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Social and economic cohesion among the regions of Europe in the 1990s.

With completion of the EC internal market in sight and economic and monetary union by the end of the decade looking probable, concern about social and economic disparities within the European Community has been growing. In the single market, the intensification of competition can be expected to expose the weakness of regions in difficulty, while the transition to EMU will place considerable burdens of adjustment on inflation-prone economies. On the whole, it is parts of the Community which are already disadvantaged., such as Greece or the South of italy, which are most vulnerable to these changes.

The realisation that there may be losers as well as winners from an acceleration of economic integration has prompted demands for more effective policies to ensure that the social and economic cohesion of the Community is addressed. There are fears that unless sufficient resources are made available to assist the less-favoured parts of the EC, the political consensus needed to sustain the momentum of integration will be threatened. The unification of Germany, bringing an additional disadvantaged area into the EC, and the turmoil associated with the transformation of Central and Eastern Europe will impose new burdens on the Community, complicating the task of achieving cohesion.

As the two inter-governmental conferences on, respectively, economic and monetary union and political union have proceeded, the issue of social and economic cohesion has moved steadily up the policy agenda. This debate can be expected to intensify once discussions on a new financial perspective for the Community budget in the next five year planning period begin in early 1992, with a culmination due during the British Presidency in the second half of the year. (2) Widening of the Community will also affect cohesion. Negotiations on the formation of a European Economic Area to include the EFTA countries within the framework of the single market have achieved agreement, with only 'technical' issues to be resolved before submission for parliamentary approval in the participating countries. This is likely to be taken further in 1993, with negotiations for full membership of the EC, starting with Sweden, Austria and possibly other members of EFTA, whose accession will increase disparities in the Community because their social and economic endowments are above the current average. The accession of the EFTA countries would, however, make it easier to raise additional resources to further cohesion as the fact that these countries have been prepared to commit funds as part of the agreement on the European Economic Area indicates.

The purpose of this note is to explore the issues which need to be addressed and suggest how the Community might resolve them.

European regional policy

Although trying to reduce disparities among the regions, particularly in the sense of assisting those with the greatest problems, has been an objective of Community policy since its foundation, it was not until 1975 that the European Regional Development Fund was established to give a clearer focus on it. In the days of the Six, before the UK, Denmark and Ireland joined, tackling this objective meant, principally, channelling effort and resources towards Southern Italy. The pattern of lending by the European Investment Bank still reflects that early emphasis. As further new members have been added with below average social and economic endowments, first Greece and then more recently Spain and Portugal, the disparities to be reduced have widened. Policy has responded in two respects, first, by enshrining the objectives in the Single European Act of 1986 and, second, by forming an integrated regional policy based on the activities of the European Regional Fund (ERDF), European Social Fund (ESF) and the guidance section of the Agricultural Guarantee and Guidance Fund (EAGGF)(3) jointly known as the 'structural funds', assisted by lending from the European Investment Bank.

The commitment in the Single European Act is set out in Article 130A:

In order to promote its overall harmonious development,

the Community shall develop and pursue its actions

leading to the strengthening of its economic and social

cohesion. In particular, the Community shall aim at

reducing disparities between the various regions and the

backwardness of the least favoured regions.

The Brussels Summit in early 1988 agreed to a doubling of the structural funds to 14bn ECU a year by 1993 with a total programme as set out in table 1. The 1988 reform also agreed to concentrate the funds on a limited number of objectives, with most of the resources being spent on the parts of the Community that are least developed. Thus the Objective 1 regions comprise the whole of Greece, Portugal and the island of ireland, most of Spain except Madrid and the North-East of the country, Southern Italy, Sardinia, Corsica and the French overseas territories. (4) Between them, these regions form much of the Southern and Western periphery of the Community. Most of the Objective 2 regions are in the so called 'rust belt'- the older industrial areas in the Northern countries, although part of Northern Spain is so designated. Objective 5b recognises predominantly rural regions in the richer member states which face problems of development. Funds spent under the other three objectives are not restricted to particular parts of the Community on a spatial basis although much of that spending also occurs in Objective 1 regions. The UK receives funds under all headings although only Northern Ireland is designated as Objective 1.

These funds between them will amount to a quarter of the EC's total budget by 1993, which is about 0.3 per cent of the Community's GDP. They are thus very small by comparison with the efforts of the member states, although, since they are concentrated heavily on the regions with the most difficulty, they can have a significant impact on the recipients, expected to amount to 3-4 per cent of GDP in Portugal, Greece and ireland, as is shown in table 2. The structural funds form an even higher proportion of investment as the table shows but even these figure. 9 underestimate the impact on structural investment where the structural funds, share can be as much as 10-20 per cent, a finding repeated in the Objective 1 regions of Spain.

Community funds are spent primarily on the physical and human infrastructure: roads, bridges, water supply and treatment, for example, in the physical case and training on the human side. The basic principle of the Community's spending is that it should help develop the regions' ability to compete in the single market by enhancing the basis from which firms can compete, namely good public facilities, communications and a skilled workforce. Spending remains within the public sector although funding such as that of car parks and local services will clearly be of benefit to specific firms. Furthermore EIB funds can be used directly for industrial development.

