetary supervision, whithin the Stability and Growth Pact it reffers
to the obligation of the Member States to reach and maintain a medium-term
budgetary objective. It presents constraints in the real convergence process by
limiting public investment for the catching-up process.
- The macroeconomic imbalances supervision. It is introduced an index system that
detects the macroeconomic imbalances.
Mere fulfillment of the nominal convergence criteria of the Maastricht Treaty does
not guarantee entry and maintenance of a state in the eurozone. Therefore, it is necessary a
deep analysis of economic and financial characteristics.
This article uses the example of countries like Romania, mainly, and Bulgaria, based
on similarities between economies.

2. Literature review
Many works have the concept of economic convergence as a subject.
Figuet and Nenovsky (2006) investigates the case of Romania and Bulgaria in the
context of the single currency and to what extent it is influenced the economic
development by the convergence with the EU. There are analyzed the nominal and real

1
PhD Candidate, Academy of Economic Studies, Bucharest, [email protected]

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convergence and EU business cycle synchronization using beta convergence. The results
indicate that Bulgaria has a higher level of convergence in the studied period.
Allam (2009) points out that depreciation and slowing economic activities during the
financial crisis hamper the situation of the new Member States of the European Union that
aimed achieving nominal convergence criteria.
Miron, Tatomir and Alex (2013) analyze the structural convergence with the euro
area of Central and Eastern European countries (CEE): Bulgaria, Czech Republic, Estonia,
Hungary, Lithuania, Latvia, Poland, Romania, Slovakia, Slovenia, between 2000 in 2010.
Results indicate that real convergence has a positive effect on structural convergence.
However, Romania and Bulgaria lags behind other CEE countries.
An important role in assessing a country's entry into Economic and Monetary Union
(EMU) plays real convergence. Catching-up process depends on the initial condition of a
state, and on its ability to catch-up the EU and the euro area. Real convergence has as main
factors: GDP per capita at purchasing power parity, labor productivity, and price levels.
The same authors state that there are two important criteria which make structural
convergence equally important. The first refers to the implications of the international
transmission of business cycles, and the second criterion shows the importance of
structural convergence in the economic development.
Sikulova and Plenk (2007) concluded in their paper that the time of adopting the
euro in the new Member States remains an open question because the real convergence
could cause risks of asymmetric shocks. The criteria set by the Maastricht Treaty are the
basis for accession to the euro area. The relationship between real and nominal
convergence is a close one. An increase in the productivity of a country leads to increased
prices, jeopardizing the achievement of nominal convergence criteria.
Giving up control of its currency means for a country that it cannot use currency
devaluation in order to stay competitive in the world market. There are some benefits of
using common currency (eliminating foreign exchange risks, promoting significant
economic growth and develoment). In contrary, in times of significant downturns, a
government that uses its local currency can reduce the real interest rate to encourage
investments in domestic businesses affirms Vodenska and Chitkushev (2013). In this
paper, the autors analyse three groups of countries and they investigate the relationships
between a group of macroeconomic indicators and sovereign debt as a percentage of GDP.
The results show that even though the European Monetary Union is strategically,
politically and economically important, the mos recent European sovereign debt crisis has
brought new challenges that need to be taken in consideration when considering the
replacement of the countries local currencies with the euro.
Theories of economic growth are closely related to those of economic convergence.
Besides the neo-classical theory (which emphasizes the idea of absolute convergence),
appear neoliberal theories (where, first, the gap is widening, then, it arrives at a period of
convergence from divergence). In the same work, Zai (2006) states that prudence
regarding support convergence is found in the neo-classical theories improved
(augmented). Endogenous growth is divided into two groups of theories: endogenous
innovation (Schumpeterian endogenous innovation) and endogenous capital (endogenous
broad capital). Finally, the existence of long-term divergence is supported by Myrdal,
Kaldor, Perroux, as regional growth patterns.
In its initial form, the neoclassical model of economic growth suggests convergence
to the same level of economic development of the states. Capital accumulation leads to
faster growth in poor countries compared to rich ones.
On the other hand, the model refers to the increase in endogenous growth in different
ways. Engine of economic growth can be called the effort made for research and

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development. Policies also influence long-term growth as Kapetanovic and Ouardighi
affirm (2009).
Dinga states that there are five distinct types of real convergence processes in the
literature: gamma-convergence () which it has as a target the synchronization of business
cycles, alpha-convergence () covering similar structure of the economy, delta-
convergence () that relates to similar levels of convergence, sigma-convergence ()
requires similar levels of GDP/capita between regions and countries, beta-convergence ()
shows a negative correlation between the initial state and convergence speed sigma. The
most common types are the sigma convergence and beta.
Sigma convergence measures the dispersion of GDP/capita between regions or
countries based on standard deviation. When the difference between the GDP/capita in
constant prices between regions or states decreases (standard deviation decreases over
time) there is convergence. A second embodiment of the extent of convergence is the
coefficient of variation. If it falls over a time period we can say there is convergence.
Beta convergence can be obtained through a regression analysis where it is estimated
the growth of GDP/capita over a period of time to its initial level. The literature found two
types of beta convergence: conditional (when countries converge to different stationary
states) and unconditional (where regions converge to steady state).

