Bulgaria: Selected Issues and Statistical Appendix

International Monetary Fund

doi:10.5089/9781451804553.002.A002

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Bulgaria: Selected Issues and Statistical Appendix

Author: International Monetary Fund

Publication Date:: 08 Aug 2006

eISBN:: 9781451804553

Language:: English

Keywords:: ISCR; CR; Bulgaria; bank; net; EU budget; per capita income; structure of the Bulgaria economy; employment rate; growth scenario; convergence prospect; Personal income; Productivity; Employment

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This paper discusses Bulgaria’s prospects for converging to the living standards of the more advanced members of the European Union (EU). The unfavorable economic environment of the early 1990s and the economic crisis in 1996–97 hurt Bulgaria’s output, employment, and investment. Following the crisis, structural reforms and a sound macroeconomic framework set the stage for a sustained recovery. The structure of the Bulgaria economy has shifted markedly over the last decade, and investment has become the main engine of growth.

Abstract

II. Bulgaria’s Growth and Convergence Prospects²⁵

39. This chapter discusses Bulgaria’s prospects for converging to the living standards of the more advanced members of the European Union (EU). Based on the growth-accounting framework, the paper assesses Bulgaria’s medium-term growth prospects and its longer-term convergence path. Bulgaria’s convergence was off to a late start compared to other central and eastern European countries (CEECs); the current level of income per capita is comparatively low. While investment and productivity growth are expected to be boosted in the medium term by the upcoming accession to the European Union (EU), convergence prospects are challenged by the large projected decline of working-age population. Nevertheless, even on optimistic assumptions, Bulgaria’s convergence will take considerable time. Prudent macroeconomic policies and structural reforms are essential for the economy to reduce vulnerabilities associated with the convergence.

A. Background

40. The unfavorable economic environment of the early 1990s and the economic crisis in 1996-97 hurt Bulgaria’s output, employment, and investment. The move to a market economy, which began in the late 1980s, was marked by a deep transformational recession. Real GDP fell sharply in the first few years of the transition (Figure 1). While this is similar to the experiences of other CEECs, Bulgaria experienced a longer period of falling output (Figure 2). The economic recovery that started in 1994-95 was interrupted by a severe financial and currency crisis in 1996-97, resulting in another deep output decline, a massive currency depreciation, and high inflation. Between 1992 and 1997, total employment in the industry sector fell by almost 18 percent. However, as the agricultural sector absorbed part of the excess labor, total employment fell by only 4 percent. The population has declined ever since.²⁶ Investment fell from around 35 percent of GDP before the transition to about 10 percent in 1997.

41. Following the crisis, structural reforms and a sound macroeconomic framework set the stage for a sustained recovery. Bulgaria’s economic performance has been characterized by robust growth and macroeconomic stability. In 1997, Bulgaria adopted a currency board arrangement (CBA), pegging its currency to the deutsche mark (and later to the euro). The CBA has been effective in supporting growth and reducing inflation. Between 1998 and 2005, real GDP growth averaged 4.6 percent (5.6 percent in per capita terms), while inflation has subsided to an average of 5 percent since 1999.

42. The structure of the Bulgaria economy has shifted markedly over the last decade, and investment has become the main engine of growth (Figure 3). The country has become much less reliant on the agricultural sector—its contribution to gross value added has almost halved over this period. The service sector has become the dominant sector in the economy. Labor productivity (measured by average output per worker) has increased substantially in the service and industry sectors, reflecting in large part the higher investment in these sectors. However, agricultural output-per-worker has declined with employment remaining largely unchanged and output falling. On the demand side, investment has recently become the main engine of growth. Buoyed in part by optimism surrounding the upcoming EU accession, investment has been strong, including foreign direct investment (FDI). As in other transition economies, convergence has been accompanied by large current account deficits, owing to both consumption smoothing and the use of foreign savings to finance its rapid investment growth.

