## NORTH MACEDONIA—INCOME CONVERGENCE AND EU INTEGRATION

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---

### Introduction
- Since 2000, North Macedonia’s real GDP per capita has grown from 20 to just below 30 percent of the EU-15 average.
- Over the same period, new EU member states closed the gap with the EU-15 by more than 20 percentage points.
- North Macedonia is a candidate for EU accession; the resolution of the name dispute in early 2019 improved prospects for opening accession negotiations.
- The European Commission’s 2019 annual report gave a positive and unconditional recommendation for opening accession negotiations, but the European Council postponed a decision on a date to formally open negotiations. The European Council will revert to the issue of enlargement before the EU-Western Balkans summit in Zagreb in May 2020.
- Economic benefits of EU accession depend on successful implementation of institutional and structural reforms. Current constraints include an underutilized labor force, a large shadow economy, and systemic weaknesses in governance, the judiciary and public administration.

### Macroeconomic and Institutional Indicators
- Macroeconomic alignment with comparator countries at time of opening accession negotiations:
  - High integration with EU markets as shown by share of exports to the EU.
  - Export-to-GDP ratio relatively high compared to peers.
  - FDI net inflows are in line with the median.
  - Fiscal position is close to the median.
  - European Commission considers North Macedonia has made some progress and is at a good level of preparation in developing a functioning market economy.
- Structural and institutional indicators are mixed:
  - EBRD transition indicators: North Macedonia is on par with the median level of countries at the time of opening negotiations (latest available data point is 2014).
  - World Bank Doing Business and WGI Regulatory Quality: North Macedonia fares well.
  - WGI indicators for control of corruption and rule of law: North Macedonia is below the 25th percentile of countries at the time of negotiations and similar to other Western Balkans countries where institutional quality remains low.
- Income convergence status:
  - Real GDP per capita in PPP terms is currently below 30 percent of the EU-15 average — about 6 percentage points lower than the median of the comparator group at the time of opening of EU negotiations.
  - 휎-convergence: North Macedonia has experienced some degree of 휎-convergence since 2000, but it has stalled since 2014; the coefficient of variation of growth versus EU-28 remains one of the highest in the region.
  - 훽-convergence: Visual evidence of 훽-convergence in the EU; for North Macedonia, growth since 2000 appears lower than suggested by its initial income level.

### Literature Review on Convergence and Benefits of EU Accession
- Fast convergence episodes typically involve:
  - Strong improvement in institutional quality, human capital, favorable demographics, high labor participation, high investment ratios, and stronger external competitiveness with increasing trade openness and FDI inflows.
- Three quantitative approaches assessing EU integration benefits:
  - Counterfactual analysis:
    - Campos et al. (2014): Without EU integration, countries’ incomes would be on average 12 percent lower.
    - Martinovic (2015): Latvia benefited significantly from joining the EU; benefits may come from EU integration starting with opening accession negotiations (1999) rather than formal accession.
    - Bower and Turrini (2009): Much accession-related growth effects occurred before official accession dates due to adoption of the acquis and investment in anticipation of accession.
  - Panel data analysis:
    - Crespo-Cuaresma et al. (2006): Poorer countries will grow faster by entering the EU.
    - Bower and Turrini (2009): Countries with lower initial income and weaker institutional quality benefit more from EU accession in terms of economic growth.
  - CGE model:
    - Breuss (2009): Positive impact from EU accession on real GDP, investment, employment, and labor productivity for Bulgaria and Romania; level effects may be temporary and not lead to permanent steady-state growth increase.

### Assessing Potential Benefits of EU Integration for North Macedonia — Data and Methods
- Panel dataset: EU-28 and Western Balkan (WB) countries over 1990–2017 using five-year periods. The last period covers the three years from 2015 to 2017.
- Outcome variable: Average annual growth of GDP per capita in PPP (Penn World Tables).
- Two empirical steps:
  1. Test for unconditional 훽-convergence:
     - Growth_i,t = 훽0 + 훽 . log(GDP per capita_initial) + δ . d_t + ε_i,t
     - A Hausman test favors fixed-effects specification.
     - Reported sample results (Table 1): 훽 = -9.033*** and 훽 = -12.797***; R2 = 0.412 and 0.154 (country and time fixed-effects included). *** p<0.01.
  2. Test for conditional 훽-convergence with growth determinants:
     - Growth_i,t = 훽0 + 훽 . log(GDP per capita_initial) + γ . X_i,t + δ . d_t + ε_i,t
     - Explanatory variables X include investment rate, inflation, openness, and institutional quality measured by an aggregate WGI (average of control of corruption; rule of law; regulatory quality; government effectiveness).
     - Also test significance of a dummy for opening of EU accession negotiations.

