The 7th Balkan Conference on Operational
Research
“BACOR 05”
Constanta, May 2005, Romania
OBJECTIVES OF MACROECONOMICS AS THE BASIS FOR
CLUSTERING OF COUNTRIES IN INTEGRATED EUROPE
MILICA DELIC
DRAGANA KRAGULJ
Faculty of Organizational Sciences, Belgrade, Serbia and Montenegro
Abstract
The EU economy is characterized by a high level of productive force,
developed infrastructure, high industrial concentration and
specialization level and highly developed agriculture in the whole. In the
same time, this region is not uniform as regards the economic
development level of its constituent parts and this is creating making
problems.
Countries in Europe can be divided in many ways and on different bases.
In this paper will be described and discussed classification, i.e.
clustering, of European countries based on indicators of achieved
objectives of macroeconomic.
Parameters regarding objectives of macroeconomics for European
countries will be analyzed and processed by the means of multivariate
statistical analysis with the goal to cluster countries with similar
macroeconomic national policies.
The clusters of countries based on objectives of macroeconomic will be
discussed. These clusters will be analyzed to judge the role of economic
flows in dynamics of integrative processes in Europe.
Keywords: European Union, objectives of macroeconomics, cluster
analysis
1. INTRODUCTION
Establishment of the European Union has introduced the new quality elements
into the international economic relations not only on this continent, but also all over the
world. The influence of these large, geographically spacious units has important effects to
the Member Countries, as well as to many other countries with which the former are
maintaining very strong trade, economic and political relations. Today’s Global economy
is characterized by many events related to changes in economic, regional, political,
democratic, and social issues. The most dramatic are the changes in Europe. On the one
side, are the changes in Western Europe which relate to economic and political
integration of these countries, and on the other, are the changes taking place in the
counties of Eastern and Central Europe, where the centrally planned economic system is
being dismantled, development of transitional processes and integration in the European,
and hence the World economy. Nowadays, a new dimension of the EU functioning is
getting apparent, and this concerns the issues relating to the integration of Central and
Eastern Europe countries and Western Balkans and to the possibility for the EU to react
to the challenges arising from the necessary and increasingly close cooperation with
almost all European countries. Twenty-seven countries are currently going through the
process of transition. They encompass 400 million people and 17% of the total surface
area. Transition is a multidimensional process which encapsulates many objectives that
must be achieved, such as: liberalization of the market and prices, privatization of
enterprises, domestic and foreign trade liberalization, reform of the banking system and
capital market; creation, harmonization, and strengthening of the institutions and policies
relevant to the functioning of a market economy; creation of conditions for attracting
foreign direct investments which will enable long-term economic growth, formulation of
policies of openness and credibility, strengthening of laws and legislative order, reforms
within the sphere of politics, etc.
All of the aforementioned objectives can fused into five groups: 1. Liberalization:
a process which enables free price formation and lowering of trade barriers so as to
compare and make competitive a transitional economy with that of a developed economy;
2. Macroeconomic stabilization: a process which brings inflation under control and
decreases it, for a period of time, after the initial high rate due to price liberalization. This
process requires control of the budget, the monetary and credit growth (adequate fiscal,
and tight monetary and credit policies), and progress through the balance of payments; 3.
Reconstruction and privatization which includes: process of creating financial sector,
reform of enterprises capable of producing goods demanded for in the market, and
transformation of ownership of enterprises into private property; 4. Conduction of social
program, which would include a care for the poor; and 5. Legislative and institutional
reforms which encompass the need for redefining the role of the state in the economy,
establishment of legal norms, laws and regulations.
2. OBJECTIVES OF MACROECONOMIC
In the economic literature the four most common objectives of macroeconomics
are singled out. This is about categories which measure and estimate macroeconomic
performance of a national economy:
1. stable growth of gross national product,
2. stable level of prices,
3. high employment levels,
4. stable (equal) balance of payments
For achieving these objectives several macroeconomic instruments are used.
These are, in fact, instruments by which creators of economic policy influence the pace
and direction of economic activities. The four most important macroeconomic
instruments are:
1. fiscal policy,
2. monetary policy,
3. income and price policies and
4. international economic policy.
Every country faces a problem of choice while defining economic policy: to the
accomplishment of which objective should be given priority. An ideal economic
condition would exist if domestic and foreign equilibriums were achieved, that is, a
condition which can be expressed through equality of the sum of production and imports,
on one side, and consumption and exports, on the other.
