Cohesion policy and regional inequalities in Europe

Cohesion policy and regional inequalities in Europe

Abstract :

· Regional policy (or cohesion policy) accounts for one-third of the European Union (EU) budget and aims to reduce disparities between the most developed and the poorest regions.

· Its funding and objectives are designed to combat the forces of industrial agglomeration, illustrated by the models of the new economic geography, which lead to growing regional inequalities.

· However, although inequalities are tending to decrease between EU countries, they are increasing between regions within several countries, revealing a divergence between the dynamics of territorial equality and the overall economic growth of countries.

· New priorities for regional policy must be put forward, particularly with regard to the financing of public infrastructure, worker mobility, and the dissemination of innovation.

The sovereign debt crisis in the eurozone has highlighted the failure of real convergence between the economic structures of the so-called « core » countries and the transition countries. At the regional level, the economic and financial integration of heterogeneous regions within a single market has not enabled the least advanced regions to catch up economically in a balanced manner.

By looking at the models of the new economic geography, we can draw some conclusions about the development of inequalities between regions in Europe and formulate avenues for reform of European regional policy, which accounts for one-third of the EU budget.

1. What is European regional policy?

European regional policy began in 1957 with the Treaty of Rome, but it was in the 1980s, with the accession of Greece (1981), Spain, and Portugal (1986), that it became one of the EU’s major policies. In particular, it aims to « reduce the gap between the various regions and the backwardness of the least favored regions. » It is therefore defined as a driver of economic convergence. This goal of « catching up » has become more pronounced since the accession of the countries of Central and Eastern Europe between 2003 and 2013. This regional policy now mobilizes a total of €350 billion, or one-third of the EU budget (Figures 1a and 1b).

European regional policy – or cohesion policy – consists of several funds designed to achieve different objectives. The Cohesion Fund is intended for the least wealthy Member States (GNI below 90% of the EU average) and primarily finances projects related to transport and energy infrastructure. The European Regional Development Fund (ERDF) and the European Social Fund (ESF) focus primarily on investments in human capital, innovation, and administrative modernization, and are distributed across European regions through three objectives:

· Objective 1 « convergence » concerns the least developed regions of the EU (with a per capita GDP below 75% of the EU average);

· Objective 2, « Competitiveness and Employment, » is intended for regions not covered by Objective 1 (including transition regions and the most developed regions);

· Objective 3, « Territorial Cooperation, » aims to strengthen cooperation between territories for urban and economic development and environmental preservation.

Nearly three-quarters of cohesion policy funds are allocated to the poorest regions and the Cohesion Fund.

Sources: DG REGIO, BSI Economics

However, regional policy is not intended to be a transfer policy. Structural funds are allocated to finance infrastructure, particularly transport infrastructure, in order to reduce transaction costs[1]. Reducing regional disparities in terms of infrastructure is one of the European Commission’s priorities. The influence of industrial location choices is supposed to enable peripheral regions to benefit from their integration into the European single market.

Neoclassical convergence models (with diminishing returns) predict that, in a market with high commercial and financial integration, regions with lower capital endowments will automatically catch up because they offer higher returns[2] than developed regions and thus attract capital. However, European cohesion policy takes a different view and justifies transfers to less developed regions on the basis of new economic geography models. These models predict that the most advanced regions will offer higher returns, particularly due to lower transaction costs, greater capital stock, and better public infrastructure. Mobile factors of production (particularly physical capital, but also intangible capital) would thus tend to cluster together to benefit from economies of scale and better dissemination of knowledge, to the detriment of peripheral regions. Cohesion policy transfers therefore aim to counteract these mechanisms.

Finally, the low mobility of the least skilled workers in Europe tends to accentuate inequalities in terms of income and unemployment rates when productive activities are concentrated in core regions. Geographical factors are therefore an important component of interregional inequalities.

European regional policy therefore does not consider the traditional view of economic convergence to be sufficient and aims to enable the inhabitants of less developed regions to benefit from the advantages of the single market.

2. Agglomeration and regional inequalities in Europe

So what about regional inequalities in Europe? Numerous studies[4] show that since the 1980s, Europe has experienced a parallel process of convergence at the national level but divergence at the regional level within Member States. Using dispersion indicators such as the coefficient of variation (standard deviation divided by the mean), these studies highlight the disconnect between national and regional dynamics in terms of GDP per capita and unemployment. Using more recent data, we can see that over the period 2000-2011, the dispersion of GDP per capita levels decreased between EU Member States, while it increased between regions within national groups (Figure 2a)[5].

