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

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

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 Core area: low countries (benelux), western germany, north-eastern france and south-eastern england

EU economic geography

EU economic geography Regions 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 41.3 120.8 134.2 18.1 Source: EU Commission 2001

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

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

Change in income standard deviation 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 -1.5 Greece 1.0 1.5 -0.8 Portugal 5.2 0.3 1.4 Spain 1.3 Finland 5.5 France 0.9 1.9 0.1 Sweden 8.9 Ireland 0.0 5.1 UK -1.9 2.7 Source: EU commission 1996 and 2003

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)

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.)

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.

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

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.

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

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.

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

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

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.

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.

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

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

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

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)

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

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

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

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

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

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

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

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

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

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

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

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

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)

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

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

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.

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 Convergence ERDF ESF Cohesion Fund Regional Competitiveness and Employment ERDF ESF European territorial Cooperation ERDF 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 %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

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

European Territorial Cooperation 2007-2013 Allocation: €7.75 bn. for cross-border, transnational and interregional cooperation Cross-border areas

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).

Indicative Financial Allocations: 2007-2013 Political allocation Indicative Financial Allocations: 2007-2013 Country National Convergence Objective Total EU Regional Funds   GDP per head, €, 2005 Million € € per head in recipient regions € per head in recipient country Share of GDP % Share of total regional funds % Bulgaria 7,913 5,888 753 6,047 768 3.15 2 Romania 7,933 16,912 778 17,316 795 3 5.6 Latvia 11,180 4,010 1,725 4,090 1,749 3.52 1.3 Poland 11,482 59,048 1,546 59,698 1,562 3.43 19.4 Lithuania 11,914 5,999 1,737 6,096 1,757 3.42 Slovak Republic 13,563 9,663 1,796 10,264 1,904 3.3 Estonia 14,093 3,011 2,221 3,058 2,247 3.31 1 Hungary 14,393 20,243 1,998 22,451 2,210 3.22 7.3 Portugal 16,891 18,316 1,750 19,147 1,847 1.82 6.2 Czech Republic 17,156 22,979 2,252 23,698 2,323 3.25 7.7 Malta 17,330 747 1,878 761 1,922 2.35 0.2 Slovenia 19,462 3,646 1,827 3,739 1,874 1.7 1.2 Cyprus 20,753 193 265 580 812 0.56 Greece 21,589 17,447 1,585 18,217 1,658 1.34 5.9 Spain 23,069 23,411 1,566 31,536 0.49 10.2 Italy 23,474 19,255 1,112 25,647 449 0.25 8.3 Germany 25,797 14,323 933 23,449 284 0.14 7.6 France 25,077 2,838 1,623 12,736 208 0.1 4.1 Finland 25,774 1,533 295 0.13 0.5 United Kingdom 26,715 2,594 949 9,468 160 0.07 3.1 Belgium 27,135 579 452 2,020 195 0.09 0.7 Sweden 27,721 1,682 188 0.08 Denmark 28,375 545 101 0.04 Austria 28,852 159 568 1,301 161 0.4 Netherlands 29,374 1,697 105 0.05 0.6 Ireland 32,197 815 207 0.06 0.3 Luxembourg 59,202 58 130 0.02

Structural Funds: Eligible areas in EU25 for Objective 1 and 2 between 2000 and 2006 Phasing-out (till 31/12/2005) 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)

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

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

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

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?