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A Model-based Analysis of the Potential Impact of EU Cohesion Policy programme 2007-2013 REGIO Open Days, October 2007 Jan in t Veld DG ECFIN, Economic.

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Presentation on theme: "A Model-based Analysis of the Potential Impact of EU Cohesion Policy programme 2007-2013 REGIO Open Days, October 2007 Jan in t Veld DG ECFIN, Economic."— Presentation transcript:

1 A Model-based Analysis of the Potential Impact of EU Cohesion Policy programme 2007-2013 REGIO Open Days, October 2007 Jan in t Veld DG ECFIN, Economic and Financial Affairs European Commission Unit A1- Econometric models

2 QUEST model simulations of Cohesion Policy programme 2007-13 Cohesion Policy is second largest item EU budget: 308 billion (in 2004 prices) Simulations relate to "convergence" objective and part of "regional competitiveness and employment" objective (262bn euros, 80% of total) Assumed payment profile based on programme period 2000- 06, i.e. transfers spread out over 2007-15 indexation 2 percent per annum, conversion exchange rates average 2006 Assuming no binding co-financing restriction Fields of intervention: –Infrastructure ( transport, environmental, telecommunication, urban rehabilitation, social infrastructure and health) –Human resources (education, labour market programmes, social inclusion, entrepreneurship, actions for women ) –Productive environment (business support,tourism, RTDI )

3 DG ECFINs QUEST II model Model consistent with economic theory – derived from micro foundations of optimising economic agents based on intertemporal decisions: agents do not act as if they only live one-period (consumption-savings) endogenously determined interest rates and exchange rates Linked global model (37 countries/regions): incorporates intercountry interactions : one countrys exports are another countrys imports (no black holes) Cohesion policy fields of interventions matched by various government variables in model Long run supply side effects : based on assumptions – range of uncertainty

4 Dynamic macro-economic models Macro-econometric models Real Business Cycle (RBC) models Macro-econometric models with micro foundations and consistent expectations Dynamic Stochastic General Equilibrium (DSGE) models Modelbuilding industryAcademics

5 GDP=C+I+GC+GI+X-M C Private Consumption: current disposable income, expected future disposable income, financial wealth, interest rates X Exports: world demand, exports prices, competitors prices (exchange rates) I Private Investment: current profits, expected future profits, capital costs (interests rates) M Imports: domestic demand, domestic prices, import prices (exchange rates)

6 GOVERNMENT DEFICIT = i*B + GC + WG*LG + GI + ben*U + TR+ ISUB – TW – TC – TIND – Tres – COH Government expenditures: government interest payments on public debt i*B government consumption, subdivided into »government purchases of goods and services GC »government wage bill (public sector employment LG times public sector wages wG) government investment GI unemployment benefits paid to the unemployed ben*U other government transfers to households TR subsidies to firms ISUB Government revenues: wage taxes TW, corporate profit taxes TC indirect taxes TIND, a residual (lump-sum) tax TRES and fiscal transfers received from the EU COH (which is negative for net contributors)

7 Structural Funds Investment in Infrastructure and Human Capital Demand impact : additional spending GDP + but potentially crowds-out private spending (interest rates, wages ) GDP - Supply side impact : Public Capital stock Productivity GDP + Human Capital (skills) Productivity GDP +

8 NMS2007200820092010201120122013201420152020 GDP0.600.921.421.782.232.593. Consumption2.942.983. Investment-2.12-2.73-2.78-2.49-2.07-1.47-0.510.862.273.88 Employment0. Price level0.290.681.171.632.102.502.993.694.634.81 Real effective exchange rate (+ = depreciation) -1.11-0.96-0.57-0.120.360.811.301.932.743.17 Net transfers rec. (% of GDP) 0.741.732. Trade balance (% of GDP) -0.70-1.18-1.29 -1.33-1.31-1.39-1.73-1.86-1.01 Simulated effects for NMS countries (% differences from base)

9 EU152007200820092010201120122013201420152020 GDP-0.11-0.16-0.19-0.21-0.22-0.23-0.22-0.15-0.07-0.08 Consumption-0.25-0.32-0.35 -0.34-0.32-0.28-0.25-0.160.06 Investment-0.20-0.46-0.65-0.80-0.90-0.97-0.99-0.93-0.81-0.82 Employment-0.02-0.08-0.13-0.16-0.17-0.16-0.15 -0.140.04 Price level-0.03-0.06-0.07-0.08 -0.07- Real effective exchange rate (+ = depreciation) -0.06-0.09-0.12-0.14-0.15-0.16-0.18-0.19-0.18-0.10 Net transfers rec. (% of GDP) -0.05-0.13-0.16 -0.14-0.13-0.17-0.160 Trade balance (% of GDP) Simulated effects for EU15 countries (% differences from base)

10 Cohesion transfers (% of GDP) and GDP effects: NMS, EU15 and EU

11 Sensitivity analysis Infrastructure investment: investment in transport infrastructure is assumed to have the same marginal product as that of private investment. All other infrastructure investment (environmental infrastructure, telecommunication infrastructure, urban rehabilitation, social infrastructure and health) is assumed to be only half as productive Human capital: educational investment is assumed to have the productive impact as described in section 4.3 above, all other human capital investment (labour market programmes, social inclusion, entrepreneurship and actions for women) is assumed to have only half the productive impact Productive environment: investment support leads to a higher capital stock, but R&D investment has only half the impact on TFP as assumed in the first scenario

12 Absorption problems – e.g. Herve and Holzmann (1998) Waste of transfers. Due to lack of adequate administrative environment, transfers may used for investment projects with zero or negative economic return. Administrative costs to ensure the best possible use of transfers. Extra resources needed for programming and monitoring that cannot be used for increasing the productive capacity of the economy. This should at least seek to avoid waste of transfers, and aim to avoid sub-optimal use Rent-seeking activities Transfers provide an incentive to economic agents in public and private sector to invest resources in directly unproductive activities to catch a rent in the form of a share of the transfers. Competition for resources absorbs resources that can no longer be used productively Diversion of funds to consumption Positive income shocks affect consumption-investment decision of private and public sectors. Because of consumption-smoothing behaviour, the increase in future consumption possibilities will lead to a higher consumption on impact, to the detriment of investment

13 Alternative productivity assumptions : Cohesion transfers (% of GDP) and GDP effects

14 Flexible Exchange Rate (PL): independent monetary authorities (inflation targetting) in short run more restrictive: higher nominal interest rates to dampen short run demand expansion in long run : nominal exchange rate depreciation to gain competitiveness Fixed Exchange Rate (LT): (Euro area, currency board, fixed pegs): in short run less restrictive: no interest rate response, higher inflation in long run : in order to gain competitiveness (real exchange rate depreciation) a period of disinflation is required (lower GDP effects)

15 Conclusions Long run gains from investment in infrastructure, human capital and R&D (Lisbon Strategy) Short run positive demand impact (but considerable crowding out) Costs to donor countries : increase in EU budget contributions (redistribution) But these GDP losses for donor countries are mitigated by gains in net exports Exchange rate regime matters: countries with fixed exchange rate may have larger short run gains, but they need period of disinflation to gain competitiveness

16 Conclusions (contd) Short run demand impact may lead to further overheating of already overheated economies These simulations assumed optimal efficient productive use of transfers (too optimistic ?) Potential absorption problems leading to lower efficiency: –Rent seeking –Protectionism –Market rigidities How can such efficiency losses be minimised? Reference: The Potential Impact Of The Fiscal Transfers Under The EU Cohesion Policy Programme, European Economy, Economic Papers, no. 283, June 2007

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