Institut für Halle Institute for Economic Research Wirtschaftsforschung Halle

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1 Insiu für Halle Insiue for Economic Research Wirschafsforschung Halle On he Twin Deficis Hypohesis and he Impor Propensiy in Transiion Counries Huber Gabrisch December 2011 No. 20 IWH-Diskussionspapiere IWH Discussion Papers

2 On he Twin Deficis Hypohesis and he Impor Propensiy in Transiion Counries Huber Gabrisch December 2011 No. 20

3 IWH Auhor: Dr Huber Gabrisch Halle Insiue for Economic Research (IWH) Deparmen: Research Affairs Phone: +49 (0) The responsibiliy for discussion papers lies solely wih he individual auhors. The views expressed herein do no necessarily represen hose of he IWH. The papers represen preliminary work and are circulaed o encourage discussion wih he auhors. Ciaion of he discussion papers should accoun for heir provisional characer; a revised version may be available direcly from he auhors. Commens and suggesions on he mehods and resuls presened are welcome. IWH Discussion Papers are indexed in RePEc-Econpapers and in ECONIS. Edior: HALLE INSTITUTE FOR ECONOMIC RESEARCH IWH Prof Dr Dr h. c. Ulrich Blum (Presiden), Dr Huber Gabrisch (Research Direcor) The IWH is a member of he Leibniz Associaion. Address: Kleine Maerkersrasse 8, D Halle (Saale), Germany Posal Address: P.O. Box , D Halle (Saale), Germany Phone: +49 (0) Fax: +49 (0) Inerne: hp:// 2

4 IWH On he Twin Deficis Hypohesis and he Impor Propensiy in Transiion Counries Absrac This aricle uses co-inegraion and relaed echniques o es for a long-run causal relaionship beween he fiscal and exernal deficis of hree pos-ransiion counries in Cenral and Easern Europe. In addiion, an impor propensiy model is esed by applying OLS and GMM. All he resuls rejec he Twin Deficis Hypohesis. Insead, he resuls demonsrae ha specific ransiion facors such as a high impor inensiy of expors and ne capial inflows affec he rade balance. Keywords: Twin Deficis, impor propensiy, ransiion counries JEL Classificaion: E62, F41, H62 3

5 IWH Zur Zwillingsdefizi-Hypohese und Imporneigung in Transformaionsländern Zusammenfassung Der Aufsaz bedien sich der Koinegraion und verwander Techniken, um auf eine langfrisige und kausale Beziehung zwischen den fiskalischen und den exernen Defizien (so genanne Hypohese der Zwillingsdefizie) von drei Pos-Transformaionsländern in Miel- und Oseuropa (Polen, Tschechien und Ungarn) zu esen. Darüber hinaus wird ein Model mi OLS und GMM geschäz, welches die (seigende) Imporneigung in den drei Ländern erklär. Alle Tesergebnisse lehnen die Hypohese der Zwillingsdefizie ab. Sadessen wird deulich, dass nich die fiskalische Posiion, sondern spezifische Transformaionsfakoren wie eine hohe Imporinensiä der Expore und Neokapialzuflüsse die Handelsbilanz beeinflussen. Schlagwörer: Zwillingsdefizie, Imporinensiä, Transformaionsländer JEL-Klassifikaion: E62, F41, H62 4

