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Regional Policy

Lotte Ovaere, KULeuvenLouvain Institute for Ireland in Europe

Fall 2011

Course outline

• Facts on Europe’s economic geography• Theory

– Comparative advantage– New economic geography

• EU Regional Policy

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Preliminary questions

• Why is it important to reduce income disparities among EU member states?

• How can trade modify the location of industries across Europe?

• What’s the role of the education level of the citizens of a country in determining the effects of trade on economic activity concentration?

Europe at night

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5

Periphery

Centrality of EU25 Regions

Intermediate

Core

Periphery

Centrality of EU25 Regions

Intermediate

Core

EU economic geography

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EU economic geographyRegions Land share

%

Population share

%

GDP share

%

Relative Unemployment rate (EU27=100)

Relative Youth unemployment (EU27=100)

Share of population with income above EU27 average

Core 14.0 33.2 47.2 74.0 60.5 88.8

Intermediate

21.1 25.5 31.7 101.0 95.3 70.3

Peripheral 64.9 41.3 21.1 120.8 134.2 18.1

Source: EU Commission 2001

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Geographic income inequality 2002

• Luxembourg is 110% richer than average

• Bulgaria only 26% of average

0 50 100 150 200 250

BulgariaRomaniaLithuania

LatviaEstoniaPoland

SlovakiaHungry

CzechiaGreece

SloveniaPortugalCyprus

SpainFrance

ItalyFinland

UKSwedenGermanBelgiumAustria

NLIreland

DKLux.

EU26=100

8Ark, Mon, West V, Miss

Luxemburg

Ireland

Denmark

NLAustria

Belgium

EU

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Change in income standard deviation 1983-93 1990-94 1995-00 1983-93 1990-94 1995-00

EU -4.4 -2.7 -1.1 Italy 1.2 0.7 -1.3

Belgium 2.6 0.8 -1.4 Netherlands

-15.9 0.2 2.0

Germany 9.5 0.6 Austria 0.6 -1.5Greece 1.0 1.5 -0.8 Portugal 5.2 0.3 1.4

Spain 2.6 1.0 1.3 Finland -0.8 5.5

France 0.9 1.9 0.1 Sweden 0.2 8.9

Ireland 0.0 5.1 UK 0.6 -1.9 2.7

Source: EU commission 1996 and 2003

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Geographic income inequality, within nations

•income distribution even more unequal at regional level.•Within nation economic activity is very unequally distributed•Income distribution has become:

–More equal in EU15–Less equal within EU15 nations (by region)

•Richest: Inner London (67000euros GDP pc)•Poorest: Lubelskie in Poland (6700euros)

Guyane (F)

Guadeloupe

(F)

Martinique

(F)

RÈunion

(F)

Canarias (E)

AÁores (P)

Madeira

(P)

Kypros

Index, EUR-26 = 100

< 30

30 - 50

50 - 75

75 - 100

100 - 125

>= 125

no data

Source: Eurostat

0 km100 500

REGIO.A1- GIS/HP/(statmap) - m98001_uk_C_A4P - 09 Jan 01

SIG16SIG16

© MEGRIN for the administrative boundaries

GDP per head by region (PPS), 1998

< 30

30 - 50

50 - 75

75 - 100

100 - 125

>= 125

Index, EU-25 = 100

< 30

30 - 50

50 - 75

75 - 100

100 - 125

>= 125

Index, EU-25 = 100

< 30

30 - 50

50 - 75

75 - 100

100 - 125

>= 125

Index, EU-25 = 100

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Geographic income inequality• French example

– Ile de France (Paris) has almost 1/3 of all economic activity

– Per capita incomes (not shown) are 158% of EU15 average

– Mediterranee has 10% of GDP, 12% of population• GDP/pop only 86% of

EU15 average

• Outre-Mer are former French colonies (poor islands in Caribbean, etc.)

0.00 0.05 0.10 0.15 0.20 0.25 0.30

Ile de France

Bassin Parisien

Nord - Pas-de-Calais

Est

Ouest

Sud-Ouest

Centre-Est

Mediterranee

Outre-Mer

GDP share

Pop share

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By looking only at the GDP, we may conclude that EEI had modest impact on the location of economic activity as a whole… changes occurring within nations rather than across nations.

BUT

EEI may have encouraged clustering of manufacturing by sector rather than by region.

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Krugman Index: Geographic Specialisation

• KI tells us what fraction of manufacturing activity would have to change to make the country’s sector-shares line-up with the sector-shares of all other EU15 nations.

