Location Effects, Economic Geography and Regional Policy Jan Fidrmuc Brunel University

Europe’s regions Concern for Europe’s disadvantaged regions has always been part of EU priorities.  Treaty of Rome: preamble. Pre-1986, most spending on regions was at the national level  Rural electrification, phones, roads, etc. Entry of Spain & Portugal created a voting block in the Council (with Ireland and Greece) that induced a major shift in EU spending priorities  Away from CAP towards poor-regions. “Structural spending” now about 1/3 EU budget.

Europe’s Economic Geography: Facts Europe highly centralised in terms of economic activity.  Western Germany, Benelux, N.E. France and S. England: 1/7 land, 1/3 of pop. and ½ GDP. Periphery has lower standard of living.  More unemployment.  More youth unemployment.  More poverty.

Geographic income inequality Income distribution even more uneven at regional level. Within nations, economic activity is very unevenly distributed Income distribution has become:  More even in EU as a whole  Less even within EU nations (across regions)

EU-wide Income Differentials Very uneven income distribution GDP per capita:  Luxembourg: 207% of EU average.  Bulgaria: 29% of EU average.

National Income Differentials Example: UK

Geographic Specialisation Krugman index of specialisation  Measures what fraction of manufacturing has to change sector to make a nation’s sector-shares same as EU average  Most EU nations becoming more specialised.

Geographic Specialisation

Theory 2 major approaches linking economic integration to change in 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:  Theory of comparative advantage explains international division of labor.  NEG explains intra-national distribution.

Comparative Advantage and Specialisation

Comparative Advantage and Specialization Countries posses different factor endowments (e.g. skilled vs unskilled labor, raw materials, climate) Factors that are relatively abundant are cheaper locally: comparative advantage With free trade, countries can specialize in producing goods for which they have a comparative advantage and import the remaining goods Result: integration leads to increased national specialization.

Agglomeration & NEG When productive factors (capital and labor) are mobile (internationally or inter-regionally), integration may have different effects. Scale economies & trade costs encourage geographic clustering of economic activity. Two possibilities:  "Overall clustering“ = some areas with lots of economic activity, others empty  “core-periphery”.  "Sectoral clustering"  each sector clusters in one region, most regions get a cluster.

Agglomeration & Dispersion Forces Lower trade costs cause  Agglomeration forces: industry clusters geographically.  Dispersion forces: industry disperses geographically.

Agglomeration Forces Many agglomeration forces:  Technological spillovers (e.g. Silicon Valley),  Labor-market pooling (e.g. City of London),  Demand linkages (a.k.a. backward linkages): locating close to final market,  Supply linkages (a.k.a. forward linkages): locating close to suppliers etc. NEG focuses on demand & supply links since they are clearly affected by economic integration (lower trade costs).

1. If some industry moves to big region 2. Expenditure Shifting workers spend incomes in big region instead of in small region 3. Market Size Effects: big market gets bigger, small market gets smaller 4. Production Shifting Due to trade costs, firms prefer to locate in big market. More industry moves to big region Circular Causality & Demand Linkages

1. If some industry moves to big region 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 4. Production Shifting Some more firms move from small market to big market, attracted by lower costs Circular Causality & Supply Linkages

Dispersion Forces Dispersion forces counter the tendency towards agglomerations of economic activity:  Rents and land prices,  High cost of non-traded services,  Competition with other firms. The NEG focuses on “local competition”  As trade costs fall, distance provides less protection from distant competitors.

Agglomeration vs Dispersion Simplified framework:  Agglomeration force: demand effect only, firms have incentive to locate close to markets  Dispersion force: local competition effect only 2 regions: North and South; North is bigger Equilibrium w/o trade: share of firms in North between ½ and 1 Trade liberalization: locating in South no longer protects firms from competition Agglomeration in North increases

Comp. Advantage and NEG Factors of production more mobile nationally than internationally (especially labor) Countries specialize according to their comparative advantage  Income convergence across countries Agglomeration of economic activity within countries  Rising inequality within countries This helps explain the pattern of regional income inequality observed in Europe

EU Regional Policy EU always had poor regions (e.g. Mezzogiorno, etc.). Much spending on poor EU regions by national governments 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.

EU Regional Policy For historical reasons, EU has five “Funds”,  Four “Structural Funds”, Spending in any qualified region.  “Cohesion Fund”. Spening only in poor-4 (Spain, Portugal, Greece and Ireland). 5 Funds work together under overall strategy. Many programs, initiatives, and objectives, BUT over 90% is spent on three priority “objectives.”

Objectives Convergence: 80% of regional aid  Aimed at reducing income disparities between regions  Eligibility: less than 75% of average EU income, and ‘phasing out regions’  Cohesion Fund: money allocated to countries (rather than regions) with below 90% of EU27 average income Regional competitiveness and employment  Aimed at strengthening competitiveness and employment  Eligibility: all non-convergence regions  Development projects to encourage innovation, entrepreneurship, etc. European Territorial Co-operation  Aimed to reinforce cross-border, transnational co-operation  Only 2% of regional aid

Convergence and Competitiveness Objective Regions: convergence competitiveness