Achievement of this ideal condition is greatly hindered by the conflict between
domestic economic policy objectives and external equilibrium. Conflicts also show up
within domestic equilibrium, and especially between developmental and stabilization
objectives. Therefore measures of economic policy directed at achieving one objective
are often found to be in direct conflict with measures for achieving another objective. In
such conditions a proper estimate in assigning priorities becomes necessary. For example,
rapid economic growth is often followed by inflation and balance of payments deficit, or
the cost of achieving external equilibrium can be deceleration in production and lesser use
of existing productive capacities. These problems of the modern world evoke a question –
how can we solve several conflicting objectives simultaneously and how much for the
sake of accomplishing one must we sacrifice another objective, the so-called “trade off”.
3. EUROPEAN INTEGRATION PROCESSES
European Union is an economic and political reality on the European continent
and one of the key factors in the international politics at the beginning of the XXI
century. Each expansion of the European integration brought new challenges, which
related to both the old and the new member states, but also to the functioning of the
Community as a whole. On May 1st , 2004 European Union found itself in front of the
fifth and, to this date, the greatest expansion. This, at the same time, represents her
greatest challenge.
The basis for the European unity represents adoption of the Schuman’s plan on
May 9th, 1950. French foreign affaires minister Robert Schuman and famous French
economist Jean Monnet, showing great political realism, revealed the plan for
establishment of European Coal and Steel Community, ECSC, i.e. the plan for putting all
of French and German coal and steel production under common administration, but
leaving the organization open to other European states. Schuman’s plan signed by six
countries in Paris (W. Germany, France, Italy, Belgium, The Netherlands and
Luxemburg) was adopted on April 18th, 1951. Treaty of Paris that founded ECSC was
enforced on August 10th, 1952 and represents a significant step and incentive towards
further economic and political integration of Europe. As the second key date we must
emphasize March 25th, 1957. The six countries signed in Rome the so-called “Treaty of
Rome” founding the European Economic Community (EEC). Simultaneously, a treaty
was concluded on establishing European Atomic Energy Community, commonly called
Euratom. These two organizations, together with ECSC make a unified entity – European
Community (EC). Treaty of Rome, as the cornerstone of European integration, determines
the basic objectives of the EEC: 1) to coordinate and connect national economies of EEC
member states and further harmonize economic development of the entire area, as a
single unified economic totality, 2) constant economic expansion towards foreign
countries, and 3) stabilization and improvement of living standards of the population.
3.1. CIRCLES OF EXPANSION OF THE EUROPEAN UNION
The first expansion of the Community happened in 1973 when by accession of
the Great Britain, Ireland and Denmark ‘the six’ became ‘the nine’. Accession of these
three countries into Community was not easy. Namely, for a long time the Great Britain
wasn’t ready to accept supranationalism in international relations and to renounce a
portion of its national sovereignty. Great Britain supported the idea of creating a single
European free trade zone, where the custom duties would be abolished amongst the
member states, but every individual state would retain a complete freedom of action when
dealing with third countries. The fulfillment of the British idea happened in January 1960
when the Treaty of Stockholm established European Free Trade Association (EFTA)
joined by Great Britain, Denmark, Sweden, Norway, Portugal, Austria and Switzerland,
Finland obtained an associate member status. EFTA members in terms of their economic
and political strength were no match in comparison with ‘the six’. In August 1964 G.
Britain, Denmark, Norway and Ireland had submitted for the first time, an application for
joining EEC membership, but because of France’s opposition, they managed, following
the third attempt, to become full members of the EC on January 1st, 1973. Norway hadn’t
joined the integration, because during referendum on EC accession 53.5% of the
electorate voted against joining. For nine years the EC functioned as the “Europe of
nine”.
The second expansion of the Community commenced on January 1 st , 1981 when
following the joining of Greece it became ‘the ten’. For Greece, which from the moment
of submitting her entry request until her accession into EC waited more than five years,
accession represented a new economic and political perspective, in the sense of faster
modernization of the backward agricultural and industrial sectors, but also introduction of
a democratic, parliamentary regime following the rule of the military junta.
The third expansion of the Community was on January 1st, 1986, when Spain and
Portugal joined. These two countries gained full membership after 8.5 years of waiting
since the day of submitting the request for the membership entry. This accession
developed with many difficulties, given the need for structural adjustment of their
economies to more developed countries of the West, and their predominant agricultural
orientation.