6 IWH 1 The Research Quesion In many counries, including pos-ransiion counries in Europe, fiscal and exernal deficis occur concurrenly. In he economics lieraure, he Twin Defici Hypohesis (TDH) saes ha a direc and causal relaionship exiss beween fiscal and exernal deficis, from he fiscal balance o he exernal balance. The widely acceped advice provided o poliicians is o cu fiscal deficis in order o avoid a financial crisis of he open economy. Laski argued (2009: 58f) ha a direc and causal relaionship occurs if and only if privae savings equals privae invesmen. In his specific circumsance, an increase in governmen consumpion will no affec eiher privae savings or invesmen, bu governmen consumpion will grealy affec he value of impors. Despie lacking saisical suppor for his premise of a saving-invesmen equilibrium, mos poliicians, many journaliss and many economiss are concerned wih he simulaneous increase in public deb and disruped exernal balances. This concern may resul from he srong belief ha he savings-invesmen equilibrium exiss in an iner-emporal framework, where marke forces drive shor-erm deviaions in he savings-invesmen balance back o equilibrium. The purpose of his aricle is o es TDH from wo differen perspecives: Firs, his aricle applies modelling echniques (co-inegraion, error-correcion and Granger causaliy ess) ha are believed o deec he rue causal relaionship beween he fiscal and exernal balances while assuming ha a long-run (iner-emporal) equilibrium exiss beween privae savings and invesmen. Second, he aricle provides a new approach in esing TDH, namely, a model ha explains he reason for an increasing propensiy o impor in pos-ransiion counries. The idea behind he model is ha he wo deficis migh be endogenous o a hird variable, sysemic ransiion. Because ransiion is no observable in saisical erms, I add wo variables o he fiscal variable ha are specific o he ransiion process in Cenral and Easern Europe: (i) he inclusion of hese counries ino inernaional producion neworks measured in erms of he impor inensiy of expors and (ii) he massive ne capial inflows following financial liberalizaion. The empirical invesigaion is performed for hree counries: he Czech Republic, Hungary, and Poland. The empirical resuls rejec TDH, bu hey suppor a model ha explains he exernal deficis by an increasing impor inensiy of expors and possibly by ne capial inflows. The paper proceeds as follows: The premises of TDH are discussed in secion wo. A non-rivial version of TDH will be defined as o be an increasing impor-gdp raio of he economy due o fiscal imbalance. In secion hree, he radiional approach in TDH esing reduced forms of naional accoun equaions is performed wih co-inegraion, error-correcion (EC) or Granger causaliy ess. I narrow my approach o direc esing of he relaionship of boh deficis and leave ou discussions of Ricardian Equivalence or he Feldsein-Horioka ess, which boh play also a role in he TDH lieraure. Secion four presens he srucural model for an explanaion of he hree economies propensiy 5

7 IWH o impor, which is esed wih co-inegraion, Ordinary Leas Squares (OLS) and Generalized Mehods of Momens (GMM) modelling. Secion five concludes. 2 On he Premises of he TDH The balance ideniy of an open economy wih a public secor is equaion (1), where S p is privae savings, D is he governmen defici and M is oal impors. Invesmen I includes privae and public invesmen:1 S P I = D+ ( X M ) (1) Dividing boh sides of equaion (1) by real income (GDP), one obains wih small leers s p i= d + ( x m) (2) where s p is he privae propensiy o save from real income and m is as he economy s propensiy o impor. A direc causal relaionship exiss beween D and ne expors only if S P = I. In such a case, ( m x) = d holds. When expors are no driven by domesic demand and, specifically, by fiscal balance, a change in fiscal defici is necessarily linked o a change in he economy s propensiy o impor: m= d (3) Equaion (3) is a core conclusion of TDH and is based on he S=I equilibrium. If he savings-invesmen assumpion is no fulfilled, hen equaion (2) saes clearly ha he fiscal defici or is change will be compleely or parially absorbed boh by privae savings and impors as well as by oher aggregaes.2 The households propensiies o save and impor deermine his disribuion. Here, we have he income muliplier in he Keynes-Kalecki model a work. A fiscal expansion will almos always disrup he exernal balance from higher impors afer higher income. Thus, a higher exernal defici following a fiscal expansion would be a rivial version of TDH. Bu, inerpreing TDH as Keynesian (Celik and Denis, 2009; Corsei and Müller, 2005) is misleading. In he Keynes-Kaleciki framework, he muliplier effecs are crucial, bu a non-rivial inerpreaion of TDH denies he muliplier. Here, an increase in he fiscal defici will no affec real income and privae savings; herefore, equaion (3) applies, and a complee ransfer of a higher fiscal defici ino he exernal balance will occur. Indeed, equaion (3) no longer follows he Keynes-Kalecki model of he sandard capialis economy, where changes in aggregae demand, including fiscal expansion, work hrough he income muliplier and he quaniy responses by firms; insead, firms respond wih price ad- 1 Public invesmen could be par of he governmen financial defici and, hence, would be added as a second independen public expendiure on he righ side of equaion (1). Such an addiion would no change he conclusions of all consideraions ha follow. 2 The ax rae, for example, has o be considered in he income creaion process afer a fiscal simulus. 6