However, it is important to remember that the Community funding is firmly embedded in the member states' own regional policies. But, according to the regulations, it is subject to the principle of 'additionality'-community spending must be additional to what the member state would otherwise have undertaken. Secondly there must be matching funding from member states/regions usually up to a minimum of equal shares in each particular programme.

In the early days, member states used to have to agree each individual project with the Commission, but the 1988 reforms were also supposed to replace project funding by programme funding. Under the new scheme each region, in concert with the member state and the Commission, was to produce a Community Support Framework, which produced a joint plan for the use of all the various funds on eligible projects, for the achievement of the aims of the policy. In practice, this has not necessarily reduced the bureaucratic overload in the way which was intended. In the UK, for example, it has increased the number of committees required to plan and monitor the use of the funds and has resulted in considerable delays in getting programmes agreed.(5) In Greece and some parts of Southern Italy, for example, the difficulties have been so great that the funds are substantially underspent.

Moreover, although the Community lays down the general principles of policy, as far as possible it is the responsibility of regional government at various levels to plan and execute the spending. This is viewed as part of the respecting of the principle of 'subsidiarity'-according to which responsibility should be assigned to the lowest tier of government able to carry it out efficiently unless there are significant spillover effects which warrant assignment of responsibility to a higher tier of government.

The impact of Community policy on the regions is not determined only by overtly regional policy. There are some other specific policies designed to alleviate regional problems, such as STAR, which seeks to provide an advanced telecommunications structure, and RECHAR, which helps to reindustrialise former coalmining regions. However, most Community policies are applied without specific regard to their regional impact. As Franzmeyer et al (1991) have shown, the structural funds do indeed redistribute funds to the least favoured regions quite effectively. (6) However, R&D policy and, most importantly, the price support element of the Common Agricultural Policy are actually regressive, transferring funds from lower income regions to higher income ones. This analysis does not allow for the impact of higher food prices on households according to their incomes so it will tend to understate the degree to which it causes real living standards to diverge. Since the CAP accounts for most of the total budget, in purely financial terms, it more than offsets the positive contribution that the structural funds make to helping disadvantaged regions in some cases.(7)

What does cohesion mean?

The foregoing discussion has proceeded as if it were clear what social and economic cohesion is and that it is primarily concerned with reducing divergence in economic indicators, such as real income per head or unemployment. in practice, that clarity does not exist. Social cohesion, for example, may depend on different criteria from economic cohesion. Although convergence in real incomes will be a key part of it, cohesion is not defined in the legislation nor does it have an established definition in any literature that we have come across. It is largely a politically determined condition which relates to the acceptability of existing disparities and the efforts being made to change them. (8) The measures currently used in Community policy tend to stress reduction in relative disparities but absolute disparities, absolute levels of social and economic provision and their rates of change also appear to be important. There is no clear means of determining the extent to which disparities should be reduced. Elimination of all disparities is not a serious objective if only because people's tastes vary and they prefer different combinations of social and economic resources. In any case, there is bound to be resistance from taxpayers who would be asked to provide the resources diverted to achieve cohesion. In practice, increasing taxation beyond some point is thought to act as a disincentive to effort, while increasing transfer benefits also acts as a disincentive for the recipients, encouraging dependency rather than efforts to increase regional value added.

The Community's objective of trying to provide some degree of equality of economic opportunity to the different regions of the EC also extends to the social dimension, where the Fundamental Charter of Social Rights and the social action programme are designed to try to provide a Community-wide level of social rights and opportunities at work and in other fields. These moves, therefore, add to the direct support for economic cohesion through the structural funds. The social dimension of integration is itself an attempt to spread some of the benefits from the completion of the single market. However, the pressure for the Social Charter also involved a fear of 'social dumping' (shifting of activity to new locations to exploit low social costs on employers) by some of the countries with higher levels of social benefits. Since, if social dumping occured, it would transfer economic activity from more to less favoured regions, it is not clear that all aspects of the social dimension will, in practice, increase cohesion.

This social aspect to cohesion includes not just the impact on levels of social provision, but involvement in the institutional process that determines the result. This ranges from involvement of the workforce in the decision-making process in firms to the exercise of the principle of subsidiarity. However, there is considerable further pressure for changes in the balance of power among Community institutions to allow greater local and regional consultation and power.

Community policy towards cohesion falls far short of that followed in most nation states, whether unitary or federal in structure. As the analysis of the MacDougall Report in 1977, updated more recently in the background papers to the Delors Report on Economic and Monetary Union in 1989, showed, existing regional economic disparities (as measured by GDP per head at any rate) in the Community are somewhat larger than in most nations but not immensely so.(9) However, that is not the major difference, as most states take major steps to offset these disparities by redistribution through the system of public expenditure and taxation (in addition, that is, to aspects of the regulatory structure which themselves lead to equalisation before any financial adjustment is required, such as requirements to provide services). MacDougall, for example, suggests that in the sample of countries his committee looked at, ex-ante regional disparities were reduced by 40 per cent on average through fiscal redistribution. Nation states also redistribute from rich to poor households irrelevant of regional location, but this sort of social intervention is not part of the existing or planned Community regional policy.