The fourth expansion, now called European Union took place in 1993, following
the enforcement of the Maastricht Treaty, was formally conducted on January 1st , 1995,
when three more countries joined: Austria, Sweden, and Finland; since on referendum in
Norway once again the majority of electorate was against joining the European Union
Norway hadn’t joined. The decision on the forth expansion once again was not reached
unanimously. Austria’s entrance generated most opposition, and she waited more than
five years to join, the longest wait of the three. Economic reasons in this case, mostly,
didn’t exist. The four key differences and reasons for disagreement between Austria and
the European Union were the problems that related to dual residence, transit, agriculture,
and environmental protection. I case of economies of Sweden and Finland, which waited
to join for 3.5 and 3 years respectively, positive effects of joining the integration were
expected.
3.2. EUROPEAN TRANSITION PROCESSES
Today Europe is faced with a historical challenge of expansion into former
socialist countries of the Central and Eastern Europe, and the Western Balkan. These
countries have since 1989 began radical social, economic and political reforms. Basic
directions of reforms are common to all transitional countries, and refer to: building
market institutions, ownership transformation, functioning of the goods and services
market, labor force and capital, liberalization of most of the prices, significant trade
liberalization, structural adjustments, restructuring of enterprises, radical changes in
public sector management, macroeconomic stability, reform of the banking system,
reform of the tax system, social security and pension system reforms, export orientation,
attracting foreign capital (direct investments, portfolio investments, concessions, opening
of foreign affiliates, free custom areas, etc.), harmonizing domestic regulations with EU
regulations, political reforms, etc. The main transition objectives in the ex-socialist
countries are of both the economic and political nature, i.e. they mean to increase the
economic efficiency and to attain stable democracy, as well as to get included into the
European integration processes on these bases. At the European Council meeting, held in
Copenhagen in 1993, the heads of the EU Member Countries agreed to accept the
associated member countries from Central and Eastern Europe into the Union
membership, which would have expressed their wish to do so. These countries shall
become full members after having fulfilled the appropriate economic and political
conditions.
On May 1 st , 2004 European Union witnessed its greatest expansion to date when
ten new members joined the integration: Hungary, Slovenia, Slovakia, Czech Rep.,
Poland, Estonia, Latvia, Lithuania, Cyprus (Greek section) and Malta. Entry of Bulgaria
and Romania is expected by the year 2007. The citizens of these countries have expressed
their will to join the European Union on referendums. The challenges to such a widely
expanded Europe are immense. This will certainly contribute to the economic power and
the strengthening of the European Union’s international role, but on the other hand, will
greatly hinder making decisions and their implementation. Many problems will surface
due to expansion of the integration: overburden of institutions, existence of various
internal and especially external priorities, strengthening of nationalism, etc. The problems
of efficient economic and political functioning of the expanded European integration will
most certainly derive from the fact that ten new countries according to the basic economic
indicators lag far behind ‘the fifteen’.
The seventh circle of EU expansion refers to the Balkan countries: Croatia, BiH,
Serbia & Montenegro, Macedonia, and Albania. European Union clearly expressed its
position that unification of Europe will not be complete until the Western Balkan
countries become her integral part, but that the progress in the process of European
integration will depend, above else, on the capability of each country to conduct
economic and political reforms and adopt the basic principles of the European Union. In
May 1999 based on the proposal by the European Commission, Stabilization and
Association Process (SAP) began, as a strategic approach towards the countries of the
Western Balkan.
The key instrument of the stabilization and association process represent the
Treaties of Stabilization and Association which are individually signed with every
country of the Western Balkan, which include multiple spheres of influence, such as
gradual, i.e. phased creation of free-trade areas between a certain country and the EU,
obligation of a country to gradually harmonize domestic laws with the EU Law, and also
various forms of support by the EU in many areas have been anticipated. Besides these,
the European Union has put forward specific requests to these countries that refer to
solving consequences of conflict and civil wars at the end of the XX century and creation
of regional cooperation between these countries. Treaty of association is preceded by the
Feasibility Study, which represents a complex social, economic and political report of the
European Commission which informs the Council of Ministers of the European Union on
the readiness of a candidate state to join suitable institutional relations with the EU. The
countries for which the Study is being made must fulfill certain political criteria: creation
of democratic institutions and the rule of law, respect of human rights, protection of
minorities, respect of international obligations, etc. Based on the conclusion of the Study
submitted by the EU Commission, the Council of the EU makes decision on finalizing the
Treaty of stabilization and association. Numerous factors influence on how long the
negotiations will last (e.g., with Croatia they lasted six months, whereas with Macedonia
more than eight). Application of certain parts of Treaty of association begins when a
country negotiated with reach principle agreement with the European commission, until
all members of the European Union ratify it.
