European Integration: A Review of the
Literature and Lessons for NAFTA
Norbert Fiess*
and
Marco Fugazza#
- September 2, 2002 -
1. Introduction
Economic integration can be described as a process and a means by which a group of countries
strives to increase their level of welfare. Regional economic integration may take different forms
depending on the degree of integration between countries. The four main types of regional
arrangements are: free trade agreements, customs unions, common markets and single markets.
A first is a preferential trade arrangement in which tariff rates among members are set to zero. In
a customs union, members additionally opt for a common external tariff. Further up in the
integration scale is the common market whose members permit free, or at least greatly increased,
factor mobility within the market. The single market is the highest form of economic integration.
A single market arrangement stipulates that all producers and consumers are governed by exactly
the same rules; implying that they must be treated equally in all parts of the market. An even
deeper level of integration is reached if countries within a single market agree to coordinate their
economic policies (Economic Union) or if countries within a single market agree to common
policies in almost every sector (Political Union).
This paper reviews theoretical and empirical evidence relevant to the NAFTA integration
experience in order to develop guidelines for policy intervention and orientation. Attention is
focused on Mexico as its less advanced level of development relative to the US and Canada might
represent an impediment to pursuing the integration process, at least politically. The discussion
centers around three major elements. First, we review the predictions of different integration
theories with respect to convergence and regional development. Second, the European experience
is used to document empirically the possible impact of the progressive creation of a completely
integrated economic area. Examples of past accession, namely the accession of the Iberian
countries and Ireland are used to illustrate the impact of economic integration, and to identify
*
#
The World Bank
CERAS, Ecole Nationale des Ponts et Chaussées
1
determinants that account for the differences in country and regional integration experiences. The
EU enlargement to some Central and Eastern European countries (CEEC) is used to illustrate the
impact of the accession of group of countries to an already existing integrated economic area.
Third, by drawing on the EU experience as a possible benchmark for a theoretical assessment, the
relevance of policy intervention in the process of economic integration is discussed.
The European integration experiences indicates that economic convergence at country level has
lead to regional inequality. Deepening economic integration among NAFTA members is likely to
exacerbate regional inequalities in Mexico, too. As a consequence, labor migratory pressures
towards the US could be maintained and possibly increase. The subsequent potential social
discontent may lead to a reversal in the political motivation of pursuing the process. In that
context, policy intervention may become relevant.
We present three major orientations for policy intervention:
•
Country wide development should be achieved by promoting economic development at
the regional level to contain inter-regional disparities. Policy makers should attempt to set
up an industrial and development strategy that explicitly accounts for regional
participation in the integration process.
•
A successful policy strategy requires the promotion of an investment-friendly
environment through the development of public infrastructure, human capital and an
increase in the efficiency of the small-scale-production/informal sector. This would
contribute to the redirection of capital towards more remote regions.
•
Policy coordination, institutional consolidation and administrative partnerships also
appear to be sine qua non measures to countrywide development and regional equity.
The paper is organized as follows. The following section presents theoretical insights regarding
the impact of economic integration. Section 3 documents the process of convergence in the EU
regions. Section 4 concentrates on the experience of three so-called cohesion countries, namely
Spain, Portugal and Ireland. The quantitative impact of EU Eastern enlargement is also discussed.
Section 5 focuses on policy intervention and discusses the EU policy approach and impact.
Section 6 presents some policy recommendations for Mexico in the context of further economic
integration with its NAFTA partners.
2
2. Economic Integration: Some Theoretical Insights
The impact of trade liberalization, and more extensively, of economic integration on countries
and regions remains an intensely debated topic, both from a theoretical and an empirical point of
view. Theoretical discussions are essentially articulated around the concept of
convergence/divergence in per capita income and/or in per worker income between
countries/regions, as well as the possible trade-off between efficiency at country level and
inequality at regional level.
Three major strands in the literature can be distinguished. The first one is based on the neoclassical approach of growth and builds on the seminal work of Solow (1956). The second one is
based on the endogenous growth theory developed by Romer (1986), Lucas (1988), Grossman
and Helpman (1991) and influenced by earlier contributions of Arrow (1963). The third is based
on the “new” economic geography theory first formalized by Krugman and Venables (1990). In
all these models assumptions about the degree of mobility of factors of production play a central
role in determining equilibria.
Increasing versus Decreasing Returns to Scale
While the neo-classical growth theory predicts some sort of convergence of per capita income
levels across countries, and by extension regions, theories based on the endogenous growth and
the “new” economic geography paradigms rather predicts divergence, at least over a certain time
horizon1.
A necessary condition for convergence is the existence of decreasing returns to scale for capital
and more generally for all reproducible factors. The definition of capital here includes all the
various sorts of capital considered in the production function, e.g. human capital and public
capital. This assumption implies that the marginal productivity of the reproducible factor
diminishes with its accumulation. As a consequence, the contribution to growth of a given
volume of investment falls as this increases, this then creates a tendency for growth to slow down
over time. If poor countries/regions are characterized by lower levels of capital in its broad
definition, then for similar levels of investment, they would enjoy higher growth rates than richer
countries. Convergence would thus occur in the cross-section. Under the assumption of
increasing returns in capital the logic is inverted and divergence is the steady state outcome.
Countries/regions with higher levels of capital tend to grow faster than their poor counterparts,
thereby leading to increasing levels of inequality.
Technological progress and its determinants are other major elements underlying converging or
diverging growth patterns. In general, countries/regions undertaking different means to generate
or adopt new technologies experience different growth rates. Diminishing returns in the
accumulation of technological capital again guarantee the gradual equalization of technical
efficiency levels2. However, as in the case of other types of capital increasing returns could be
observed. For instance, if the cost of additional innovations (related to R&D investment) falls
with scientific or production experience, the return to technological investment may increase with
the stock of accumulated knowledge. Here, differences in levels of technological effort could
become permanent across countries/regions, leading to a sustained increase in the level of
1
2
See Box 1.
See among others Abramovitz (1979,1986).
3
international/interregional inequality. This situation is treated formally in Lucas (1988), Romer
(1990) and Grossman and Helpman (1991).
In addition to decreasing returns in the reproducible factors and technological diffusion, structural
change (reallocation of productive factors across sectors) can be considered as a third possible
convergence mechanism. Poorer countries/regions typically tend to have relatively large
agricultural sectors and a redundant feature of the agricultural sector is lower labor productivity
with respect to the manufacturing and service sectors. As a consequence, the flow of resources
out of agriculture and into manufacturing and/or services tends to increase average productivity.
As structural changes are generally more intense in poor countries/regions than in richer ones,
this may contribute significantly to reductions in productivity across territories. The relation
between the evolution of output per worker and output per capita is not straightforward if
employment and participation rates are allowed to vary. For instance, if the productive capital
stock and the technological knowledge remain essentially the same, higher participation coupled
with higher employment levels would lead to higher output per capita but lower output per
worker.
In neo classical models, convergence predictions are reinforced by open economy considerations,
as the flow of mobile factors and/or international trade contributes to the equalization of factor
prices and domestic products per worker. Furthermore, countries/regions specialize according to
their comparative advantage. In that sense, a low level of productivity is no impediment to benefit
from trade. The opposite would be true for models of endogenous growth.
Box 1: Convergence Concepts
Three concepts of convergence dominate the literature: σ-convergence, absolute β-convergence and
conditional β-convergence. σ-convergence arises when the dispersion of the distribution of income per
capita in different countries/regions (measured for instance by the standard deviation of its logarithm)
tends to decrease over time. Absolute β-convergence refers to the case where poorer countries/regions
tend to catch up with richer ones in levels of GDP per capita or in GDP per worker. Conditional βconvergence arises when the relative position of each country/region within the income distribution tends
to stabilize over time3. σ-convergence could not occur without some sort of β-convergence. The two
concepts of β-convergence have very different implications. Absolute β-convergence implies a tendency
towards the equalization of incomes within a sample of countries/regions. Conditional β-convergence
implies that each country/region converges only to its own steady state. As steady states can vary
dramatically from one territory to another, a high degree of inequality can persist in the long run.
In neo-classical models the technology is such that, all things equal, poor countries/regions in terms of
GDP per capita and/or per worker, grow faster than rich ones (absolute β-convergence). If poor and rich
countries only differ by their initial level of per capita GDP, i.e. they face identical technology and
preferences, then, inequality eventually disappears in the long run. If countries differ in other aspects, too,
then convergence takes the form of the stabilization of the distribution of relative income per capita across
territories (conditional β-convergence and σ-convergence). In endogenous growth models, rich
countries/regions grow faster than poor ones and inequality is expected to increase infinitely. These
contrasting predictions are the outcome of possibly contrasting assumptions about the properties of the
production function at a point in time and the dynamics of technological progress.
3
See Barro and Sala-i-Martin (1990,1991).
4
Increasing Returns and Geography
Models of geographic economics show that regional integration, by reducing transaction costs
between regions, may lead to self-sustaining inequality. Like endogenous growth models the
driving forces are economies of scale, imperfect competition and phenomena of localized
spillovers. With these forces at work, a cumulative causation process is created, which tends to
open regional differences. Spatial concentration itself creates an environment that encourages
spatial concentration. Geographic economic models are generally divided into two major
categories4. The first category builds on the Krugman (1989,1991) model based on footloose
labor5 (the core-periphery model), the second on vertically-linked industries introduced by
Venables (1996) and Krugman and Venables (1995).
In Krugman (1991) two distinct cycles of circular causality exist. First, when more firms decide
to locate in a given area, workers are assumed to follow. Their migration will lead to expenditureshifting. Other things equal, firms prefer to be in the biggest market. As a consequence,
expenditure-shifting due to migration induces more production-shifting and the demand-linked
(expenditure-linked) cycle repeats. Second, because individuals are assumed to show love-forvariety, production-shifting lowers the price index in the destination territory and raises it in the
provenience territory. Migration is assumed to equalize real wages. Hence, the initial tendency to
concentrate lowers nominal industrial wages in the destination territory to offset the fall in the
price index. Lower labor costs in the destination territory further encourage the relocation of
firms, so that the cost-linked cycle repeats.
In the vertically linked industries models à la Krugman and Venables (1995) and Venables
(1996), firms are supposed to use other firms’ output as intermediate inputs. Labor is taken to be
completely immobile. If some firms decide to relocate in a given territory then two distinct cycles
of causality are also obtained. First, the demand-linkage comes from expenditure on
intermediates by the newly relocated firms. As in the previous model, expenditure-shifting from
relocating firms leads to more production-shifting. Second, cost linkage arises from a saving in
trade costs on a larger fraction of intermediate inputs used by firms in the larger market6. Again,
initial relocation of some firms causes even more firms to relocate to the biggest market.
In Krugman (1991), economic integration, when interpreted as a fall in transport costs, could lead
to a core-periphery equilibrium, where all industries would be concentrated in one unique region,
[if these transport costs fall below a certain threshold]. In Krugman and Venables (1995) the
equilibrium outcome is less dramatic. Industrial territorial concentration can again be observed if
trade costs fall below some critical level. However, regional concentration of industries can lead
to an increase in wages relative to other territories because of labor immobility. The rise in labor
cost acts as a dispersion force and the relationship between economic integration and
agglomeration becomes non-monotonic. Puga (1999) presents a model that captures both
Krugman (1991) and Krugman and Venables (1995) in a unified framework. The author shows
that relocation of workers towards territories with higher real wages would reinforce
agglomeration. Without labor mobility, wage differences moderate agglomeration and sustain
non-extreme equilibria in which all regions have industry, even if in different proportions. Puga
4
See Ottaviano and Puga (1998) and Ottaviano (1999) for an review of the literature and technical considerations.
See also Ottaviano, Thisse and Tabucchi (2001).
6
Martin and Ottaviano (1999) introduce an R&D sector that is affected by the these demand and cost linkages. They
show that in such a context, linkages become inter temporal and affect the rate of growth.
5
5
and Venables (1996,1999) detail the phase of spreading development triggered by cost
differences in a multi-regions framework. Development may not be a smooth process, again
indicating the existence of a non-monotonic relationship between transport costs and
agglomeration. All these models suggest that the ability of poorer regions to catch up relies on
integration being as complete as possible in terms of skill and technology and on a non fully
rigid7 response of wages to change in industrial employment.
Faini (1996) also investigates the link between convergence and factor mobility in a framework
where returns to scale are increasing in the production of non-traded intermediate inputs and
diminishing to capital, the reproducible factor. Moreover, the migration choice is given some
solid micro foundations which is usually lacking in models of economic geography. With an
immobile labor force, the model predicts full convergence despite increasing returns. Indeed, due
to diminishing returns to capital, a location arbitrage is generated by capital accumulation within
one territory. With labor mobility, the model can produce a pattern of diverging territorial growth.
In particular, diverging growth is more likely with increased scope for economies of scale and a
higher mobility of labor. Labor migration relaxes the labor supply constraint in the receiving
region, where wages net of individualized migration costs are higher, and thus avoids a dramatic
fall in the marginal productivity of capital due to decreasing returns. With sufficient labor
mobility, the return to capital becomes an increasing function of the capital stock. However,
because of diminishing returns to capital, growth in the labor receiving region is limited by the
availability of migrant labor from the sending region.
We may assume that migration is an inferior good, that is, the propensity to migrate falls with
absolute income growth even with unchanged wage differentials. As in the economic geography
context, a non-monotonic relationship could appear between economic integration and
agglomeration of economic activity. As far as economic integration increases income, in absolute
terms, in the less advanced regions we would first observe rising divergence due to labor
mobility. After a critical income level has been reached, labor mobility will gradually decrease
and regions will start to converge, once diminishing returns to capital become the predominant
driving force.
Foreign Direct Investment
Foreign Direct Investment (FDI) can play an important role in the convergence process by
closing the technology gap between economic partners through the transfer of skills and
technology. Technology transfer may occur through: direct technology transfer from affiliates of
multinationals to local companies through supply chain and production linkages8; diffusion of
know-how through migration of employees from multinationals to local companies; imitation of
technology applied by affiliates of multinationals by local companies. The longer-term benefits of
FDI on a recipient country depends on the ability of the economies to absorb new technologies
and on the educational level of the local population (see e.g. Borensztein et al. 1998), as well as
on the stability of the institutional framework, e.g. market regulations, industrial property rights
and infrastructure (see e.g. Markusen 2000). These elements indicate that FDI does not
necessarily benefit all regions in a given state the same way. FDI, if concentrated in a restricted
number of regions may induce regional disparities in economic development and growth. More
generally, the effects of FDI depend on the link to local capital accumulation and production
7
8
See Faini (1999) for a theoretical treatment of the impact of unionized wage determination.
See for instance Baldwin and al. (1999).
6
composition as well as on the skill composition of labor demanded. If FDI leads to capital
accumulation without altering the composition for labor demand then it is likely to benefit labor
earnings and thus relieve labor migratory pressures. If FDI is biased toward either low or highskill labor, then capital accumulation would increase labor earnings and possibly employment of
one skill category relative to the other. This could generate migratory pressure for the FDI
disadvantaged labor skills category unless FDI brings technological progress. Baldwin and
Venables (1993) use a framework in which FDI and skilled labor are complements in order to
analyze the link between FDI, international labor mobility and convergence across countries.
Because FDI and human capital are complementary, foreign capital inflows affect wages of
skilled workers. Since current and expected wage differentials affect the migration decision, the
inflow of physical capital affects the long-run level of human capital. Finally, the current and
future stock of human capital affect the return of FDI in that country. As a result, the framework
generates a circular relationship between labor mobility and FDI which can lead either to a
vicious circle (divergence in income per capita) characterized by high migration flows and low
levels of FDI, or to a virtuous circle (convergence in income per capita) characterized by low
migration and high FDI levels. The authors show that migration is always too fast, and foreign
investments inflows too slow from a socially optimal point of view.
From a theoretical view point, the impact of economic integration on convergence of per capita
income across countries and regions varies according to the assumption made about returns to
scale in production; the degree of competition prevailing in product markets and the degree of
mobility of factors across regions and countries. Box 2 presents a simple heuristic framework for
economic development and growth accounting.