### Empirical Results — Regression Findings
- Evidence of conditional 훽-convergence: initial GDP per capita remains strongly significant after controlling for economic and institutional factors.
- Investment ratio is positively associated with faster GDP per capita growth.
- Selected regression coefficients — European Union (Table 2):
  - Initial GDP per capita (log): -3.698***, -3.692***, -3.556***, -4.771***
  - Investment ratio (percent of GDP): 0.135*, 0.138*, 0.136*, 0.282***
  - Inflation: -0.033***, -0.034***, -0.033***, -0.009***
  - Openness: 0.027***, 0.028***, 0.027***, 0.031*
  - Institutional Quality Index (WGI): 0.966*
  - Control of corruption (WGI): 0.740**
  - Rule of Law (WGI): 0.809
  - Dummy EU negotiations: 2.876**
  - R2: 0.470, 0.472, 0.466, 0.324
  - Notes: All regressions include time fixed-effects and a constant; *** p<0.01; ** p<0.05; * p<0.1. Robust standard errors.
- Selected regression coefficients — NMS and WB (Table 3):
  - Initial GDP per capita (log): -19.558***, -19.328***, -19.242***
  - Investment ratio (percent of GDP): 0.140*, 0.104, 0.156**
  - Inflation: -0.001, -0.005, -0.003
  - Openness: -0.034, -0.023, -0.050
  - Dummy EU negotiations: 3.612**, 3.484**, 3.124**
  - Institutional Quality Index (WGI): 5.077**
  - Control of corruption (WGI): 5.237***
  - Rule of Law (WGI): 4.765*
  - R2: 0.472, 0.497, 0.478
  - Notes: All regressions include time and country fixed-effects and a constant; *** p<0.01; ** p<0.05; * p<0.1. Robust standard errors.

### Key Findings and Interpretations
- Unconditional and conditional 훽-convergence are present in the EU and in the NMS+WB samples.
- Investment ratio is positively associated with faster GDP per capita growth.
- Inflation is generally negatively associated with growth in EU regressions (significant in several specifications).
- Openness shows a positive and significant association in EU regressions; results are less clear or negative in NMS+WB regressions depending on specification.
- Institutional quality measures (aggregate WGI, control of corruption, rule of law) are positively associated with growth, with stronger and significant effects in the NMS+WB sample.
- The dummy for opening of EU accession negotiations is positive and significant in NMS+WB regressions (coefficients around 3.124 to 3.612 and significant at **), suggesting that the period of opening negotiations is associated with higher growth in those countries.
- For North Macedonia specifically:
  - Macroeconomic integration indicators are comparable to peers at opening of accession negotiations.
  - Institutional quality (control of corruption and rule of law) lags behind comparator medians and remains an obstacle to faster convergence.
  - Empirical analysis implies that EU accession negotiations and associated improvements in institutions, rule of law, and control of corruption can significantly boost income convergence.

### Empirical findings on growth determinants (new EU member states)
- Institutional quality is positively associated with higher GDP per capita growth.
- Results are robust across different measures of institutional quality and subcomponents such as rule of law and control of corruption.
- Institutional measures are introduced one at a time to avoid correlations among measures.
- The opening of EU accession negotiations is associated with a statistically significant and positive impact on growth, consistent with Martinovic (2015) and Bower and Turrini (2009).

