The econometric model for the Mezzogiorno (MOMEZ)

1. Regional economic modelling and CSF 2000-2006 policy analysis: the Italian experience in using MOMEZ for the Mezzogiorno Guido Pellegrini - University of Bologna and Ministry of Economy and Finance Aline Pennisi - Public Investment Evaluation Unit, Department for Development Policies (DPS) UVAL Open days – 4th July 2006

2. The econometric model for the Mezzogiorno (MOMEZ) The econometric model for the Mezzogiorno (MOMEZ) was built by the Department for Development and Cohesion Policies, as an instrument for the evaluation of the impact of the MDP (Mezzogiorno Development Plan, now CSF 2000-2006) on growth of Southern regions in Italy SEMINAR ON MACROECONOMIC MODELLING AND CSF POLICY ANALYSIS

3. Outline of the presentation MOMEZ and the CFS 2000-2006 logic Theoretical and econometric issues in setting a regional model for evaluation The structure of MOMEZ and the main differences with a typical UE Hermin-type models Some results about multipliers and elasticities of MOMEZ General evaluation uses of the model Building different policy scenarios Some results and recent examples

4. MOMEZ and the CFS 2000-2006 logic

5. MOMEZ is strictly linked to the CSF logic • The growth mechanism: the basic idea of the CSF (and of the model) is that growth comes from the effects of actions on the economic and social context, that lead to an increase in productivity. This induces the accumulation of human and physical capital, and increases output. • The policy effect channels: Policy effects are captured by changes of public expenditure in infrastructure and state aids. Moreover, changes in expectations and in the social and economic environment induced by policies can be captured by some specific indicators that are named in CSF and in MOMEZ as “break-through” variables. SEMINAR ON MACROECONOMIC MODELLING AND CSF POLICY ANALYSIS

6. Theoretical and econometric issues in setting a regional model for evaluation

7. Theoretical and econometric issues in model setting Estimating a regional econometric model for evaluation in a dualistic economy requires to deal with several issues: • Modelling a dualistic country • How to model the growth mechanism • How to capture the externalities induced by the policy SEMINAR ON MACROECONOMIC MODELLING AND CSF POLICY ANALYSIS

8. Growth mechanism in a dualistic country /1 • Mezzogiorno reflects an incomplete transformation of the Italian economy, with the prevalence of small and low-productivity firms in manufacturing, agriculture and trade and the specialization in traditional sectors. • A dual economy is a not well integrated structure, where both a developed area and a more traditional and developing one co-exist in the same country. • The Northern Italy and the Mezzogiorno are a good example of a dualistic system.

9. Growth mechanism in a dualistic country /2 There are 3 main sources of growth that a developing area can experience within a dualistic environment: • the “neighbourhood” effect: the more advanced neighbourhood can play a conducive role in the development of the Southern regions through the spread of technology and the locomotive demand effect. Even a “close” area can be affected by the international demand through the role of the neighbourhood area • Policy actions can accelerate development offsetting market failures and improving growth transmission channels • Spillover effects may affect agents' expectations modifying the links between regions.

10. Growth mechanism in a dualistic country /3 In MOMEZ: • We adopted a biregional approach, where Mezzogiorno and the Center-North areaare modelized in a similar way. • The model is inserted in a competitive market environment, where large intertwining and several spillovers across markets and regions exist. • We explicitly consider the presence of policy effects and externalities.

11. Modelling the growth mechanism /1 • A theoretically –founded growth model should include an accumulation equation related to different production factors. • A developing area suffers not only shortage of physical capital, but also a mismatch in human capital: the stronger the complementarity between physical and human capital, the wider the gap. This can explain why the relevant production constraints come from the supply side rather than the demand side.

12. Modelling the growth mechanism /2 In the medium-long run the crucial bottleneck in growth is the endowment of production factors. The choice is therefore in favour of a supply-oriented model, with a central role played by accumulation mechanisms. This is coherent with the desired impacts of regional policies, that are mainly in areas such as infrastructure, human capital, and productivity. This choice implies that the setting is only slightly affected by short-term demand shocks, and suggests that the model can be meant for long-term analysis.

13. Modelling the growth mechanism /3 • Another big issue: the econometric way of modelling the economic take off of a group of adjacent regions. • If a local economy takes off, the behaviour and the expectations of agents in the area change radically with respect to the past. • Therefore, the parameters of a model describing the previous behaviour of the economy will also change. • Technically, here the Lucas critique clearly applies. And data on structural changes are usually not available. .

14. Modelling the growth mechanism /4 • There are two ways to tackle this problem: • to follow Lucas critique and identify the “deep parameters” modelling expectations in an explicit way • To use a calibration technique which relies on parameters estimated in a different context. • In our analysis we use both of these approaches. .

15. How to model the policy impact /1 The task of modelling policy transmission channels is not easy. The mere inclusion of proxy variables for different kinds of public expenditure cannot capture the multiplicative effects and the interactions coming from changes in both the expectations and the socio-economic environment of the taking off economy.