7
3. Economic Integration in the European Union: A General Picture
This sections offers a brief review of the evolution of some major economic indicators in the
process of European economic integration. The aim is illustrate some of the theoretical insights
discussed in the previous section. First, empirical studies that deal with the qualification of the
(non)convergence process are presented. Second, we consider empirical studies that document
production factor movements with possible links to economic integration. Finally, we present
some empirical investigations that study the evolution of economic landscape in Europe.
3.1 Income and Productivity
Figure 1 and table 1 show per capita GDP (in PPS) in EU Member States and disparities in per
capita GDP by region in Member States respectively. We first observe that the cohesion countries
(Ireland, Greece, Portugal and Spain) have moved considerably closer to the Community average
in terms of per capita GDP9, and even exceeded it in the case of Ireland. Second, we observe a
general reduction in regional disparities albeit at a lesser extent than at the national level. As
shown in table 1, regional disparities have increased in some member States, for instance
Portugal, Finland and Ireland.
Evidence on convergence across European regions varies depending on the methodological
approach. There are three broad categories of studies. The first category focuses on the estimation
of convergence equations using either cross-sectional or panel techniques. Studies of this
category aim to identify both the existence of convergence and the possible sources of
convergence; these studies are essentially linked to standard and new growth theories. The second
category investigates the distributional dynamics of national/regional income and productivity
measures. The third category relies on descriptive techniques and focuses on spatially-oriented
convergence analysis. Studies of the latter two categories may not offer any direct quantitative
insight about the sources of convergence but yield an understanding of the nature of the
convergence process as well as of its dynamics controlling for geography; these approaches are
related to polarization and economic geography theories.
3.1.1 Convergence Regressions
The typical convergence equation usually has GDP per capita (similarly GDP per worker-labor
productivity) as the dependent variable. The independent variables are initial GDP and different
variables to control for fundamentals determining steady state conditions. These regressions are
essentially based on the Barro and Sala-i-Martin (1991) model of conditional convergence. Most
of the studies based on the seminal works of Barro and Sala-I-Martin (1991,1992,1995) are
consistent with the view that less advanced regions grow more rapidly relative to more advanced
ones10. The rate of international convergence in Europe over multi-decade periods appears to be
around 2 % per year. These studies also contain some evidence of sigma convergence.
As reported in tables 2, 3 and 4, there is often evidence of conditional convergence in all subperiods in 1950-1992 independent of the number of regions included in the sample. Moreover,
the difference between cross-sectional and panel estimates remains reasonable.
9
The experience of the Iberian countries and Ireland are analyzed extensively in section 3.
See for instance Sala-i-Martin (1994), Armstrong (1995), Neven and Gouyette (1995).
10
8
Boldrin and Canova (2001), however, arrive at slightly different conclusions. Their sample
includes more regions than Barro and Sala-I-Martin, particularly less advanced regions11. Their
sample period spans 1980 to 1996 which is shorter than in Barro and Sala-I-Martin, but closer to
current time. Despite allowing for various specifications, sub-samples and sub-periods, none of
their results identify β-convergence of per capita GDP. β-convergence is observed only for GDP
per worker. Boldrin and Canova also find no strong evidence of σ-convergence of GDP per
capita or labor productivity. The sample standard deviation of the distribution of regional per
capita income ranges from 0.27 in 1980 to 0.25 in 1996. The standard deviation of the
distribution of regional labor productivity is found to be the same in 1980 and 1996. Strong
oscillations are obtained for both measures.
Various authors argue that the slow process of convergence obtained in “classical” convergence
studies could be due to bias arising from the use of econometric specifications that do not
adequately account for unobserved differences across countries or regions. To address this, some
studies adopt panel techniques and estimate fixed-effects convergence models for a variety of
national and regional samples12. Results suggest that countries converge rapidly (at rates of up to
12 % per annum) towards very different steady states. This is also observed for regions within a
country (at rates of up to 20 % per year).
Differing results due to methodological differences can be seen in Table 5. The table presents
some estimates of the same equation using three different techniques: ordinary least square
(OLS), ordinary least squares with dummy variables (LSDV) to estimate regional effects and the
Arellano’s orthogonal deviations (OD) procedure used to avoid short sample bias that may affect
LSDV estimates.
High values of convergence rates may be due to the fact that panel estimates capture short-term
adjustments around trends rather than long-term growth dynamics. In that sense, Shioji (1997)
and de la Fuente (1998) provide some evidence that panel estimates of the convergence rate may
not provide the appropriate information about the speed at which economies approach their
steady states. However, the authors show that once this bias is corrected for, convergence rates
remain compatible with sensible theoretical models.
3.1.2 Convergence and Distributional Dynamics
Part of the empirical literature on convergence, besides attempting to answer the question of
whether convergence has taken place, also attempts to identify the possible existence of
convergence clubs and the trajectory of countries/regions.
Quah (1993, 1995, 1996a, 1996b) argues that convergence regressions only provide a convenient
way to summarize the behavior of a “typical” country or region but are unable to qualify intradistributional dynamics. To get around this limitation, Quah proposes estimates of the stochastic
kernel that governs the evolution of the whole distribution. For Europe, Quah obtains no evidence
of multi-modality in the distributions of regional GDP per capita distribution over the 1980-1992
11
12
185 European regions of 15 countries are in the sample.
See among others Islam (1995), Canova and Marcet (1995), Gorostiaga (1998).
9
period. 13 This result excludes the existence of convergence clubs among European regions.
Lopez-Bazo and al. (1999), however, by applying similar techniques but including further regions
from additional countries14 into Quah’s countries sample, detect the existence of a substantial
group of regions with levels of GDP per capita below the average and with a trend. This result
suggests that this group of countries converges towards a lower level of GDP per capita than the
other economies. As far as GDP per worker is concerned, all studies indicate a higher
concentration of the distribution over the 1981-1992 period. This is also the only significant
which emerges from the literature. Lopez-Bazo and al. (1999) use a rank-size function expanded
to convergence analysis to identify regions responsible for the shape of and changes in the whole
distribution. Results indicate that overall inequality remained constant in terms of GDP per capita
and decreased in terms of GDP per workers in the 1980s. Furthermore, a greater increase in
inequality among the richest regions is observed in the first half of the 1980s and a larger
decrease in the second half. In terms of mobility, the authors identify strong persistence in the
distributional position for the poorest regions. This indicates a poverty trap mechanism.
Convergence is found to rely on the behavior of countries whose GDP per capita is close to and
above the average. Larch (1994) shows that for 1970-1990 a high degree of persistence
characterizes regions located both in the upper and lower intervals of GDP per capita of the
distribution. The author also shows that mobility across the distribution decreased in the 1980s
compared with the 1970s. Boldrin and Canova, (2001) somewhat corroborates this persistence
results although adopting a slightly different approach. They consider the distribution of some
variables in 1980 and 1996 and estimate a long-run distribution predicted according to prevailing
conditions. They find that features of the GDP per capita distribution are very persistent with no
sign of systematic catching-up. However, they conclude against convergence clubs by noting that
the number of regions with income above national average decreased between 1980 and 1996,
while regions with below national-average income tended to disperse. They also find mild
evidence of convergence across regions in average labor productivity in 1980-1996.
3.1.3 Convergence and Geography
Studies that include a geographical space dimension in the investigation of convergence are
needed to complete the somewhat general picture offered by simple growth regressions and to
qualify evidence from distributional dynamics-oriented analyses.
Neven and Gouyette’s (1994) results underline higher homogeneity among the Northern regions
of the European Union than among the Southern ones. They also observe that Northern regions
experienced a strong convergence process only in the second half of the 1980s, while this was
observed in the first half of the decade among poor Southern regions. In the second half of the
1980s the convergence process stagnated among Southern regions. When looking at countriesspecific experiences we also observe large internal differences which suggest the existence of a
polarization process that fits the core-periphery model. Mauro and Podrecca (1994) show that the
dispersion of GDP per capita for the Italian regions rose slightly in the 80s suggesting that the
North-South gap has not been closing. Dunford (2001) extends the analysis to 1952-1996 and
shows that initial North/South convergence in the 1960s and 1970s gave way to divergence in the
13
His sample contains the 1980-1989 Eurostat data on purchasing power standardized per capita incomes in 79
European regions: 10 in Belgium-Luxembourg, 11 in Germany, 18 in Spain, 20 in Italy, 9 in the Netherlands, 11 in
the UK.
14
Notably Greece, Portugal and France.
10
1980s and first half of the 1990s. During 1991-1997, however, some southern provinces showed
substantial improvements relative to more developed northern provinces. A similar picture is
found for Spain. Artis and al. (1997) observe significant variations in the growth of the Spanish
regions in the eighties. De la Fuente’s (1997) analysis points to the possibly indefinite persistence
of important North-South disparities. As for Portugal, such a pattern is less obvious as
documented in Pontes (2000). Lopez-Bazo and al. (1999) propose some formal tests of spatial
association. They are able to detect macro-regions showing values of GDP per capita or worker
far above the average, as well as regional clusters with significantly below-average values. In
GDP per capita, local clusters of regions are observed in Germany, Italy, Spain, Portugal and
Greece. High values are detected in southern Germany and northern Italy. Particularly low values
are detected in some southern regions of Italy and Spain as well as in all Portuguese and Greek
regions.
The evidence reviewed indicates that the process of convergence in Europe is complex and
contains regional and even provincial specificities. Generally speaking, empirical results identify
a decrease in regional inequalities between the 1950s and 1970s, and a relative stagnation in the
aftermath of the oil crisis in 1972. We also observe some form of polarization within the
peripheral regions supportive of a core-periphery expansion process. The appearance of this
phenomenon is in line with the stagnation of regional convergence.
3.2 Labor Migration
Labor mobility is one of the key regional adjustment mechanisms to localized shocks. Workers
are expected to respond to inter-regional wage and employment differentials and thus offset the
effects of a localized shock. However, while migration can be treated as a normal good (i.e.
decreasing with the level of income and wealth), the existence of migration costs may discourage
workers from moving to regions with better labor market perspectives thereby contributing to the
persistence of substantial inter-regional disparities.
Nevertheless the impact of labor mobility should not be overstated. A recent OECD study (1999)
concludes that transnational labor mobility is very limited and Eichengreen (1993) shows that
even within a country, labor mobility remains limited. Furthermore, evidence from the US shows
that the response to income differentials can occur following a significant time lag (30 to 40
years in the case of the South-North black migration in the United States (see Beine, Candelon
and Hecq, 2000).
With the creation of the Single Market, nationals of EU countries have become legally free to
locate anywhere in the union. Nevertheless, intra-European mobility is relatively low. As an
example, intra-EU migration rates both in the Euro Zone and the EU-15 are low for the 19901998 period, between 1.5% and 4%, and have been steadily decreasing since 199215. Moreover,
inter-regional labor mobility within member states is also low, with 1.2 % of employed people
15
Eichengreen (1993) estimates indicate that intra-European migration represents less than 0.2% of the total
population of the Union . As a basis for comparison, the equivalent figure for the United States is around 1.5 %.
11
changing residence in 1999. However, as noted in an OECD (2001) study, the number of EU
nationals in immigration inflows in the EU-15 has risen slightly in recent years16.
European labor migration has been highest, when labor mobility was restricted. According to
Zimmermann (1995), post war migration in Europe can be divided into four phases: the period of
war adjustment and decolonization (1945-1960), South-North labor migration (1960–1973),
restrained migration (1974-1988) and the collapse of socialism (1989).
Subsequent to full employment in the mid 1950s, labor shortages encouraged many European
countries to open their borders to foreign labor during the 1950s and 1960s. Migrants from
Southern European countries (Italy, Greece, Spain, Turkey and Yugoslavia) and North Africa
(Morocco and Tunisia) and predominantly went to Northern European countries (France,
Germany, UK, Switzerland, Belgium and The Netherlands). Zimmermann (1995) estimates the
total number of South to North migration from 1950 to 1973 at around 5 million.
The third phase of migration started after the recession in 1973, when fears of increased social
tensions and recession after the first oil price shock in 1973 abruptly stopped labor recruiting
from abroad. Measures to induce return migration failed and after a short drop in immigration
during 1974 and 1975, immigration started to rise again mainly as a result of family migration
and the admission of refugees and asylum seekers. Stricter immigration policies in Northern
Europe as well as improving economic conditions in Southern Europe contributed to the fact that
during the 1970s Southern European countries reversed their role from emigration to immigration
countries, absorbing migrants from neighboring African countries, as well as Asia and Latin
America.
The last phase of migration in Europe has been dominated by East-West migration and a strong
inflow of asylum seekers and refugees. It began at the end of the 1980s when the collapse of
socialism created a major supply of potential migrants. However, mass migration never
materialized, migration from Central and Eastern Europe reached its peak in 1993. It has fallen
since then and many Eastern European migrants have even returned home (Brücker et al. 2001).
These facts suggest that labor mobility has represented a stabilizing or inter-regional and international convergence component prior to the oil crisis. Moreover, while institutional evolution
and economic development may have dampened labor mobility of EU, migration pressure from
non-EU countries remains very high. As a response, EU member states have recently establish
guidelines for a common immigration policy (EU-Seville summit June 2002).
16
The countries with the highest proportions of EU nationals in their foreign population are Luxembourg (89%),
Belgium (62%), Spain (43%) and France (37%).
12
3.3 Capital Flows and FDI
The strong economic convergence experience until the mid 1970s was accompanied by net labor
and capital migration. After that date, net and gross labor migration decreased rapidly. Gross
capital flows on the other hand increased substantially in the aftermath of the oil shocks as
depicted in graph 2. Net capital flows are however much lower and of the four poorest European
countries, only Spain and Ireland have become net receivers of foreign direct investment.
Intra-EU FDI experienced its highest growth in the second half of the 1980s. The strong growth
of FDI during this period reflects the reaction of the industry to the Single Market Program as
well as large investments in the financial sector.
This increase in FDI flows observed in the mid-80s coincides with a world-wide expansion of
FDI. Nevertheless, Iberian countries benefited relatively more than other EU countries from this
trend. This could indicate a positive relationship between FDI inflows and economic integration
in line with standard theoretical insights. Theory however, also indicates that significant flows
into relatively underdeveloped countries/regions should not be taken for granted as the capability
of a territory to absorb capital, essentially defined by the amount and specialization of human
capital, is a determining factor. Indeed, as documented in more detail in the next section, FDI
flows to Spain and Portugal have been concentrated in the wealthiest regions. As for the CEEC10, we also observe an increase in FDI inflows during the 1990s: Poland, the Czech Republic and
Hungary have attracted almost 80% of the total amount of the FDI flows (in net terms). During
1995-1997 about 60% of the FDI flows to the CEEC-10 originated in the EU.
In 1999, the FDI stock represented between 20 to 30% of GDP in both Spain and Portugal. The
respective figure for Ireland was almost 60%. As for CEEC-10 countries, the percentage varies
from 15 to 20 percent for most accession countries including Poland and from 30 to 50 percent
for Hungary, the Czech Republic and Estonia.
These facts suggest that integration is likely to stimulate FDI flows and possibly as a
consequence medium/long term growth perspectives.
3.4 Industrial Concentration and Specialization
Theory indicates that the process of economic integration is likely to affect industrial
concentration and/or production specialization patterns.
Haaland and al. (1999) show that between 1985 and 1992 the pattern of industrial concentration
changed substantially. They find that on average, the relative concentration index (a modified
version of the Hoover-Balassa index) increased by 11.4% during this period, and only very few
industries have seen a reduction in relative concentration. This index provides information about
the level of industry concentration across countries. The authors use another index that indicates
whether the core of some industrial activity takes place in only a limited number of countries. A
comparison of the two indices allows to identify the type of country in which a given industry
tends to be concentrated. Textiles and railroad equipment tend to be concentrated in small
countries. Other industries like motor vehicles, electrical apparatus and machinery are more likely
to be found in larger countries. Midelfart-Knarvick and al. (1999) identify comparative advantage
as the driving force behind the concentration/specialization pattern (the small country case),
13
home market effects or agglomeration forces (the large country case). Some econometric analysis
in cross-section confirms these findings. In particular, the most important explanatory variable for
relative and absolute concentration is demand side concentration. Further, there is also evidence
of demand linkage effects, that is concentration on the demand side and concentration on the
production side are mutually influential.
