1. The impact of the EU's Structural and Cohesion Funds on real convergence in the EU Dr. Reiner Martin EU Countries Division European Central Bank
Warsaw, 27 November 2003

2. Introduction
"The evidence examined in [the 2nd Cohesion Report] shows that over the previous programming periods ( and ) Community cohesion policies have had some notable success. This is perhaps most visible in the case of the regions where development is lagging behind, where there has been a general process of catching up in economic and social terms." (European Commission, 2001).

3. Introduction
“The best thing the EU could do for Greece is to cut off the structural funds immediately (…); anybody who works hard at a regular business is regarded as an idiot, since it’s much easier to set up a project to draw in European subsidies.” (The Economist 27 March 2003, quoting a ‘senior Greek official in Brussels’).

4. The EU’s Structural and Cohesion Funds
Overview
Introduction
The EU’s Structural and Cohesion Funds
Infrastructure and human capital as determinants for real convergence
Evaluations of the Structural and Cohesion Funds
Conclusions

5. No sector-specific policy like the Common Agricultural Policy (CAP)
The EU’s Structural and Cohesion Funds
Main aim is to improve long-term growth and employment prospects (supply-side approach)
No fiscal federalism
No sector-specific policy like the Common Agricultural Policy (CAP)
Less firm-level oriented than most national regional policies

6. European regional policy objectives during the 2000-06 period
The EU’s Structural and Cohesion Funds
European regional policy objectives during the period
Relatively poor regions (Objective 1)
Regions with specific economic problems (Objective 2)
Education, training and employment outside Objective 1 regions (Objective 3)
Cohesion Fund for relatively poor Member States

7. Population covered by European regional policy objectives (in %)
The EU’s Structural and Cohesion Funds
Population covered by European regional policy objectives (in %)

8. EU resources for structural action
The EU’s Structural and Cohesion Funds
EU resources for structural action
From EUR 8 billion per year (1989) to 32 billion in 1999 (1999 prices)
From 20% of EU budget (1987) to above 35% (1999)
European Summit in Berlin (1999) resulted in slight decline of available resources for compared to

9. The EU’s Structural and Cohesion Funds
EU resources committed to structural action, Breakdown according to Member State and objective*

10. The EU’s Structural and Cohesion Funds
Functional distribution of EU Funds in Ireland, Greece, Portugal and Spain, (in %)*

11. Financial resources for Acceding Countries
The EU’s Structural and Cohesion Funds
Financial resources for Acceding Countries
Until 2004 EUR 3 billion per year for all 12 AC and Candidate Countries (1999 prices)
Between May 2004 and end 2006 EUR 21.7 billion for 10 AC (1999 prices)
2/3 of this will be Structural Funds, 1/3 Cohesion Fund
AC likely to be fully eligible for Objective 1 status (except Prague, Bratislava and Cyprus)

12. Convergence theory Divergence theory
Determinants of real convergence
Convergence theory
Free movement of goods and factors of production ensures that all regions achieve their technologically determined optimal level of capital intensity
Economic integration will lead to ‘automatic’ convergence
Conditional convergence theory: allows for regional/national differences in production technologies
Divergence theory
Stresses differences in technology, transport costs and external effects
Policy action is required to bring about convergence
Empirical evidence for last 20 years for the EU shows convergence at the national level but less so at the regional level

13. Infrastructure and real convergence
Determinants of real convergence
Infrastructure and real convergence
Public infrastructure supports long-run growth by providing complementary inputs for private production
However, the net positive effect on production depends on whether it crowds in more private investment than it crowds out
Why public infrastructure?
Public good case
Increasing-returns-to-scale/natural monopoly case

14. Determinants of real convergence
Empirical evidence
Major methodological problems (e.g. accounting for quality differences, reverse causality)
There is reasonable evidence of positive effects of public investment on growth
Benefits of public investment are greatest in countries with a low level of infrastructure capital stock
Identification of key infrastructure bottlenecks is crucial in order to ensure an appropriate return on public infra-structure investments

15. Human capital and real convergence
Determinants of real convergence
Human capital and real convergence
Endogenous growth theory gives considerable importance to human capital as explanatory factor for growth
Idea that human capital also increases the capacity to innovate and to adapt new technologies
Why public investment?
Social returns to individuals’ investments in education might outweigh private returns
Case for publicly subsidised education is reinforced if credit markets are imperfect

