Lecture 1 & 2 Regional Policy

Economic integration does not affect all regions equally. While integration can raise aggregate efficiency and growth, it often coincides with persistent and sometimes widening regional disparities in income, employment and productivity. These lectures introduce the empirical facts on regional inequality, examine competing theoretical explanations, and motivate the role of government and EU-level regional policy.

The central analytical tension is between models that predict convergence through markets and mobility, and models that predict divergence through agglomeration and path dependence. Understanding this tension is essential for evaluating whether regional policy is necessary and, if so, how it should be designed.

This map highlights stark spatial disparities in GDP per capita across Europe. Core regions in Northern and Western Europe dominate the upper end of the income distribution, while Southern and Eastern regions lag behind. Importantly, these differences persist even within economically integrated areas, suggesting that market integration alone does not guarantee convergence. From an exam perspective, this motivates questioning the sufficiency of neoclassical convergence mechanisms.

Large income gaps also exist within countries, not just between them. This undermines explanations based solely on national institutions or policies and shifts attention towards region-specific characteristics such as industrial structure, human capital and geography. For policy, this implies that national-level redistribution may be too blunt to address localised disparities.

Employment rates vary substantially across regions, reinforcing the idea that regional inequality is multidimensional rather than purely income-based. Persistent employment gaps can generate self-reinforcing dynamics, as low employment discourages investment and skill accumulation.

High shares of young people not in employment, education or training (NEETs) are concentrated in poorer regions. This is particularly damaging from a dynamic perspective, as it reduces future human capital and locks regions into low-growth trajectories.

The UK exhibits some of the most pronounced regional inequalities in the G7. London is among the richest regions in Europe, while many other UK regions rank among the poorest in Northern Europe. This contrast provides a concrete case study for evaluating regional policy, especially post-EU membership.

Key empirical takeaway

The Solow model provides the benchmark neoclassical explanation of regional income differences. (c.f. Lecture 7-8 - The Era of Sustained Economic Growth)

Core assumptions

Under these assumptions, poorer regions with lower capital–labour ratios should grow faster than richer ones, leading to convergence.

The model predicts that:

In a regional context, this implies that integration, by facilitating capital mobility and labour migration, should accelerate convergence.

By incorporating human capital, the augmented Solow model refines the convergence prediction. Poor regions converge only if they share similar savings rates in physical and human capital. This concept of conditional convergence aligns better with observed data but still struggles to explain persistent divergence between otherwise similar regions.

From a strict neoclassical perspective:

This provides a clear benchmark against which alternative theories can be assessed.

New Economic Geography (NEG) models challenge the convergence result by emphasising increasing returns, transport costs and market access. Location matters because firms benefit from proximity to large markets.

The Belgium–Spain example illustrates how moderate reductions in trade costs can actually concentrate production in central regions rather than low-cost peripheral ones. This result is crucial: integration can worsen peripheral outcomes unless trade costs fall sufficiently.

The non-linear relationship between trade costs and location explains why partial integration may increase inequality. This is a frequent exam application: explain why integration has ambiguous regional effects.

Agglomeration arises from:

These mechanisms generate self-reinforcing concentration of economic activity.

Demand and supply linkages further strengthen agglomeration, as firms and workers co-locate to exploit complementarities.

Congestion, high rents and competition counteract agglomeration. The spatial equilibrium reflects the balance between agglomeration and dispersion forces.

Historical advantages can persist long after their original cause disappears. The portage example shows how early geographic advantages shape modern city size, reinforcing the NEG prediction of path dependence.

NEG takeaway

Governments intervene on:

In NEG models, intervention may be efficiency-enhancing rather than distortionary.

Policy tools include:

The effectiveness of these tools depends on local institutional quality and absorptive capacity.

EU-level coordination prevents free-riding and ensures a critical mass of investment. It also reflects political solidarity within an integrated market.

EU regional policy focuses on:

Most funding targets regions with GDP per capita below 75 percent of the EU average.

The key instruments are the ERDF, ESF and Cohesion Fund, with emphasis on human and physical capital accumulation rather than short-term redistribution.

Assessing causal effects is difficult because funds are targeted at poorer regions. This creates endogeneity problems that complicate evaluation.

Empirical findings are mixed:

This reinforces the idea that policy design and local conditions matter.

Becker, S.O., Egger, P. and von Ehrlich, M. (2013) ‘Regional transfers in Europe: Do we need fewer of them or different ones?’, VoxEU.

Bleakley, H. and Lin, J. (2012) ‘Portage and path dependence’, Quarterly Journal of Economics, 127(2), pp. 587–644.

Boldrin, M. and Canova, F. (2001) ‘Inequality and convergence in Europe’s regions’, Economic Policy, 16(32), pp. 205–253.

Krugman, P. and Venables, A.J. (1990) ‘Integration and the competitiveness of peripheral industry’, in Unity with Diversity in the European Economy. Cambridge: Cambridge University Press.

Midelfart-Knarvik, K.H. and Overman, H.G. (2002) ‘Delocation and European integration: Is structural spending justified?’, Economic Policy, 17(35), pp. 321–359.

Solow, R.M. (1956) ‘A contribution to the theory of economic growth’, Quarterly Journal of Economics, 70(1), pp. 65–94.