National budgets which result in this redistribution are very considerable in size, amounting to perhaps 30-40 per cent of GDP, but this is the gross budget not the net transfer. The MacDougall Report concluded, for example, that it would be possible to reduce disparities in the Community of 9, for the most disadvantaged regions, by a similar 40 per cent with a Community budget which amounted to some 2 1/2 per cent of Community GDP, in what was described as a prefederal phase of integration, rising to perhaps 7 per cent in a fully federal European system. The parameters have changed with the Community of 12 and discussion of whether any particular form of transfers constitutes a federal system raises hackles unnecessarily at this stage of the debate. While a case can be made for expanding the Community budget, the point remains that very substantial inroads could be made into the problem of regional disparities during 1993-8 within the existing budgetary framework of the Community.

The scope for change

By 1992, the share of Community GDP accounted for by the Community budget is expected to be 1.2 per cent. Even if the budget continues to grow by 3 per cent a year in real terms, as it has done for the past decade, it will not exceed the limit for contributions, of 1.4 per cent of GDP, currently in force, by 1998. The current structure of the budget is dominated by agricultural price support and it is this mechanism which distorts the flow of funds from richer to poorer states and regions. In the draft budget for next year, shown in table 3, it is clear that over half the budget goes on agriculture, almost exactly twice that going on structural operations.(10) Just leaving the agricultural budget fixed in real terms and keeping the share of other non-structural expenditure constant as a share of Community GDP would permit over 50 per cent to be added to the structural funds in real terms. A further doubling of the structural funds over the next five years would however, require cuts in the agricultural budget. Since some cuts do seem politically feasible a rise in spending on structural operations of 2/3 to 3/4 would not be an unreasonable target.(11)

However, the spending side of the picture is only part of the problem. The Community does not raise its revenue on the basis of ability to pay, that is, in relation to the GDP of member states but from four resources'
 agricultural levies
 customs duties
 GDP share.

The first two are dependent on production and trade patterns, again dominated by agriculture. Even VAT is not a neutral tax. Only the fourth resource is directly related to GDP and it is not usually called upon, as the other three resources have to be exhausted first before it is needed to meet Community expenditures. As a result, the net contributions of the member states differ very considerably from what might be regarded as equitable (charts 1 and 2). Given their relative GDP per head, shown in chart 3, Greece and Ireland and to a lesser extent Portugal are substantial beneficiaries to an extent which might appear appropriate. Spain, however, benefits only slightly in net terms and there is a strong possibility that if nothing is changed it could become a net contributor before the end of the next budget perspective. The Netherlands and Denmark, despite having GDP/head well above the Community average, are nevertheless substantial net beneficiaries from the budgetary system. The effects of this on cohesion are considerable. If the Dutch and Danish net benefits from agricultural price support were merely lowered to the Community average, this would have amounted to a change of 3bn ECUs in 1989, equivalent to the total outlay of the combined regional and social funds in Spain, Greece, ireland and Portugal.

There are thus two issues to resolve here. First, the current budgetary system in the Community, by having revenue requirements which are not closely related to ability to pay, combined with an expenditure pattern that returns funds to the contributors, with only limited regard to the impact on cohesion, appears both inequitable and unwieldy. it is arguable that greater equity might be achieved in the Community if budgeting were more on a net than a gross basis. Secondly, responsibility for financing policies to advance cohesion could be deemed to be the responsibility of member states, or even the regions themselves, unless they have insufficient fiscal capacity.(12) We can thus separate the need for the expenditure from the ability to pay. Moving towards net budgeting would help to reduce the problem of having inadequate funds for redistribution. How this should be achieved is clearly a major issue for debate. Over the years, several proposals have been put forward for achieving an appropriate degree of equity in the EC. That by Padoa-Schioppa (1987), suggesting a progressive relationship between GNP per capita and net transfers as a proportion of GDP, offers a promising way forward.(13) The proposal is that net budgetary contributions by the member states should follow a curvilinear path according to their GDP per head as shown in chart 4, within reasonable bounds of variation to prevent the system becoming too restrictive (14).

The need for change

There are three simple reasons why action will be required on the achievement of social and economic cohesion during the next year: existing measures seem to be having a relatively limited impact on disparities; the disadvantaged are becoming more vociferous in their demands for improvement; and the events of the 1990s are likely to increase the pressures towards disparity not lessen them.

The major potential impact comes from the completion of the Single Market. The removal of many internal barriers should enable the European economy to operate more efficiently, increasing the forces of competition, permitting larger scale production and reducing the ability to protect or segment markets. As a result, it is widely expected that there will be a boost to the European Community's growth. The Cecchini report (1988), suggests that failure to have a full single market is costing the EC roughly 4-7 per cent of GDP. Although it is questionable whether all the potential gains will be realised by the current programme of changes in regulations, it is nevertheless clear that there will be a substantial increase in growth in the Community as a whole.