3. Aspects on nominal convergence

For adopting the euro, a country must meet the nominal convergence criteria. The
recent financial crisis has raised new challenges for states that wish to adopt euro, asking
them to meet difficult criteria. States seeking entry into the euro area should provide a real
GDP growth similar to most developed countries in this area.
As well as the challenge to meet and maintain the nominal convergence indicators
according to criteria set by the Maastricht Treaty, these countries face with the economic
catching-up process, according to Ouardigha and Kapetanovic (2009).
The five nominal convergence criteria laid down in the Maastricht Treaty refers to:
- Price stability; inflation rate must not exceed by more than 1.5% average inflation rate for
the first three EU Member States that had the best results in terms of price stability;
- Long-term interest rate: the average must not exceed by more than 2% average rate
of the three Member States with the best results;
- Budgetary discipline: the budget deficit should not exceed 3% of GDP and public
debt 60% of GDP;
- Exchange rate stability: the national currency must fall within a narrow fluctuation
band of 2.25% and a broad band of 15% for two years before entering the European
exchange rate mechanism ERM II.

3.1. The inflation rate criterion

According to the Statute of the National Bank of Romania (NBR), Law no.
312/2004, the primary objective of the National Bank of Romania is to achieve and
maintain price stability. The main focal point of the Romanian economy is given by
inflation. In 2004 there was an inflation of 9.3%, the first year with inflation expressed by
one figure after 1990.
In August 2005, the central bank adopted inflation targeting strategy. The reason for
the change of strategy is that monetary targeting (based on aggregate M0 as an operational
objective and M2 as an intermediate objective) was no longer an effective strategy.
Disinflation has slowed down in 2005. In late 2006 it reached the target of 4.87% and
the average inflation rate was 6.56%. Inflation rate of nominal convergence criterion refers

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to the average inflation rate rather than the rate on Consumption Price Index. It is noted
that this criterion was not met either in 2010 or in 2011.
Inflation has seen a decrease in the second half of 2013 due to lower food prices and
reduced value-added tax on bread and bakery products.
Inflation rate continues to decrease in 2014. However, in 2015 is expected to rise to
3.3% due to recovery in domestic demand.
It can be said that it is a criterion quite problematic for a country because there are
many factors that may increase inflation (domestic demand, rising energy prices and food).
In states which have monetary inflation targeting strategy (Czech Republic, Poland,
Romania) values of inflation differ.
Among the possible reasons of missing the inflation target in the coming years we
can mention the future conduct of fiscal policy, wage increases more than labor
productivity growth and aggregate supply shocks (oil and natural gas price increase).

Table number 1 - Inflation rate (Romania-EU-28)

(HIPC, in percentage)
2015
Countries/Years 2010 2011 2012 2013 2014
(estimate)
Bulgaria 3,0 3,4 2,4 0,4 -0,8 1,2
Romania 6,1 5,8 3,4 3,2 2,5 3,3
UE 2,1 3,1 2,6 1,5 1,0 1,5
Average of the three countries with the lowest 0,9 1,5 1,2 0,3 0,3 0,6
inflation rate in the EU
Source: Eurostat Database, European Commission Forecast, 2014

3.2. The long-term interest rate criterion

In Romania it is difficult to analyze the interest rate, in conditions of launch by 2006
of only two long-term bonds: in April 2005 at an interest rate of 6.75% and 2006 at an
interest rate of 7,49% both with a maturity of ten years. It is noted that in the 2010-2014
period, the interest rate remains above the average of the first three countries with the
lowest inflation rate in the EU, although a downward trend.

Table number 2 Long-term interest rate (Romania-EU-28)

(ten-years bonds as a percentage)
Countries/Years 2010 2011 2012 2013 2014
Bulgaria 6,0 5,3 4,5 3,4 -
Romania 7,3 7,2 6,6 5,4 -
Average of the three countries with the lowest inflation rate 2,8 2,3 1,5 1,7 -
in the EU
Source: Eurostat Database

3.3. The budget deficit criterion

In 2008, although the European Commission forecast was 3.2%, the consolidated budget
deficit was 5.4%. Because this level was above the reference value of the Treaty of Maastricht,
the European Commission recommended our country measures to reduce this indicator.
Deepening budget deficit in 2010 is due to cyclical and structural factors. Deficit
criterion has been met since 2012.
Certain elements favoring fiscal imbalances such as wage policy imprudent rapid
growth of pensions and fiscal policy inconsistency can be removed by the Ministry of
Economy and Finance by taking structural measures to strengthen the role of fiscal policy,
ie a plan of rationalization of public expenditure and implementing EU multiannual

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budgetary planning process and discussions with the central bank monetary policy makers
according to Socol (2009).

