EUROPE

Autumn 2007

by Philippe Maystadt

Policymakers have long debated whether to take the jobs to the people or the people to the jobs. But unlike in the United States, Europe’s labour force moves hardly at all. Philippe Maystadt, President of the European Investment Bank, suggests ways to get it moving and spread economic development more evenly

From its earliest days, the European Union has aimed for balanced economic development across its many regions. The Maastricht treaty contains the striking phrase “overall harmonious development”, but however admirable this sentiment may be, requiring Europe’s poorer regions to grow faster than its richer ones raises at least one very awkward question.

Just how much should we try to reduce the differences in regional living standards? As we simply don’t have any robust “scientific truth” about the “right” level of disparities and the correct speed of convergence, I’ll be comparing economic disparities in the Union with those in the United States to assess whether there has been any convergence in regional disparities. But we must bear in mind that while the US has been a nation state for more than two centuries, the European Union is best seen as a confederation of 27 states under a supra-national structure.

Let us first take a historical look at the western part of the Union. In 1960, disparities in what later came to be the EU 15 western European member states, were about twice as large as those between the states of the US. Today they are comparable with American income disparities. Over the past 40 years, the level of regional disparities in the United States has remained broadly constant, and the population-weighted standard deviation of average GDP per head has halved since 1960.

Income disparities have halved both in nominal terms when expressed in euros and in real terms when taking into account differences in purchasing power across Europe’s regions. This is by no means self-evident as in less-developed countries money buys more goods and services than in more advanced countries. That means income disparities between rich and poor countries are less pronounced when expressed in real terms than when expressed in nominal terms.

Income convergence in western Europe first saw a period in which real incomes moved closer together, followed by a period of converging prices. In the 1960s and early 1970s disparities in purchasing power declined by about 40%, then stalled. From the mid-1970s to 1990, nominal income disparities came down by about 40%. With the introduction of the euro and with falling inflation, nominal convergence and real convergence have grown similar, both of them making gradual progress since the mid-1990s.

The average population of the EU’s 15 western European states is about 25m, many more than the 6m for the average US state which is more in line with the population of the average EU region. So perhaps it is more useful to compare the 51 US states with the EU’s 72 regions, such as Bavaria, Wallonia, Ile-de-France and the Canary Islands.

The convergence trend in the EU at country-level is reflected in the regions. But income disparities in the regions are nevertheless still substantial in western Europe when compared with the American states. It is true that poorer EU countries tend to outgrow richer ones, but poor regions do not necessarily outgrow rich regions or even the country average. So regional disparities may persist over time or even grow, posing a challenge for policymakers concerned with creating higher economic growth as well as regional cohesion.

And what about wealth disparities in the EU of 27? With the accession of 10 new states in 2004 and another two at the beginning of this year, the Union’s membership now spans central and eastern Europe. In the 1990s, these formerly communist countries had to face temporary slumps in their average income as most of their industrial production was virtually made obsolete overnight. New production capacity has now been created and new markets conquered, but the catching-up process is still far from complete. The convergence process of the new member states can, however, only be considered on the basis of the short period of 1993-2005.

Unsurprisingly, regional disparities in income are much greater across the enlarged EU’s countries than across the US states. In 2005, average income disparities were twice as high within the then 25 member states as within the American states. But they have come down by nearly one third over the past 12 years. In 2005, the population-weighted standard deviation of GDP per person for the 25 was at a level of the EU-15 countries in the early 1980s. As with the 15, income convergence for the regions again turns out to be slower than convergence between countries. Recent empirical evidence suggests that the central and eastern European regions benefiting most from EU membership are the regions around the country’s capital city or those sharing a border with one of the 15 countries.

If today’s Union of 27 members, regional disparities in Europe are larger than on the other side of the Atlantic, does this mean that the Union’s regional policies are not delivering? Not necessarily. Analysing the effectiveness of public expenditure is a complicated task, not least because the world outside the Union, without structural funds and other support mechanisms, is not directly observable. But as long as the poorer member states grow faster than their richer counterparts, one should not be overly concerned about temporary increases in intra-national disparities.

It is even probable that a temporary increase in intra-national disparities is the very thing that makes us rich. Globalisation and technical change are reshaping production structures all over Europe, leading to the decline of traditional industries and the fast growth of high-technology manufacturing, banking and finance, scientific research and business services. The fact that companies in these sectors benefit from setting-up operations close to one another may boost economic development at the expense of peripheral regions. But to try and prevent these dynamic forces from unfolding would be like cutting the branch we are sitting on!

Also, the EU’s member governments are themselves probably in a better position than Brussels to assess how best to help their poorest regions. The Union has since long recognised this by allocating 90% of the structural funds to the member countries, provided they improve production in laggard regions through investment in infrastructure, human capital and productive physical capital.

It should also be borne in mind that the cost of the EU’s regional policies – although an important part of its budget – is small compared with national income redistribution. Progressive income taxation, social transfer systems and in some countries like Germany even the sharing of tax revenues across regions are all policies that channel a significant part of national income from high-income to low-income regions. This implies that actual inter-regional disparities in living conditions are smaller than the disparities in GDP per person discussed earlier.

In the United States, successful convergence in economic conditions across regions relies strongly on labour mobility. The internal migrations of the workforce are the main driver of income convergence, helped by a common language and all the other factors that foster mobility in America, such as comparatively easy access to housing and children’s education. By contrast, in the Union labour is largely immobile, and despite all the populist speeches about the “Polish plumber” the net migration flows between regions are generally not at all sensitive to the unemployment differentials between these regions. Europe’s labour immobility is of course partly caused by language and cultural differences, and these are barriers that cannot easily be removed. But those barriers that could be tackled include reforming housing policies, reducing the cost of moving and reviewing the conditions under which people are entitled to social benefits so as to end fears of losing long-term benefits.

Reducing the labour supply in economically depressed areas of Europe and increasing it in our booming regions would trigger a dynamic process that would do much to reduce differences in wages and unemployment rates. It’s time we started to think seriously about how to turn this from theory into practice.