8 IWH jusmens. A siuaion of S p = I would reflec a emporary momen a bes, where he economy produces a capaciy oupu and any increase in effecive demand causes price increases in he privae secor. In earlier TDH lieraure based on he Mundell-Fleming Model, a fiscal expansion booss aggregae demand above aggregae oupu. The privae secor responds wih higher prices, and he financial secor responds wih higher ineres raes; hus, capial inflows cause he real exchange rae o appreciae. Wih he given oupu, he propensiy o impor increases, and savings ou of real income remains consan. Recen TDH lieraure applies an iner-emporal approach o household behaviour. When households assess a ax reducion (a governmen defici) as permanen, hey will no change heir consumpion plans. When here is consan iner-emporal income, privae savings will also remain consan, and he fiscal defici will become an iner-emporal exernal defici (Corsei and Müller, 2006). Because savings-invesmen balances are rarely in equilibrium in acualiy, he deecing of iner-emporal effecs ha a fiscal defici exers on he exernal balance require specific economeric modelling, such as co-inegraion ess, VARs or error-correcion (EC) models wih level daa of he variables. Levels are assumed o presen long-erm relaionships while firs differences or raes of change, such as hose used in he muliplier approach, are assumed o have only a shor-erm effec, reflecing he marke forces adjusmen back o equilibrium. A brief review of he lieraure reveals ha only a few auhors have esed TDH for one or more Cenral or Easern European counries wihin a larger group of counries wih co-inegraion equaions (Fiddrmuc 2003; Celik and Denis, 2009; Keenci and Uz, 2010). The common foundaion for hese sudies is a reduced-form equaion in he naional accouns framework of3 X M = ( Y T C ) ( T G ) I = S P + S G I (4) wih real income Y. Dividing all iems by Y, an empirically esable equaion is: x P m = 0 + γ 1( s ) + γ 2 ( g ) γ 3 γ inv + ε (5) Wih he explici assumpion (Fidrmuc, 2003, p. 137, and Keenci and Uz, 2010, p. 4) ha privae savings equals invesmen, a reducion of governmen savings will disrup he rade balance. Equaion (5) may be subjec o a es for co-inegraion if ime series are non-saionary. If TDH holds, γ 2 mus be posiive, and γ 3 mus be negaive. In addiion, a counry would be perfecly inegraed in he world economy when boh coefficiens are close o 1. In his case, he budge defici and invesmen would be financed by world financial markes. If, however, γ 3 were significanly lower han 1, he Feld- 3 I follow he presenaion of Fidrmuc (2003), and Marinheiro (2006, for Egyp). 7