• Most EU nations have became more specialised– EU economies seem to

be specialising more in their comparative advantages

Specialisation of European Industrial Structure, 1970-73 & change 1970-97

-0.2 0 0.2 0.4 0.6 0.8

IrelandFinland

DenmarkPortugalGreece

NLSpain

SwedenBelgium

ItalyAustria

GermanyUK

France

Average1970-73

Change, 1970-73 to 1994-97

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Summary of facts

1. Europe’s economic activity is highly concentrated geographically at the national level and within nations

2. Geographic Distribution of economic activity has become more concentrated within countries (proxy: income per capita)

3. Only modest reallocation of industry across nations

4. Specialization on a sector-by-sector basis5. Sub-national level: industry more concentrated

spatially.

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Theory• 2 major approaches linking economic integration to

change in the geographic location of economic activity

• Comparative advantage suggests nations specialise in sectors in which they have a comparative advantage

• New Economic Geography suggests that integration tends to concentrate economic activity spatially

• General idea:– Use c.a. approach to explain cross-nation facts– Use NEG to explain within nation facts

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We will focus on these two aspects - specialization at the international level and agglomeration within the countries.

The first is the standard economic logic that connects European integration and the location of economic activity. The uneven distribution of activity is explained through given “natural differences” among European nations or what economists call comparative advantage.

The second focuses on how closer integration encourages the geographic clustering of economic activity.

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Comparative Advantage and Specialisation

-52%

-50%

-42%

-35%

-30%

-16%

-9%

-4%

13%

15%

25%

44%

58%

83%

-80% -60% -40% -20% 0% 20% 40% 60% 80% 100%

Germany

DenmarkSwedenAustria

FinlandNetherlands

France

BelgiumUK

Ireland

GreeceItaly

Spain

Portugal

Low-education labour Medium-education labour High-education labour

Relative labour endowments in Europe83% above EU average

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Question

• Portugal and Germany:

What do you expect according to their relative labour endowments? Think of ‘comparative advantage and specialization’

• Think of 2 sectors, e.g. clothing and pharmaceuticals

Hecksher-Ohlin Theorem

• Countries export the good that uses its relatively abundant factor intensively

• Beneficial for both nations• But different skill groups are affected

differently• Integration makes it easier to trade• Portugal shifts resources to production of

clothing

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Trade liberalization allows nations to specialize in sectors where they have a comparative advantage.

This effect of liberalization can have important effects on the location of industry: it encourages specialization nation–by–nation, even without firms moving internationally.

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Agglomeration & NEG• When productive factors can cross borders

(international or inter-regional) integration may have very different effects

• Scale economies and trade costs generate forces that encourage geographic clustering of economic activity.

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Question

• Give examples of sectors on which there exist scale economies.

• What about cheese production and car engine production?

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There are two types of clustering:– "Overall clustering“ = some areas with lots of

economic activity, others empty “core-periphery”– "Sectoral clustering" = each sector clusters in one

region, but most regions get a cluster

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Agglomeration & Dispersion Forces• Basic idea is that lowering trade costs affects both

– Agglomeration forces• Tend to lead industry to cluster geographically

– Dispersion forces• Tent to encourage industry to disperse geographically

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Agglomeration Forces

• Many agglomeration forces– Technological spillovers (e.g. silicon valley)– Labour market pooling (e.g. City of London)– Demand linkages (a.k.a backward linkages)– Supply (cost) linkages (a.k.a forward linkages)

• Demand & supply links are clearly affected by economic integration (lower trade costs)

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1. Some firm moves to big region

To have access to a bigger market and reduce trade cost

2. Expenditure Shifting,Firm and its workers spend

incomes in big regioninstead of in small region

3. Market Size Effects:big market gets bigger, small market gets smaller

4. Production Shifting,

Due to trade costs firms prefer to locate close to big market. More industry moves to big region

Circular Causality & Demand LinkagesMarket size

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1. Some firm moves to big region

2. Production ShiftingMigrated firms’ output now

cheaper in big region & dearer in small region (trade costs)

3. Cost Shifting,

Availability of wider range of locally available intermediate goods makes big region cheaper place to

produce

4. Production Shifting

Some more firms move from small market to big market, attracted by

lower costs

Circular Causality & Supply LinkagesCost of production

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Question.

• Given the benefits of agglomeration for the firm, why don’t we observe all economic activity to be located in a single place?