16. How to model the policy impact /2 One solution is to choose variables for expectations and changes in social and economic environment due to policy actions. We decided to use some specific indicators that were named “break-trough” variables. These variables were chosen because in those areas in which signals of remarkable local development occurred they improved significantly (at the end of the previous regional policies in Italy) They give a sign that a break-trough with the past is occurring.

17. The 13 key breakthrough variables and their indicators They are chosen through a critical analysis of the economic situation and of the structural characteristics of the southern economy If the expected “break” in the Mezzogiorno actually takes place, it will be caught by the evolution of these variables.

18. Main features of the model and differences with Hermin-type models

19. Main features of the model • The model captures the main growth mechanisms of the developing areas of a dualistic economy and selects the principal transmission channels of public policies. • it is focused on the supply side; disequilibria between demand and resources are solved by import-export from the Centre-North (not through price equilibria) • it is disaggregated into 4 sectors (agriculture, industry, services, public administration) • It consists of 38 behavioural equations and 60 identities (about 90 variables in time-series since 1980, of which 40 exogenous) • different multipliers for capital public expenditure related to infrastructure and state aid

20. Exogenous variables Break-through variables (low and high hypotheses) GDP Labour market, wages and incomes TFP Public Invest. sud K (kapital) Pu.Ad. capital expenditure (QFU) Capital utiliza- tion Centro-Nord (sub-model) Private investment State aids sud consumption International variables B.P. export import Public investm. centro-nord

21. Differences with Hermin-type models The logic is similar (supply-side model; effects through TFP) but: - our model is disaggregated only into four sectors (Hermin more) - Hermin-type models have a price endogenous cycle. We do not have price circle. - in Hermin-type elasticities to policy variaibles are fixed values, calibrated outside the model’s frame; in our case they are estimated within the model - in our model the whole strategy underlying the CSF and all public policies for the development of least favoured areas (EU and national) are taken into account - basically our model is designed to evaluate our policy strategy, Hermin a standard strategy

22. WHAT THE MODEL IS NOT It is not a tool designed for forecasting, because it is not oriented to short term analysis It is not a tool built up to analyze the Southern economy, because not all possible transmission channels are taken into account.

23. MULTIPLIER ANALYSIS The true test of the model is in the evaluation of the impact of several shocks. We use a standard procedure, shocking some exogenous variables and comparing the results with a baseline solution. This procedure allows us to empirically calculate the multipliers and to show the long run properties of the model. This is basically a test of theoretical and empirical consistence of the model. .

24. Shock on world demand ..

25. Shock on public investment ..

26. General evaluation uses of the model

27. The model’s main evaluation tasks • to evaluate the coherence of the programme with its objectives given the macroeconomic and other sustainability constraints(is the strategy compatible with the stability pact, demographic trends, international demand, etc..?) • to identify the transmission channel of the implementation of the development plan(starting from public investments which other economic variables are affected and to what extent? Is the strategy that is going to be implemented affecting the right variables?) • to give an estimation of the impact of the plan on GDP and employment of the Objective 1 Regions : global target.(what is the growth rate of the area that is expected as a consequence of the overall intervention? what conditions must be met to guarantee the targeted growth rates?)

28. MOMEZ is integrated within the framework of the other models used at DPS Regional public accounts forecasting model Regional public accounts Data bases National develop. Fund monitoring system Public capital expenditure frame (1996-2009) Macro-economic model (MOMEZ) European funds monitoring system Short and medium term territorial growth forecast model Data bases Official documents, Economic and Financial Government Plan

29. Building different policy scenarios

30. Preliminary idea on how the model works Evaluation question: ….what growth rate is expected for the Mezzogiorno area as a consequence of the overall intervention? etc… Exogenous variables: Public policy variables (infrastructure/state-aid expenditure) Breakthrough variables International variables MACROECONOMIC MODEL Different growth scenarios representing different hypotheses on the exogenous variables

31. Four basic scenarios used for evaluation purposes • Baseline / counterfactual scenario (no increase foreseen in public expenditure according to specific a investment plan) • Planned public capital investment only (“historical trend” for breakthrough variables – no externalities) • Planned public capital investment with low externalities (“optimistic trend” for breakthrough variables) • Planned public capital investment with high externalities (“more optimistic trend” for breakthrough variables)

32. Examples and recent results

33. Verifying consistency with global objectives ….. Achieve for the Mezzogiorno a significantly higher growth rate than in the EU (average EU-15) Mezzogiorno growth rate (annual % change) – various scenarios

34. Monitoring the global objectives: current scenarios compared to those of the ex-ante evaluation Why ? What happened ? Mezzogiorno growth rate (GDP annual % change) – various scenarios

35. Today’s scenario versus the ex-ante scenario: quantifying “responsibilities” Mezzogiorno growth rate (GDP % change 2000-2008)

36. Changes in the international context EU-15 GDP growth rate World imports growth rate

37. Changes in total public capital expenditure Public capital expenditure in the Mezzogiorno (real values)

38. Changes in breakthrough variables / 1: “attracting tourism” – comparing ex-ante, intermediate and today’s expectations

39. Changes in breakthrough variables / 2: “law enforcement” – comparing ex-ante, intermediate and today’s expectations

40. Evaluation of impact respect to counterfactual situation Mezzogiorno growth rate (annual % change) – various scenarios