9 IWH sein-horioka puzzle would hold. Fidrmuc (2003) applied co-inegraion ess for individual counries and found a negaive impac of he fiscal defici on he rade balance from 1990 o 2001 in Poland and Hungary. Resuls for Bulgaria and he Slovak Republic were no significan. Wih panel co-inegraion, Celik and Denis, 2009, found a posiive and significan relaionship beween he fiscal balance and he rade defici for six emerging markes, including he Czech Republic. Keenci and Uz (2010) found srong evidence of a co-movemen beween he wo deficis for five of he six EU members (Poland was he excepion). Their approach, a bounds esed auoregressive disribued lag (ARDL) model, allows for he combinaion of variables a differen orders of inegraion and, herefore, a mix of level and firs difference variables. However, in all of hese sudies, conclusions regarding causaion from fiscal o exernal defici are no well addressed since co-inegraion also allows for he reverse relaionship. Increased compeiion for impors may disrup he budge balance because of he decline of domesic producion and decreased ax revenues (Summers, 1988). Szakolczai (2006), wihou any economeric esing, finds ha boh he fiscal and he exernal deficis of Hungary are o a cerain exen independen, have auonomous causes, and mus herefore deal wih separaely (Szakolcai, 2006, p. 41). In my sudy, ess and model esimaes use quarerly naional accoun daa for he hree counries from he firs quarer of 1995 unil he fourh quarer of Daa are aken from Eurosa (GDP, gross fixed capial formaion, final consumpion of privae households and general governmen balance), Main Economic Indicaors of he OECD (rade balance in % of GDP), Inernaional Financial Saisics of he IMF (curren accoun in percenage of GDP) and naional saisical offices of he hree counries via Daasream (expor and impor daa). Privae savings ou of GDP were calculaed as he sum of gross fixed capial formaion, he budge posiion, and ne expors. All daa are nominal; inflaion biases should be reduced by using raios or shares in regressions. All variables are seasonally adjused wih Census As usual, daa are sensiive o revisions. Two differen ses of rade daa since EU enry mus be inegraed (inra-eu and exra-eu rade), and recen revisions in he Czech Republic and Poland end o increase impor daa. For Poland, general governmen daa were available only from he firs quarer of 1999 on, hough oher earlier years include he cenral budge. Daa from he firs quarer of 1995 were esimaed using a regression of general governmen daa and cenral budge daa from he firs quarer of 1999 hrough he fourh quarer of The laer daa were provided by he WIIW. The correlaion has a significanly posiive bu no very high coefficien; herefore, esimaed daa should be considered wih cauion. 8

10 IWH 3 Fiscal and Exernal Balances 3.1 A Visual Inspecion A visual examinaion of privae savings and invesmen rejecs he idea of a rough ideniy beween boh aggregaes (Figure 1). The reader should noe ha here is a significan correlaion beween privae savings and invesmen ( Horioka-Feldsein- Puzzle ). Hence, boh variables are no endogenous o exernal savings. Figure 1: Privae savings und gross fixed capial formaion (naional currency unis) a a Czech Republic and Hungary: billions, and Poland; millions of naional currency unis. ***, **, *: significances a he 1 %, 5 % and 10 % confidence levels. SP: privae savings, INV: invesmen. Sources: Eurosa; own calculaions. Figures 2 and 3 illusrae he relaionship beween he fiscal balance and he exernal balances. The lef panel of boh figures presens acual daa. Figure 2 sugges a rejecion of he TDH wih respec o he rade balance. The correlaions are eiher nonsignifican (Hungary and Poland) or negaive (Czech Republic); however, hey should be posiive in suppor of he TDH. Wih respec o he curren accoun, only Hungary has a significanly posiive correlaion (Figure 3). This resul could be explained by profi repariaions of foreign firms ha exensively influenced Hungary s curren accoun in he pas. Baxer (1995) argued ha causaliy and correlaion migh be disored by he business cycle where he budge balance improves during a recovery bu where he rade balance migh deeriorae and he propensiy o impor increases. The righ panel shows he rend of he ime series obained by he Hodrick-Presco filer. The resuls are no differen from acual daa, and one can perform ess wih he former ha include more informaion han rend daa. 9

11 IWH Figure 2: Trade Balance and Fiscal Balance (in % of GDP) ***, **, *: significances a he 1 %, 5 % and 10 % confidence levels. TB: rade balance; BDEF: budge defici. Sources: Eurosa; own calculaions. 10

12 IWH Figure 3: Curren Accoun Balance and Fiscal Balance (in % of GDP) ***, **, *: significances a he 1 %, 5 % and 10 % confidence levels. CA: curren accoun (defici); BDEF: budge defici. Sources: Eurosa; own calculaions. 11