The issue here is whether that boost will exacerbate, reduce or largely leave unaffected the disparities among the various regions of the EC. Regional disparities can widen in the Community even if every individual region gains from closer integration. A very pure market approach would suggest that free movement of factors as well as products would result in a migration of capital towards low cost, high unemployment regions and a migration of labour in the other direction. Between them, these would be equilibrating forces. However, labour is highly immobile in Europe, see Mayes (1990) for example, and the labour market is unlikely to do much to solve the problem.(15) Capital on the other hand is genuinely much more mobile. Less favoured regions can get access to funds at better rates of interest and access to a wider range of financial services through the full opening of the single market.

The effect of the single market on inward direct investment is likely to be of greater importance. The work of Nam et al (1991) suggests very clearly that the factors which attract investment to particular regions are not going to be enhanced by the building of infrastructure in the less favoured regions to an extent which will lead to any great flow towards them. On the contrary, some of the investment in the peripheral regions has occurred because of the existence of barriers, which made exporting to those markets more difficult, and because high levels of support were made available.(16) As forms of state aids are not permitted and as the barriers fall, it makes more sense to firms to exploit economies of scale and, more important, the agglomeration economies from having the whole network of business services in the 'core' regions of the Community.

Thus, set against the general increase in Community GDP, is a pressure which may widen disparities for many of the Objective 1 regions. The outlook for the Objective 1 regions is, however, far from uniform. The prospects for some such, as the Abruzzo or Valencia, which have made some. progress in recent years, are more promising than in regions such as Calabria, where problems are acute. By and large, Nam et al expect Objective 2 regions to benefit from the completion of the Single Market, as they do some of the Objective 5b regions. The rationale is simple. Objective 2 regions already have a network of business services and an environment and culture geared towards manufacturing. Their problem is to switch from declining to growing industries. Hence, investment to speed that process of change will help those regions recover and the prospects are therefore that much better than for the Objective 1 regions. There is the added irony for peripheral areas that improving communications not only makes exporting easier, but it also facilitates importing. if importers (exporters from the core regions) are better able to respond to the challenges of lower barriers, then the problems of peripheral regions may be compounded.

The more recent challenge of economic and monetary union exacerbates the problem. While it is true that high inflation countries potentially have the most to gain from lower costs of borrowing,(17) lower uncertainty and hence higher investment, innovation and growth, they also have a problem of adjustment to converge' on the criteria of inflation, internal and external balance and public debt. By and large the least favoured regions lie in the countries with the greatest problems of covergence--Greece, Italy, Portugal-or in the countries with the highest rates of unemployment - Spain, Ireland. Since convergence inevitably involves a process of budget tightening and deflation to squeeze the inflationary problems out of the system, this will directly increase disparities in the short run and worsen cohesion. The experience of France and Italy in increasing their unemployment by a total of 1% million while managing to keep their exchange rate within the EMS bounds does not bode well for the other less advantaged regions (Barrell, 1990). Although these adjustment problems are temporary, such short-run costs are the immediate threat to cohesion. Their extent is so large, such as the budget deficit in Greece equal to 15 per cent of GDP, that protracted low growth will be needed to correct them.

The numbers quoted for the micro-economic benefits by the Commission in One market, one money (European Economy no 44) are much smaller than those for the Single Market--in general less than 1 per cent of GDP. On top of that the inflationary countries will lose the contribution that seignorage gives to government revenues. Hence the relative advantages are likely to be small, in static terms at any rate, for the less favoured regions. However, One market, one money does go on to stress the possible benefit of dynamic effects such as higher investment, greater innovation and more effective competition. These dynamic effects will at least in part, accrue to producers, and since these will tend to be in the core regions this may also increase disparities. Worse still there is the possibility that the dynamic effects could be negative for those who experience negative static effects (see Kaldor, 1971, for example). in this scenario, initial difficulties squeeze profits and lead companies to cut back on investment and R&D. This in turn leads to lower competitiveness and hence slacker sales and profitability in a worsening spiral.

The experience of German unification has not helped the confidence of the less favoured regions. They have seen the collapse of activity in the Eastern Lander in the face of competition and they have seen the turnround in German trade and investment, which has moved away from the South and the West of Europe towards the East. With the rest of Eastern and Central Europe also experiencing extreme difficulty and knocking on the doors of the Community for help there is clearly a fear that funds and assistance will be diverted. Thus far, the uncertainties still prevailing have restricted the flow of investment but the whole of Europe has had to pay higher rates of interest to help finance German unification. This must, at the margin, reduce the funds available elsewhere. In purely geographical terms, much of central Europe is actually nearer the core of the EC than is the periphery of the current EC.