However, this does not mean that regional inequalities in living standards have increased everywhere. In the core eurozone countries, regional inequalities actually decreased over the period (Figure 2b). Furthermore, when we look at the dispersion of net disposable household income( after social transfers, Figure 2b), we see that inequalities are much smaller and also tend to be decreasing. The importance of national redistribution mechanisms has helped to correct geographical inequalities in wealth production. The growth of regional inequalities in terms of production does not necessarily seem to be accompanied by a growth in individual inequalities.

Sources: Eurostat, Macrobond, BSI Economics

How can this disconnect between national and sub-national dynamics be explained? It would appear that Member States are following the catch-up trajectory predicted by classical convergence theories, while within countries the agglomeration forces defined by new economic geography models are playing a greater role. The presence of economies of scale and positive externalities linked to the ease of knowledge diffusion in the fields of research, innovation, knowledge dissemination, public infrastructure sharing, and market size leads to the agglomeration of production centers. These phenomena are more significant at the subnational level because there are still significant barriers for companies to relocate abroad. Examples include transport costs, competition, distance from markets and, more generally, low mobility of production factors within the EU, compounded by certain public policies that favor the development of clusters, particularly in the field of R&D. These self-perpetuating mechanisms therefore lead to growing regional disparities in terms of GDP per capita, with labor and capital productivity being higher in certain « core » regions, to the detriment of regions in transition.

However, these agglomeration phenomena appear to be beneficial for the overall growth of Member States. They enable more efficient sharing of infrastructure and production networks, better labor market matching (links between companies and training centers), and better dissemination of innovations. The efficiency gains achieved through these economies of scale enable catching-up countries to grow faster, leading to convergence in GDP per capita at the national level.

Here we see a divergence between the dynamics of regional equality and overall growth in the country. Indeed, we note (Figure 3a) that over the period 2000-2011, regional inequalities increased more in the countries that most recently joined the EU. In the « convergence » countries (Z EURO transition[8]), these inequalities also increased, while they decreased in the core eurozone countries. The parallel between the average annual growth rate and the increase in inequality over the same period highlights this trade-off: the countries that experienced the strongest growth over the period 2000-2011 are those that experienced the largest increase in regional inequality (Figure 3b[9]). These dynamics illustrate the emergence of a trade-off between balanced regional development and rapid economic growth with a view to convergence.

The objectives of European cohesion are not those of maximized economic growth for Member States, but rather economic development shared by all regions. This explains why, from an economic profitability perspective, economic policy funds are not allocated to the most productive areas.

Sources: Eurostat, BSI Economics

3. What arethe priorities for regional policy?

There are four main areas of reform for European regional policy:

1. Focus on production and innovation infrastructure rather than reducing transport costs. Reducing the cost of transporting goods between regions can have adverse consequences for the least wealthy region, as it allows companies in that region to migrate to the most productive hubs to benefit from spillover effects, while retaining access to the market in their region of origin. Investments should be allocated as a priority to the development of infrastructure to attract businesses to peripheral regions: intra-regional transport, training and research centers, etc.

2. Promote the dissemination and appropriation of knowledge and innovation. Policies aimed at improving telecommunications systems, vocational training, equal access to credit for businesses (to encourage investment), and administrative modernization can enable less wealthy regions to better capture and appropriate the spillover effects of core regions.

3. Promote worker mobility. To prevent growing inequalities affecting the least mobile workers, regional policy could facilitate access to housing (mobility of social housing rights in France, for example) or social rights equivalencies (social benefits, training rights, pension contributions). Firstly, this would enable companies located in less favored regions to attract skilled workers, thereby improving labor market matching. Secondly, it would reduce inequalities in terms of unemployment rates and GDP per capita if workers follow companies to where they create jobs.

4. Supplement national transfers. Regional policy must reinforce geographical criteria in the allocation of transfers within each country for those who cannot benefit from the gains of the single market, the least mobile workers, and the sectoral restructuring of regions in decline.

Conclusion

It is very difficult to estimate the precise impact of European cohesion policy instruments on regional growth and the reduction of regional inequalities in Europe. Although there is convergence in GDP per capita levels among European countries, industrial agglomeration forces seem to favor productivity gains in the most capital-rich regions, thereby preventing a balanced catch-up by the less wealthy regions, resulting in growing regional inequalities.

By influencing the location choices of businesses or promoting mechanisms for spreading productivity gains and sharing wealth, cohesion policy could combat the growth of inequalities between regions more effectively.

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