4. CLUSTERING OF THE COUNTRIES
In this paper we will present some results of the statistical analysis made on data
regarding objectives of macroeconomics for countries in Europe. European countries
included in the analysis are divided in five groups, regarding their status in integrative
process in Europe.
The groups and belonging countries are:
1. Euro area: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy,
Luxembourg, Netherlands, Portugal and Spain.
2. Other members of EU15: United Kingdom, Denmark and Sweden.
3. New 10 EU members: Cyprus, Czech Republic, Estonia, Hungary, Latvia,
Lithuania, Malta, Poland, Slovakia and Slovenia.
4. West European countries out of EU: Iceland, Norway and Switzerland.
5. South-east European countries out of EU (candidates): Albania, Bosnia and
Herzegovina (B and H), Bulgaria, Croatia, Romania, Serbia and Montenegro (S and
M), the former Yugoslav Republic of Macedonia (FYR M) and Turkey.
For these countries and the five years period, are analyzed following data [1]:
GDP - Gross domestic product (Percentage change over the preceding year, 1999-2003);
UIR - Standardized unemployment rates (Per cent of civilian labor force, 1999-2003);
CPR - Consumer prices (Percentage change over the preceding year, 1999-2003);
IOUT - Real gross industrial output (Percentage change over the preceding year, 1999-
2003).
The goal of the analysis was to see how the countries will be clustered on the basses of
achieved objectives of macroeconomics and the techniques used are methods of
multivariate statistical analysis: principal component analysis and cluster analysis.
4.1 PRINCIPAL COMPONENT ANALYSIS
Principal component analysis is technique which is used to check correlation
between variables and remove redundancy in the data caused by it [2]. The elementary
data matrix is reduced so that the number of variables describing research units is
reduced. New variables are the factors and each factor represents the whole group (highly
correlated mutually) of original variables. Factors are not correlated mutually, but the
majority of the original variability in data is conserved. Each unit then achieves its values
for each of those factors. The new matrix still contains almost all unredundanced
information contained in the previous matrix.
The matrix used in the analysis described here, had 36 rows (countries- research
unites) and 20 columns (variables). In principal component analysis for the data, executed
in SPSS [3], it is concluded that in the analysis can be continued with five factors, i.e.
principal components. These five factors describe 88% of total original variability in data.
The new matrix, which was used in farther analysis, had 36 rows, but only five columns.
In the addiction, variables in this matrix are unredundanced and not correlated.
From the rotated component matrix, presented in Table 4.1.1., it can be seen what
variables are important for each factor [2]. It can be seen that the first factor, i.e.
component, represents influence of consumer prices (CPR) and the second regards
unemployment rates (UIR). Other tree components are formed from data regarding GDP
and real gross industrial output (IOUT) for specific years. The third component is
connected with data for years 2002 and 2003, the forth for the year 2000, and the fifth for
the year 2001.
Component
1 2 3 4 5
GDP99 -.854 -.110 .127 .226 -.292
GDP00 2.229E-02 -1.09E-02 .372 .678 -.134
GDP01 -.122 -1.95E-02 .224 .278 .776
GDP02 .354 8.859E-02 .819 .212 .197
GDP03 9.765E-02 .206 .868 7.743E-04 .162
UIR99 6.684E-02 .984 9.761E-02 2.558E-02 2.620E-02
UIR00 4.752E-02 .985 .135 -1.61E-02 6.454E-02
UIR01 7.950E-02 .982 .146 -7.78E-03 6.212E-02
UIR02 5.107E-02 .989 .112 -1.07E-02 -3.13E-02
UIR03 6.153E-02 .989 5.225E-02 1.420E-02 -4.55E-02
CPR99 .927 -1.41E-02 .205 5.717E-02 -.237
CPR00 .964 .149 2.078E-02 .138 -4.49E-02
CPR01 .952 .168 -5.17E-02 .184 -5.96E-03
CPR02 .840 -6.36E-02 .284 8.894E-02 -.419
CPR03 .803 -.122 .276 3.313E-02 -.399
IOUT99 -.672 -.190 -1.44E-02 .419 -.406
IOUT00 7.537E-02 2.424E-02 7.677E-02 .866 .144
IOUT01 -.147 8.935E-03 .331 -.192 .627
IOUT02 .142 5.130E-02 .710 .420 .101
IOUT03 -9.59E-02 .198 .846 7.354E-02 6.573E-02
Extraction Method: Principal Component Analysis.