In a similar spirit, Midelfart-Knarvick and al. (2000) compare the industrial structures of EU
countries. They find that industrial structures within the EU have become increasingly diverse
during the period 1980-1990. The industrial structures of the four largest EU economies (UK,
Germany, France, and Italy) are found to be relatively similar. However, similarities are
disappearing at an increasing rate. The four Cohesion States (Greece, Ireland, Portugal, and
Spain) also show increasingly diverging industrial structures. The authors also find that Spain has
become more similar to the main industrial economies. Ireland is more similar to Belgium,
Denmark, and the Netherlands. Finland and Sweden have remained similar but are becoming
increasingly different from other European countries. In addition, the increasing sectoral
specialization of EU countries has followed an uneven pace (see Figure1 in Puga 2001). They
find little change in specialization during the 1970s. However, there is a phase of rising
specialization, particularly acute since the early 1980s for the 1980s entrants and since the mid1990s for entrants in 1995.
These studies suggest that economic integration among EU member states has led to regional
concentration of economic activity and specialization of production, pinpointing the risk of
observing a trade-off between efficiency and equity - both at EU and country level.
14
4. Economic Integration in the European Union: Some Country Experiences
Economic integration is expected to affect an economy through several channels. As in the
previous section, we focus on five: GDP per capita and worker; structural change; labor
migration; foreign capital flows and income inequality. Structural change is usually associated
with changes in the degree of openness, the geographical and product composition of trade and
sectoral composition of employment.
We first consider the accession experience of the Iberian countries and Ireland. We then present
the case of the CEEC-10 countries, which are currently the focus of EU enlargement discussions,
the first wave being expected to occur in 2004.
4.1 The Iberian Countries Experiences
Both Portugal and Spain became official members of the European Union on January 1st, 1986.
However, achieving full integration took all the 1980s. Barriers to free labor mobility were only
removed in 1993, in concordance with the start of the Single Market.
In the 1960s, Iberian countries were relatively underdeveloped compared to their European
neighbors. Convergence was quite fast during 1960-75. At the beginning of the sixties, GDP per
capita (in PPS units) in Spain was 55% of the EU average. In 1975, it reached 75%. For Portugal,
these figures were 40% and 60%, respectively. The catching-up process stopped in both countries
in the following decade. After EU accession in 1986 and up to 1996, GDP per capita improved
again in both countries with respect to EU average. Spanish and Portuguese GDP per capita stood
respectively at 75% and 63% of the EU average in 1996. In 2000, GDP per capita reached almost
78% of the EU average in Spain and 65% in Portugal. Spain showed very rapid convergence in
labor productivity in the period 1960-1986 and remained at about 95% of the EU average in the
following decade. In Portugal, labor productivity caught up at a higher pace in the 1960s and
1970s but almost stagnated during 1986-1996.
Spain and Portugal experienced additionally regional disparities. At regional level, in Spain
disparities in per capita GDP increased in the period 1980-1999 while disparities in per worker
GDP were decreasing. In Portugal, GDP per worker has converged across regions over the same
period, while GDP per capita was converging until the mid 1990s. Since then however, this
tendency has been reversed to some extent as shown in table 1. Spanish and Portuguese labor
markets show pronounced regional differences, which are much more pronounced in Spain. For
example, wages in Extremadura and Galicia are more than 20% below Madrid levels. In Portugal,
wages in the Lisbon and northern regions are up to 13% higher than in the rest of the country.
As documented in Box 3 households earnings distribution evolved differently in Spain and
Portugal along EU integration. These differences are due to a large extent differences in various
institutional features.
Labor Migration
The impact of economic integration on migration flows is at best mitigated. From 1960 to 1975 ,
important migration flows accompanied sectoral changes in both countries. Due to lack of
available data and empirical studies, we focus in this section on Spain. As already mentioned, this
15
period was characterized by an expansion in manufacturing and an increase in agricultural
mechanization, resulting in substantial labor flows out of agriculture. Migratory workers headed
towards manufacturing-intensive regions in Spain and other European countries, in particular
France, Germany and Switzerland. Estimates show that 42% of the 100,000 workers who were
leaving Spain each year were emigrating to these three countries. In that context, during 19601975, international migration has played an important role in the Spanish convergence process.
As documented in Rodenas (1994), remittances from migrants abroad covered between 17% and
30% of the Spanish trade deficit during 1960-1973. There is also evidence of the temporary
nature of migration during this period. The 1973 international crisis reduced migration flows, as
the economic recession and lower earnings differentials made migration abroad less attractive17.
Internal inter-regional migration was also somewhat reduced during the late 1970s and early
1980s. The ratio of inter-regional gross flows to population averaged 0.62% over the period
1962-1973. In 1980, the ratio fell to 0.19%. While the fall in out-migration can be explained by a
reduction in wage/income and unemployment rate differentials between Spain and European
migratory targets, the decrease in inter-regional migration within Spain does not seem to have the
same causes. Indeed, although wage differentials across regions declined slightly, unemployment
differentials increased steadily during this period (see Bentotila and Dolado (1991)). As argued
by Bentotila and Blanchard (1990), higher unemployment could have contained labor mobility
within Spain, as employment prospects deteriorated across the board. Using data from 1964 to
1986, Bentotila and Dolado (1991) find that net inter-regional migration responds to
unemployment and wage differentials but with long lags and low elasticities. Moreover, the
elasticity to unemployment differentials is inversely related to aggregate unemployment.
Migratory flows recovered in the 1980s. In 1985, the ratio of gross flows to population was
0.19%. It reached 0.65% and 0.60% in 1990 and 1995 respectively. However, Bentotila (1997)
shows that absolute net migration18 fell by 90% from the period 1962-1964 to the period 19901994. Interestingly, the traditionally poor and high unemployment regions (Andalusia and
Extremadura) have become net immigration regions and the richest ones (Madrid and Catalunia)
net out-migration regions.
Foreign Direct Investment and Public Funds
Iberian countries, despite an observed catching-up pattern since the early eighties, have remained
low-wage for EU standards. In 1984, average hourly costs in industry reached 73% of the EU-12
average in Spain and 23% in Portugal. In 1995, these figures were 82% and 34%, respectively. In
this context, Iberian countries appeared to be good candidates to receive FDI inflows. Standard
theory predicts FDI flows from capital-intensive/high-wage countries to labor-intensive/lowwage countries. FDI inflows increased in the 1980s in both countries and in particular after their
EU accession. However, it is important to note that this increase coincided with a worldwide
increase in FDI flows since the mid eighties. After an initial increase until the beginning of the
1990s, FDI flows to both countries have since fallen to levels which prevailed in the late
seventies and early eighties as shown in graph 3 .
17
18
See Antolin (1992).
Sum of the absolute values of net inflows to regions divided by population.
16
FDI to Spain is found to be heavily concentrated in the richest regions (Navarra, Catalonia and
Madrid), while Andalusia, Extremadura and Galicia lag far behind. Hence, the association
between differences in FDI inflows and regional economic development are almost unavoidable.
As for Portugal, the picture is somewhat mixed. There is clear evidence of a concentration of FDI
in the most developed regions. Indeed, the Lisboan area and the North received 90% of all FDI
inflows in 1994, while the less developed southern regions received only about 2%. This pattern
of concentration remained similar through out the 1990s. As mentioned above, GDP per capita
has shown some (weak) tendency to diverge across regions only since the mid 1990s.
Various studies19 indicate that public funds, both national and European, partly offset the effect of
FDI concentration and significantly promote human capital formation in the most remote regions
in both countries. For instance, De la Fuente and Vives (1995) find that European Structural
Funds, by improving public infrastructures, have significantly contributed to the regional
convergence pattern in regional productivity. They also show that the elimination of regional
differences in the endowments of public capital has also contributed towards the reduction of
regional inequality.
There is however, a difference between Spain and Portugal in the allocation of public funds specially of European funds and to a large extent of national funds. In Spain, public funds are
relatively more concentrated in less advantaged regions than in Portugal. With respect to
European funds, in Spain, the most remote regions (e.g. Extremadura, Andalucia, Asturias)
benefited the most from European funding over the 1986-1994 period20. In Portugal, the share of
total European funding received by the most advanced region (Lisboa and V. Trejo) increased in
the period 1986-96, while the share of less advanced regions remained almost constant and even
declined. The differences in the allocation of public funds by no means contradicts the evidence
that public funds significantly contributed to human capital accumulation and improvements in
labor productivity in the most remote regions of both countries; the difference between Spain and
Portugal is essentially a matter of scale.
Openness and Trade Composition
In the Iberian countries, exports and imports to GDP ratios have been increasing since the 1960s
and 1970s. Interestingly, there was no significant break at the time of EU accession. We note only
a large increase in Spanish exports in 1993. Portugal has been historically more oriented towards
free trade and Portugal was a founding member of the EFTA in the 1960s. In Spain, trade barriers
with the EU were dismantled only at the beginning of the 1990s, in accordance with the EU
accession treaties. Imports plus exports (total trade) represented 15% of GDP in 1960 for Spain
and only 40% for Portugal. In 1996, the figure was 45% for Spain and 70% for Portugal.
Moreover, a clear pattern of concentration of exports and imports to and from the EU has been
appearing. In 1999 trade with EU partners represented 78% and 70% of total trade for Portugal
and Spain respectively.
With regard to the composition of trade, both Spain and Spain share the tendency in Europe of a
relative increase of intra-industry trade (two-way trade) with respect to inter-industry trade (one19
20
Some contributions are discussed more precisely in section 5.2.1.
See inter alia Jimeno and al. (2000) for a presentation of the patterns.
17
way trade). Nonetheless, one-way trade has remained stronger in the Portuguese trade
composition. In 1999, one-way trade represented 61.1 % and 95.1 % of Portuguese Intra-EU and
Extra-EU trade respectively. For Spain, these figures were 44% and 86%. The share of intraindustry in total trade increased by 10% in Portugal and 14% in Spain between 1986 and 1995.
Structural Changes
Significant structural changes took place along the way to EU integration in both countries,
however, structural changes did not systematically coincide with the time of EU accession.
Both Portugal and Spain went through important shifts in sectoral employment. Adjustment in
sectoral employment started earlier in Spain even though labor reshuffling was more intense in
both countries after accession. All in all, Portugal’s sectoral composition of employment still
significantly deviates from the EU average, despite significant changes since the 1980s. In 1985,
22% of the Portuguese labor force was in agriculture, 33% in industry and 45% in services. A
decade later, these figures were 12%, 30% and 58% respectively. In Spain, agriculture employed
16% of the labor force, industry 32% and services 52% in 1985. In 1996 these figures were 9%,
29% and 62% respectively, fairly close to the EU average. The large fall in the share of industry
employment is due to the deep crisis in a number of sectors like steel and ship-building which
were heavily hit by the oil shocks.
The impact of openness and integration on the skill composition of the labor force was not the
same in the two countries. One might have expected that both countries would have tried to
benefit from their comparative advantage in the production of labor intensive goods. However,
we observe that skill up-grading and wage increases for high-skill workers in Portugal were much
more industry-specific than in Spain. The Portuguese manufacturing sector shows a very small
change in the relative demand by skills. In Spain there is evidence for above-average skill
upgrading, and the increase in wage and employment shares for high-skilled workers is even
higher than for the service sector. These findings suggest that the reshuffling of the Spanish labor
force was driven by skill-biased technological progress, which contributed to the shift of Spanish
industry from traditional sectors to semi and high-skill based products in line with other EU
exports. It underlines the tendency to engage in intra rather than inter-industry trade. Panel data
for Spanish firms confirm that technology rather than international trade remains the main
determinant of the rise in skill demand. In Portugal on the other hand, international trade and
specialization in specific low-skilled intensive manufacturing (e.g. textiles), have been the major
driving forces of the observed changes in the labor force.
Institutions
The different convergence dynamics of GDP per capita and GDP per worker in Spain and
Portugal can be related to different developments in employment rates. Indeed, the employment
rate fell dramatically during the 1975-1996 period in Spain. In Portugal, the employment rate
remained somewhat constant over the same period. The two countries also show different
developments in unemployment rates. Unemployment rates increased in both countries after the
mid 1970s. However, while unemployment in Portugal remained below 10% with cyclical
fluctuations and no significant trends in the 1975-95 period, Spanish unemployment reached 22%
in the mid 1980s and almost 25% in the mid 1990s. The higher level of Spanish unemployment
18
rates relative to Portugal, and the relatively low responsiveness of the Spanish labor market to
shocks are usually attributed to more rigid labor market institutions and more generous
unemployment insurance schemes.
Dolado and Jimeno (1997) and Marimon and Zilibotti (1998) argue that the huge increase in
Spanish unemployment in the 1980s was also due to the incapacity of the manufacturing and
service sectors to absorb continuing worker flows from agriculture which had started in the
sixties. By contrast in Portugal, worker flows from agriculture only became significant in the
1980s and were absorbed by the service sector.
Interpreting the Stylized Facts
In general, regional integration contributed to the convergence of Iberian countries and their
European partners. Nevertheless, the differences in the convergence process of the two countries
indicate differences in policy orientations and institutions which may have played a significant
role in the distributive impact of the economic integration.
Previous sections suggest that two main elements make up the difference in the Spanish and
Portuguese integration experience. First, although both economies were much less developed than
their neighbors’, Spain was relatively more advanced than Portugal. With much lower labor costs
in Portugal, a comparative advantage almost naturally arose in low-skill labor intensive
production. Spain opted for the promotion of higher skilled labor production. The fact that
Portugal was already fairly open at the time of EU accession and trade patterns were already
clearly established, further helps to explain the difference in adopted development strategies.
Another difference between Spain and Portugal is that concerns about regional development and
cohesion were already on the Spanish political agenda before talks about integration to the EU
started. This was not the case in Portugal, where a regional development plan was essentially
established in order to conform with the EU conditionality clause.
Spain, for example, paid a lot of attention to the promotion of the skill upgrading of the labor
force and consequently put a lot of effort into the promotion of social and public infrastructures
of less advanced regions. This was not the case in Portugal, at least in the years following EU
accession. Figures for 1995 indicate that upper secondary education was attained by 20%
(Portugal) and 28% (Spain) of the population aged between 25 and 64. The respective figures for
university education were 11% and 16%. The lower level of economic development and a less
pronounced willingness to promote labor force skill-upgrading may explain why public funds
(national and European) are more concentrated in advanced regions in Portugal.
19
Box 3: Earnings Inequality in Cohesion Countries
Economic integration has had a mitigated impact on income and wage inequality in Spain and Portugal.
Jimeno and al. (2000) document the evolution of household income inequality and wage inequality in the
Iberian countries during the course of EU accession. Household inequality in Portugal decreased during
the 1980s but increased in the first half of the 1990s. The fall in inequality during the 1980s was due to
relative improvements for the poorest households21, this trend was completely reversed for 1990-1995.
The income share of the first decile in 1995 (3%) fell below the corresponding figure in 1980. In Spain,
initial inequality was lower than in Portugal and decreased over the full 1980-1995 period. The fall in
inequality was due22 to the reduction of inequality between and within groups, as well as to a demographic
change resulting in a higher share of relatively better off middle- and old-aged people.
Jimeno and al. (2000) find that contrary to total income, labor income inequality increased in both
countries during the 1980s and specially during the first half of the 1990s. For Portugal, in 1995, the
distribution of total household income was more unequal than the distribution of labor income. The
opposite is true for Spain, where labor income appears to account for most of total income and as such
contributes the most to income inequality. Transfers are also found to play an important role in Spanish
income distribution. The importance of regional factors seems however to be less important in explaining
Spanish income inequality. The authors attribute this result to high heterogeneity in personal attributes
across individuals in the same region.
The different distributional patterns between Spain and Portugal can be largely explained by institutional
factors. Returns to tenure are significantly higher in Spain than in Portugal, as are wage penalties to new
firm-entrants. This is largely due to a high incidence of fixed-term contracts in Spain. Workers within this
job category receive lower wages and experience shorter job tenures than workers with permanent
contracts.
In both countries, wages of production workers are lower than wages of non-production workers.