16. Determinants of real convergence
Empirical evidence
Methodological problems (proxies for human capital, reverse causality)
Some evidence that education is beneficial for growth but weaker than theory would suggest
Diminishing returns on education, primary education being the one with the highest return
On-the-job training and adult education could be also beneficial but the available evidence is rather limited

17. Types of evaluations Some common problems
Evaluations of the EU Funds
Types of evaluations
Evaluations for specific projects or programmes
Analyses based on aggregate public investment or EU transfers as explanatory variable
Macroeconomic models
Some common problems
Lack of sufficiently long and detailed regional time series for many variables
Funds have operated for relatively short period (particularly problematic for the identification of supply-side effects)

18. Evaluations for specific projects or programmes
Evaluations of the EU Funds
Evaluations for specific projects or programmes
Quality of the evaluations varies considerably
Somewhat less interesting from a macroeconomic perspective
Indispensable for making the right choices in designing concrete projects and programmes
Venables and Gasiorek (1999) use models based on economic geography to investigate inter-regional spill-over effects of major CF funded infrastructure investments
Location of such projects crucial for extra-regional effects

19. Econometric tests using cross-section or panel-data analyses
Evaluations of the EU Funds
Econometric tests using cross-section or panel-data analyses
This strand of evaluations suffers in particular from data constraints
On balance rather pessimistic although there is some heterogeneity in the results
Recurrent issue is the impact of the quality of national institutions in the recipient countries on the effectiveness of the Funds

20. Macroeconomic models HERMIN
Evaluations of the EU Funds
Macroeconomic models
Results differ considerably, depending on the model specifications and the ways in which the models take the impact of the Funds into account
HERMIN
HERMIN introduces the effect of the Funds in two ways:
1. Standard expenditure and income shocks
2. Policy externalities (Increased TFP, increased attractiveness for FDI, enhanced ability of endogenous industries to compete abroad)
Simulation assumes funding to terminate after 2006
Supply-side effects of 1-2% GDP growth per year for Cohesion Countries and Eastern Germany

21. Evaluations of the EU Funds
HERMIN simulation results on the impact of Objective 1 CSFs on the level of real GDP in the Cohesion Countries and Eastern Germany
(in % deviation from baseline)

22. Evaluations of the EU Funds
QUEST II
QUEST II model is forward-looking, with behavioural equations based on the intertemporal optimisation of households and firms
Real interest and exchange rates are determined endogenously, so that possible crowding-out effects can be taken into account
Impact of Funds is modelled as increase in the public capital stock, which impacts on a neo-classical production function
For the results of QUEST II simulations for the Cohesion Countries are low compared to HERMIN
HERMIN and QUEST II estimates for supply-side effects are more similar

23. Evaluations of the EU Funds
QUEST II simulation results on the impact of Objective 1 CSFs on the level of real GDP in the Cohesion Countries
(in % deviation from baseline)

24. Considerable uncertainty about the long-term supply-side effects
Conclusions
Short-term redistribution and demand effects of the Funds more easily identifiable and relatively undisputed
Considerable uncertainty about the long-term supply-side effects
‘Smallest common denominator’
Well designed measures to upgrade infrastructure and to increase human capital are likely to have a positive impact on growth
In particular in regions where infrastructure and human capital are likely to represent growth bottlenecks
On balance the results suggest that EU regional policy can have a positive long-term impact on economic growth in the recipient countries and regions

25. Improvements to the current system of regional support
Conclusions
Improvements to the current system of regional support
Further strengthen the focus on physical and human capital building
Improvements of Member States’ administrative capacity could become a new priority for the Funds
Further simplifications of the procedures
Improved co-ordination between EU regional policy, national regional policy and non-spatial European and national policies
Further spatial concentration of support
Enlargement shifts main dimension of income differences from regions to countries
Allocation of funding may thus need to become more strongly based on national socio-economic characteristics

26. More far-reaching lessons
Conclusions
More far-reaching lessons
Funds can only exert a positive impact on real convergence if the supported countries are characterised by a stable macro-economic environment and institutional and microeconomic structures that are conducive to growth
Low level of inflation and sound budgetary policies
Regulatory framework that facilitates the setting-up and growth of endogenous companies as well as FDI, a business-friendly tax system, sound financial markets
Look more closely at the link between factor returns and productivity in order to ensure for example that wage-setting systems take local productivity differences sufficiently into account

27. Thank you for your attention!