Rotation Method: Varimax with Kaiser Normalization.
Table 4.1.1 Rotated component matrix
4.2 CLUSTER ANALYSIS
The second step is the use of factor scores matrix for finding clusters of countries.
Cluster analysis is the technique used for solving problems of this kind [2]. The main
target in clustering is to find units, countries, with similar values for factors, i.e. countries
with similarity in data on objectives of macroeconomics.
All countries are classified by cluster analysis in one of mutually exclusive
clusters, which are completely covering the observed territory.
There exist different techniques and methods for clustering elements. They are
basically divided on hierarchical and nonhierarchical methods. Analysis described here is
performed in SPSS, by the means of agglomerative hierarchical Ward’s method and
squared Euclidean distance [3]. In each step of the procedure, the new element is joined
to the “nearest” cluster. The dynamics of agglomeration can be graphically observed in
dendrogram. From the same chart it can be seen how distant the elements and the clusters
are. Different number of clusters can bee identified, depending on wonted hierarchical
level.
Dendrogram regarding clustering of European countries described in this paper is
given in Chart 4.2.1.
Rescaled Distance Cluster
C A S E 0 5 10 15 20 25
Label Num +---------+---------+---------+---------+---------+
1 Germany 5
1 Italy 8
1 France 4
1 Portugal 11
2 UK 15
2 Denmark 13
4 Norway 27
1 Netherlands 10
4 Switzerland 28
1 Finland 3
3 Hungary 19
1 Luxembourg 9
3 Malta 22
1 Belgium 2
2 Sweden 14
1 Spain 12
1 Austria 1
4 Iceland 26
3 Cyprus 16
3 Slovenia 25
1 Ireland 7
5 Albania 29
5 B and H 30
5 FYR Macedonia 33
1 Greece 6
3 Czech Republic 17
3 Slovakia 24
5 Bulgaria 31
5 Croatia 32
3 Poland 23
3 Estonia 18
3 Latvia 20
5 Romania 34
3 Lithuania 21
5 S and M 35
5 Turkey 36
Chart 4.2.1 Dendrogram
4.3. CLUSTERS
Dendrogram can be cut at different distances. Dendrogram in Chart 4.2.1. is cut three times
in order to form hierarchical structure of clusters. The clusters – supergroups, groups, subgroups
and their members are given in Table 4.3.1.
Supergroup Group Subgroup Country
1 France
SGA GA1 GA11 1 Germany
1 Italy
1 Netherlands
1 Portugal
2 Denmark
2 UK
4 Norway
4 Switzerland
GA12 1 Austria
1 Belgium
1 Finland
1 Luxembourg
1 Spain
2 Sweden
3 Cyprus
3 Hungary
3 Malta
3 Slovenia
4 Iceland
GA2 1 Ireland
5 Albania
1 Greece
SGB GB1 GB11 3 Czech Republic
3 Poland
3 Slovakia
5 Bulgaria
5 Croatia
GB12 3 Estonia
3 Latvia
5 Romania
GB13 3 Lithuania
GB2 5 B and H
5 FYR Macedonia
SGC 5 S and M
SGD 5 Turkey
Table 4.3.1 Clusters
The structure of clusters is formed of four supergroups: SGA, SGB, SGC and SGD. SGA
consists of two groups (GA1, GA2) with their subgroups, as well as the supergroup SGB (groups
GB1, GB2). The fact that Serbia and Montenegro and Turkey are the only members of the
supergroups SGC and SGD, respectively, means that macroeconomic flows in these countries differ
from all other countries analyzed here. Members of subgroups are very similar in their
achievements and, as the level of the clustering increases, the differences between the members of
the same cluster (group or supergroup) are increasing too, but they are still more similar to the
countries in their cluster then these from the others.
5. CONCLUSION
From the dendrogram in Chart 4.2.1 and corresponding Table 4.3.1 it can be seen that the
countries observed in this analysis (excluding Serbia and Montenegro and Turkey) are grouped in
two big groups. The only country candidate clustered in supergroup SGA is Albania, while the only
country member of EU clustered in SGB is Greece. Subgroup GA11 consists of developed West
European countries, while in the subgroup GA12 are clustered other old members of the Union, as
well as some of the new members. Members of SGB are new members of EU and the candidates,
i.e. South-east European countries out of EU.
From the clustering of the countries presented in this paper it can be concluded that degree
of achieved objectives of macroeconomics, although showing differences among the countries, is
not judgmental in determination of the order of countries to be joined to European Union.
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