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Dispersion Forces

• Many forces lead to a tendency of firms to avoid agglomerations of economic activity– Rents and land prices– High cost of other non-traded services (e.g. unskilled

labour)– Congestion costs and Local Competition with other firms

• The NEG focuses on “local competition” since it is clearly related to trade costs– As trade costs fall, distance provides less protection from

distant competitors

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EQUILIBRIUM

How European integration affects the equilibrium location of industry?

Spatial density of economic activity in equilibrium depends upon the balance of the pro-concentration (agglomeration) forces and anti-concentration (dispersion) forces.

Simple framework

• One agglomeration force: demand linkage– Big market– Trade costs– Increasing returns to scale– Ignore feedback effect (flat aggl. force curve)

• One dispersion force: local competition

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Agglomeration vs. dispersion forces

% firms in big region

Agglomeration and dispersion forces

Dispersion force

Agglomeration forcesEA

B

Economic integration

• Reduces trade costs• Big market effect does not change• Impact on competition effect

– Trade barriers protect firms from competition– Local competition becomes global– Dispersion no longer succeeds in avoiding

competition– Dispersion force drops

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Effects of integration

% firms in big region

Agglomeration and dispersion forces

Dispersion force

Agglomeration forces

E

Dispersion force with freer trade

E’

100%

Complicating factors

• Circular causality in agglomeration forceUpward sloping agglomeration force curve

• Shift in dispersion force curve: additional dispersion forces at work

• …

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Bringing two theories together

• Essential role for factor mobility• With factors perfectly mobile within

countries (NEG) and perfectly immobile between countries (CA), theory predictions come close to reality

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Question

• Is there a trade-off between national and regional convergence?

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EU Regional Policy• EU always had poor regions (Mezzogiorno, etc.)

– much spending on poor EU regions, but very little by EU (pre 1986)

• 1973, Ireland (poor at the time joined); 1981, Greece joined but no major reorientation of EU spending priorities.

• In 1986, Iberian enlargement shifted power in Council and spending priorities changed

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

Structural Funds

Poor Vote-Share

CAP

Enl

arge

men

t

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EU Regional Policy• For historical reasons, EU has 5 “Funds”,

– 4 Structural Funds: spent in any qualified region

* European Regional Development Fund: infrastructure, job-creating investment, local development, small firms

* European Social Fund: unemployment

* Fisheries Guidance: modernizing fishing industry

* Agricultural Guidance and Guarantee Fund: rural development and aid for farmers mainly in less developed regions

– 1 Cohesion Fund: spent only in poor-4 (Spain, Portugal, Greece and Ireland)

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EU Regional Policy

• Funds work together under overall strategy

• Many programs, initiatives, and objectives, BUT over 90% is spent on three priority “objectives”

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3 Objectives

• Objective 1 (about 70% of structural spending):– spending on basic infrastructure and

production subsidies in less developed regions– generally defined: regions with incomes less

than 75% of the EU average – about 60 “objective 1 regions”; they have

about 20% of the EU population.

Objective 1 regions 2000-2006

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3 Objectives

• Objective 2 (about 10% of structural spending):– projects in regions whose economies are specialized in

declining sectors• coal mining, fishing, steel production, etc.

– spending should support economic and social “conversion”

– about 18% of the Union's population lives in ‘Objective 2” regions.

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3 Objectives

• Objective 3 (about 10% of the funding): – measure to modernize national systems of

training and employment promotion. – all EU regions excluding objective 1 regions.

Objectives, Structural Funds and Instruments 2007-2013

ERDF ESFCohesion

FundConvergence

Regional Competitiveness and Employment

European territorial Cooperation

ERDF

ERDF

ESF

Objectives Structural Funds and instruments

infrastructure,

innovation,

investments

etc.

vocational

training,

employment

aids etc.

MemberStates with a

GNI/head below 90%

environmental and

transport infra-

structure,

renewable energy

all Member States and regions

Objective and Budget allocation

Objective %Cohesion budget %of EU27 population covered

Convergence 82 Standard Convergence regions (34)Phase-out convergence regions(3)Cohesion Fund nation(34)

Regional competitiveness and employment

16 All non-convergence regions(66)

Territorial cooperation 2 100

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Structural funds allocation by type of region 2007-13

Convergence: €199.3 bn.

Phasing out: €13.9 bn.

Phasing in: €11.4 bn.

Competitiveness: €4.5 bn.

Cooperation: €7.8 bn.

Cohesion Fund: €69.6 bn.