13 IWH 3.2 Co-inegraion The raionale behind co-inegraion modelling is ha iner-emporal equilibrium forces may be overlapped by oher deerminans in saisical or reporing errors wih (primarily) shor-erm characer; hence, saisical daa migh be conaminaed by real world phenomena, such as non-economic variables or insiuional differences. Co-inegraion is assumed o be a echnique for revealing he rue world and he long-run adjusmen process of wo or more variables. From a echnical poin of view, non-saionary ime series ha are inegraed a I(1) show a long-run co-inegraing relaionship ha is undersood o be in equilibrium. A Vecor Error Correcion Model (VECM) may help o idenify he saisical causaliy; in addiion, VECM shows he shor-erm adjusmen of he variables o he long-run equilibrium pah hrough he Error-Correcion (EC) erm. The equaion ha will be esed for co-inegraion is a version of equaion (5) ha excludes privae savings and invesmen. i i i i exbal = α + α ( BDEF ) + ε 0 1 (6) i i wih exbal as eiher he rade ( TBi = x mi ) or he curren accoun (CA) balance of counry i a ime. BDEF is he budge variable (-g) and is mosly in defici. The exclusion of privae savings and invesmen are legiimae when one wans o es he TDH using he assumpion of a long-run equilibrium for boh aggregaes. (Noe ha his assumpion is cerainly no confirmed by he saisical daa, bu i migh hold in a somehow rue world.) Wih his assumpion, he TDH canno be rejeced when α1 is posiive in he co-inegraion equaion. If he assumpion can be rejeced, hen S=I does no hold rue over he long run. I absain from panel modelling, because he modelling benefi of more observaions can be counerbalanced by disadvanages ha are ypical of combining significanly differen counries. Moreover, I do no use a bounds esing approach, because he mix of level and firs difference daa conradics he purely longerm characer of he TDH (which requires using variables of he firs order only). Table A1 in he Annex presens he resuls of he ADF es for all variables, which ener he es sage in his aricle. The sraegically crucial variable BDEF is saionary (I(0)) for he Czech Republic and Hungary, where TB is I(1) for all hree counries and CA is I(0) for he Czech Republic only. Therefore, he applicaion of co-inegraion ess is reduced o Poland s budge and rade deficis. Boh he race and maximum likelihood es saisics reveal he possibiliy of a weak co-inegraion beween he rade balance raio and he fiscal balance raio a he 10 % significance level. A co-inegraing relaionship exiss, when ess saisics reveal a co-inegraing relaionship a leas a he 10 % level of significance. In his case, a VECM can be applied o deec which of he variables is endogenous and which is exogenous. The Johansen coinegraion es idenifies one weak co-inegraing relaionship for Poland a he 10 % significance level (rade and maximum likelihood es resuls in Table A2). The lag- 12

14 IWH lengh is one wih a linear rend in he levels of he daa; only an inercep in he coinegraion equaion was assumed. The co-inegraion equaion for Poland is (-value in brackes): TB = *( BDEF) (7) PL (3.573) PL The lag lengh is one (lowes Akaike Informaion Crierion). The hypohesis of coinegraion in he sense of he TDH can be rejeced since he coefficien o he budge balance has a negaive sign and is significan a he 1% level. A VECM shows no clear causaliy, since he wo possible error-correcion (EC) erms are significan and have a negaive sign. In he case of Poland, he esimaed wo EC equaions (-values in brackes) are: BDEF = ( TB ) 0.390( BDEF ) 0.262( EC ) 1 1 ( 0.025) ( 0.129) ( 3.034) ( 2.442) (8a) TB = ( TB ) ( BDEF ) 0.053( EC ) 1 1 (0.0073) ( 4.771) (0.099) ( 1.434) 8b) The EC erm is negaive in boh equaions, and significan a he 1 % level in equaion (8a), and a he 10 % level in equaion (8b). Boh equaions do no repor even a shorrun adjusmen beween he wo main variables. For he Czech Republic and Hungary, he esing procedure can be reduced o Grangercausaliy ess wih levels (BEDF and CA in case of he Czech Republic) or firs differences (BDEF and TB for boh). The Granger causaliy ess wih firs differences of he rade and curren accoun balance for he Czech Republic and Hungary yield no resuls ha suppor he TDH. The weak causaliy in case of Hungary (1 lag) is only significan a he % level (Table 1).4 Table 1: Pairwise Granger Causaliy Tess wih firs differences (-values in brackes) Czech Republic Hungary 1 lag 2 lags 1 lag 2 lags BDEF does no Granger Cause CA CA does no Granger Cause BDEF ** BDEF does no Granger Cause TB * TB does no Granger Cause BDEF **, *: significances a he 5 % and 10 % confidence levels. 4 Granger causaliy ess for he Czech Republic and wih levels confirm he nonsignifican correlaion depiced in Figure 3. 13

