According to the standard neoclassical growth model, convergence should be driven by capital flows towards the lower income countries, which  1  I would like to thank Jonathan Yiangou, Neale Kennedy and Grigor Stoevsky for their contributions to this speech. BIS central bankers’ speeches  1  have low capital-to-output ratios and hence a higher marginal return on capital. An increase in labour productivity in the catching-up economies would also accelerate convergence, as capital deepening would empower production in those economies and organisational processes would gradually reach the standards of efficiency set by more mature regions. When EMU was launched, the conditions for economic convergence to proceed according to this model seemed to be present. Nominal interest rates between higher and lower income countries converged rapidly. Capital flowed towards lower productivity economies where the marginal product of capital was higher, supported by the elimination of exchange rate risk within the euro area. For example, from 1999 to 2008 exposures from banks in higherincome economies towards those in the catching-up economies (Spain, Ireland, Greece and Portugal) increased more than fivefold. Facilitated by these flows, capital accumulation accelerated in these countries: from 1999 to 2007 average growth in capital services in catching-up economies ranged from around 5% to almost 9%, compared with a range of 2% to 3.5% in more productive economies. On the surface, these developments appeared to be contributing to convergence: GDP growth in catching-up economies was generally faster than in higher income economies.
In 1997 and 1998 the economy shifted from an upturn with high growth rates to an expansion with lower growth but low unemployment, labour shortages in many sectors and strong growth in labour costs. The period of strong expansion has ebbed away in the course of the past year. Winter 2002 marked the turnaround in the Norwegian economy. Growth in the mainland economy is now lower. Unemployment is approaching the average for the 1990s. Industrial leaders are pessimistic. Companies report a decline in production, employment and orders for both the export and domestic markets. Many companies have relocated or have plans to relocate all or some of their production operations abroad. In particular, enterprises producing capital goods are experiencing problems. The number of bankruptcies has increased sharply. The number of bankruptcy petitions is the highest in nine years. If we disregard personal bankruptcies, there has been an increase of 32 per cent from the first quarter of 2002 to the first quarter of 2003 - 200 more than a year ago. The largest increase in the first quarter is in retail trade and the property management and commercial services sector, while manufacturing and the construction sector accounted for the largest increase in the previous quarter. The number of bankruptcies increased in all counties compared with 2002, with the sharpest increase in Hordaland, Buskerud and Oslo (161, 111 and 18 per cent respectively from 2001 to 2002). Oslo accounted for most bankruptcy petitions, with 249 in the first quarter.