### Policy considerations and conclusions on accession and institutions
- The EU accession process constitutes a fundamental anchor for institutional reform momentum.
- Significant efforts to improve institutional quality in new member states took place in the years prior to EU accession to comply with Copenhagen criteria on:
  - stability of institutions,
  - guaranteeing democracy and the rule of law,
  - the existence of a functioning market economy,
  - the capacity to cope with competitive pressure and market forces within the EU.
- Analysis shows that opening of EU accession negotiations and better quality of institutions, rule of law, and control of corruption can improve growth prospects.
- When EU negotiations start for the country discussed, it is planned that:
  - chapters 23 (judiciary and fundamental rights) and 24 (justice, freedom, and security) will be opened first, followed by
  - chapter 32 (financial control).

### Country-specific policy recommendations (North Macedonia)
- Boost the contribution of labor to growth by:
  - increasing participation rates and human capital,
  - reducing structural unemployment,
  - reducing skill mismatches through implementing more active labor market policies,
  - increasing completion rates and quality of secondary education,
  - upgrading and modernizing the vocational educational system.
- Improve institutions and governance (including control of corruption, voice and accountability, rule of law, and government effectiveness) to address emigration drivers tied to differences in income levels per capita and employment prospects and to help reverse net migration flows.
- Reorient investment toward infrastructure to close the sizable infrastructure gap:
  - Better infrastructure and trade logistics would boost TFP growth (which is estimated to have turned negative in the aftermath of the global financial crisis) and attract more FDI inflows, with positive growth spillovers.
  - Jirasavetakul and Rahman (2018) estimate that cumulative gains in FDI inflows for North Macedonia could reach up to 4 percentage points of GDP in the medium term if the country improves education and governance strength towards the best performer among new EU member states.
- Note: The investment rate in North Macedonia is broadly in line with historical benchmarks and the “golden rule” range (see IMF 2016) but should be better oriented toward infrastructure.

*Source: IMF staff synthesis of "NORTH MACEDONIA—INCOME CONVERGENCE AND EU INTEGRATION" (December 27, 2019).*

### References ____________________________________________________________________________ 11

### NORTH MACEDONIA—INCOME CONVERGENCE AND EU INTEGRATION

### Introduction
- Since 2000, North Macedonia’s real GDP per capita has grown from 20 to just below 30 percent of the EU-15 average.
- Over the same period, new EU member states closed the gap with the EU-15 by more than 20 percentage points.
- North Macedonia is a candidate for EU accession; the resolution of the name dispute in early 2019 improved prospects for opening accession negotiations. The European Commission’s 2019 annual report gave a positive and unconditional recommendation for opening accession negotiations, but the European Council postponed a decision on a date to formally open negotiations. The European Council will revert to the issue of enlargement before the EU-Western Balkans summit in Zagreb in May 2020.
- Economic benefits of EU accession depend on successful implementation of institutional and structural reforms. Current constraints include an underutilized labor force, a large shadow economy, and systemic weaknesses in governance, the judiciary and public administration.

### Macroeconomic and Institutional Indicators
- North Macedonia’s macroeconomic indicators are broadly aligned with comparator countries at the time they started EU accession negotiations:
  - High integration with EU markets as shown by share of exports to the EU.
  - Export-to-GDP ratio relatively high compared to peers.
  - FDI net inflows are in line with the median.
  - Fiscal position is close to the median.
  - European Commission considers North Macedonia has made some progress and is at a good level of preparation in developing a functioning market economy.
- Structural and institutional indicators are mixed:
  - EBRD transition indicators: North Macedonia is on par with the median level of countries at the time of opening negotiations (latest available data point is 2014).
  - World Bank Doing Business and WGI Regulatory Quality: North Macedonia fares well.
  - WGI indicators for control of corruption and rule of law: North Macedonia is below the 25th percentile of countries at the time of negotiations and similar to other Western Balkans countries where institutional quality remains low.
- Income convergence status:
  - Real GDP per capita in PPP terms is currently below 30 percent of the EU-15 average — about 6 percentage points lower than the median of the comparator group at the time of opening of EU negotiations.
  - 휎-convergence: North Macedonia has experienced some degree of 휎-convergence since 2000, but it has stalled since 2014; the coefficient of variation of growth versus EU-28 remains one of the highest in the region.
  - 훽-convergence: Visual evidence of 훽-convergence in the EU; for North Macedonia, growth since 2000 appears lower than suggested by its initial income level.