15 IWH In summary, he co-inegraion ess, VEC modelling (for Poland) and Granger causaliy ess (for he Czech Republic and Hungary) confirm he resuls of visual inspecion. No daa suppors he TDH for he hree pos-ransiion counries. A simple explanaion for hese resuls migh be a lack of any shor-run and long-run savings-invesmen equilibrium. However, he evaluaion of he effecs of he fiscal balance on he rade balance migh have been influenced by expors, which parly follow oher deerminans (world demand) in conras o impors (domesic demand). 4 The Propensiy o Impor This secion ess a model of impor propensiy wih four variables, fiscal balance, expors, impor inensiy of expors and ne capial inflows, according o: i i i i i X i m = β + β ( BDEF ) + β x β β CA+ µ M 4 (9) which is a parly re-arranged and augmened version of equaion (5). Compared wih equaion (5), he expor-gdp raio is moved o he righ of equaion (6). This variable is now reaed as independen variable from he fiscal balance and he impor-gdp raio. Since expors improve he economy s capaciy o impor, x may be inerpreed as a rade balancing variable, and in regressions, β 2 should be posiive and close o 1. The model has been augmened by wo addiional variables: Firs, X M is a srucural variable measuring he impor inensiy of expors. In conras o he expor-gdp raio x, his variable is a rade de-balancing variable where a higher impor inensiy of expors leads o a smaller variable value bu conribues o a higher propensiy o impor for he economy, and β 3 should receive a negaive sign. The design of his variable is direcly linked o re-expors, ousourcing, fragmenaion rade, producion sharing and foreign direc invesmen, which inegrae he emerging markes, among hem ransiion counries ino a worldwide producion area, and which is widely documened in he rade lieraure. The specific role of less-emerging marke economies in his srucure of labour division is he lower end in verical inra-indusry rade (Gabrisch, 2009) and assembling in manufacuring (Ando and Kimura, 2000). Relying on daa from he cenral saisical office in Poland, Łaski e al. (2010) calculaed he size of he fiscal muliplier for he Polish economy wih an impor share in Polish expor value of 60 % in Second, ne capial inflows are proxied by he curren accoun defici (CA) when changes in foreign reserves are disregarded. β 4 capures he impac of ne capial inflows on he impor-gdp raio hrough he exchange rae effec. Ne capial inflows conribue o a higher propensiy o impor hrough an appreciaion of he naional currency. 14