43. Despite its strong recent economic performance, Bulgaria remains one of the poorest countries in the region. Bulgaria’s GDP per capita is trailing far behind the average of EU-25 countries (see Table 1). At market exchange rates, Bulgarian GDP per capita is less than one-tenth of the average of the EU-15 and about one-third of the average of new member states (NMS). On a purchasing power parity (PPP) basis, Bulgaria’s GDP per capita is about 30 percent of the average level of the EU-25 and about half of NMS. In light of these huge differences, one would expect (a) a comparatively much higher growth rate given that income levels are so low, and (b) a longer catch-up period. To learn more about Bulgaria’s growth and convergence prospects, the next section assesses the country’s medium-term growth prospects, and section C discusses the convergence path and how long it is likely to take Bulgaria to converge to the EU-15 income level

Table 1.

CEECs: GDP per Capita at PPP and Market Exchange Rate, 2004

Source: WDI.

Table 1.

CEECs: GDP per Capita at PPP and Market Exchange Rate, 2004

	GDP per capita, PPP (current international $)	GDP per capita (current US$)
Bulgaria	8,077.9	3,109.2
Romania	8,479.5	3,374.1
Czech Republic	19,408.3	10,475.2
Estonia	14,555.0	8,331.0
Hungary	16,814.4	9,961.8
Latvia	11,653.3	5,867.9
Lithuania	13,107.0	6,480.0
Poland	12,974.3	6,345.7
Slovak Republic	14,622.5	7,634.8
Slovenia	20,939.3	16,115.0
EU-15 average	28,630.74	31,837.59
EU-25 average	26,410.39	27,997.74
NMS-8 average	14,739.81	7,814.80

Source: WDI.

Table 1.

CEECs: GDP per Capita at PPP and Market Exchange Rate, 2004

	GDP per capita, PPP (current international $)	GDP per capita (current US$)
Bulgaria	8,077.9	3,109.2
Romania	8,479.5	3,374.1
Czech Republic	19,408.3	10,475.2
Estonia	14,555.0	8,331.0
Hungary	16,814.4	9,961.8
Latvia	11,653.3	5,867.9
Lithuania	13,107.0	6,480.0
Poland	12,974.3	6,345.7
Slovak Republic	14,622.5	7,634.8
Slovenia	20,939.3	16,115.0
EU-15 average	28,630.74	31,837.59
EU-25 average	26,410.39	27,997.74
NMS-8 average	14,739.81	7,814.80

Source: WDI.

B. Bulgaria’s Medium-Term Growth Prospects

44. Given data limitations, this chapter uses a growth-accounting framework to explain Bulgaria’s growth prospects in the medium term. Growth accounting decomposes the growth rate of output into contributions from factors of production (labor and capital) and total factor productivity (TFP) growth. With this framework, one can make a forward-looking growth projection by projecting employment levels, investment, and productivity growth.

45. A growth-accounting exercise suggests that Bulgaria’s recent growth experience has been driven largely by the growth of productivity.²⁷ Employment in Bulgaria had been declining in the past decade, generating negative labor contributions to growth until 2001. The employment level started to rise only in 2002 when the unemployment rate began to decrease. Investment rates remained low until the FDI-induced investment boom of 2003-04. The main driver of Bulgaria’s recent growth experience has been the growth in TFP, which provides a measure of the efficiency of a given set of factor inputs (capital and labor) in generating output. The World Bank attributed this to the outcome of “shedding excess capacity and eliminating inefficiencies” (see World Bank, 2005). This is similar to the experience of the NMS and raises a related key question: Has the TFP growth achieved thus far eliminated the bulk of the inefficiencies of central planning?

46. Over the medium-term, growth is expected to accelerate slightly to around 5.9 percent (Table 2). Faster capital accumulation, mainly from EU accession-related investments, is expected to play a more important role in the medium-term growth, while the growth contribution of labor is likely to fall in light of projected population decline. Productivity is expected to grow by 3.4 percent per year, up from 2.9 percent in the previous five-year period, as efficiency and capacity are expanded. The country’s medium-term growth prospects hinge, however, on Bulgaria’s ability to successfully absorb the investment and implement institutional and structural reforms.

Table 2.

Contribution to Real GDP Growth

(In percent)

Source: Staff calculation

47. Contributions from investment look promising in the medium term. With the prospect of joining the EU, expanding domestic markets, and relatively cheap factors of production, Bulgaria has become a popular investment destination. FDI has increased rapidly in the last few years, and investment is now the main contributor to GDP growth. It is estimated that this trend will continue. Moreover, the EU accession-related investments to improve the quality of infrastructure and institutions should have crowding-in effects, attracting yet more private investments and raising productivity. Under the baseline scenario, total gross investment is projected to reach 31 percent of GDP by 2011. This implies that capital will contribute about 2.4 percentage points per year to real GDP growth in the next five years.