### Literature Review on Convergence and Benefits of EU Accession
- Successful fast convergence episodes typically involve:
  - Strong improvement in institutional quality, human capital, favorable demographics, high labor participation, high investment ratios, and stronger external competitiveness with increasing trade openness and FDI inflows.
- Three quantitative approaches in literature assessing EU integration benefits:
  - Counterfactual analysis:
    - Campos et al. (2014): Without EU integration, countries’ incomes would be on average 12 percent lower.
    - Martinovic (2015): Latvia benefited significantly from joining the EU; benefits may come from EU integration starting with opening accession negotiations (1999) rather than formal accession.
    - Bower and Turrini (2009): Much accession-related growth effects occurred before official accession dates due to adoption of the acquis and investment in anticipation of accession.
  - Panel data analysis:
    - Crespo-Cuaresma et al. (2006): Poorer countries will grow faster by entering the EU.
    - Bower and Turrini (2009): Countries with lower initial income and weaker institutional quality benefit more from EU accession in terms of economic growth.
  - CGE model:
    - Breuss (2009): Positive impact from EU accession on real GDP, investment, employment, and labor productivity for Bulgaria and Romania; level effects may be temporary and not lead to permanent steady-state growth increase.

### Assessing Potential Benefits of EU Integration for North Macedonia — Data and Methods
- Panel dataset: EU-28 and Western Balkan (WB) countries over 1990–2017 using five-year periods. The last period covers the three years from 2015 to 2017.
- Outcome variable: Average annual growth of GDP per capita in PPP for each period (Penn World Tables used).
- Two empirical steps:
  1. Test for unconditional 훽-convergence (equation (a)):
     - Growth_i,t = 훽0 + 훽 . log(GDP per capita_initial) + δ . d_t + ε_i,t
     - A Hausman test favors fixed-effects specification.
     - Table 1 reports evidence of unconditional 훽-convergence in the EU and in a smaller sample of NMS and WB countries.
     - Reported sample results (Table 1): 훽 = -9.033*** and 훽 = -12.797***; R2 = 0.412 and 0.154 (country and time fixed-effects included). *** p<0.01.
  2. Test for conditional 훽-convergence with growth determinants (equation (b)):
     - Growth_i,t = 훽0 + 훽 . log(GDP per capita_initial) + γ . X_i,t + δ . d_t + ε_i,t
     - Explanatory variables X include investment rate, inflation, openness, and institutional quality measured by an aggregate WGI (average of control of corruption; rule of law; regulatory quality; government effectiveness).
     - Also test significance of a dummy for opening of EU accession negotiations.

### Empirical Results — Regression Findings
- Evidence of conditional 훽-convergence: initial GDP per capita remains strongly significant after controlling for economic and institutional factors. Countries with higher investment ratios tend to grow faster.
- Regression Results — European Union (Table 2 notes and coefficients):
  - Columns (1)–(4) present varying specifications. Selected coefficients reported:
    - Initial GDP per capita (log): -3.698***, -3.692***, -3.556***, -4.771***
    - Investment ratio (percent of GDP): 0.135*, 0.138*, 0.136*, 0.282***
    - Inflation: -0.033***, -0.034***, -0.033***, -0.009***
    - Openness: 0.027***, 0.028***, 0.027***, 0.031*
    - Institutional Quality Index (WGI): 0.966*
    - Control of corruption (WGI): 0.740**
    - Rule of Law (WGI): 0.809
    - Dummy EU negotiations: 2.876**
    - R2: 0.470, 0.472, 0.466, 0.324
  - Notes: All regressions include time fixed-effects and a constant; *** p<0.01; ** p<0.05; * p<0.1. Robust standard errors.
- Regression Results — NMS and WB (Table 3 selected coefficients):
  - Columns (1)–(3) selected coefficients:
    - Initial GDP per capita (log): -19.558***, -19.328***, -19.242***
    - Investment ratio (percent of GDP): 0.140*, 0.104, 0.156**
    - Inflation: -0.001, -0.005, -0.003
    - Openness: -0.034, -0.023, -0.050
    - Dummy EU negotiations: 3.612**, 3.484**, 3.124**
    - Institutional Quality Index (WGI): 5.077**
    - Control of corruption (WGI): 5.237***
    - Rule of Law (WGI): 4.765*
    - R2: 0.472, 0.497, 0.478
  - Notes: All regressions include time and country fixed-effects and a constant; *** p<0.01; ** p<0.05; * p<0.1. Robust standard errors.

