Trade, governance and income convergence in the European Union: Evidence on the “theory of relative backwardness”

Abstract

At the core of the formation of the European Union (EU) in 1993 was the economic goal to create a European Common Market to ensure freer trade and perhaps to create an egalitarian Europe. The post-1993 period saw the biggest enlargement of the EU to date from a meagre 3 member countries (Benelux) at the dawn of its creation to now 28 member countries, imposing a unique and dominating feature in terms of its range and size in the world economic milieu. Obviously, the cementing force behind such integrative process was an idea to create a more economically powerful and politically vibrant economic entity, which can compete against the mighty United States' economy. What motivates the backward region of the EU to join this strategic move? Undoubtedly, it was sheer hope and expectation to catch-up the economically more powerful nations of the Union by deriving benefits from the integration. There are proliferation of studies showing that convergence indeed had happened in the EU. Our study makes a humble attempt to shed light on the role of trade (both intra–EU and EU versus the world) and government expenditure in explaining per capita income convergence in the EU during the period of 1995–2017. As opposed to the standard neo classical approach, we have adopted the Theil inequality analysis in a panel data framework, which provides us with a much richer analytical framework to focus on the underlying factors determining the per capita income convergence in an open economy. The major finding of this paper is that policy intervention in the form of trade openness and government expenditure did contribute to per capita income convergence in the EU during the period of our study. Moreover, we are able to show that trade with the world and government expenditure enabled the relatively lower income countries to increase their per capita income to a greater extent in comparison to the relatively higher income countries, which eventually help in narrowing down the gap in per capita income across the countries of the EU. Additionally, we found that occasional shocks such as financial crisis could not reverse the convergence process.