48. Over the medium term, one of the major challenges to Bulgaria’s growth prospects is its relatively low labor force participation rate and declining population. Labor force participation and employment rates in Bulgaria are comparatively low (Figures 5). The employment rate is also well below the Lisbon agenda’s 2010 target rate of 70 percent. Moreover, Bulgaria’s population has been declining for almost two decades, and is projected to decline further. This, of course, raises a concern about medium-term growth prospects. Over the past four years, Bulgaria has managed to increase its employment level mainly by lowering the unemployment rate, which reached a record low of 10 percent at end-2005. Given that the current level is close to the EU-25 average of around 9 percent and already lower that the NMS-8 average of 13 percent, sizeable further reductions in the unemployment rate will be a challenge.

49. Over a longer horizon, the decline and ageing of the population continue to be worrisome. Population projections by Eurostat, the World Bank’s World Development Indicators (WDI), and Bulgaria’s National Statistics Institute (NSI) all suggest that population will continue to decline (Figure 7). By 2035, population in Bulgaria is projected to have declined by about 20 percent.²⁸ The median age of population will increase from 40 years in 2005 to 51 years in 2035. The working-age population is projected to decline by more than 30 percent in the next 30 years, lowering its share in total population from 69 percent to 62 percent. Although net out-migration could reverse as living standards rise, it may not be enough to offset the decline due to natural factors

50. Positive contributions from labor inputs are thus essential for a more rapid catch-up. Bulgaria can potentially achieve higher per capita income growth and a faster catch-up process by minimizing the decline of employment. In the baseline scenario, it is assumed that, by 2001, the labor force participation rate will return to its 2001 level of 62.5 percent, and the unemployment rate will be lowered to the current EU-15 average of 8.8 percent by 2011, raising the employment rate only modestly. These assumptions are necessary simply to maintain the employment level in the next five years. However, from a historical perspective, there is room for Bulgaria to raise employment further than assumed here. As in other CEECs, Bulgaria experienced a massive shedding of labor during the transition (Figure 6). The contribution of labor could be raised if Bulgaria could achieve the employment rate witnessed during the early 1990s.

C. Catch-Up, Long-Term Convergence Prospects, and Growth Scenarios

51. A prospectively slow and prolonged convergence period poses a challenge for Bulgaria. With the large initial income difference, it will take decades for Bulgaria to converge to the living standards of the EU. A key challenge for policy makers is how to benefit from the growth opportunities from EU accession while limiting the vulnerabilities associated with the catch-up.

52. Even with optimistic assumptions, it will take about 20 years to reach the current level of per capita income of the EU-15. Assuming a constant real GDP growth rate of 6 percent and Eurostat’s population projections, Bulgaria may not reach the EU-15’s current level of PPP-adjusted GDP per capita until 2025 (Figure 8).

53. In terms of absolute convergence, it is estimated that it would take Bulgaria several decades to close the income gap. Absolute convergence assumes that the GDP growth of a lower income country should be higher than the growth of the higher income country, and the growth differential would decline as the income gap closes.²⁹ The speed at which the income gap can be closed depends on the country’s medium-term growth rates and their initial level of income per capita. Using the 2000-04 growth experience as a starting point, it could take Bulgaria about 20 years to close half of the current income gap and more than 40 years to reach three-fourths of the average income per capita of the euro area. Table 3 compares Bulgaria’s estimated time required for convergence with that of other CEECs. Bulgaria’s convergence is considerably longer than the other countries except Poland, whose growth experience has been less impressive in the recent years.

Table 3:

Convergence with Euro Area Income per Capita 1/

^{^1/}The convergence half-life is calculated as ln(2)/β, where β=-(g-g*)/ln(Y/Y*), g is per capita income growth, Y is the per capita income level in PPP terms, and * indicates the euro area. Sources: WDI; Schadler and others (2006); and staff calculations.