16 IWH Equaion (9) is subjec o a co-inegraion es. Again, we may exclude he Czech Republic and Hungary from esing because heir budge balance daa are saionary (see Annex Table A1). Wih a lag lengh of wo, one co-inegraing relaionships could be idenified a lhe 5 %, and 3 relaionships a he 10% significance level (Table A3). The co-inegraion equaions (-saisics in brackes) read PL PL PL X PL PL m = ( BDEF ) ( x ) ( ) ( CA ) M (10a) ( 1.454) (8.131) (2.107) (0.079) for one lag, and for wo lags: PL PL PL X PL m = ( BDEF ) ( x ) 0.516( ) ( CA M (0.025) (59.228) ( ) (1.280) PL ) (10b) Equaion (10a) only shows a weak confirmaion of he TDH, bu no (10b) wih wo lags. Since he resuls are inconclusive, I urn o a more pragmaic approach in modelling: he use of a firs-difference equaion model for he impor propensiy according o X i δ CA+ ζ M i i i i m = BDEF 0 + δ 1 ( ) + δ 2 x + δ 3 + δ 4 i (11) The regression resuls are repored in Table 2. The OLS esimaion in Model 1 reveals ha a change in he budge defici does no significanly affec he impor-gdp raio, hough in wo cases he nonsignifican impac is negaive. The oher variables obain he prediced signs and are highly significan. The coefficien o he expor-gdp raio akes he expeced value of around 1. The impor-inensiy of expors conribues o an increasing impor-propensiy of he enire economy. An increase of his inensiy by 1 per cen increases he impor-gdp raio beween 0.3 and 0.5 per cen. Increased ne capial inflows a higher curren accoun defici explains for he increase of he impor propensiy in Hungary and Poland bu no in he Czech Republic. The impac of ne capial inflows on he impor-gdp raio is higher in Hungary han in Poland. The OLS model migh suffer from wo sources of inconsisency: omied variables and endogeneiy. Therefore, we esimaed a second model wih GMM. Because here is no obvious choice of insrumen oher han lagged variables, conclusions abou causaliy are necessarily enaive. 15

17 IWH Table 2: Regression resuls for changes in he impor-gdp raio Variables Model 1 (OLS) Model 2 (GMM) Czech Hungary Poland Czech Republic Hungary Poland Republic (BDEF) x 1.032*** 1.069*** 1.093*** 1.071*** 1.071*** ((X/M) *** *** *** *** CA ** *** * Consan Diagnosic saisics Adjused R-squared Durbin Wason F- a /J-Saisic b * * AIC observaions a for OLS esimaes; b for GMM esimaes. Insrumens: one-lagged variables. ***, **, *: significances a he 1 %, 5 % and 10 % confidence levels. BDEF: Budge defici; x: expor-gdp raio; (X/M) impor inensiy of expors; CA: ne capial inflows (curren accoun defici). GMM resuls deviae from OLS esimaes wih respec o all variables in he case of Poland and o he impor inensiy of expors and ne capial inflows in he case of Hungary. In general, he resuls again rejec TDH. One reason for he nonsignificance of he variables, which were significan in he OLS model, may be due o he poor qualiy of he insrumens. The J-saisic of he insrumen orhogonaliy C-es indicaes ha for Poland and he Czech Republic: he insrumens used are no correlaed wih he error erm, while in he case of Hungary, he insrumens are no valid. In Poland, he inclusion of one-lagged variables as insrumens diminishes he validiy of all he insrumens.5 For he Czech Republic, we a leas obain a reasonable esimaion resul, which confirms he resuls of Model 1 (OLS). 5 Conclusions Each empirical specificaion and modelling approach rejecs TDH. I agree wih Szakolcsai (2006) who argues ha each defici, he fiscal as well as he exernal, has specific causes. Wih respec o he rade defici, he resuls for all hree counries sugges increased impor inensiy of expors as he main driver as well as ne capial inflows in Hungary and Poland. The poliical conclusions seem o be clear: a reducion of he fiscal deficis in he pos-ransiion counries would no conribue o a major decline of exernal imbalances. Raher, srucural/indusry policies should have a srong emphasis on he producion srucures in he economy and suppor he inclusion of domesic inermediary goods ino expor aciviies. Moneary policy should consider he real exchange rae. Furher research should use more firm-level daa in demonsraing he impor inensiy of expors. 5 Tesed insrumens included he money marke spread o Germany, inernaional credi. 16

