The Impact of European Integration and Enlargement on Regional Structural Change and Cohesion

1. The Impact of European Integration and Enlargement on Regional Structural Change and Cohesion Regional structural change and cohesion in the EU: Policy Recommendations Dr Edgar Morgenroth Economic and Social Research Institute

2. Introduction The aim of the Workpackage were to: • Compile the main findings – covered in other presentations • Provide a general characterisation of the winning and loosing regions • Identify the overall distributional implications of EU enlargement. • Assess the effectiveness of current policies • Identify necessary changes in EU policies and suggest additional policy initiatives if appropriate.

3. Rationale for Policy • Large income (and other) differences can destabilise the EU or even individual member states – political economy • Poor countries can get stuck in a poverty trap – new economic theories • Market inefficiencies can hinder convergence – traditional economic theories • Of course disparities may also be an efficient outcome – no policies needed?

4. Political Economy • Alleviating disparities in order to maintain political stability is not strictly speaking an economic argument for interventions but this does not make this rationale any less relevant. • EU policy aims at reducing disparities – 75% of EU GDP (Objective 1 – Convergence Priority)

5. Cumulative Causation • In the endogenous growth literature externalities that can be increased through key investments can permanently increase the growth rate – poor countries may be left behind • Increasing returns to scale, transport costs and market size differences will lead to a progressive relocation of the IRS industries to the core.

6. Market Failure • The poor functioning of markets may lead to divergence between regions • Trade barriers (tariff or non tariff) protect inefficient firms – if these are in poor regions then these do not benefit from competition if they apply to rich regions then firms from poor regions cannot benefit from the larger market • Low factor mobility results in inefficient allocation of resources – labour & capital

7. Tradeoffs • Equity vs. efficiency • It is always possible to reduce disparities by taking from the rich and giving to the poor – this might lead to disincentive effects in both type of regions – aim to maintain Objective 1 status! • Policy interventions should result in decreasing need for such interventions – sustainability • Simple transfers that do not improve the structure of the regional economy will not work

8. Who should carry out policy interventions? • If disparities are either of the political economy or poverty trap type, policy will need to be instigated at the national or supernational (EU) level. • If however they are of the market failure type then the source of these will determine the level at which policy should be enacted. There is however a role for the EU and/or the Member States in ensuring that the necessary action is taken.

9. Current Policy - EU • The primary regional policy tool of the EU is the Community Support Framework (Structural Funds, Cohesion Fund, Pre-Accession Structural Funds). • CSF – investment in infrastructure, human resources and aids to productive sector • Other policies – Common Agricultural Policy, Competition, Internal Market.

10. EU- Policy Effectiveness • The ‘Structural Funds’ have been assessed in a number of studies. • Given the resources expended this is an important task. • Some find significant impacts while others do not. • These differences are to a large extent due to the methodologies that are utilised.

11. EU- Policy Effectiveness • Problems in evaluation: • Availability of comprehensive EU-wide regional databases limited the analysis • The EU has been developing gradually, with integration occurring steadily between various states at various times. This leads to evolving convergence benchmarks and blurs the assessment of policy impacts. • Independent regional policies have been implemented by the Member States – it is difficult to disentangle the impact of the CSF independently of other policies

12. EU- Policy Effectiveness • I-O models – Beutel (2002) best suited to identify the short term Keynesian effects - • Single equation econometric models and multi-equation econometric models - Ederveen et al. (2002) – no impact • Small macro-models - De la Fuente and Vives (1995) – EU policy helped convergence • Fully specified macroeconomic models is discussed, e.g., in Bradley et al. (2004) HERMIN, Roeger (1996) QUEST – mixed impacts

13. Hermin Results • The simulation yield a large range of results on the impact on GDP, employment, unemployment, productivity, government borrowing....(27 variables) • Given the range of results that are available but the limited time for this presentation it is useful to concentrate on just one – the ‘cumulative GDP multiplier’: • The increase is relative to the no-Structural Funds baseline level!

14. Policy Impact

15. Current Policy – EU-15 • A variety of regional policies are enacted by the national governments and regions in the EU-15. • In many countries regional policy has a long tradition but has had patchy results – Mezzogiorno vs. Bavaria – rankings of regions tend to be persistent but trends in disparities differ across countries.

16. Current Policy- NMS • Regional policies were by in large not considered until the mid-1990’s. • Initially some countries re-drew regional boundaries and reformed regional administrative structures in order to prepare for accession • Too early to identify impact

17. Specialisation – EU-15 • Institutional integration does not appear to be associated with specialisation • The link between economic integration and specialisation is difficult to establish • No catastrophic re-location and agglomeration of IRS industries • Weak core-periphery pattern

18. Specialisation – EU-15 • Slow convergence of specialisation degrees and industrial structure • Diverse regions seem to better off • Regions focused on heavy industries and the primary sector are performing poorly

19. Specialisation - NMS • A number of linked processes have impacted on specialisation – political restructuring, trade re-orientation, integration • Differentiated impact • Divergence between the regions in the NMS • Core-periphery patterns • Regions with external border perform less well – these are more specialised

20. Specialisation - NMS • Manufacturing and the primary sector have declined strongly in most NMS regions – growth in services • Regions that have had the most structural change have not performed well • Shift from capital intensive heavy industry to labour intensive industries (comparative advantage) in many regions • Nevertheless there is a positive relationship between high IRS-capital intensive industries and GDP

21. Foreign Direct Investment • FDI has changed the pattern of industrial location across and within countries • Some countries have benefited more (e.g. Hungary and Estonia) • Spatially differentiated location patterns – distance from core determines type and level of FDI inflow (e.g high-tech in Hungarian regions with EU border)

22. Foreign Direct Investment • Weak linkagas between foreign and indigenous firms • Agglomeration among foreign firms • FDI has positively impacted on regional growth but has not led to convergence

23. ‘Winners and Losers’ • Regions heavily focused on the primary sector (EU-15 and NMS) have not performed well • Similarly those with a specialisation in heavy resource intensive industries • More diverse regions have done better • Weak core-periphery pattern – capital city regions do better, regions with external border do worse

24. Policy Recommendations • A diversified industrial structure appears to aid the level and growth of GDP – support diversification • Specialisation in the primary sector and resource intensive industries is associated with low pc. GDP – support restructuring. • EU-15 industrial structures and pc. GDP are converging slowly – increase structural convergence.

25. Policy Recommendations • CSF – aids to the productive sector need to be focused on diversification and away from primary and poor growth secondary sectors • Other CSF interventions need to be targeted accordingly – especially human resources • The CSF has a differentiated impact across countries and regions – the underlying institutional and economic structure is an important determinant of these differences. • In cases where the impact is likely to be low these constraints need to be tackled first.

26. Policy Recommendations • The NMS are getting more dissimilar compared to EU-15 • This may have a negative long-term impact by locking the NMS into more labour intensive industries which are only competitive as long as wages are low – importance of FDI • FDI can help poorer regions in the EU especially high-tech firms but linkages between indigenous and foreign firms need to be fostered.