However, this wage gap is twice as high in Portugal than in Spain. This may be explained by the
compressing effects of trade unions’ intervention in wage determination in Spain23. In addition, interindustry wage differences are lower in Spain than in Portugal. In Portugal, there is some evidence that
some sectors, in particular export-oriented sectors such as textiles, pay particularly low wages relative to
other similar skill-intensive sectors.
Nolan and Maître (2000) using Irish household survey data show a pronounced widening of the
distribution of hourly earnings except at the very bottom. There is evidence that the increase in returns to
higher levels of education accounts for a substantial proportion of the increase in earnings dispersion over
that period24. There is also evidence that inequality among households headed by a self-employed person
(farmers included) is higher that among households headed by an employee. However, the substantial
increase in labor force participation of married spouses has if anything an equalizing effect on the
household income distribution25. Moreover, unemployment has fallen dramatically. Other empirical
investigations26 generally suggest that earnings inequality did not increase substantially during the 19871994 growth period.
Different inequality measures indicate that household (equivalent) income inequality is similar in Ireland
and Spain and below the level of income inequality in Portugal. Portugal, among the three, is the country
with the least generous welfare system.
21
See Rodrigues (1993).
See del Rio and Ruiz-Castillo (1999).
23
See Dolado and al. (1997).
24
See Barrett and al. (1999).
25
See Callan and al. (1998).
26
See inter alia OECD (2000) and O’Neil and al. (1999)
22
20
As previously documented, FDI is mostly concentrated in the more advanced areas of both
Iberian countries. As such, a higher concentration of public funds and of FDI in the more
advanced regions of Portugal, would suggest a higher degree of regional inequality in Portugal
than in Spain. In fact, the opposite has been observed if GDP per capita is taken as a measure of
inter-regional inequality. Moreover, we could also expect a higher degree of labor mobility in
Spain due to the rise in the average skill level of the workers. Indeed, theoretical insights indicate
that in the presence of migration costs, skills upgrades can induce an income effect which can
provoke migration. On the other hand, if employment conditions in the sending regions improve,
this result might not hold. Previously presented results, however, suggest that the labor market
performance in the potential sending regions deteriorated relative to potential destination regions
in the aftermath of EU accession. This should have exacerbated migratory pressures in Spain.
Again, the facts indicate that Portuguese workers have a higher propensity to migrate than their
Spanish counterparts.
This apparently non-expected evidence (i.e. lower than expected regional inequality in Portugal
and lower than expected labor mobility in Spain) is explained by differences in the institutional
framework, which are a central to understanding the different convergence experiences of the two
countries. More precisely, the higher degree of flexibility in the Portuguese labor market and the
lower degree of generosity in the Portuguese transfer system explain this to a large extent. On the
one hand, labor flexibility has guaranteed high levels of employment in Portugal and as such
contributed to regional convergence in labor productivity, and GDP per capita convergence. On
the other hand, less generous social transfers in combination with higher labor market flexibility
may have preserved inter-regional mobility as a valuable option for Portuguese workers. In Spain,
the low degree of labor mobility has been linked to inefficient unemployment benefits schemes,
i.e. benefit schemes which are not contingent on employment, and institutions that exacerbate
employment protection rather than facilitating turnover27.
4.2 The Irish Experience
The Irish growth experience of the nineties has often been seen as a miracle28 and possibly
benefit most of the households29. However, a closer analysis suggests that despite perhaps some
lucky industrial predictions, the exceptional Irish economic performance was essentially the
result of a coherent set of policy choices. It is also usually stated that a major factor of the Irish
success has been its EU integration. Nevertheless, as argued by Görg and Ruane (1999),
accession to the EU, though essential, has been only one of its determinants. Indeed, Ireland
joined the EU in 1973 while its exceptional growth experience refers to the late 1980s and 1990s.
Integration to the European Union undoubtedly created the incentives and provided the necessary
financial support to build up the production environment conductive to growth. A potentially
efficient production environment together with direct and free access to EU markets explain the
27
As stated previously, however, labor migratory flows of the sixties and early seventies are likely to have played an
important role in national and regional convergence as argued by Raymond and Garcia (1996).
28
Annual average growth rates of real GDP (employment) and FDI flows have remained above EU averages during
the nineties. Over the 1995-1997 period real GDP (employment) in Ireland has grown at an average rate of 8.4%
(4.1%) against 2.3% (0.4%) in the EU.
29
See Box 3
21
huge FDI inflows, mainly from US companies, in the first half of the 1990s30. FDI inflows
represented 2.8 % of Irish GDP in 1995-1996 and 1.2% of EU GDP. US capital expenditures in
the Irish electronics equipment sector accounted for 25.5% of total US expenditures in this sector
between 1992 and 1995 in the EU. These figures were 1.3% and 0.9% respectively for Portugal
and 7.0% and 5.0% for Spain.
An efficient production environment was created by relatively low labor costs for a relatively
well educated population, an efficient infrastructure, the existence of agglomeration economies in
weightless industrial sectors, and appealing fiscal conditions specially for foreign companies.
Labor costs remained relatively low probably due to the existence of a nationwide cohesive social
pact relating mainly unions employers and the State. Ireland opted for a social-partnership
approach in the late 1980s parting with their traditional British-style industrial relations system.
The partnership agreements guaranteed wage moderation in exchange for the promise of income
tax cuts without assessing the received level of social payments. While educational spending and
attainment remained below the level of other European countries roughly until the mid-1970s,
this gap has been reduced and even reverted as the median educational attainment for younger
age groups now actually surpasses that in the UK31.
Industrial policy in the 1970s focused on low transportation cost sectors like electronics and
pharmaceuticals and promoted agglomeration economies. The Irish Industrial Development
Agency (IDA) identified these sectors as the most promising investment opportunities for multinational companies in Ireland. The relatively low transport costs requirements of these sectors
were regarded as favorable given the peripheral location of Ireland. Moreover, rapid growth was
anticipated in the 1970s for these sectors and the US was identified as the most likely investor,
given the significant share of US companies in these sectors. The fact that Ireland and the US are
sharing the same language and cultural ties, may also have helped to steer US investors to Ireland
rather than to other parts of Europe. Fiscal policy proved to be another major determinant of the
considerable FDI flows. Prior to 1982, foreign companies’ profits arising from all new export
sales were receiving a full tax holiday. Since then, manufacturing firms have been entitled to an
automatic preferential corporate tax rate of 10% on all manufacturing profits independent of the
sales origin. Discretionary investment grants are also made available for all manufacturing firms.
According to Barry (2000), Ireland also benefited from “first-mover advantages”, i.e. being
among the first countries to actively seek out FDI.
Barry, Bradley and Hannan (1999) further stress the importance of EU structural funds in the
Irish growth experience. EU structural funds helped Ireland’s regional infrastructures. For
instance, EU aid largely paid for a digital-based communication network in the late 1970s which
helped attract international communication centers. EU financial transfers further eased the socioeconomic costs of sectoral employment reshuffling. In 1970, 26% of the active population was in
agriculture, compared to 10% nowadays. Macroeconomic simulations indicate that Structural
Funds contributed about half of one percentage point to annual GDP growth rates of the 1990s.
30
31
See for instance de la Fuente and Vives (1997)
See Denny and al. (1999).
22
4.3 The Eastern Countries Experience and the EU enlargement
The Eastern Countries experience (CEEC-10) of EU accession differs from the experience of
Spain, Portugal and Ireland in many aspects. First, the level of development of the CEEC
economies is much lower compared to the respective levels in Iberian countries and Ireland at the
time of their accession; it compares more to the level of Mexico at the time of NAFTA accession.
Collectively, CEEC countries stand at 33% of the EU-15 average in 1997, while Portugal and
Spain reached 53% and 70% of the EU-12 GDP per capita at the time of Southern enlargement.
Second, the degree of heterogeneity between CEEC countries is much higher than that among
Iberian countries.
Given the magnitude of these differentials and the great depth of integration involved by the
accession, especially regarding labor mobility, it is not surprising that there are mounting
concerns that Eastern enlargement may have undesirable effects on labor markets and income
distribution of present EU members.
This section reviews some contributions that attempt to assess the impact of full EU accession of
the CEEC countries. The discussion first covers the projected impact on trade, FDI and their
possible contribution to CEEC economic catch-up. Second, some labor market projections are
presented. We concentrate here on labor migration and the evolution of wage distributions.
Impact on trade and FDI
EU and CEEC-countries, taken collectively, are expected to benefit from trade and FDI flows
induced by Eastern enlargement. However, the benefits might not be shared equally among all
countries and regions.
Empirical evidence on the impact of FDI is in generally mixed (Bellak, 2000). An assessment of
the net impact of FDI is complicated by a positive relationship between local productivity and
FDI. FDI alone does not allow a determination of cause and effect, as it is plausible that FDI is
directed to firms which have experienced already a high level of productivity. Furthermore, it is
important to distinguish between long-run and short-run effects of FDI. In the short-run, the net
effect of FDI on local firms can be ambiguous, as FDI initially increases the competition in the
host country. The long-run impact of FDI depends on the absorption capacity of the host country.
Average Hourly Labor Costs (EU-15 1998=100)
Portugal
Spain
Ireland
CEECs-10
39
72
95
15
Slovenia
46
Poland
17
Bulgaria
6
Sources: EUROSTAT, World Development Indicators (2000 edition), IMF International Financial Statistics (Various
Editions) and Brucker and al. (2001) calculations
Döhrn et al. (2001) expect that the impact of EU enlargement will benefit the central and northern
EU members to a larger extent than the southern and western periphery. Gual and Martin (1995),
and Corado (1995), present a similar view. The higher benefit for central and northern EU is
largely explained by their geographical proximity and by the similarity in factor endowments
between EU accession countries and Southern EU members. According to Döhrn et al. (2001),
Portugal seems to stand to loose from EU enlargement. Indeed, as noted earlier, Portuguese
exports are mainly labor intensive. In such a context, competition from CEECs countries would
quite threatening, as labor costs are noticeably lower. As shown in table YY only Slovenia has
23
labor costs that are above Portuguese costs. All other CEECs show labor costs that are more than
twice as low. Portugal is therefore likely to be exposed to a fairly large level of trade diversion.
Moreover, its potential for trade creation remains relatively low. Spain, and to a lesser extent
Ireland might follow Portugal as their potential for trade creation has been falling between 1993
and 1998, while their exposure to trade diversion has been rising at the same time. The peripheral
countries of the EU are also expected to be more affected by trade diversion through a possible
re-orientation of trade flows in line with geographical proximity, as Central and Northern Europe
have closer links with Eastern and Central Europe than with the peripheral EU countries. Brüstle
and Döhrn (2001) show that shares of horizontal intra-industry trade between Germany and the
Czech Republic, Slovenia and Hungary has already exceed relations observed between Germany
and Portugal and take this as evidence that the German economy might be better integrated with
the bordering non-EU Central European countries than with peripheral EU countries.
Boeri, Brücker and al. (2001) on the other hand find no evidence that EU cohesion countries
(Greece, Portugal, Spain and Ireland) will be adversely affected by the Eastern enlargement
through the displacement of their exports to the rest of the EU. According to their findings, if
trade diversion occurs, it is likely to be limited to EU trade with other transition countries.
Buch and al. (2001) investigate whether there is evidence for FDI diversion from Southern
Europe to CEECs. Raw figures, as plotted in figures XX and XY could indicate that such a
pattern has been occurring. As documented earlier, FDI flows into Southern countries such as
Spain and Portugal have been declining since the early 1990s while FDI flows to the CEECs have
considerably increased. However, according to simulations based on gravity model equations32
such a diversion effect is anything but significant. Comparison of expected (simulated) and actual
FDI figures suggest that FDI inflows have been overshooting for some time in the southern
countries, pushing FDI stocks above their long-run equilibrium and explaining why FDI inflows
are currently relatively low in relation to their long-run average. By contrast, the CEECs continue
to build up their FDI stocks and as a consequence receive relatively large FDI inflows.
Empirical evidence of the impact of FDI in Eastern Europe and Central Europe is still
fragmented. So far it seems that even though FDI from the EU since 1990 has transferred
significant technology to the EU accession countries, effects until now are restricted to the
recipients. Spillovers to the rest of the economy are seldom observed. Dörr and Kessel (1999)
report some positive spillover effects of FDI to companies in the Czech Republic and Hungary,
however, the positive impact is limited to companies in the direct supply chain. Konings (1999)
finds no direct spillover effects in case studies for Bulgaria, Poland and Romania. Due to low
levels of technology in Bulgaria and Romania, long-run effects of FDI also appears limited given
32
The methodology consists of first analyzing the determinants of FDI common across countries and their
importance through the estimation of a gravity equation. The gravity equation has the log of FDI flow (stock) from
country h (home country) to country g (host country) as the dependent variable. Explanatory variables are the GDP in
the host country, its population and the distance between country h and g. The ratio of GDP devoted to Imports, the
size of the financial proxied by the ratio of broad money M2 to GDP and a dummy variable for EU membership are
further included. In that framework, cross-section regressions of bilateral FDI flows are run for the countries of the
sample under consideration. In a second step, estimates obtained of gravity equation coefficients are used to perform
out-of-sample forecasts. These forecasts are then compared with actual figures of flows (stocks). See Brenton and al.
(1999) for a first application of the gravity model approach to FDI.
24
an insufficient absorption capacity. Due to a higher absorption capacity in Poland spill-over from
FDI seems possible in the long-term.
Döhrn et al. (2001) find that FDI in CEECs is highly concentrated on the capital and the border
regions, and - despite an overall positive impact - has tended to increase regional disparities.
Impact on Migration and Labor Markets
In general, Boeri, Brücker and al. (2001), find no significant impact of Eastern enlargement
related changes in FDI and trade on wages and employment of existing EU countries. This is
essentially due to the small size of CEEC economies relative to the EU. Nevertheless, some wage
and job displacement effects are expected to occur at sub-national level. They would possibly
concern unskilled workers in services, construction and transport, and residents in the relatively
rich regions of the Southern EU border with the CEEC.
Due to large income and wage differentials between the CEEC and the EU and to the fact that the
CEEC labor force is about 1/3 of the labor force of the EU, the impact of migration on EU labor
markets can be expected to be more sizeable than that of FDI and trade. Recent studies show
however that the impact of the EU enlargement on wages and unemployment is likely to be
moderate even in the two countries most likely to be affected: Austria and Germany. These two
countries currently attract about 80% of the migrants originating from the CEEC-10. As shown in
Boeri and Brücker (2001) immigration from the East is estimated to increase from 0.85 million in
1998 to a peak of 3.9 million approximately 30 years after the liberalization of labor mobility.
Net annual migration flows are estimated to stabilize at around 100,000 to 150,000 people per
year after an immediate increase to 335,000. All in all, projected population originating from the
CEEC countries should not represent more than 1% of the EU-15 countries.
Microeconometric exercises indicate that a one percent increase in the employment share of
migrants in a given industry would decrease Austrian wages by a negligible 0.25 percent and
German wages by 0.6 percent. At the same time, the probability of native workers’ being
dismissed increases by 0.8% in Austria and 0.2% in Germany. The impact of migration in the
white collar labor market is found to be neutral. This almost insignificant impact is due to the fact
that CEEC-10 migration is likely to head for industry branches with the best employment and
earnings prospects, that is the most prosperous ones. Those branches are expected to respond to
the increase in labor supply.
As for trade and FDI, the impact of migration on EU labor markets is most likely to be felt at subnational level, that is in border areas. In addition, as educational levels of CEEC migrants are
often found to be relatively high, they could start competing with higher skilled groups after some
time in the host country. More people would thus feel threatened by CEEC migrants. Another
possible adverse effect of migration is that, while in the tradable sector output is expected to
adjust to an increase in labor supply, this might not be the case in the non-tradable sector. As a
consequence, the impact on employment and wages in the latter sector could be more significant
than in former.
To avoid adverse effects of CEEC migration on EU labor markets and to prevent social tension
which could prompt permanent migration restrictions, Boeri and Brücker (2001) advocate
temporary restrictions on CEEC migration. Temporary migration restrictions could take the form
25
of immigration quotas which also have the additional benefit of providing an indication of
potential future migration pressure and, potentially reducing uncertainties associated with model
based migration flow projections33.