### Key Findings and Interpretations
- Unconditional and conditional 훽-convergence are present in the EU and in the NMS+WB samples.
- Investment ratio is positively associated with faster GDP per capita growth.
- Inflation is generally negatively associated with growth in EU regressions (significant in several specifications).
- Openness shows positive and significant association in EU regressions; less clear or negative in NMS+WB regressions depending on specification.
- Institutional quality measures (aggregate WGI, control of corruption, rule of law) are positively associated with growth, with stronger and significant effects in the NMS+WB sample.
- Dummy for opening of EU accession negotiations is positive and significant in NMS+WB regressions (coefficients around 3.124 to 3.612 and significant at **), suggesting that the period of opening negotiations is associated with higher growth in those countries.
- For North Macedonia specifically:
  - Macroeconomic integration indicators are comparable to peers at opening of accession negotiations.
  - Institutional quality (control of corruption and rule of law) lags behind comparator medians and remains an obstacle to faster convergence.
  - Empirical analysis implies that EU accession negotiations and associated improvements in institutions, rule of law, and control of corruption can significantly boost income convergence.

*Source: IMF staff synthesis of "NORTH MACEDONIA—INCOME CONVERGENCE AND EU INTEGRATION" (December 27, 2019).*

### 13.      Finally, we focus more specifically on growth determinants in new EU member states

### 13.      Finally, we focus more specifically on growth determinants in new EU member states

### Empirical findings on growth determinants
- Institutional quality is positively associated with higher GDP per capita growth.
- Results are robust across different measures of institutional quality and subcomponents such as rule of law and control of corruption.
- To avoid potential correlations among these measures, institutional measures are introduced as explanatory variables one at a time.
- The opening of EU accession negotiations is associated with a statistically significant and positive impact on growth, suggesting it is a major catalyst of growth-enhancing structural reforms, in line with Martinovic (2015) and Bower and Turrini (2009).

### Policy considerations and conclusions on accession and institutions
- The EU accession process constitutes a fundamental anchor for institutional reform momentum.
- Significant efforts to improve institutional quality in new member states took place in the years prior to EU accession to comply with Copenhagen criteria on:
  - stability of institutions,
  - guaranteeing democracy and the rule of law,
  - the existence of a functioning market economy,
  - the capacity to cope with competitive pressure and market forces within the EU.
- The analysis shows that opening of EU accession negotiations and better quality of institutions, rule of law, and control of corruption can improve growth prospects.
- When EU negotiations start for the country discussed, it is planned that:
  - chapters 23 (judiciary and fundamental rights) and 24 (justice, freedom, and security) will be opened first, followed by
  - chapter 32 (financial control).

### Country-specific policy recommendations (North Macedonia)
- Boost the contribution of labor to growth by:
  - increasing participation rates and human capital,
  - reducing structural unemployment,
  - reducing skill mismatches through implementing more active labor market policies,
  - increasing completion rates and quality of secondary education,
  - upgrading and modernizing the vocational educational system.
- Improve institutions and governance (including control of corruption, voice and accountability, rule of law, and government effectiveness) to address emigration drivers tied to differences in income levels per capita and employment prospects and to help reverse net migration flows.
- Reorient investment toward infrastructure to close the sizable infrastructure gap:
  - Better infrastructure and trade logistics would boost TFP growth (which is estimated to have turned negative in the aftermath of the global financial crisis) and attract more FDI inflows, with positive growth spillovers.
  - Jirasavetakul and Rahman (2018) estimate that cumulative gains in FDI inflows for North Macedonia could reach up to 4 percentage points of GDP in the medium term if the country improves education and governance strength towards the best performer among new EU member states.
- Note: The investment rate in North Macedonia is broadly in line with historical benchmarks and the “golden rule” range (see IMF 2016) but should be better oriented toward infrastructure.

*Source: 1mkdea2020002 - 13.      Finally, we focus more specifically on growth determinants in new EU member states*

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_Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1mkdea2020002.pdf_