18 IWH References Ando M., Kimura, F Fragmenaion in Europe and Eas Asia: Evidences from Inernaional Trade and Foreign Direc Invesmen Daa. In: Jong Kil Kim P.B. Ruffini (eds. ). Corporae sraegies in he age of regional inegraion. Pp , Edward Elgar: Chelenham, Barro, R. J Are Governmen Bonds Ne Walh? Journal of Poliical Economy, 82, Barro, R. J The Ricardian Approach o Budge Deficis. Journal of Economic Perspecives, 3(2), Baxer, M Inernaional Trade and Business Cycles. In: Grossmann, G. and K. Rogoff (eds.), Handbook of Inernaional Economics, vol. 3, Norh-Holland Elsevier, Amserdam, pp Corsei, G. and Müller, G. J Twin Deficis: Squaring Theory, Evidence and Common Sense. Economic Policy, Ocober 2006, pp Deniz, P. and Çelik, S., (2009), An Empirical Invesigaion of Twin Deficis Hypohesis for Six Emerging Counries (April 17, 2009). Available a SSRN: hp://ssrn.com/absrac= (2 January 2012). Fidrmuc, J The Feldsein-Horioka-Puzzle and Twin Deficis in Seleced Counries. Economics of Planning, 36, pp Gabrisch, H Verical inra-indusry rade, echnology and income disribuion: A panel daa analysis for EU rade wih Cenral-Eas-European counries. Aca Oeconomica, vol. 59 (1), pp Keenci, N., and Uz, I., Deerminans of curren accoun in he EU: he relaion beween inernal and exernal balances in he new members. MPRA, online a hp://mpra.ub.uni-muenchen.de/27466/, posed 17. December Łaski, K Miy i rzeczywisość w poliyce gospodarczej i w nauczaniu ekonomii. Łaski, K., Osiaynski, J., and Zieba, J The Governmen Expendiure Muliplier and is Esimaes for Poland in WIIW Working Paper No 63. Vienna. Marinheiro, C. F Ricardian Equivalence, Twin Deficis, and he Feldsein- Horioka puzzle in Egyp. GEFM, Faculy of Economics, Universiy of Coimbra, Porugal. Esudios do GEMF No. 7. Summers, L. H Tax Policy and Inernaional Compeiiveness, in: J. A. Frenkel (ed.), Inernaional Aspecs of Fiscal Policies) NBER Conference Repor), Chicago: Universiy of Chicago Press, Summers, L. H The Scienific Illusion in Empirical Macroeconomics. Scandinavian Journal of Economics 93 (2), Szakolczai, G., The riple defici of Hungary. Hungarian Saisical Review, Special Number 10,

19 IWH Annex Table A1: ADF-es resuls Level 1s difference All in % of GDP and seasonally adjused Poland BDEF (fiscal balance) *** CA (curren accoun balance) ** *** TB (rade balance) *** m (impors) *** x (expors) *** Czech Republic BDEF *** *** CA *** *** TB ** m *** x *** Hungary BDEF *** *** CA *** TB *** m *** x *** ***, **, *: significances a he 1 %, 5 % and 10 % confidence levels. Table A2: Johansen co-inegraion es for Poland (rade and fiscal balance) Trace λ max Eigenvalue H 0 Trace 10 % Criical Value H 0 λ max 10 % Criical Value r = 0* r = 0* r r Noes: A lag lengh of one is used on he VAR (p =1). The esimaions were obained assuming a linear rend in he levels of he daa, and only an inercep in he co-inegraion equaion. * denoes rejecion of he hypohesis a he 0.1 level. Criical values: MacKinnon-Haug-Michelis (1999). Table A3: Johansen co-inegraion es for Poland (impor-gdp raio) Trace λ max Eigenvalue H 0 Trace 5 % Criical Value H 0 λ max 5 % Criical Value r = 0* r = 0* r r r r r r r r Noes: A lag lengh of wo is used on he VAR (p =1). The esimaions were obained assuming a linear rend in he levels of he daa, and only an inercep in he co-inegraion equaion. * denoes rejecion of he hypohesis a he 0.05 level. Criical values: MacKinnon-Haug-Michelis (1999). 18