5. Economic Integration and Policy
5.1 The EU Approach of Policy Intervention
The Treaty of Rome expresses in its preamble the necessity for member states "… to strengthen
the unity of their economies and to ensure their harmonious development by reducing the
differences existing between the various regions and the backwardness of the less favored
regions". This clearly communicates the willingness to contain regional disparities from the very
start of European integration34.
With the European Monetary Union and launch of a common currency of all participating
member states, the insurance dimension of Structural Funds has been deepened, as with the
exchange rate an important tool to deal with asymmetric shocks was removed (see Box 4). Van
Rompuy and al. (1991) argue that “States agreed on centralization of competences and on the
discipline implied by the adherence to the EMU in exchange for redistributive mechanisms”.
In a currency area, without internal nominal exchange rates, adjustment to asymmetric shocks
must take place through changes in relative prices. When prices and wages are not flexible
enough to compensate for the absence of nominal exchange rates, asymmetric shocks might lead
to regional recessions and persistent regional unemployment differences. If the labor force is
mobile, workers will migrate to booming regions making the adjustment less costly (at least in
terms of unemployment). In the absence of migration, interregional fiscal transfers can help
smooth the negative effects of asymmetric shocks.
The relevance of fiscal transfers increases when labor mobility and the responsiveness of regional
relative prices is low. Previously reviewed evidence shows that in Europe labor reacts very
slowly to shocks and subsequent differentials in labor market outcomes. Fatas and Decressin
(1995) and Nahuis and Parikh (2002) find that regional labor markets adjust to labor demand
shocks essentially via labor participation, which if anything does not contribute to the
equalization of regional outcomes. Various studies indicate that relative regional prices tend to
fluctuate less than relative prices at international level (Eichengreen 1991, De Grauwe and
Vanhaverbeke 1993; von Hagen and Neuman 1994; Obstfeld and Peri (1998)).
The main instruments of the European Commission to reduce regional disparities are a series of
the Structural Funds (the largest being the European Regional Development Fund), the Cohesion
Fund and the European Investment Fund35. In 1996, EU Structural Funds represented 3% of GDP
33
See also Bertola and al. (2002) for a comprehensive discussion.
Box 5 presents the major dates in the construction of the EU.
35
The main steps in the evolution of European Regional are documented in Box 7 and Policy Eligibility criteria and
funds objectives are briefly presented in Box 8.
34
26
in Portugal, 1% in Spain and 2.5% in Ireland. These funds have been significantly increased in
the three countries since the early 1990s and strongly contribute to gross fixed capital formation
as reported in table 6. For the 2000-2006 period, these transfers will account for one third of the
Community’s budget, or €213 billion, which represents approximately 0.4% of EU-GDP; €195
billion will be spent by the four Structural Funds and €18 billion by the Cohesion Fund. As
shown in graph YY the financial effort of the Structural funds peaked in 1999, when it
represented 0.45% of EU-GDP.
The EU compensating transfers contain both short-medium re-distributive/insurance measures to
help offset the adverse impact of temporary asymmetric shocks, as well as measures to facilitate
structural change:
•
•
•
70% of the funding goes to regions whose development is lagging behind. They are home
to 22% of the population of the Union;
11.5% of the funding assists economic and social conversion in areas experiencing
structural difficulties. 18% of the population of the Union lives in such areas;
12.3% of the funding promotes the modernization of training systems and the creation of
employment outside the Objective 1 regions where such measures form part of the
strategies for catching up.
27
Box 4: Monetary Integration and Business Cycle Synchronization
On January 1999, European countries entered the third stage of the Economic and Monetary Union and
adopted the Euro as the single currency for twelve participating countries. The success of a monetary
union depends on the costs induced by abandoning nominal exchange rates as an important stabilization
instrument. In the empirical literature on European monetary integration, stabilization costs of a common
currency are generally linked to the importance of asymmetric (real) shock, i.e., the degree of business
cycle dissyncronization, as in the absence of such shocks, no stabilization instrument is required and the
benefits of a common currency36, will outweigh the costs of loosing a national currency. On the other hand
if asymmetric shocks are frequent and substantial, exchange rate flexibility becomes an important
adjustment mechanism, especially since other stabilization channels, i.e., labor mobility, real wage
flexibility, discretionary fiscal policy or budgetary transfers are found to be limited. 37
As shocks are not observed directly, empirical studies rely on econometric methods for their identification.
Helg et al. (1995) and Bayoumi and Eichengreen (1993) adopt a structural VAR approach, whereas Artis
and Zhang (1995) develop an identification scheme based on cyclical components. Rubin and Thygesen
(1996), Beine and Hecq (1997) and Beine, Candelon and Hecq (2000) use a codependence framework.
Filardo and Gordon (1994), Beine, Candelon and Sekkat (1999) and Krolzig (2001) use a Markov
Switching VAR model. This empirical work demonstrates that it is important to distinguish between short
and long-run effects. Bayoumi and Eichengreen (1993), Helg et al. (1995) and Rubin and Thygesen (1996)
use first-differenced variables in the VAR representation. However, such a specification does not allow for
long-run relationship between the variables. Beine and al. (2000), overcome this by investigating common
trends and common cycles simultaneously, where evidence of a common European cycle is taken as
evidence of perfect synchronization of shocks. Breitung and Candelon (2000, 2001) use a frequency
domain common cycle test to analyze synchronization at different business cycle frequencies.
The general conclusion emerging from the empirical literature is that there is a distinction between a core
of countries facing similar disturbances and a periphery in which idiosyncratic shocks are important.
Further, there is no general agreement about the precise composition of the European monetary union.
Expect for Germany and its small neighbors (Austria, Belgium and the Netherlands), there is no general
consensus on the inclusion of other European countries.
36
These benefits generally refer to microeconomic efficiency gains. De Grauwe (1996) compares the expected
importance of these benefits.
37
Labor mobility in Europe, both at national and regional level, is low compared to international standards, however,
but is generally not perceived as an important adjustment mechanism. European real wage flexibility is also low
(Bean 1994, Abraham, 1996)), however, its stabilization effects are also found to be quite limited (Blanchard and
Katz, 1992).
The Growth and Stability Pact limits scope for discretionary national fiscal policy. EU budgetary instruments
(Structural and Cohesion Funds) and loans from the European Investment Bank are more long-term and thus more
suitable for dealing with structural change than with short-term stabilization following an asymmetric shock.
28
5.2 The European Experience: Financial Support Based Policy
This section reviews empirical studies which attempt to assess the contribution of EU financial
support programs to convergence. The relevance of these programs is also assessed from a
theoretical point of view.
5.2.1 An Empirical Assessment
Some authors argue that the impact of EU financial assistance on regional convergence is
questionable or even counter-effective. However, based on country evidence reviewed in the
previous section, such a statement might be too general. Local specificities and country-specific
institutions appear to shape the impact of financial transfers.
Boldrin and Canova (2001) evaluate derived long-run distributions and find no evidence of a
positive impact of EU policies on the pattern of convergence across European regions. Other than
Ireland, they do not find any sign of systematic catching-up of poor and EU-funded regions in
terms of per capita GDP or GDP per worker. For unemployment rates, the picture is slightly more
mitigated. There is evidence that the number of regions with high unemployment and which
receive Structural Funds has increased over the period 1983-1997. However, there is also
evidence that unemployment has fallen in some recipient regions. Labor productivity
developments also suggest that European policies have not effectively fostered convergence. In
sum, Boldrin and Canova conclude that European policies might have assisted redistribution,
however, they have not managed to enhance the growth potential.
According to Bertola and al. (2002), Boldrin and Canova’s (2001) results are however likely to
suffer from serious methodological drawbacks as their analysis only control for EU aid, but not
for regional fixed effects. As illustrated by Ederveen, Gorter and Nahuis (2001), once regional
fixed effects are introduced, the impact of EU transfers on convergence becomes positive and
significant.
As already mentioned, macroeconomic simulations show that the spending programs of the
Structural funds added 0.5% to Irish annual GDP growth in the 90s38. Table 7 presents the effects
of structural intervention on GDP and unemployment for Ireland, Portugal and Spain. In Portugal,
GDP rose by 8.5% over and above what would have been expected in the absence of assistance
from 1990 to 1999. The corresponding figure for the unemployment rate is –0.4%.
De la Fuente and Vives (1995), present some evidence of the impact of regional policies in Spain
in the 1980s and 1990s. They find that education and public capital are both important
determinants of regional productivity, and regression results indicate that education appears to be
more important than public capital. They further show that eliminating regional differences in the
endowments of public and human capital would reduce regional inequality by around one-third in
the long-run. This suggests that supply-side oriented policies can contribute significantly towards
regional convergence. De la Fuente and Vives find, however, that the reduction of regional
inequality in Spain during the 1980s relied significantly more on the convergence of educational
levels than on the development of infrastructure. Their empirical investigations also indicate that
the European Structural Funds contributed to increases in per capita output between 0.34% and
38
Considering the high rate of average real growth in Ireland at this time, this represents an internal rate of return in
the order of 6% to 7 % per annum on the funds invested.
29
1.40% during 1986-1990. In Andalusia and Asturias the impact was 2.5%. In these two regions,
ESF have increased the public capital stock by up to one tenth. De la Fuente (1997) results further
suggest that technological catch-up, together with the equalization of educational levels and the
redistribution of employment across regions accounts for most of the observed reduction in
regional disparities in Spanish labor productivity between 1964 and 1991. In addition, a
convergence decomposition shows that education contributed between 20 and 25% to total
convergence, technological diffusion contributed almost one third and the evolution of the
capital/labor ratio accounted for the remaining 40%. A further decomposition of the capital/labor
ratio suggests that converging ratios are predominantly the result of regional reallocation of
employment rather than of capital flows. Nevertheless, low levels of labor mobility in the 1980s
suggest, as noted earlier, that these results refer to the large migratory flows of the sixties and
early seventies. Jimeno and al. (2000) also find a negative(positive) impact of ESFs (FDI inflows)
on regional productivity and per capita GDP differentials. Jimeno and al. further report that EU
Structural funds, unlike FDI flows, are concentrated in less favored regions like Extremadura,
Galicia or Asturias. EU Structural funds appear therefore to contributed very significantly to a
regional equalization of public capital. However, their equalizing effects on regional labor
productivity has not been strong enough to offset the divergence resulting from FDI flows.
In Portugal, the equalizing effects of ESFs are less obvious. A regional examination of EU
Structural funds shows increasing concentration in the developed region of Lisbon. During 19891993 this region received 38% of the total compared to 19% during 1986-1988. Between 1994
and 1996 this share amounted to 33%. However, as noted in Jimeno and al. (2000), despite a
noticeable geographical concentration, the increase in levels of EU Structural Funds have been
accompanied by a fall in the regional dispersion of per capita GDP until the mid 1990s. Ramos
(2001) further argues that EU Structural funds contributed significantly to spending on education
and infrastructure. This could indicate to some extent a negative impact of ESFs on regional
differentials, although as discussed earlier, non rigid institutions may have played a major role.
As suggested by the reviewed studies, an assessment of the impact of EU Structural Funds is not
straightforward and does not generate clear-cut results. The possible interactions with institutions
and in particular labor market institutions is likely to be crucial. On the other hand, the very
nature of infrastructure financed by those funds may also matter significantly.
5.2.2 A Theoretical Assessment
Theory does not generate unambiguous results. On the one hand, there is the view that, in the
absence of intervention, regional inequality tends to increase over the economic development
path. This view is linked to the belief that increasing returns are pervasive. As seen in section 2,
increasing returns are expected to generate a process of circular, cumulative causation leading to
increasing concentration of production and thus to increasing inequality. Production factors, when
mobile, will flow to richer regions characterized by lower unit costs, higher wages and larger
market size. On the other hand, standard neoclassical models with their assumption of decreasing
returns to the reproducible factors, predict that regional disparities due to differences in regional
relative factor endowment will diminish over time. Within this line of reasoning, trade and factor
flows contribute to the equalization of factor prices.
30
Imperfections in factor markets are likely to generate and maintain inequalities. For instance,
wage rigidities can be expected to increase the cost advantage of the more favored region and
lead to above-average unemployment rates in the less favored regions. If centralized wage
bargaining takes place, then wage levels may not perfectly reflect labor productivity in all
regions. In that context remote regions with more abundant labor than capital would not be
attractive to firms on account of relatively higher labor costs.
Similar proportions of Structural Funds are allocated to develop infrastructure, provide training,
extend telecommunications services and disseminate the tools and know-how of the information
society. Implementing training programs targeted at workers in less-advanced regions appears to
be a desirable measure according to all of the theoretical contexts considered previously. In neoclassical growth models, training is likely to increase the speed of convergence as it aides the
equalization of relative factor endowments and thus of factor prices. Endogenous growth models
would strongly advocate training programs for low-skill workers in less favored regions. Indeed,
increased training, as long as it generates higher levels of human capital, can permit less favored
regions to jump on a path of higher growth. This argument can also be found in some of the new
economic geography models39. If training effectively facilitates innovation and knowledge
diffusion, it can contribute to increase aggregate growth and reduce regional inequalities.
Training can also be a determinant in the increasing sectoral specialization by leading to selfreinforcing agglomeration.
Predictions about the desirability of subsidies to enterprises producing in less favored regions are
somewhat mitigated. Both neo-classical and endogenous growth models support these kinds of
subsidies to the extent that they effectively lead to either capital accumulation or technological
progress. Both effects would speed up convergence or equivalently contain divergence. New
economic geography models analyze precisely some of the externalities that arise from the
location of individuals firms which affect firms in other regions. There is no single prediction
about the impact of enterprises’ subsidies because of the multiplicity of equilibria that
characterizes this sort of model. Their desirability is negatively related to the degree of mobility
of production factors. The degree of factor mobility can however be influenced by institutions.
E0ventually, their desirability certainly depends upon underlying economical and political
motivation. Another argument against direct support to firms is that it could encourage nonrationalized and/or highly risky projects. In that situation large deadweight losses are expected.
Infrastructure investments are essentially devoted to improve transport infrastructure. The
European Commission sees the improvement of the transport infrastructure as “ a key role in
efforts to reduce regional and social disparities in the European Union and in the strengthening of
its economic and social cohesion” (Commission of the European Communities, 1999). Growth
models have little to say about transport costs per se. Nevertheless, if interpreted as a measure to
stimulate trade, it would be supported by neoclassical models; if interpreted as an improvement in
public infrastructure (i.e., public capital) it would be supported by endogenous growth models.
New economic geography models are by far the most appropriate to assess the relevance of such
policies in terms of contribution to the reduction of regional disparities. A better connection
between two regions with different development levels is generally found to have ambiguous
effects. On the one hand, firms in the less developed region are given better access to the inputs
39
See Martin (1999a).
31
and markets of the more developed region. On the other hand, it is easier for firms in the more
advanced region to access less the advanced region from a distance. This can harm the
industrialization prospects of less advanced regions through intensified competition. Moreover,
the overall impact of lower transport costs for poorer regions, besides depending on the very
characteristics of the projects, also depends on the regional economic environment. With low
interregional labor mobility and small interregional wage differentials, a reduction in transport
costs can be expected to foster regional disparities, as argued by Faini and Schiantarelli (1983),
for Southern Italy. However, improvements in local rather than interregional infrastructure may
have beneficial effects for the less developed region40. Indeed, this could increase the impact of
regional production externalities. Martin (1999a), argues that intra-regional infrastructures that
lower cost innovation are likely to contain inequality across regions without hampering overall
growth performance, despite a bigger spatial concentration of firms. Puga and Venables (1997)
and Fujita and Mori (1996) study the impact of hub-and-spoke41 interconnections relative to
multilateral connections42. They show that hub-and-spoke networks promote agglomeration in the
hub of the network and tend to trigger disparities between spoke regions. An example is the
Trans-European Transport Network designed to give much of the EU better access to the main
activity centers. However, the effective outcome as illustrated in Puga (2001) is likely to be an
increase in the gap in relative accessibility between core and peripheral areas which reinforces the
position of core regions as transport hubs.
