Real income convergence and the patterns of financial integration in the EU
We analyse income convergence among the EU28 countries throughout 1995–2017 and the relationship
with the convergence patterns of EU financial systems. We apply the nonlinear latent
factor model of Phillips and Sul (2007, 2009) to real incomes and the IMF financial development
indices for financial markets and financial institutions (Svirydzenka, 2016), and identify convergence
clubs endogenously. We have several results. First, income disparities narrowed significantly
over the last twenty years; yet, the growth convergence process lost momentum triggered
by the global financial crisis and countries legacies shaped up asymmetries that have crystallised.
Second, countries' financial systems exhibit high fragmentation, especially for financial markets,
with the new EU member states at a lower financial development, confirming the existence of a
two-tier Europe. Overall, the convergence patterns for real incomes and financial development are
strongly correlated. Finally, the financial structure matters and market-oriented economies feature
higher long-run growth, indicating the need to implement pan-European policy actions that
increase the opportunities of risk diversification, enhance capital raising and channel large-scale
financing to firms.