Table 3:

Convergence with Euro Area Income per Capita 1/

	2004 income per capita relative to Euro area, PPP (in percent)	Years to close half the income gap	Years to reach per capita income ratio of 75%	Years to reach per capita income ratio of 90%
Bulgaria	28.7	18	39	66
Romania	30.2	18	37	63
Czech Republic	68.9	14	5	19
Estonia	49.1	6	8	34
Hungary	59.2	10	9	33
Latvia	42.8	7	11	41
Lithuania	46.3	7	10	33
Poland	45.8	27	39	73
Slovakia	51.6	17	20	54
Slovenia	74.0	8	1	16

Table 3:

Convergence with Euro Area Income per Capita 1/

	2004 income per capita relative to Euro area, PPP (in percent)	Years to close half the income gap	Years to reach per capita income ratio of 75%	Years to reach per capita income ratio of 90%
Bulgaria	28.7	18	39	66
Romania	30.2	18	37	63
Czech Republic	68.9	14	5	19
Estonia	49.1	6	8	34
Hungary	59.2	10	9	33
Latvia	42.8	7	11	41
Lithuania	46.3	7	10	33
Poland	45.8	27	39	73
Slovakia	51.6	17	20	54
Slovenia	74.0	8	1	16

54. Growth scenarios illustrate the challenges Bulgaria will face in achieving a more rapid convergence. The long time period required for catch-up raises the question of what is needed to speed up convergence. Following Schadler and others (2006), this section considers alternative investment and productivity growth scenarios required to reduce by 20 percent the time estimated to close half of the income gap (i.e. closing half of the income gap in 14½ years rather than 18 years). In order to achieve the goal, Bulgaria’s per capita GDP would have to grow at an average rate of about 7¾ percent per year during 2006-11. With the population projected to decline by ¾ percent per year, overall GDP growth would need to reach about 7 percent per year. Given a projected labor contribution to growth of 0.1 percent as shown in Table 2, two scenarios illustrate required rates of productivity growth and investment to achieve the target growth rate:

Given the productivity growth of 3.4 percent in the baseline, the investment rate would have to be almost 10 percentage points of GDP higher than the baseline, raising the investment-to-GDP ratio to more than 40 percent of GDP in 2010, compared to less than 30 percent in 2005.
Alternatively, the higher required growth rate could be achieved through higher productivity growth. Given the contribution of capital assumed in the baseline scenario, TFP growth would need to average 4½ percent per year, a third higher than in the baseline and 1½ percentage points higher than the productivity growth rate observed during 2001-05. While productivity growth of 4½ percent has been achieved in some emerging market economies, a key question for Bulgaria is: how would such a large improvement in productivity be achieved, given the fact that the average TFP growth rate of 2.9 percent per year during the previous five years owed a great deal to the reduction of inefficiencies and excess capacity, on which much of the achievable progress has already been made.

D. Conclusions

55. Bulgaria’s convergence was off to a late start compared to other CEECs, and its convergence to EU living standards will be prolonged. Following its emergence from crisis, Bulgaria’s growth experience has been impressive, and prospects are promising. However, Bulgaria’s real GDP per capita only reached the pre-transition level a few years ago. Given its low current level of income and its declining and aging population, Bulgaria’s convergence will take decades. Thus, the medium-term challenge confronting authorities is daunting.

56. Prudent macroeconomic policies are key for sustained economic growth and smooth catch-up. Similar to Romania, Bulgaria is facing a “marathon” rather than a “sprint” in its convergence to EU living standards (see IMF, 2006). Past experience highlights that an economic crisis can significantly delay a country’s catch-up. And as Bulgaria’s economic and financial integration in the EU increases, shocks emanating elsewhere in the EU will be felt more rapidly and extensively than otherwise. The more flexible and adaptable the Bulgarian economy, the greater will be its capacity to absorb the impacts of such shocks. In turn, an accelerated structural reform agenda holds the promise, other things being equal, of speeding up convergence to EU living standards.