Martin (1999b) develops the growth dimension in the study of the interactions between public
policies and regional inequalities. Long-term growth is framed by endogenously determined
innovation. Geographical concentration of production activities is supposed to increase
opportunities to reduce the cost of innovation. The framework highlights the fact that industrial
location inequality does not always mirror income inequality and that policy intervention may
exacerbate this non-correspondence. For instance, lowering transport costs within a poor region
(small market) does lead to lower industrial agglomeration but at the cost of higher inter-regional
income inequalities and lower growth. Lower transport costs within the poor region make it more
attractive to producers. However, because of lower concentration, innovation is more expensive
and this depresses growth. Moreover, lower concentration and thus less competition, means
relatively higher profits in the richest region (largest market). In this framework, only a reduction
in the cost of innovation or an increase in the rate of diffusion of innovation will lead to lower
concentration, lower income inequalities and higher growth. This kind of results may justify the
importance attributed to the development of an information society and the increasing share of
funds dedicated to the diffusion of the communication technologies.
40
See Martin and Rogers (1995).
Places are connected by routes going through a common center or hub.
42
Places are connected pairwise with routes of similar quality.
41
32
5.3 The European Experience: Institutional Convergence
The Eastern enlargement of the EU represents one of the most challenging component of the EU
construction process. The fundamental role played by regional policies, notably in the aftermath
of EMU, has led European authorities to promote the administrative capacity of potential
candidates to undertake sound regional development plans in an integrated economic, social and
legal environment. Moreover, it is believed that institutional reforms to adopt the EU model
create the necessary environment to attract private interests.
To become a full EU member, candidate countries are expected to fulfill certain criteria that go
beyond economic considerations. The Copenhagen European Council, in 1993 established precise
membership criteria after agreeing that enlargement to CEEC countries could take place. As
presented in Box 6 these requirements are articulated around three major arguments: stability of
institutions, existence of a functioning market economy and ability to adopt obligations of
membership (implementation of the entire “acquis communautaire”). At the end of 1994, the
Essen European council laid out a pre-accession strategy to prepare the CEEC countries for EU
membership. This strategy was enhanced in 1997, and special strategies have been defined for
Malta and Cyprus.
Each strategy refers to trade, political dialogue, legal approximation as well as various areas of
co-operation. All these issues are dealt within country (group of countries) specific agreements:
Europe Agreements or Association Agreements. The pre-accession strategy further includes
accession partnerships that provide direct assistance for specific needs; pre-accession financial
assistance programs to help institution building and promote investment; and access to European
Community programs and agencies.
Pre-accession financial assistance occurs essentially via three major programs. The most
important is the Phare program43 dedicated to financing institution building and investment.
Twinning launched in 1998 is the main instrument for institution building. The intention is to
help the candidate countries develop modern efficient administrations necessary to implement the
acquis of current Member States. Twinning involves the secondment of EU experts to candidate
countries to accompany an ongoing process. A total of 475 Twinning projects were undertaken
between 1998 and 2001.
Accession criteria and the implementation of a pre-accession strategy are supposed to help
economic integration by creating the most appropriate economic and institutional environments
articulated around competitive market functioning and democratic institutions. According to
Boeri, Bücker (2001), the credibility gain of CEECs due to prospective EU membership in terms
of institutional and economic stability has played a major role in attracting foreign investment. As
noted earlier, total capital flows to CEECs have increased substantially in the second half of the
1990s. Net annual capital inflows to the ten CEECs ranged from between US$14 billion and
US$28 billion in the period 1995–1998. The positive link between credibility and FDI is
reinforced by the evidence of huge differences in the allocation of capital flows between
43
Annual budget of 1560 million euros
33
individual candidate countries. In 1999, almost 85% of net capital flows into the CEECs were
concentrated in the first-round candidate countries.44
6. Containing Regional Inequalities in Mexico
The North American Free Trade Agreement (NAFTA) was signed on August 12 1992, and went
into effect after ratification on January 1st, 1994. It was aimed at reducing and ultimately
eliminating (after a phase-in transition of up to 15 years) most of the barriers to trade and
investment across the member countries, creating a $7 trillion market with a population of 370
million people.
The NAFTA experiment is quite different from integration initiatives in the EU. The possible
scope of economic and social integration is much greater in the European case. The different
scope of economic and social integration is also linked to a different motivation behind
integration. While NAFTA is predominantly a trade agreement, the European integration
initiative had a strong political motivation from the very beginning , intending to foster European
unity after the devastating impact of century-long European rivalry which culminated in the
Second World War.45 A strong politically motivated vision for unity helped the EU process of
economic integration and it is uncertain if the current level of integration would have been
reached if economic considerations only had prevailed.
Like other free-trade agreements NAFTA is not meant to harmonize trade barriers with respect to
non-member countries. As such, much of the agreement specifies detailed rules-of-origin, to
avoid evasion of national tariffs and quotas through trans-shipment. In some respects, NAFTA is
closer to the EU Single Market scheme than to traditional free-trade agreements. Besides the
eventual elimination of trade barriers among the countries, NAFTA specifies non-discriminatory
access provisions (with respect to telecommunications and government procurement for large
contracts) and regulatory provisions (with respect to the protection of intellectual property rights
and technical standards) which are similar in character, though more limited in scope, to
provisions under the Single Market Program.
The removal of barriers to labor mobility is however less relevant to NAFTA. Indeed, only
temporary entry permits for certain business categories are contemplated under NAFTA.
Undocumented migration from Mexico to the US remains substantial, ranging between three and
six millions and suggests that migration could represent a major economic concern.46
44
While EU accession prospects can increase FDI and capital flows, this is unlikely to be automatic or permanent.
The Southern EU enlargement episode shows that FDI and other capital flows increased substantially at first, but
declined later to pre-accession levels.
45
European Integration started with the declaration of then French Foreign Minister Robert Schuman in 1950 who
suggested to place Franco-German coal and steel production – the main resources for warfare at that time—under a
common High Authority. Over the following decades the process of European integration intensified and the number
of member states grew from six to fifteen today. The gradual construction of the European Union helped resolve
conflicts between countries which had been almost constantly at war with each other.
46
Bean et al. (2002) estimate the illegal-resident population in 2001 at a midrange total of nearly 8 million (7.8) –
between a low estimate of 5.9 millions and high of 9.9 millions. About 58% of illegal residents are of Mexican
origin, while a further 20% is from Central America.
34
Labor migration from less developed countries is often perceived to generate social and economic
problems in the richer destination countries due to adverse wage and employment effects. Trade
liberalization and economic integration, on the other hand, are expected to create employment
and wealth in the less developed country and as a consequence should stop workers from
migrating. The impact of liberalizing trade between Mexico and the US is not expected to change
migration dynamics dramatically. The European experience does not support that a higher trade
intensity brings about a reversal of migration flows, it shows that the turnaround of migration
flows in some countries (Spain and Greece) occurred well before trade barriers had been
dismantled. This indicates that the turnaround in European migration occurred not as a result of
trade liberalization, but through economic development and catch-up in Southern Europe. A
similar pattern is expected to emerge for Mexico-US migration in the longer run.
In the meantime, migration dynamics will remain driven by economic differences between the
two countries. Markusen and Zahniser (1999), point out that wage convergence for unskilled
workers between the two countries is expected to remain very low, and will most likely not be
strong enough to halt migration. Further, persistently high rates of unemployment and
underemployment are enduring features of the Mexican economy and may remain too high to
stop Mexicans from migrating North.
The extreme differences in economic development between Mexico and its NAFTA partners at
the signing of NAFTA is comparable to the differences in economic development between the
CEEC accession countries and the EU.47 They were perceived, in particular in the US, to cause
major changes in specialization patterns and massive jobs dislocation in the US. Previously
reviewed studies indicate that the negative impact of the EU Eastern enlargement on EU wages
and employment is expected to remain low enough as not to create any social tension. Recent
investigations for NAFTA show a similar finding: a negative integration effect on wage and
employment may not materialize. Indeed, US workers - including the most at risk, the unskilled
– appear to have gained through NAFTA. An explanation can be found in the fact that trade
openness was already strong at the time of signing NAFTA and that Mexican and US border
industries have become vertically integrated as documented in Hanson (1998). Vertical
production relationships imply no competition between US and Mexican unskilled workers. As
such, Mexico-US labor migration may not prove as harmful as expected.
Freeing up labor movements is still one of the main issues to be considered in the context of a
deepening of NAFTA. Although free labor mobility is not an obstacle to regional economic
integration, free movement should remain an objective for the longer term, once economic
convergence has progressed further. In the meantime, free trade agreements could be
complemented by a positive migration policy, whose primary objective would be to discourage
unauthorized immigration and regulate flows within the free trade area. Similar policies are
currently under consideration in the EU Eastern enlargement debate.
47
The heterogeneity of economic development within NAFTA is much more comparable to the level of
heterogeneity found between the EU-15 and CEEC accession countries in the current wave of EU accession than
during the Mediterranean accession experiment of the 1990s. While Canada’s per capita GDP is 80% percent of the
US, Mexico reaches only about 12% of per capita GDP of the US. In comparison, the CEEC-10 accession countries
reach about 14% of EU-15 per capita GDP, while the respective figures for Portugal and Spain at the time of their
accession were 53% and 70%.
35
Portugal, Spain and Ireland joined the EU at different stages of development and have
experienced different economic progress since. While Ireland has surpassed the EU average level
of labor productivity and GDP per capita, Spain has almost reached the EU average level of labor
productivity, but at a cost of higher unemployment. Portugal on the other hand managed to catchup both in terms of labor productivity and GDP per capita.
From the experience of these countries several lessons can be drawn which might be relevant for
NAFTA. As argued in Boeri, Burda and Köllo (1998), countries which prepared for EU
membership had to reshuffle their economic structure. In fact, structural change did not end with
EU accession and proceeded afterwards at an even faster pace. Due to relatively rigid labor
markets, structural change caused higher unemployment. As such, EU integration had a negative
effect on the labor market, although, as shown previously, there were striking difference in the
evolution of aggregate unemployment in Spain and Portugal, highlighting country-specific
institutional arrangements. Trade reform and liberalization did not only affect employment and its
composition, but also wages and wage inequality. The EU experience shows that EU integration
has exacerbated regional inequalities and regional inequalities are linked to capital accumulation
– in particular FDI.
The EU integration process shows that deeper economic integration is likely to require policy
makers to centralize at least part of their decision making process, whether economic or social.
The EU experience can provide a better understanding of integration-induced changes in the
economic and industrial geography and help formulate appropriate policies to deal with resulting
negative social and economic effects. Further, integration without policy monitoring can lead to
increasing inter-regional inequalities, exacerbating migratory pressures and generating
unsustainable social tensions. As such, there appears to be an important role for policy
intervention in achieving successful economic integration. The previous sections allow us to draw
three major conclusions about desirable policy intervention in a context of deepening economic
integration:
•
•
•
inter-national convergence should be achieved through the promotion of inter-regional
convergence
inter-regional convergence is likely to rely on policy intervention, and policy intervention
should favor intra-regional development
institutional factors can be expected to play a predominant role in the economic
integration process.
The second point is particularly relevant to the Mexican case and needs further qualification.
Standard theory indicates that inter-regional convergence could be achieved through factor and in
particular labor mobility. However, in the presence of increasing returns, for example due to
localized spillovers, labor mobility can be expected to exacerbate regional divergence. In that
context, policy intervention should be targeted at intra-regional development. The European
experience also indicates that policy interventions need to be properly framed and, in order to be
fully effective, policy intervention requires an institutional framework which preserves efficient
labor migration decisions.
36
Before providing possible policy orientations for Mexico, the following section assesses regional
inequality in Mexico.
6.1 Regional inequality in Mexico
The EU experience shows that EU integration has exacerbated regional inequalities, and a similar
picture is found for Mexico. It appears that through NAFTA integration, regional disparities in
Mexico have increased as a consequence of FDI regional concentration; the inherent relocation of
economic activity and subsequent worker migration from remote regions and regions with
formerly protected sectors. With regard to regional concentration of FDI, Mexico’s NAFTA
integration resembles most closely the EU integration experience of the Iberian countries, and to
some extent the CEEC countries.
Juan-Ramon and Rivera-Batiz (1996) investigate the pattern of regional growth in Mexico from
1970 to 1993. They find evidence of real per capita GDP convergence during the period 19701985 to be higher than average national per capita growth (2.41% per year on average), and
divergence during the relatively lower-growth period of 1985-1993 (-0.37% per year on average).
Their results hold across states and regions, and within regions. They do not find any evidence of
convergence clubs.
Esquivel and Messmacher (2002) study the main sources of regional convergence in Mexico
between 1960 and 2000. They show that regional output per capita converged during the 1970s,
while it remained relatively stable in the 1960s and 1980s and diverged in the 1990s. While the
lack of convergence between 1960s and 1990s is attributed to the evolution of labor market
variables (the employment rate and the participation rate), regional divergence in the 1990s was
mostly driven by the divergence observed in labor productivity. An analysis of the determinants
of productivity suggests that the change in the regional pattern of productivity is associated with a
structural change in the 1990s. In particular, education and infrastructure have become more
important in explaining output per capita and productivity. The divergence process of the 1990s
has exacerbated the already high degree of regional inequality in the Mexican economy.
Hanson (1998) argues that trade reform contributed significantly to the contraction of
employment in the Mexico City manufacturing belt and to the rapid expansion of manufacturing
employment in the US border regions. Hanson shows that trade reform induced a strong negative
correlation between industrial employment in Mexico and distance to the United States, i.e., the
opportunity for employment in the industrial sector decreases with distance from the US border.
Hanson also shows that strong backward-forward linkages are at play in the border regions.
Because backward-forward linkages are based on localized spillovers, his results suggest that
highly specialized regional industrial centers are the main feature in the post trade reform
production landscape of Mexico. The regional specialization that characterized the pre-reform
period has been disappearing in favor of multiple manufacturing sites (maquiladoras)
concentrated in the Northern Mexican regions at the border with the United States.
48
Bean et al. (2002) estimate the illegally-resident population in 2001 at a midrange total of nearly 8 million (7.8)
unauthorized residents – between a low estimate of 5.9 millions and high of 9.9 millions. About 58% of illegal
residents are of Mexican origin, while a further 20% is from Central America.
37
Maquiladoras are assembly plants which mainly import parts and components from the US and
export the finished or intermediate products back to the US. The expansion of maquiladora-based
trade led to increased vertical supply linkages between US and Mexican firms. These linkages
have contributed strongly pulling economic activity in Mexico towards the North and to making
the US-Mexico border regions an integrated labor area.
Aroca and Maloney (2002), show that FDI flows to Mexico have been highly regionally
concentrated. They simulate the migration impact of a rise in investment of both 10% and 100
million dollar in the various Mexican regions. Their results indicate that net out-migration is
expected to fall in FDI receiving regions, and suggest that regional concentration of FDI has
fueled migration from remote Central and Southern Mexican to more developed Northern
Mexican regions and eventually the United Sates.49
Increased wage inequality is not only the result of geographically concentrated FDI, but also due
to FDI investments favoring skilled labor. Feenstra and Hanson (1995) present evidence for the
latter and argue that the rising wage inequality observed in Mexico in the 1980s is related to
productive foreign capital inflows which further contributed to the expansion of maquiladoras.
Feenstra and Hanson provide some evidence that these capital inflows induced a production shift
towards relatively skill-intensive goods and link it to the outsourcing of North American
multinational firms. As a consequence the relative demand for skilled labor increased. Feenstra
and Hanson show that in the regions where FDI was most concentrated, growth in FDI accounted
for more than 50% of the increase in the share of skilled labor in total wages.
6.2 Policy Implications
6.2.1 Defining the Policy Orientation
The stylized facts presented in previous sections indicate the following:
•
•
•
•
•
•
Economic integration in Mexico has been accompanied by a rise in regional inequality.
FDI has played an important role in reshaping the regional map of economic activity and
has thus significantly contributed to the rise of regional inequality.
FDI has been substantial but has remained highly concentrated in the Northern border
regions.
FDI contributed to a rise in wage inequality essentially by increasing the skills premium.
Economic activity related to FDI inflows is likely to be characterized by local spillovers
FDI appears to be a good substitute for labor mobility, however the degree of substitution
is higher in more advanced regions.