To set against these worries is the fact that of the current applicants to join the Community, Sweden and Austria are of above average income. While this will widen the disparities in a technical sense(18), it Will also increase the funds available to help the less favoured regions. if Turkey, which is also an applicant, were to join, this would be a totally different story as it has both a much lower GDP per head and a large population.(19)

There are of course other more general factors, discussed in A New Strategy for Social and Economic Cohesion after 1992, which may also increase the pressure for greater efforts to achieve cohesion. One example worth mentioning here is the increasing concern for the environment. With environmental audits necessary for major projects and action to avoid eco-dumping, (shifting projects to regions where environmental regulations are weaker) costs of projects in the less favoured regions may rise. In the same way if the social action programme leads to higher social security burdens on employers, this may increase unit labour costs. With migration unlikely to act as a safety valve and a faster natural increase in working population in many of the Objective 1 regions, the result would be higher unemployment (Ermisch, 1991).

How should the Community try to advance cohesion?

There are many possible ways forward but in A New Strategy for Social and Economic Cohesion after 1992we outlined a set of economic principles that the Community could follow. These are reproduced in table 4 and derived from the discussion that follows.

The basic approach

In the foregoing discussion, we have ignored the questions of what regions should be eligible for expenditure and what sort of projects should be eligible for financing. The Community has adopted the view that all expenditure should be related to specific eligible programmes of work. There are, however, at least three main schools of thought about the appropriate approach to reducing regional disparities. These can be denoted as the market, redistribution and structural intervention approaches.

Market forces

At one extreme, one might characterise a market approach that would suggest that the best way funds and the Community's powers should be used is to ensure that there really is a single market and that goods, services, labour and capital can move freely. Under these circumstances, the market itself should solve the main problems of regional disparity. Lower costs in the disadvantaged regions should encourage a capital inflow which would help their relative development. Labour would move to regions of high wages and excess demand hence tending to move factor prices towards equality. This is essentially the traditional neo-classical approach.

Few people now believe that such an approach would work on its own.(20) As Padoa-Schioppa (1987) puts it, 'any easy extrapolation of [these] ideas to the real world of regional economics in the presence of market opening would be unwarranted in the light of economic history and theory,(21). The markets involved are too inflexible. Even in a single market, sunk costs and imperfections can inhibit the reduction of disparities and may even cause them to be increased. Indeed, others, such as Kaldor (1971), have suggested that there may a process of cumulative causation, with successful regions following a virtuous circle of high investment, high productivity, high innovation and high profits, while the less-favoured regions get into a converse, vicious circle of difficulties, from which it is difficult to emerge. Such empirical evidence as there is, as shown in chart 3, for example, tends to suggest that there is no overwhelming tendency for either convergence or divergence.

Structural intervention

The interventionist approach, on the other hand, argues that there are obvious cases of market failure which need to be offset. The simplest of these is the creation of the infrastructure--this is usually publicly provided in most societies even if much of the cost is then recouped from the beneficiaries through taxation or charges. Less favoured regions do not have the resources to provide the necessary facilities themselves. A similar argument may apply to the labour force given that it is not particularly mobile. Trained labour may be difficult and costly to obtain and hence less favoured regions may get into a downward spiral of low skills, low growth and high unemployment from which they do not have the resources to emerge, especially if it is the skilled and the entrepreneurial who are induced to emigrate by market forces. This is recognised to be a serious problem in Greece, Ireland and the Mezzogibrno. As an illustration 30 per cent of irish graduates leave to work abroad within one year of graduation. The argument can be extended to finance and to help for small firms, which tend to be much more important in relative terms in poorer regions. In this framework, intervention is seen very much as a positive sum game allowing underutilised resources to be brought into play.

It is not clear where to draw the line on intervention, how far regional authorities should get involved with creating a local structure of business services, how much they should seek to encourage inward investment, help promote exports and so on. What can be argued however is that unless the Community sets the rules for such interventions, whether or not it directly finances them, the idea of creating a single market in which all can compete on equal terms would be vitiated. National barriers and support would be replaced by regional interventions, fragmenting rather than unifying the market.

Recent developments in thinking have focussed on two positive aspects of structural intervention. The first is the encouragement of indigenous sources of growth rather than seeking an inflow of capital-this enables a focus on the regions' own sources of strength (Albrechts et al, 1989). One of the objections put forward to the capital inflow route is that it tends to focus on industries dependent for their success on lower labour costs. Although this may have favourable effects on employment, it can lock the region into having to maintain that cost advantage and hence not adopt the higher skilled and higher value-added activities needed to close the remaining gap. It may also have only limited spinoff effects into the rest of the economy. The second aspect is the importance of creating a local environment of innovation, linking education, training, research, business and finance in a network of private and public sector efforts (Camagni, 1991, for example).

Inter-regional transfers

The third approach is to argue that all the emphasis on particular interventions is mistaken, all that is required is redistribution of income within the Community. The problem of poor regions is shortage of resources. While need might determine the size of the transfers, it would be up to the region to decide how to spend them--in the same sort of way that is used for transfers to households within the member states. Hence it would be up to a region whether it felt that the increase in resources was best translated into continuing growth by spending on specific infrastructure or industry support or by cutting taxation to increase the incentives to business.

In some versions of this approach (Porter, 1990, for example) it is accepted that growth is an inherently unbalanced process. The problem is to achieve the delicate balance between opening markets up as far as possible to enable the forces of competition to push resources towards locations where they can be used most efficiently, and compensating those regions which lose out. indeed it is necessary for governments to foster these areas of success in order to maximise the benefits available for redistribution.