Total: €347.4 billion

• in current prices

European Territorial Cooperation 2007-2013

Allocation: €7.75 bn. for cross-border,

transnational and interregional cooperation

Cross-border areas

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Spending priorities and Guiding principles• A good deal goes to physical infrastructure such as roads,

bridges, regional airports, etc.• Lisbon Agenda emphasizes other spending: research and

innovation, infrastructure of European importance, industrial competitiveness, renewable energies, energy efficiency, eco-innovations and human resources.

• The Structural Funds are not spent on projects chosen at the European level.• Choice of project and their management are solely the

responsibility of the national and regional authorities.• As a matter of principle – the so-called additionally principle,

Community funding should not be used to economize on national funds (difficult to verify).

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Political allocationIndicative Financial Allocations: 2007-2013

Country National Convergence Objective Total EU Regional Funds  GDP per head, €, 2005 Million € € per head in 

recipient regions

Million € € per head in recipient country

Share of GDP %

Share of total regional funds %

Bulgaria 7,913 5,888 753 6,047 768 3.15 2Romania 7,933 16,912 778 17,316 795 3 5.6Latvia 11,180 4,010 1,725 4,090 1,749 3.52 1.3Poland 11,482 59,048 1,546 59,698 1,562 3.43 19.4Lithuania 11,914 5,999 1,737 6,096 1,757 3.42 2Slovak Republic 13,563 9,663 1,796 10,264 1,904 3.3 3.3Estonia 14,093 3,011 2,221 3,058 2,247 3.31 1Hungary 14,393 20,243 1,998 22,451 2,210 3.22 7.3Portugal 16,891 18,316 1,750 19,147 1,847 1.82 6.2Czech Republic 17,156 22,979 2,252 23,698 2,323 3.25 7.7Malta 17,330 747 1,878 761 1,922 2.35 0.2Slovenia 19,462 3,646 1,827 3,739 1,874 1.7 1.2Cyprus 20,753 193 265 580 812 0.56 0.2Greece 21,589 17,447 1,585 18,217 1,658 1.34 5.9Spain 23,069 23,411 1,566 31,536 778 0.49 10.2Italy 23,474 19,255 1,112 25,647 449 0.25 8.3Germany 25,797 14,323 933 23,449 284 0.14 7.6France 25,077 2,838 1,623 12,736 208 0.1 4.1Finland 25,774 0 0 1,533 295 0.13 0.5United Kingdom 26,715 2,594 949 9,468 160 0.07 3.1Belgium 27,135 579 452 2,020 195 0.09 0.7Sweden 27,721 0 0 1,682 188 0.08 0.5Denmark 28,375 0 0 545 101 0.04 0.2Austria 28,852 159 568 1,301 161 0.07 0.4Netherlands 29,374 0 0 1,697 105 0.05 0.6Ireland 32,197 0 0 815 207 0.06 0.3Luxembourg 59,202 0 0 58 130 0.02 0

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Structural Funds: Eligible areas in EU25 for Objective 1 and 2 between 2000 and 2006

Phasing-out (till 31/12/2005)

Objective 1

Phasing-out (till 31/12/2006)

Special program

Objective 2

Objective 2 partly

Phasing-out (till 31/12/2005)

Phasing-out partly (till 31/12/2005)

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Impact of 2004 and 2007 enlargement• New members are much poorer than EU15• Difficulties:

– Cost of structural spending could rise substantially– 10 new poor nations make some poor regions in

EU15 look relatively rich• Pushes them above 75% of EU25 average

• Political power in Council likely to shift spending priorities

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Impact of 2004 Enlargement• Some regions that will be

pushed above 75% of average will lose Objective 1 status

• Some, like northern Finland and Sweden are unaffected– Low pop density criteria

• All of 2004 entrants have less than 75% of EU25 average– Except Cyprus

Regions below 75% in EU25

Regions “statistically” above 75%

Regions above 75% in EU15

Others

Regions below 75% in EU25

Regions “statistically” above 75%

Regions above 75% in EU15

Others

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New cohesion policy programs

• JASPERS: Joint assistance in supporting projects in European regions.

• JEREMIE: Joint European resources for micro to medium enterprises

• JESSICA: Joint European support for sustainable investment in city areas

• Modernisation of public services

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Question• Educational level in all EU nations is rising. How

would this affect the spatial allocation of production?

• Considering that low-skill intensive sectors generate lower added-value, why is it important to transfer funds to poorer countries, i.e. to intervene in the natural forces of agglomeration and dispersion forces?

• Assuming ethical arguments are not enough, which rational and selfish arguments may justify the reduction of inequality among EU members?