49
Another element that is expected to keep migratory pressure high is Mexico’s still abundant labor force in
agriculture. In 1994, the share of the labor force in agriculture was 25.8% and it remained steady between 1991 and
1994. Moreover, a substantial part of this population is working in the maize (corn) sector which is a highly
protected. Burfisher, Robinson and Thierfelder (1994), document that unskilled labor remains the abundant factor in
Mexico with respect to the other two NAFTA members. Theory would predict losses for import competing sector, in
the Mexican case: the maize sector. In that context, migration pressures are likely to appear due to sectoral
adjustment. Using a computable general equilibrium model, Robinson and al. (1993) show that trade liberalization in
the agricultural sector would substantially increase rural-urban migration within Mexico and migration from Mexico
to the US.
38
•
Labor mobility has not slowed down as migration pressures from more remote regions
persist and are likely to remain high.
These results indicate that promoting even higher labor mobility across Mexican regions would
not help to revert this diverging trend, rather it would reinforce it. Moreover, high rates of
unemployment and under-employment, especially among low skilled workers, suggest that such a
policy is likely to create social tensions and push distressed workers further North, increasing
migratory pressures to the United States. This suggests that Mexican worker mobility is the
outcome of a decision taken in a very risky context in most cases. With very high risk of
“failure”, for example unemployment/underemployment, health threatening conditions of life and
work in the host region, mobility may not represent a wealth improving choice and could, as such
be considered inefficient.
There is scope for a policy strategy that promotes regional development and the European
experiences can be informative. Events in Portugal highlight the need for policy equity between
regions at different development stages. The Spanish experience indicates the importance of
improvements in human capital, but experiences of both countries suggest that labor market
institutions should be reformed, if labor markets are not functioning. The Irish experience
underlines the desirability of industrial strategy with medium to long-term objectives. The EU
Eastern enlargement experience and events in Ireland show that the institutional environment
needs to be responsive to foreign investment.
As such, policy intervention in Mexico should focus on:
•
•
•
•
•
a region-based and regional-equity-oriented policy intervention plan,
the promotion of human capital accumulation,
an employment enhancing institutional environment,
a medium and long-term region-based economic development strategy,
an investment friendly institutional and economic environment.
6.2.2 Policy Components
This section presents policy instruments which can help achieve the previously defined policy
objectives within the context of the Mexican economy.
Compensating Transfers
The EU policy response to regional inequality has been a series of compensating transfers which
are (1) short-medium re-distributive/insurance measures and (2) attempts to enhance the potential
for regional economic growth and development, as well as inter-regional social cohesion.
The financial support of the EU to less advantaged regions aims to stimulate productive private
investment through direct subsidies of firms and projects, transfer of know-how and/or the
creation of public infrastructure. The rationale for public investment is essentially the support of
private investment and the promotion of human capital accumulation. Public investment is one
39
way to address a high geographical concentration of FDI, and it can take the form of
compensating disadvantaged regions directly or of providing infrastructure to attract foreign
investors. As to the first, in the main EU recipient countries Structural and Cohesion Funds
mostly flow to less-advantaged regions, thereby compensating for the concentration of FDI
inflows in the most developed regions. The Irish experience shows that public infrastructure has
significantly contributed to the inflow of FDI.
It has often been argued that EU policies of directly funding firms and projects have been
inefficient and characterized by high deadweight losses. Some empirical evidence shows that it
can be ineffective to directly subsidize investment in remote regions. Tondl (1999) shows that
over the 1975-1994 period, the income level of Southern EU regions has been largely determined
by employment/educational levels and past public investment, while the impact of private
investment has been positive but almost insignificant. The insignificant impact of private
investment may be due to the poor performance of directly subsidized investment through
Structural Funds.
The European experience indicates that private investment subsidy schemes, while desirable for
many aspects (e.g. a regional demand stimulus and employment creation) in the short-run should
be embedded in a longer-term strategy focused on the development of an economic activity
enhancing public infrastructure50 and the promotion of human capital accumulation.
Public infrastructure investments and human capital accumulation should be pursued jointly, as
this helps to establish an investment friendly environment. Investing in human capital alone may
not be sufficient to ensure regional development. As labor is mobile, higher skilled workers can
migrate to more advanced areas with better earnings prospects, thus increasing outward migration
and regional disparities. Infrastructure investments are therefore required at the same time to
attract investors, to generate local employment opportunities and to increase earnings prospects
within the region.
The European experience indicates that while EU financial transfers might not have accelerated
convergence across regions it may well have contained a divergence process. However,
compensating cross-border transfers are not the only way to deal with regionally concentrated
FDI. While they require a strong political commitment to the integration process, the EU
experience also teaches that institutions at the national level play a significant role in containing
regional inequality and facilitating structural change and economic catch-up.
Flexible Labor Market Institutions and a Role for the Small-Scale-Production/Informal Sector
Studies of the Iberian countries recognize the desirability of institutional flexibility to
accommodate structural changes. While inflexible labor market institutions are often made
responsible for high unemployment and non-adjusting labor movements in Spain, the positive
performance of the Portuguese labor market is often attributed to a flexible institutional
framework. However, institutional flexibility in the labor market may come at a cost for wage
inequality, indeed, as documented earlier, wage inequalities are higher in Portugal than in Spain.
50
This point is developed extensively below.
40
Labor market institutions do not seem to create high rigidity in the Mexican labor market as
documented in World Bank (1999). For instance, Mexican unions contribute to the creation of
employment (feather-bedding) rather that to a rise in wages. Moreover, the minimum wage does
not appear to be particularly binding51. The Mexican unemployment insurance system is
somewhat insufficient and steps should be taken to lessen the negative impact of high turnover
rates on the welfare of displaced workers. Some good measures are non-statutory firing costs
agreed in collective bargaining, a greater emphasis on advance notification in the case of
dismissals rather than on procedural obstacles to layoffs, unemployment benefits of shorter
duration and in-works benefits; and minimum wages differentiated by age. All these measures
can guarantee a relatively high turnover at minimum cost for displaced workers while at the
same time preserving important labor mobility incentives52.
While Mexican labor is highly mobile, the previously documented persistence of high
unemployment, especially among unskilled workers, seems to indicate that Mexican labor
migration has not improved overall labor market outcomes. This points to structural inefficiencies
in the Mexican labor market which are linked to a pronounced formal-informal divide of the
Mexican labor market, which is common to developing economies.
Within the traditional “dualistic” view of labor markets in less developed countries, the informal
sector is seen as the residual of a highly distorted formal sector labor market, where unions and/or
government regulation keep wages above their equilibrium level, rationing workers into the
informal sector where they are then left completely unprotected by labor legislation. Participation
in the non-regulated informal section the economy is thus seen as non-voluntary, and workers
regard the formal sector always as the better alternative.
Recently the view has emerged that that as a first approximation, the informal sector should be
treated as an unregulated/unprotected entrepreneurial sector that may be desirable to many
workers. In other words, the choice to participate in the informal sector is a rational one. This
rationality could be linked to elements like the misalignment of implicit and explicit labor taxes
with perceived benefits or the desire of workers to retain a degree of independence in their work.
There is evidence that the informal sector in Mexico, which is essentially involved in the
production of non-traded goods, has features of a dynamic entrepreneurial sector which has a
potential to improve overall labor market efficiency. It is often argued that in an effort to
formalize the economy, rather than strictly enforcing formal sector compliance, incentives should
be given to informal sector workers to comply with taxes and formal labor market institutions. As
a temporary strategy, it might even be justified to directly support informal sector activity through
a variety of policy measures.53 Elements of such a strategy could consist of the following:
•
Lowering production costs in the informal sector as part of a general insurance scheme.
The aim would be to support participation in the self-employed non-traded goods sector
rather than providing insurance benefits. For instance, displaced workers could be given
the option to invest part of their unemployment benefit rights in self-employment. Such
51
See Maloney and Nunez (2001)
See inter alia Bertola and al. (2002) for a discussion.
53
See Maloney (1998) and Fiess, Fugazza and Maloney (2002).
52
41
measures are in line with in-work-benefits measures, as they provide genuine incentives to
return to work. By explicitly allowing the conversion of unemployment insurance to a
subsidy for self-employment, deadweight losses usually associated with any
unemployment insurance scheme could be minimized.
•
Subsidize training for self-employed. As documented previously, individual training is
believed to play a central role in regional development within the European Union. It
remains nonetheless necessary to set up a framework able to minimize subsidy farming .54
Recent studies indicate that the self-employment sector is attractive to a large extent
because of the work independence, however, the moral hazard aspect of such subsidy
schemes is likely to be non-significant. Eligibility to such schemes would be contingent
on compliance with the legal system. While the scheme itself would require additional
financial resources, the costs of auditing and deterrence are expected to fall and the
efficiency of tax collection to increase as informal actors would become identifiable.
•
Re-evaluation of micro-credit policies. By providing the informal self-employed with
access to financial support schemes, whether public or private, it could be possible to
bring the informal sector into the fiscal and institutional system. As a consequence, the tax
evasion component of informality could be contained. Promoting the integration of the
informal sector into the formal system would possibly create fiscal incentives more
efficiently than a purely deterrent approach.
•
Realign cost and benefits of participation in the formal economy. It may be the case that
lowering the costs attached to the uncertainty of economic activity could also facilitate the
implementation of higher labor standards. Displaced workers would be able not to take
the first job opportunity. They would be able to wait for a suitable position either in terms
of salary, or social security coverage, or both, forcing potential employers to raise labor
standards or, as far as informal employers are concerned, to adjust their standards to
match those offered in the formal sector.
Infrastructures and Investment Friendly Environment
An efficient local public infrastructure is needed, especially in regions that do not have any
comparative advantage due to location. This is the case for most of the Central and Southern
Mexican regions relative to Northern border regions. As mentioned previously, Aroca and
Maloney (2002) findings indicate that investment per se can not solve the issue of poverty and
possible subsequent migration. Rather, funds should be devoted to improving public
infrastructures and promoting human capital accumulation.
Previously reviewed theoretical contributions indicate that the presence of good public
infrastructures are necessary to make a region attractive. As mentioned previously, this has been
the case in Ireland, which thanks to EU aid became an international communications center by
the late 1970s. The accessibility of the region is also a determinant factor especially when
considering the possibility of producing intermediate components. With relatively good
accessibility, i.e., good transport infrastructures, currently remote regions may effectively take
54
Subsidy farming simply refers to those who would become unemployed on purpose just to get the subsidy.
42
off. By generating some economic wealth in these regions, demand could grow and attract firms
producing goods for the local market. This could also be true for horizontal type FDI55.
In order to promote regional development, previous sections indicate that public spending should
concentrate on the development of intra-regional (e.g. transportation network within the region)
infrastructures rather than inter-regional ones (e.g. transportation network across regions). Public
investment in inter-regional transport infrastructures may not increase the already concentrated
industrial activity landscape in Mexico. It might be the case that regions adjacent to the northern
border regions benefit from transportation infrastructures as they would become more attractive
to US firms. Indeed, intermediate goods produced in Mexico and exported to US firms are
transport intensive as documented in Hanson (1998). Lowering transportation costs could expand
the production radius that would guarantee profitable vertical relationship production. However,
transportation costs inherent to the Southern adjacent regions would have to fall relative to the US
border regions, meaning that more funding should be dedicated to the former.
If public infrastructure is oriented towards an improvement of the economic environment, public
funding could help stabilize economic activity in the short run and contain migratory flows.
Moreover, if part of the funding is, as in the case of remote EU regions, devoted to education and
human capital development in general, long term economic perspectives would improve. Future
potential investors would face a better skilled local labor force. We previously documented the
fact that CEEC countries had a relatively well-skilled labor force and this feature has positively
contributed to attracting foreign investors. In the case of Spain, convergence in education levels
has contributed substantially to output catch-up.
Region-Based Industrial Strategy
The case of Ireland is very instructive in terms of industrial strategy. The choice in the 1970s of
promoting the implementation of non-transport-intensive industries has been one of the key
determinants of its impressive growth experience. However, this choice had to be coupled with
the creation of a Single Market to be as growth enhancing as it has been. In that sense, Mexico
should consider its industrial policy in various future possible contexts. The most probable
scenarios would be the prevalence of the status quo or a deeper economic integration with its
present NAFTA partners. A third possibility could be additional economic integration throughout
the Americas A fourth possibility could be a combination of deeper integration within NAFTA
and NAFTA enlargement.
The Mexican economy is likely to benefit from deeper economic links with South America,56
however, the growth impact is likely to be much smaller than the one experienced after the
opening to US capital. Indeed, unless the US participates in the free trade area enlargement,
Mexican industries stand little to gain as they are mostly devoted to vertical supply relationships
with US firms. Assuming that the US is part of the agreement, intensified trade would certainly
55
See Venables (2001) for discussion.
At present, trade links between Mexico and the rest of Latin America are weak. Mexico exports US$ 3 billion to
other Latin American countries or 1.9 percent of total exports, and imports US$ 4.7 billion or 2.8 percent of total
imports.
56
43
sharpen regional inequalities within Mexico and accentuate its nondesirable side effects as the
northern regions would still be the more advantaged by further integration.
Thus, the main objective of a regional equality enhancing strategy remains the full implication in
the growth process of the more remote regions. Generally speaking, it appears to be rather
challenging to establish a proper industrial policy that is fully independent of the relationship
with US firms. It becomes even more challenging to identify a policy that would benefit those
regions that are far from the US border. Some of them could strongly benefit from the
development of the tourism industry. Other regions however, do not present any apparent
attractive feature. In both cases, the development of public infrastructure seems again a sine qua
non condition to sustainable economic development. Geographically disadvantaged regions
should focus on the production of those elements entering the production of exports to the US,
which are neither transport cost intensive nor dependent on local spillovers. This would provide
less advantaged regions with public infrastructure that promotes small-scale production and could
help promote economic development: contain migratory flows and eventually reduce regional
inequalities.
Coordination and Institutional Partnership
The evidence of high economic integration between the US-Mexico border regions would call for
some degree of (perhaps more macro) policy coordination between the two countries as suggested
by previous theoretical arguments. Indeed, Robertson (2000), finds that the United States’ and
Mexico’s labor markets are closely integrated. This is particularly true for border regions with the
US. As shown in Hanson (1998), the opening of the Mexican economy in the 1980s promoted the
development of vertical supply relationships between US and Mexican firms which due to their
transport intensive characteristics are mostly located in the border regions. Hanson further finds
that employment growth in US border regions is strongly positively correlated with export
production in neighboring Mexican regions.
In the EU enlargement episodes, institutional convergence, appears to have played an important
role in attracting foreign investment. Previous sections documented that a country’s credibility
was boosted after undertaking reforms to fulfill EU accession criteria and that this has helped to
attract substantial investment inflows. Mexico and possible future members of NAFTA could
also enjoy higher investment flows by committing to sound institutional reforms that could
promote both political and economic stability. Potential financial aid could be made conditional
on the implementation of institutional reforms that help promote investment. In line with previous
arguments, an important role could be given to the implementation of clear regional development
plans, as in the EU. Before receiving Structural funds, countries are required to set up a regional
policy plan. This has been a major issue for Portugal which had no such plan at the time of its
accession to the EU.
The EU strategy of enlargement and integration also dedicates funds to the development of the
administrative apparatus in acceding and candidate countries. Administrative partnerships
between current and future EU member states have been set up to improve administrative
efficiency in the latter countries to guarantee the implementation of the “acquis communautaire”.
This approach helps institutional convergence, it also helps promote an investment friendly
environment as costs of integration as a result of malfunctioning administration and poor
44
institutions are reduced. Such initiatives would be particularly welcome for Mexico and its
NAFTA partners. By promoting an efficient institutional and administrative framework, both
national and foreign private investors are likely to reconsider downward the risk associated with
investment in Mexico. As a consequence this could lead to new production and opportunities for
trade diversification.
Again, this kind of measure should be implemented in a spirit of regional development and
cohesion. It might then be the case to insist on partnerships with more remote regions. Indeed, as
these regions tend to be the ones most in need of public infrastructures, particular attention should
be given to the efficient management and allocation of public funds.