Current Community policy does not extend to unhypothecated, transfers, although the Spanish proposals to the intergovernmental conferences would like to see a move in that direction. Some of the source of opposition to this move is that member states providing the funds wish to be assured of their beneficial use. This is not just a worry about weak administration leading to excessive cost but to outright fraud with funds being syphoned off such as is alleged to be the case in the South of Italy. Furthermore, such transfers may sustain the clientilist culture and create dependency.


There is however considerable scope for change even within the existing framework of projects designed to improve the ability to compete. The current choice of what sort of projects and regions should be eligible for support is by no means a definition of the feasible set and the specific choice has been widely questioned. This can be illustrated by the following five examples:

- The range of suitable projects could be increased to incorporate more 'social' infrastructure, including education, health and environmental concerns.

- The form of eligibility can be improved. Using GDP per head is all very well when the nature of the choice of whether a region deserves support is a very broad one. However, it takes no account of interregional flows, which may mean that retained income per head in the region is considerably different from GDP. The most outstanding anomaly is Groningen in the Netherlands which is easily the highest region in terms of GDP per head but is actually one of the worst off regions in the Netherlands, the discrepancy occurring because Groningen is an abstraction point for natural gas. (22)

- There is no reason why all parts of infrastructure should be equally lacking and hence more sensitive use of indicators might be more appropriate.

- It is also unlikely that regions move directly from having insufficient infrastructure to requiring virtually no support just because they cross the borderline which determines Objective 1 status, so that a graded scale of support might be appropriate.(23)

- Furthermore, it is not clear that following purely spatial delineations of need for social and economic cohesion is always appropriate. Problems relating to ethnic minorities or urban areas may not be picked up by the existing system. Given the worries that are increasing about immigration both from North Africa and from Eastern/Central Europe, this sort of more 'horizontal' focus may become increasingly appropriate.

Instruments of policy

Indeed, focusing on regions as such may not be identifying all the facets of the problem of social and economic cohesion, as some of the issues relate purely to poverty. Hence, the correct response would be to target that poverty directly by transfers to households rather than concentrating purely on structural investment which may, because of the pattern of revenue raising and expenditure, result in a transfer from the poor in rich regions to the rich in poor regions. Achieving greater cohesion, therefore, might involve a rather wider range of instruments of policy than supplementary funding for forms of assistance currently in use.

An alternative means of trying to achieve some measure of equalisation is to operate on the disparities in the levels of unemployment. Such disparities themselves are prima facie indicators of market failure. Hence there is an argument for transferring funds to regions with higher levels of unemployment to allow them to correct the structural factors which are contributing to the problem. This argument, put forward by MacDougall (1977), has been repeated more recently in van der Ploeg (1991) and Wyplosz (1991). it may now have some greater chance of being adopted, especially as financial support for the longer term unemployed tends to be increasingly linked to vocational retraining.

One of the previous objections is that it permits regions to have higher wage levels than can be sustained and enables them to avoid reducing the real wage until the labour market clears'. in all these forms of transfer, the fear is that they may act as a disincentive. Recipients may become dependent on the transfer and reduce their efforts accordingly, while donors may be less inclined to strive so hard if tax rates are higher in order to finance the necessary transfer. This is one of the reasons why the Community prefers the current system of improving the supply-side so that incentives are generated rather than destroyed among the recipients, and that the programme remains small so that the tax disincentive among the donors is negligible.

One of the problems with the current interventionist approach is that the public sector initiatives can become divorced from the private sector needs. it is after all the private sector which is going to provide the bulk of the economic activity which stems from the infrastructure which has been provided. Failure of the two to coordinate can mean that the facilities are underutilised or the new skills irrelevant to job opportunities. Currently, the private sector is not directly involved in the formulation of the Community Support Frameworks which set out the programmes of Community assisted projects, nor is it a participant in the monitoring of how well the programmes are going.

There is considerable support for the idea that a concerted development partnership between private industry, local government, research institutes, universities and sources of finance can be successful (Hingel, 1991 for example). Such partnerships can create 'islands of innovation', with success stories like the Rhone-Alpes and Emilia-Romagna regions. In any case, a requirement for public funds to exert leverage on private sector funds would tend to help the projects which are supported be more productive.

Organisational structures

One aspect of cohesion which is often neglected is that the way the policies are administered also contributes to the extent of cohesion. This is not just a matter of subsidiarity. All tiers of government have a responsibility in securing cohesion, but each has its own advantages. It is argued on the one hand that the more localised the administration, the greater the likelihood that it will be able to identify and respond to local needs. Furthermore, the more localised is responsibility the greater the chance that motivation will be enhanced as people involved identify with the objectives of the policies. This parallels the concern in firms that responsibility should be decentralised to operating units.

