Regional Policy

1. Regional Policy Lotte Ovaere, KULeuven Louvain Institute for Ireland in Europe Fall 2011

2. Course outline • Facts on Europe’s economic geography • Theory • Comparative advantage • New economic geography • EU Regional Policy

3. 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?

4. Europe at night

5. EU economic geography

6. EU economic geography

7. Geographic income inequality 2002 • Luxembourg is 110% richer than average • Bulgaria only 26% of average

8. Luxemburg Denmark Ireland NL EU Austria Belgium Ark, Mon, West V, Miss

9. Change in income standard deviation

10. 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)

11. 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.)

13. 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.

14. 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

15. Summary of facts • Europe’s economic activity is highly concentrated geographically at the national level and within nations • Geographic Distribution of economic activity has become more concentrated within countries (proxy: income per capita) • Only modest reallocation of industry across nations • Specialization on a sector-by-sector basis • Sub-national level: industry more concentrated spatially.

16. 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

17. 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.

18. Comparative Advantage and Specialisation Relative labour endowments in Europe 83% above EU average

19. 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

20. 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

21. 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.

22. 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.

23. Question • Give examples of sectors on which there exist scale economies. • What about cheese production and car engine production?

24. 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

25. 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

26. 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)

27. Circular Causality & Demand Linkages Market size • Some firm moves to big region To have access to a bigger market and reduce trade cost 4. Production Shifting, Due to trade costs firms prefer to locate close to big market. More industry moves to big region 2. Expenditure Shifting, Firm and its workers spend incomes in big region instead of in small region 3. Market Size Effects: big market gets bigger, small market gets smaller

28. Circular Causality & Supply Linkages Cost of production 1. Some firm moves to big region 4. Production Shifting Some more firms move from small market to big market, attracted by lower costs 2. Production Shifting Migrated 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

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

30. 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

31. 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.

32. 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

33. Agglomeration vs. dispersion forces Agglomeration and dispersion forces Dispersion force B A Agglomeration forces E % firms in big region

34. 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

35. Effects of integration Agglomeration and dispersion forces Dispersion force Dispersion force with freer trade E’ E Agglomeration forces % firms in big region 100%

36. Complicating factors • Circular causality in agglomeration force Upward sloping agglomeration force curve • Shift in dispersion force curve: additional dispersion forces at work • …

37. 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

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

39. 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 Enlargement

41. 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)

42. EU Regional Policy • Funds work together under overall strategy • Many programs, initiatives, and objectives, BUT over 90% is spent on three priority “objectives”

43. 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.

44. Objective 1 regions 2000-2006

45. 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.

46. 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.

47. Objectives, Structural Funds and Instruments 2007-2013 infrastructure, innovation, investments etc. vocational training, employment aids etc. environmental and transportinfra- structure, renewableenergy all Member States andregions MemberStateswith a GNI/headbelow 90% Objectives Structural Funds and instruments Convergence ERDF ESF Cohesion Fund ERDF ESF RegionalCompetitiveness and Employment European territorial Cooperation ERDF

48. Objective and Budget allocation

49. Structural funds allocation by type of region 2007-13 Total: €347.4 billion Convergence: €199.3 bn. Cohesion Fund: €69.6 bn. Phasing out: €13.9 bn. Phasing in: €11.4 bn. Competitiveness: €4.5 bn. Cooperation: €7.8 bn. in current prices

50. European Territorial Cooperation2007-2013 Allocation: €7.75 bn.forcross-border, transnational and interregional cooperation Cross-border areas