Appendix I. Growth Accounting

Basic set-up

The growth-accounting analysis starts from a standard general production function, which can be written as

\begin{matrix} Y = F (A, K, L) & (A 1) \end{matrix}

where Y is output, which is a function of three inputs of production: A is technological progress, K is capital, and L is labor. We can decompose the growth rate of output into contributions from the three inputs by taking logarithms of the above equation and taking derivatives with respect to time to get

\begin{matrix} \frac{\dot{Y}}{Y} = \frac{F_{A} A}{Y} \frac{\dot{A}}{A} + \frac{F_{K} K}{Y} \frac{\dot{K}}{K} + \frac{F_{L} L}{Y} \frac{\dot{L}}{L}, & (A 2) \end{matrix}

where $\dot{X} = \frac{dX}{dt}$ Suppose that the level of technological progress (A) enters the production

function in a Hicks-neutral way, so that $Y = A \cdot \tilde{F} (K, L)$ then F_AA = Y. The above growth accounting can be written as

\begin{matrix} \frac{\dot{Y}}{Y} = \frac{\dot{A}}{A} + \frac{F_{k} K}{Y} \frac{\dot{K}}{K} + \frac{F_{L} L}{Y} \frac{\dot{L}}{L} . & (A 3) \end{matrix}

The marginal products of capital and labor (F_K and F_L, respectively), which are not measurable directly, can be estimated by their observed factor prices. If the factors of production are paid their social marginal products, so that F_K=R (the rental price of capital) and F_L = w (wages), then F_LL= wL, which is the total amount of wages paid in the economy. Hence, F_LL/Y = wL/Y is the fraction of GDP used to pay wages or the labor share of GDP, denoted by s_L. Similarly, F_KK/Y=RK/Y is the capital share of GDP, denoted by s_K.

In addition, the contribution of technological progress to growth, $\overset{\cdot}{A} / A$ , although not observable, can be calculated from (A3) as a “residual” of the actual growth rate of output and the part that can be explained by the growth of capital and labor:

\begin{matrix} \frac{\dot{A}}{A} = \frac{\overset{\cdot}{Y}}{Y} - S_{K} \frac{\overset{\cdot}{K}}{K} - S_{L} \frac{\overset{\cdot}{L}}{L} . & (A 4) \end{matrix}

The value $\overset{\cdot}{A} / A$ is often described as an estimate of total factor productivity (TFP) growth.

Estimate of the capital stock

Estimate of the capital stock is one of the important components in the growth-accounting exercise. In this chapter, we use the perpetual inventory method to construct a series of capital stock. The measures of the stock of physical capital come from the accumulation of figures on gross physical investment, along with estimates of depreciation of existing stocks:

\begin{matrix} K_{t} = (1 - δ) K_{t - 1} + I_{t}, & (A 5) \end{matrix}

where δ is the depreciation rate and I_t is gross investment in period t. Substituting the previous period processes into the above equation, we get the following relationship

\begin{matrix} K_{t} = (1 - δ)^{t} K_{0} + Σ_{j = 1}^{t} (1 - δ)^{t - j} I_{j} . & (A 6) \end{matrix}

Capital stock at period t is determined by the initial level of capital, K₀, the series of investment for all intervening periods, and the depreciation rate. Because there is no widely used estimate of the initial capital stock for Bulgaria,³⁰ we arbitrarily assume 1990 as the initial year and assume that real investment in 1991 is equal to depreciated capital stock with a 5 percent depreciation rate (I₁₉₉₁ = δK₁₉₉₀). This implies that K₁₉₉₀=I₁₉₉₁/0.05.

Using this method of estimation, it is not very crucial to get a precise initial level of the capital stock, since the initial level will depreciate over time and become less relevant in the calculation. The assumed depreciation rate, however, plays a crucial role. An appropriate depreciation rate would depend on the nature of physical capital stocks and their service lives.³¹ Instead of assuming a fixed depreciation rate throughout the whole period of analysis, we use information on “consumption of fixed capital,” an item in the national income accounts that measures the depreciation of capital stocks. The results are not qualitatively different from those obtained by assuming a fixed depreciation rate, however.