Set against this motivation for smaller units of administration is the problem of competences, particularly in planning, project appraisal and management. A minimum size of area is required to achieve these, although to some extent this can be got round by the use of taskforces. This implies an enhanced role for regional authorities. Regional structures vary considerably among the member states, but this might imply, for highly centralised states like the UK, that they do not have the structures for achieving the maximum competitive success within the Community. The relative success of the Weish, Scottish and Northern Irish authorities might therefore have implications for England.

There has been some pressure within the intergovernmental conferences to enhance the role of the regions directly in Community decision making. One possibility that has been advocated is the formation of a regional committee, perhaps along the lines of the Economic and Social Council. More adventurous proposals include creating a second regionally based chamber for the European Parliament. Obviously, it is in the interests of the regions and of the Commission to press towards a 'Europe of the Regions', as this would heighten their power relative to that of the member states. Thus it is not surprising that some of the pressures for cohesion are bracketed with pressure for an increasingly federal structure within the Community. (24)

Accountability, monitoring and evaluation

Thus far we have discussed how the structural funds could be spent and how that spending should be organised, but the Community also needs to be convinced that the funds are being spent as intended, that value for money is ensured and that resources are being directed where they can achieve most. It might be expected that in a group of advanced countries, procedures would already be in place to achieve this, however, Malcolm Levitt's researches for A New Strategy for Social and Economic Cohesion After 1992 suggest this is far from the case. (25)

In several cases, existing funds are administered according to lower standards than the best practice prevailing elsewhere in the Community.(26) Projects require proper ex-ante cost benefit appraisal and assessment of their contribution to reducing disparities and improving cohesion, monitoring of the progress of work in order to change them where necessary in the light of experience and an ex-post evaluation of their success and performance. Member states need to be assured of value for money and the pursuit of efficiency. (27) Ultimate responsibility lies with the Court of Auditors but despite repeated identification of urgent problems in their annual reports, the Community has been slow to act to tighten up. In practice, it is the member states' systems which need attention. In the UK, the use of Community funds is subject to exactly the same process of scrutiny as UK funds because matching funding is required for all projects and those UK funds must be treated according to the normal rules.

Cofinancing, additionality and absorption

Not only is there a need for greater financial control over the use of the structural funds but three further administrative features of the rules are also thought to retard the ability of less advantaged regions to respond to the opportunities available. The first is the requirement that Community funds be matched by local funds. Since it is rare for local administrations to have much revenue raising powers of their own, this in effect means that central government has to provide matching funding. Where governments are under severe budgetary pressure, this may be difficult to achieve. Particularly when this is coupled with the second requirement of additionality. it is clear in the South of Italy, for example, that agreement among all the different interested parties is difficult to achieve and hence there are delays in agreeing programmes.

The principle of additionality is that Community funds should add to not substitute for existing spending. This is of course almost impossible to prove and has been the subject of friction between the UK and the Commission.(28) For less advantaged regions, lowering the additionality requirement shifts the nature of the transfers from commitment to specific programmes to unhypothecated transfers going on general expenditure or on reducing taxation or deficits.

The last problem is simply one of absorption. If existing funds cannot be spent, it is difficult to sustain the argument that they should be increased. However, regions which have difficulty in organising spending of the funds may be those in greatest need so it would not be satisfactory merely to divert funds to those who could put them to immediate use. A positive attempt to increase absorption through administrative assistance and training would be the most obvious step.

Concluding remarks

Unless countervailing policies are implemented soon, disparities in the EC are likely to widen rather than narrow during the 1990s. This will be a direct consequence of moves by the Community to accelerate economic integration, and not because of exogenous factors. Although the doubling of the Structural Funds will undoubtedly mitigate the effects on less favoured regions, the efficiency and effectiveness of the funds have been widely questioned. Their limited scale is also a problem, especially when other Community expenditure--notably on agricultural support negates the redistributive impact of total Community spending.

The intergovernmental conferences and the forthcoming process of agreeing the budget perspective for 1993-8 offer a major opportunity to reform the strategy for increasing social and economic cohesion in the Community. This would involve not just an expansion of the budget but a major reallocation of net contributions, a widening of the objectives and instruments for achieving an equality of opportunity for the regions of the Community to compete on equal terms and a tightening of procedures to ensure that the Community gets value for money for its efforts. No doubt there will be a wealth of proposals as the debate develops. The six principles advocated in A New Strategy for Social and Economic Cohesion between them set out an agenda for the future based on economic principles. Past experience tells us, however, that political compromise rather than economic principles will dominate the decision-making process.


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(1) In producing this note the authors have been aided by their earlier research project, A New Strategy for Economic and Social Cohesion After 1992, commissioned by the Directorate General for Research at the European Parliament, and presented by the President of the Parliament Enrique Baron Crespo in Strasbourg on 27th November, 1991. Thanks are due to all those who helped with the project, particularly, Alan Shipman, Malcolm Levitt and Giuseppina Madonia within NIESR, Rory O'Donnell at the Economic and Social Research institute in Dublin, Michael Tsinisizelis at the University of Athens, Manuel Ahijado at the Universidad de Educacion a Distancia in Madrid, Manuel Brandao Alves at the Technical University in Lisbon, Michael Fritsch, Karin Wagner and Carl Friedrich Eckhardt at the Technical University in Berlin Robert Morsink at the Netherlands Economic institute, Anthony Comfort and Frank Wiehler at the European Parliament, Arthur Brown at the University of Leeds and to Sir Donald MacDougall who advised Parliament on the project and encouraged us greatly in our work. The present note is, however, purely an exposition of our own views and does not implicate those of any of the people who have helped us or the institutions we or they work for. Naturally we hope they will agree with us. Andrew Britton, Alan Shipman and Garry Young provided helpful comments on an earlier draft.