Cross-border Institutions
The EU has been least successful where there have been attempts to implement interventionist
policies, such as the Common Agricultural Policy; technological and industrial policies; and
regional development policies. It has been most successful in areas where the policy has been
non-interventionist, where bureaucratic restraint has been exercised and where free free-trade and
private sector-led development has been encouraged. However, the existence of supranational
bodies can compromise the interests of member countries and is likely to be a source of conflict.
It is necessary for member countries to show willingness to sacrifice national sovereignty for
regional objectives. The concept of "subsidiarity" used in the case of the EU appears a useful
guiding principle for cross-border institutions in general. The concept of subsidiarity requires
that issues should be resolved at the most decentralized level possible. Thus, instead of requiring
complete harmonization of standards and policies, the focus should be on establishing nondiscriminatory rules and a binding mechanism for dispute resolution.
45
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Appendix:
Box 2: Agglomeration, Inequality and Labor Mobility: A Simple Framework
Income
Inequalities
AA
RR
Industrial Agglomeration
MM
DD
Wages
Differential
We consider a two region model in which firms can locate in either region. The North region is relatively
richer in capital than the South. Labor is initially supposed to be mobile. That is, workers, like firms, can
chose their location.
We assume that firms have an interest in being close to the richest area, the largest market, because they
maximize the benefits of economies of scale that characterize industrial production. On the other hand, as
firms are in a monopolistic environment, more agglomeration signifies lower profits and thus lower interregional income inequality.
When moving, workers face some costs that are linked to various factors like, travel costs, costs for
obtaining information about housing and employment opportunity in the destination region, family ties
and social network. All these factors imply that there is a positive wage differential between northern and
southern wages.
Equilibrium wage differential could vary with the degree of industrial agglomeration in the context of
imperfect labor markets or institutionalized wage determination.
Spatial agglomeration has a positive impact on the wages differential. The classical reason is that demand
for labor increases as capital accumulates as long as there is no technological structural change. Moreover,
wages in the agglomeration territory can be pushed upward because of technological progress induced by
for instance localized technological spillovers.
The wage differential is also affected by the movement of labor. When mobility is possible, workers flows
would tend to keep wage differentials variability low.
56
We present a possible relationship between labor earnings inequalities, regional income inequalities and
agglomeration. The AA curve shows that industrial agglomeration intensifies with increasing income
inequalities because firms prefer to be next to the largest market. The RR curve shows that industrial
agglomeration by increasing competition among the firms in the territory reduces the profits of
monopolistic businesses and at the same time income inequality between regions. The DD curve shows
that agglomeration is synonymous of higher labor demand in the territory of higher industrial
concentration which increases the wage differential. The MM curve shows that as agglomeration increases
labor migration increases as well and, ceteris paribus, the wages differential tends to fall.
If labor was not mobile the MM curve would disappear. This could give rise to a positive relationship
between wage and income inequalities. With mobile labor, the relationship can be reversed.
A situation with competitive markets, decreasing returns and fully mobile factors would correspond to a
graph with only a RR curve with however a different interpretation, and a MM curve.
The impact of a rise in FDI
An increase in FDI in the Northern region implies a rise in income inequalities for a given degree of
industrial agglomeration. This produces a right shift of the RR curve. This also implies that for a given
level of agglomeration, the wage differential increases: the MM curve shifts to the right. As a
consequence, regional income inequalities have increased and so have industrial agglomeration. We also
observe an outflow of labor from the Southern regions.
Box 5: The Construction of the EU
EU-6: 1957, 25 March: Treaty of Rome establishing the European community : Italy, France, Belgium,
Germany, the Netherlands, Luxembourg.
Past Enlargements
EU-9: 1973, 1 January: accession of the UK, Denmark and Ireland (Norway was engaged in the
application process but accession was rejected at referendum).
EU-10: 1981, 1 January: accession of Greece.
EU-12: 1986, 1 January: accession of Spain and Portugal.
EU-15: 1995, 1 January: accession of Austria, Finland and Sweden.
Current EU applicants
First wave: Cyprus, Czech republic, Estonia, Hungary, Poland, Slovenia
Second wave: Bulgaria, Latvia, Lithuania, Malta, Romania, Slovakia, Turkey
Prospective: Norway, Switzerland
57
Box 6: The Copenhagen Criteria –EU Membership
These criteria were defined at the Copenhagen European Council in 1993. Various criteria regarding
economic and political features were determined and represent necessary conditions for EU accession57.
According to the Copenhagen criteria, "membership requires that the candidate country:
• has achieved stability of institutions guaranteeing democracy, the rule of law, human rights, and
respect for and protection of minorities,
• the existence of a functioning market economy as well as the capacity to cope with competitive
pressures and market forces within the Union, and
• [has] the ability to take on the obligations of membership, including adherence to the aims of
political, economic and monetary union."
Stable Democratic Institutions
Countries wishing to become members of the EU are expected not just to subscribe to the principles of
democracy and the rule of law, but actually to put them into practice in daily life. They also need to ensure
the stability of the various institutions that enable public authorities, such as the judiciary, the police, and
local government, to function effectively and democracy to be consolidated.
Respect for fundamental rights is a prerequisite of membership, and is enshrined in the Council of
Europe’s Convention for the Protection of Human Rights and Fundamental Freedoms, and the Protocol
allowing citizens to take cases to the European Court of Human Rights. Freedom of expression and
association and the independence of the media must also be ensured.
The integration of minority populations into society is a condition of democratic stability. A number of
texts governing the protection of national minorities have been adopted by the Council of Europe, in
particular the Framework Convention for the Protection of National Minorities which safeguards the
individual rights of persons belonging to minority groups.
A Functioning Market Economy
Proof of the existence of a functioning market economy requires a number of conditions to be met:
• equilibrium between demand and supply is established by the free interplay of market forces
(trade and prices are liberalized)
• barriers to market entry (establishment of new firms) and exit (bankruptcies, liquidations) are
absent
• the legal system, including the regulation of property rights, is in place; laws and contracts are
enforceable
• macroeconomic stability has been achieved, including price stability and sustainable public
finances and external accounts
• there is broad consensus on economic policy
• the financial sector is sufficiently developed to channel savings towards investment.
A minimum level of economic competitiveness is required in order to withstand the competitive pressures
and market forces at play within the Union. Significant factors to be taken into account include
• a sufficient degree of macroeconomic stability, so that economic agents can make decisions in a
predictable and stable climate
• a sufficient amount of human and physical capital, including infrastructure (energy, transport and
telecommunications), education and research – at an appropriate cost
57
See European Union (1997) Bulletin of the European union . Supplement 5/97 p. 39 - 47
58
•
•
•
the extent to which government influences competitiveness through trade policy, competition
policy, State aids, support for SMEs, etc.
the volume and nature of goods already being traded with Member States
the proportion of small firms in the economy.
The Ability to take on the Responsibilities of Membership
In applying for membership, the candidate countries accepted the objectives of the Treaty on European
Union, including political, economic and monetary union. The candidate countries must contribute to and
support the Common Foreign and Security Policy.
Although unable to join the euro immediately on accession, the candidate countries will have to adopt the
‘acquis’ of Stage 2 of EMU. This implies central bank independence, coordination of economic policies,
and adherence to the relevant provisions of the stability and growth pact. New Member States must forego
central bank financing of public sector deficits, and complete the liberalization of capital movements.
Finally, they must participate in an exchange rate mechanism and avoid exchange rate fluctuations.
Candidate countries must also adopt and implement the entire ‘acquis communautaire’ upon accession.
EU legislation must not only be transposed into national law, but must also be implemented and enforced.
This requires that new administrative structures are set up, existing administrations are modernized,
administrators are properly trained, judicial systems are reformed and members of the judiciary are trained
in Community law.
59
Box 7: European Structural Funds and the Cohesion Fund
A. The Structural Funds
The Structural Funds provides grant aid for projects that encourage and facilitate economic regeneration
and revival in areas where the decline of traditional industries has caused serious economic and social
problems. There are four structural funds:
ERDF: The European Regional Development Fund is aimed at reducing regional imbalances and assisting
disadvantaged regions, particularly, areas facing restructuring problems and industrial decline and rural
areas.
ESF: The ESF aims to improve employment opportunities in the European Union by providing financial
support towards the running costs for vocational training schemes, guidance and counseling projects, job
creation measures and other steps to improve the employability and skills of both employed and
unemployed people. It also provides support for research and improving the capacity of organizations to
better help their target communities.
EAGGF: The European Agricultural Guidance and Guarantee Fund finances the common organization of
the agricultural markets, the processing of agricultural products and the structure of agricultural holdings.
FIFG: The Financial Instrument for Fisheries Guidance finances measures for the adjustment of fisheries
and aquaculture structures as well as the processing and marketing of their products.
The Structural Funds have three priority Objectives, four Community Initiatives and the Rural
Development Plan:
Objective 1: Development Lagging Behind - to promote the development and structural adjustment of
regions whose economic development is lagging behind - usually those regions whose per capita GDP is
less that or close to 75% of the Community average.
Objective 2: Industrial Areas and Regions in Decline - to convert the areas hardest hit by industrial
decline, where traditional industries such as coal and steel, textiles and shipbuilding can no longer
compete successfully, causing major social and economic hardship and dislocation for the local workforce.
Areas where the average rate of unemployment and the percentage of industrial employment is higher that
the Community average.
Objective 3: Combats long term unemployment; assists young people and those at risk from exclusion
from the workforce; promotes equal opportunities and improves women’s position in the workforce;
promotes adaptability and entrepreneurship in the workforce; and improves training, education and
counseling for lifelong learning.
Community Initiatives: LEADER +, URBAN II, INTERREG IIIA, and EQUAL address issues of interest
to the European Union as a whole, particularly transnational links and exchange of experience. There is
also a initiative on trans-national co-operation to fight discrimination and inequality preventing access to
employment.
Rural Development Plan: Provides a mechanism for supporting the sustainable development of rural
territories. The Plan is based around a menu of 10 possible measures, including agri-environment, support
for less favored areas, the wider adaptation and development of rural communities and processing and
marketing of agricultural products.
60
Who is Eligible?
In most cases, applications for finance from the Structural Funds must be submitted by recognized
organizations, which are supported by a public body. Eligible bodies include the Public sector, Local
Authorities, the Voluntary Sector, Registered Charities, Community Groups, Training Organizations,
Education Establishments and the private Sector (subject to special conditions).
B. The Cohesion fund
The Single European Act of 1987 first introduced economic and social cohesion as a key policy in its own
right. The prerequisite for the introduction of the single European currency was a high degree of
convergence in both the economic performance of the participating Member States and in the economic
policies pursued by the Member States. For the poorer Member States, this required significant
adjustments. As a consequence, a conflict of objectives emerged. On the one hand the poorest Member
States had to invest heavily to increase their growth capacity which called for an expansion in public
expenditure. On the other hand, the accession to the single currency area required to reduce budget deficits
and keep public debt under control which called for a reduction in public expenditure. Thus, the
Maastricht Treaty of 1993 established the Cohesion Fund by which financial assistance could be
channeled to the least prosperous Member States in order to allow them to increase growth improving
investment without impeding public finance rationalization.
The Fund was launched in May 1994. The eligibility threshold is defined as those Member states who
have a GNP per capita below 90 per cent of the European average and who are willing to follow economic
strategies towards convergence. The current beneficiaries of the Cohesion Fund are Greece, Ireland, Spain
and Portugal.
Cohesion Fund support remains conditional upon Member States not running excessive deficits. Projects
financed by the Fund must comply with EU legislation, in particular the rules relating to competition
policy, environmental protection and public procurement.
Two main types of project are funded: environmental projects and transport infrastructure projects.
Environmental projects serve the objectives of the EU environmental policy are:
• Preserving, protecting and improving the quality of environment
• Protecting Human Health
• Assuring prudent and rational use of natural resources
Transport infrastructure projects must help
• to settle or improve infrastructure within the Trans-European Network (TEN)
• or else to provide access to the TEN
Influencing migration decisions does not appear to be an easy task. Particularly because migration flows
across European regions are much lower than expected. Migration flows in Europe appear not to react to
wage and employment differentials. One reason for this could be the existence of substantial migration
costs, such as costs related to housing, family ties, loss of network, transportation (commuting),
information, language, culture, religion and portability of social security and more generally speaking
welfare rights. The issue of current non portability of welfare rights could possibly call for the
harmonization of welfare systems across European countries.
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Box 8: The time table of the main events of the European Union’s regional policy construction
1957 The countries signing the Treaty of Rome refer in its preamble to the need "to strengthen the unity of
their economies and to ensure their harmonious development by reducing the differences existing between
the various regions and the backwardness of the less favored regions".
1958 Setting-up of two sector-based Funds: the European Social Fund (ESF) and the European
Agricultural Guidance and Guarantee Fund (EAGGF).
1975 Creation of the European Regional Development Fund (ERDF) to redistribute part of the Member
States' budget contributions to the poorest regions.
1986 The Single European Act lays the basis for a genuine cohesion policy designed to offset the burden
of the single market for southern countries and other less favored regions.
1989-93 The European Council in Brussels in February 1988 overhauls the operation of the solidarity
Funds (now referred to as the Structural Funds) and allocates ECU 68 billion to them (at 1997 prices).
1992 The Treaty on European Union, which came into force in 1993, designates cohesion as one of the
main objectives of the Union, alongside economic and monetary union and the single market. It also
provides for the creation of the Cohesion Fund to support projects in the fields of the environment and
transport in the least prosperous Member States.
1994-99 The Edinburgh European Council (December 1993) decides to allocate almost ECU 177 billion
(at 1999 prices), one third of the Community budget, to cohesion policy. Alongside the Structural Funds, a
new Financial Instrument for Fisheries Guidance (FIFG) is created.
1997 The Treaty of Amsterdam confirms the importance of cohesion and also includes a Title on
Employment which stresses the need to work together to reduce unemployment.
2000-2006
The Berlin European Council (March 1999) reforms the Structural Funds and adjusts the operation of the
Cohesion Fund. These Funds will receive over €30 billion per year between 2000 and 2006, i.e. €213
billion over seven years. The Instrument for Structural Policies for Pre-accession (ISPA) and the Special
Accession Program for Agriculture and Rural Development (SAPARD) complements the PHARE
program to promote the economic and social development of applicant countries in Central and Eastern
Europe.
Source: European Commission
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Graph 1: GDP per capita in PPS terms
Convergence in Europe and EU accession
1.2
1.1
ratio to EU average
1
0.9
Spain &
Portugal
Ireland
0.8
0.7
0.6
0.5
0.4
2000
1998
1996
1994
1992
1990
1988
1986
1984
Ireland
1982
1980
1978
1976
1974
1972
1970
1968
1966
1964
1962
1960
Spain
Portugal
Graph 2: FDI in The European Union
EU
EU4
Southern
Northern
UK-F-G
Core
8E+11
6E+11
4E+11
2E+11
98
94
19
90
19
86
19
82
19
78
19
19
19
70
-2E+11
74
0
19
FDI US$ (billions)
1E+12
Notes: For Total EU FDI is the sum of the 15 country members. EU4 is Cohesion Countries (Ireland, Spain, Italy
and Greece). EU Southern is EU4 plus Italy. EU Northern is Norway, Finland and Denmark. There is no data for
Denmark in 1979 and 1980. Core is UK, France, Germany plus the Netherlands, Belgium-Luxembourg and Austria.
Source: IMF IFS line 78BEDZF - DIR. INVEST. IN REP. ECON., N.I.E. (US $).
63
Graph 3: Foreign Direct Investment in Cohesion Countries and Italy
0.25
Ireland
Portugal
0.2
Spain
Italy
Greece
Ratio to Total EU FDI
0.15
0.1
0.05
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
1979
1978
1977
1976
1975
1974
1973
1972
1971
1970
0
-0.05
Source: IMF IFS line 78BEDZF - DIR. INVEST. IN REP. ECON., N.I.E. (US $). For Total EU FDI is the sum of the
15 country members. There is no data for Denmark in 1979 and 1980.
0,5
0,4
0,3
0,2
0,1
% GDP (line)
40000
35000
30000
25000
20000
15000
10000
5000
0
0
19
89
19
91
19
93
19
95
19
97
19
99
20
01
20
03
20
05
EUR million (bars)
Graph 4: Change in the scale of the Structural Funds, 1988-2006
Source: European Commission
64