Appendix II. Speed of Real Convergence

The Solow-Swan growth model implies that the growth rate of real income per capita is determined by

\begin{matrix} \frac{\dot{\hat{y}}}{\hat{y}} \approx - β * .1 n (\frac{\hat{y}}{\hat{y} *}), & (\begin{matrix} A 7 \end{matrix}) \end{matrix}

where $\hat{y}$ is the level of real income per effective unit of labor and $\hat{y} *$ is the steady state level of income per effective unit of labor. β* is the speed at which per capita income approaches its steady state level. Because the solution to the above differential equation (A7) is

\begin{matrix} 1 n (\hat{y} (t)) = (1 - e^{- β * t}) 1 n (\hat{y} *) + e^{- β * t} 1 n (\hat{y} (0)), & \begin{matrix} (A 8) \end{matrix} \end{matrix}

the time t for which $\begin{matrix} \ln (\hat{y} (t)) \end{matrix}$ is halfway between the initial level of income, $\begin{matrix} \ln (\hat{y} (0)) \end{matrix}$ , and the steady state level, $\ln (\hat{y} {}^{*})$ , satisfies $e^{- β * t} = 1 / 2$ The half-life of convergence is, therefore, ln(2)/β*.

References

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Prepared by Pipat Luengnaruemitchai (EUR).

While the decline has been mainly due to natural factors, out-migration, notably of persons of working age, has aggravated the decline.

On account of both a lack of reliable data on capital stocks and the structural breaks caused by the economic crisis in 1996-97, the present growth-accounting analysis is confined to the period after 2000. Appendix I discusses issues in growth accounting and describes the assumptions used in this paper.

The projected decline in total population is mainly due to negative rate of natural increases. The projections assume relatively low and declining net out-migration.

See a discussion about the real convergence in Barro and Sala-i-Martin (2004). Appendix II also briefly discusses the implications of Solow-Swan growth model to the speed of real convergence.

Many researchers have used an estimate of capital stocks from Nehru and Dhareshwar (1995) as the initial level of capital stocks. Unfortunately, Bulgaria was not included in the sample.

In constructing the measure of physical capital stocks, researchers assume different depreciation rates for Bulgaria. For example, the World Bank (2005) use depreciation rates of 6.0-7.5 percent in its calculation, while Ganev (2005) assumes a depreciation rate of 5 percent.

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Bulgaria: Selected Issues and Statistical Appendix

Author: International Monetary Fund

Volume/Issue:: Volume 2006: Issue 299

Publisher:: International Monetary Fund

ISBN:: 9781451804553

ISSN:: 1934-7685

Pages:: 148

DOI:: https://doi.org/10.5089/9781451804553.002

Keywords
II. Bulgaria’s Growth and Convergence Prospects25
References

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Real GDP and Real GDP per capita, 1980-2005

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CEECs: Growth of Real PPP-Adjusted GDP per Capita, 1990-2004

(In percent)

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Bulgaria: Share of the Economy, by sector and by expenditure

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Bulgaria: Growth Accounting, 2001-2005

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Emerging Markets: Employment as percent of Working-age Population (15-64)

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Employment Rates in selected CEECs, 1990-2004

(In percent of population between 15-64)

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Bulgaria: Population Structure and Projections

Population Structure and Projections

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Age Structure, 2004 and 2035

(Eurostat projection; in percent)

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Bulgaria’s Convergence to the Current Level of EU15’s PPP-adjusted real GDP per capita

(with different assumptions on overall real GDP growth; assuming Eurostat population projections)

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EU and CEECs: Growth and GDP per capita

Foresee

Table 3:

Convergence with Euro Area Income per Capita 1/

	2004 income per capita relative to Euro area, PPP (in percent)	Years to close half the income gap	Years to reach per capita income ratio of 75%	Years to reach per capita income ratio of 90%
Bulgaria	28.7	18	39	66
Romania	30.2	18	37	63
Czech Republic	68.9	14	5	19
Estonia	49.1	6	8	34
Hungary	59.2	10	9	33
Latvia	42.8	7	11	41
Lithuania	46.3	7	10	33
Poland	45.8	27	39	73
Slovakia	51.6	17	20	54
Slovenia	74.0	8	1	16

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Abstract

II. Bulgaria’s Growth and Convergence Prospects25

A. Background

B. Bulgaria’s Medium-Term Growth Prospects

C. Catch-Up, Long-Term Convergence Prospects, and Growth Scenarios

D. Conclusions

Appendix I. Growth Accounting

Basic set-up

Estimate of the capital stock

Appendix II. Speed of Real Convergence

References

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II. Bulgaria’s Growth and Convergence Prospects²⁵