Table Number 3 Budgetary balance

(Romania UE-28, as percentage)
2015
Countries/Years 2010 2011 2012 2013 2014
(estimate)
Bulgaria -2,4 -1,2 0,1 -1,1 -0,7 -1,1
Romania -6,8 -5,5 -3,0 -2,3 -2,2 -1,9
UE -3,8 -1,5 -1,0 -0.5 0,2 0,2
Source: Eurostat Database, European Commission Forecast, 2014

3.4. Public debt criterion

Low share of public debt to GDP, below the EU average, gives a possibility for
upgrading Romanian economy by contracting foreign loans. However, from 2010 to 2014,
public debt increased from 30.5% to 39.9%.

Table Number 4 Public debt

(Romania UE-28)
Countries/Years 2010 2011 2012 2013 2014 2015
(estimate)
Bulgaria 16,2 16,3 18,4 18,9 23,1 22,7
Romania 30,5 34,7 38,0 38,4 39,9 40,1
UE 80,1 83,0 86,8 88,9 89,5 89,2
Source: Eurostat Database, European Commission Forecast, 2014

3.5. Exchange rate criterion

Each Member State may decide entry into ERM II without fulfilling any formal
preconditions. Importantly it is as at the entry into ERM II, the country has a favorable
level of nominal and real convergence with the countries that are already in Economic and
Monetary Union to avoid a currency crisis. In Romania, in November 2004 began the
process of flexible exchange rate. This criterion depends on meeting inflation criterion.
Regarding the stability of the exchange rate, the currency must fall within a narrow
fluctuation band of 2.25% and a broad band of 15% for two years before entering the
European exchange rate mechanism ERM II.
Domestic price stability is ensured by increasing the effectiveness of monetary
policy. Balassa-Samuelson effect should not be offset by the exchange rate policy of the
central bank. A sustained improvement in labor productivity, improved macroeconomic
situation and international low yields lead to increased capital inflows, with unavoidable
pressures for real appreciation of the domestic currency. Socol (2009) said that in order to
maintain macroeconomic balance is recommended and appropriate fiscal policy
(restrictive), besides the exchange rate policy applied.
By applying a restrictive fiscal policy when it comes to capital inflows: reducing
aggregate demand, limiting real appreciation of the exchange rate, current account deficit
limit, mitigate rising prices and increasing savings.
Although right now, our country meets the criteria of nominal convergence, Romania
should not rush to join the euro area, but should wait until you have a level of real
convergence (income per capita) in Euro area. It would also have to prove that it can
maintain the level of those criteria.

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 4. Aspects on real convergence
The catching-up process of a country should not be seen as an automatic result of
European Union accession. The structure of the economies has to become similar in real
convergence. Both, the catching-up and the convergence, are based on economic growth.
The crisis period shows a period of stagnation for the real convergence process.
Ghizdeanu (2012) states that Romanias potential gross domestic product will improve
until 2020. The annual growing pace for the potential gross domestic product is estimated
at 3% annually, as compared to almost 5% before 2008.
Even if the real convergence criteria are not stipulated in the Maastricht Treaty, they
have an important role in adopting a common currency. Policy makers should give more
attention to real convergence because of its importance in economic cohesion of a
monetary unions Member States.
In terms of GDP/capita, Romania has made significant progress between 2001 (20%)
and 2008 (43%), followed by a slight decrease in 2010 (40.6%). There are differences
between the values of GDP in the euro zone and the European Union.

5. Conclusions
A main concern within European Union is to accomplish a sustainable economic
growth. It is also
The financial crisis of 2007-2008 brought to light a number of weaknesses within the
European Union and the euro area. Amid them, the need for better coordination between
Member States' economic policies became evident. Fiscal and budgetary surveillance is the
first component in the new coordination by introducing constraints in the real convergence
process towards limit the public investment for catching-up process.
It is not enough to fulfill the nominal convergence criteria in order to have an
economic performance in the euro zone. It has to be accompanied by fiscal and structural
policies, by flexible domestic production factors.
A tricky problem for Romania is to adopt the euro. Given that the nominal
convergence criteria are met, the question is how and when Romania would have to take
this step. Little progress made by our country is not enough to meet the new status.

Aknowledgement
This work was cofinanced from the European Social Fund through Sectoral
Operational Programme Human Resources Development 2007-2013, project number
POSDRU/159/1.5/S/142115 Performance and excellence in doctoral and postdoctoral
research in Romanian economics science domain

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