w 109 long-run economic aspects of the european union's eastern ...

ANNEXEStraditionally measured would thus be equal to 80 %, whereas the share of tradedgoods in consumption would be only 20 %. As this set of numbers might actuallydescribe the Estonian case one must be extremely careful in using the ratio ofexports to GDP as the relevant measure of openness.These difficulties in measuring the size of the traded goods sector are compoundedby the uncertainties in the nature of the catch-up process in Central and EasternEurope. In particular the assumption that the rate of productivity growth shouldbe the same might be inappropriate because under central planning this sector wasthe most underdeveloped of all.Overall, it is thus extremely difficult to provide a precise estimate of the B-S effectbased on theory alone. The only certainty is that any reasonable bound must berather wide and that more open economies are less likely to show large inflationdifferentials with the Euro zone for the simple reason that more of their consumptionbaskets consist of imported goods.1.2 EMPIRICAL INVESTIGATION BASED ON EURO AREA DATAA number of studies argue that a substantial proportion of the inflation differentialsthat remain between the countries participating in the Euro zone are due tothe convergence of prices to a common level. Such price level convergence could beexpected to take place in the Euro area for two reasons. First, the completion of theinternal market and increased cross-border price transparency contribute to reducingdifferences across countries in the prices of traded goods. Second, withregard to goods which are less easily traded across national borders (e.g. housingand services), convergence of productivity and living standards across the Euroarea would create a tendency towards price level convergence. This latter effect iscommonly known as the Balassa-Samuelson effect described above 4 . The forcesleading to a convergence of non-tradable goods prices are mainly related to realeconomic convergence. Countries that are in a catching-up process tend to havehigh productivity growth rate in the internationally exposed sector, but not in thenon-tradable goods sector. If nominal wages grow by the same rate in tradablegoods and non-tradable goods sectors due to labour mobility or centralised wagesetting procedures, then costs will grow faster in the non-tradable goods sectorand this will be reflected in higher inflation. Increased mobility of capital andlabour across the single market and the Euro area will promote an equalisation offactor prices, which will tend towards equalisation of non-tradable goods prices 5 .169In both sectors, convergence of price levels would give rise to some differentials ininflation rates across countries in the transition period, with ‘low price level’ countriestending to experience somewhat faster rates of price increase than ‘high pricelevel’ countries.