Asymmetric developments in the EU: Is the Lucas Paradox behind?

• Thesis title in Czech: Asymetrický vývoj v EU: Je příčinou Lukasův paradox?
• Thesis title in English: Asymmetric developments in the EU: Is the Lucas Paradox behind?
• Key words: konvergence, Evropská unie, Lukasův paradox, tok kapitálu
• English key words: Convergence, European Union, Lucas Paradox, Capital flow
• Academic year of topic announcement: 2017/2018
• Thesis type: diploma thesis
• Thesis language: angličtina
• Department: Institute of Economic Studies (23-IES)
• Supervisor: PhDr. Jaromír Baxa, Ph.D.
• Author: hidden - assigned by the advisor
• Date of registration: 11.06.2018
• Date of assignment: 11.06.2018
• Date and time of defence: 17.09.2019 09:00
• Venue of defence: Opletalova - Opletalova 26, O206, Opletalova - místn. č. 206
• Date of electronic submission: 31.07.2019
• Date of proceeded defence: 17.09.2019
• Opponents: prof. Ing. Oldřich Dědek, CSc.

Guidelines

Development in European Union (EU) is showing that even despite high amount of effort in economic integration, differences in cross-country development are still at play. Capital flow differences could be one of the key factors in these divergences as presented in Aizenman et al. (2013), Eng, Wong (2016) and Gourinchas, Jeanne (2013). In these recent studies, pattern of “Lucas Paradox” can be observed, where capital is flowing to developed countries instead of developing. Aim of this study is to quantify, whether this paradox is present in EU and how it might contribute to explaining convergence or divergence across countries. Quantitative measurement will be done by panel vector autoregression model (Panel VAR), which allows to obtain impulse responses between variables related to capital flow and economic convergence. Following research of Beckman, Czudaj (2017) and Kelemli-Ozcan et al. (2017), main focus will be put on effect of productivity, current account and real interest rate.

Hypotheses:
1. Causalities are significant between GDP growth, capital flow, CA, TFP and real interest rate – core of this hypothesis lies on relationships between GDP growth and capital flow, and capital flow and CA, TFP and real interest rate
2. Capital flow is missallocated in EU – hypothesis tests whether capital accumulation is relatively evenly distributed among countries according to their comparative advantages, or this relation no longer holds or is altered
3. Significant differences exist in impulse responses between Euro and non-Euro countries – main focus will be put on response of GDP growth on shock in capital flow

References

Core Bibliography:
Staehr K., Vermeulen R. (2016). How competitiveness shock affect macroeconomic performance across euro area countries. ECB, No. 1940.
Lopez-Garcia P., F. di Mauro et al. (2015). Assessing European competitiveness: the new CompNet micro-based database. ECB, No. 1764.
Berthou A., Dhyne E. et al. (2015). Assessing European firm´s export and productivity distribution: the CompNet trading module. ECB, No. 1788.
Dees, S., F. di Mauro, M. H. Pesaran and L. V. Smith (2007). Exploring the international linkages of the euro area: a global VAR analysis, Journal of Applied Econometrics, Vol. 22, no. 1, 1 – 38.
Comunale M. (2017). A panel VAR analysis of macro-financial imbalances in the EU. ECB, No. 2026.
Eng Y.-K., Wong Ch.-Y. (2016). Asymmetric growth effect of capital flows: Evidence and quantitative theory. Economic Systems, Vol. 40, 64 – 81.
Beckmann J., Czudaj R. (2017). Capital flows and GDP in emerging economies and the role of global spillovers. Journal of Economic Behaviour & Organisation, Vol. 142, 140-163

Preliminary scope of work

Methodology:
Core of methodology used in this research is going to be based on panel VAR model. Panel VAR will allow to measure cross-country impulse-response functions between variables. According to survey from Canova and Ciccarelli (2013) evaluating usage of panel VAR, this model is suitable for measuring interdependencies between countries following defined economic theory. Extensive literature review will be used to establish links between capital flow, economic growth, total factor productivity indicator (TFP), current account (CA) and real interest rate. Expected signs, duration and magnitude of impulse-response functions will be discussed for preselected possible scenarios. In similar research area VAR model was successfully used by Comunale (2017) and Staehr, Vermeulen (2016) for evaluating macroeconomic imbalances for aggregated data within Euro area. This approach will be modified to capture responses on capital flow and its impact on overall convergence in EU. To evaluate structural differences across countries and capture heterogeneity, several divisions between control and treatment group will be introduced, from which the main interest will be put on division according to Euro adoption. Comparison of model´s response functions will show how much these differences are significant in terms of magnitudes and duration.

Expected Contribution:

Contribution lies in extending existing research by using panel VAR methodology and estimation of impulse-response functions. Measuring whether “Lucas Paradox” within EU in some form exists will help understand how asymmetries in capital flow are created. Capital misallocation was examined by Gopinath et al. (2017) for southern countries of EU, this research will continue by expanding to whole EU area and using Panel VAR, allowing to compare effect of capital flow across countries. Establishing dynamic relation between Capital Flow, GDP growth, CA, TFP and real interest rate across countries would help in explanation of overall convergence or divergence in EU through above mentioned channels. In addition, measuring effect of potential heterogeneity, due to Euro adoption, related to these channels, could further explain potential causes of convergence/ divergence. Using obtained results, review and assessment of effectiveness of potential policy will be discussed. Discussion mainly focused on whether policies for narrowing capital accumulation through researched channels across countries are needed and how their effect could be potentially significant related to economic convergence in EU.


Outline:

Introduction: containing motivation, research questions and structure of study
Literature review: introducing current research in measure of convergence and establish economic intuition of relationships between model variables
Data overview: list of variables used in model estimation, data description and limitation
Methodology: panel VAR model between capital flow, CA, TFP, GDP growth and real interest rate within EU countries; for measuring influence of Euro adoption, model will be split between euro area and control group of non-euro area countries
Empirical results: discussion of obtained impulse responses to capital flow for each variable and its economic intuition, robustness checks
Concluding remarks: summary of results and their policy implications with respect to capital flow regulation