(2) The debate will be stimulated by the publication of the Commission's own mid-term assessment of the impact of the doubling of the Structural Funds in real terms over the period 1988-93.

(3) More widely known in the Community by its French initials FEOGA.

(4) The classification of regions used most widely by the EC in this context (referred to as NUTS2) divides the Community into 171 regions. This results in 35 regions for the UK, covering very unequal populations and land areas. While the typical size is 1.5-2million, covering a number of administrative counties, they vary between 300,000 in the Highlands and islands to 6.8 million for Greater London.

(5) See the evidence from the Welsh and Scottish Offices to the House of Lords Select Committee investigating European Regional Policy for example.

(6) The loans and grants from the ECSC also redistribute funds towards the Objective 2 regions. However, like the structural funds these ECSC funds involve specific expenditure on projects designed to alleviate regional problems. They are therefore likely to be qualitatively different in impact from fiscal transfers to regional authorities which are not linked to specific expenditures and from transfers to households or firms from outside the region. The impact of policy and the incidence of the tax and public expenditure systems are not the same issue although both affect regional incomes.

(7) The real impact of the structural funds is, ECU for ECU, likely to have a greater impact on regional development than will CAP payments. That is certainly the intention of the policy.

(8) As Arthur Brown pointed out in our work for the European Parliament, analysis, in practice, tends to be confused by the use of multiple meanings for cohesion in the same document.

(9) To take the US as an example.

(10) Only the guarantee section of the CAP is referred to under the heading agriculture', the much smaller guidance section is included in 'structural operations'.

(11) No doubt there will be some countervailing pressure to use at least some of any cuts in the Community agricultural spending to reduce the Community's budget as a whole.

(12) This is in effect the financial counterpart to the principle of subsidiarity-fiscal responsibility for achieving the aims of Community policy should lie at the lowest administrative level with the capacity to meet it efficiently, unless there are significant spillover effects to other parts of the Community.

(13) This is explored in more detail in section 4 of A New Strategy for Social Economic and Cohesion after 1992.

(14) It has also been argued that a progressive own-resource would clearly link expenditure with taxation in the minds of EC institutions and encourage greater fiscal responsibility (Biehl, 1989). Proposals for an explicit Eurotax levied within the member states would provide an equally clear link between the costs of EC expenditure programmes and taxation in the minds of taxpayers.

(15) The higher skilled parts of the labour force, particularly the more entrepreneurial and professional tend to find it easier to move. Their departure could lower the availability of critical skills, worsening rather than easing the problems.

(16) There is already evidence that manufacturers, enticed to the South of Italy by the lure of a ten year tax holiday, are now moving on to other locations once the ten-year period has expired. The need to rationalise in the face of the single market makes such decisions easier to take.

(17) It is, however, debatable whether there will be falls in real as well as nominal interest rates.

(18) The average is raised while the GDP of existing Community regions is unchanged, hence widening the gap.

(19) Malta and Cyprus also have applications on the table but their membership would not have an important impact on the structural funds available for existing member states.

(20) in some respects One market, one money implies that nominal convergence is a precondition for real convergence and that it should follow on from it.

(21) We have been helped by the collaboration of Rory O'Donnell at the Economic and Social Research Institute in Dublin particularly his more recent and unpublished paper The Evolution of the Theory of Regional Development.

(22) The other major indicator of less-favoured regions, currently used, unemployment, also, suffers from a number of drawbacks. Its values are in part dependent on the social and administrative settings in which it operates. it is widely thought to overstate the problems in Spain and understate those in Portugal and Greece, for example.

(23) The Abruzzo region in Italy, having just made the transition from being typical of the South of italy to being more akin to the North, feels that the complete removal of Community funds will make it less attractive than neighbouring regions and hence that it may fall back again within a few years.

(24) This is clear example of playing both ends against the middle.

(25) See Section 6.3.1.

(26) Nor are they administered according to the worst practice which prevails in the EC.

(27) It might be thought that such rules were largely unexceptional but the region of Extremadura in Spain was very firm in the view that the need for much of its infrastructure projects was so manifest that any detailed assessment of the benefit would be wasted effort. indeed it is scarcely surprising that it is a general experience that regional administrations would like to receive funds with as few strings attached as possible.

(28) Substantial funds under the RECHAR programme are currently held up because the Commission does not believe that the UK is obeying additionality requirements.
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Author:Begg, Ian; Mayers, David
Publication:National Institute Economic Review
Date:Nov 1, 1991
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