The uneven distribution of economic activity across regions

Economic activity will always be unevenly distributed across regions and forever cause growth disparities between specific cities or clusters; it is endemic to capitalist development. Disparities can be found on a worldwide scale, city wide, or, as in this case, amongst member states of the European Union. Furthermore uneven distribution is not only limited between countries as a whole; countries can also suffer from domestic growth disparities. Tackling these disparities and supporting convergence has become a key priority for the European Union, especially as widening occurs and further countries are incorporated increasing regional disparities.

The European Union displays staggering differences between regions’ economies. For example, “per capita GDP in the City of London is 334% of the EU average–more than a dozen times greater than per capita GDP in north western Bulgaria, which is just 26% of the EU average” (presseurop.eu, 2010). Domestic disparities are also a major concern, in Germany for example; “a huge disparity emerges if we compare the city of Chemnitz in Saxony, where per capita GDP is 82% of the European average, and Hamburg, where it’s more than twice as high, at 192%” (presseurop.eu, 2010). Surprisingly, some poorer regions of Germany are on par with areas of Estonia in terms of GDP and employment rates. Furthermore, we can only expect divergences to get worse as the EU continues to widen. Widening has already increased disparities within the EU in social, territorial and economic terms significantly. Indicative of this are Bulgaria and Romania, the two most recent entries into the EU which currently “occupy the last two places in the European Union with 41 and 45 per cent of average EU GDP” (BalkanInsight.com, 2010). Even though Mingardi (2010: 14) believes that, “increased liberalisation”, in the form of the widening of the EU, “will allow better division of labour, more efficiently located labour and therefore lower prices for producers and consumers”, at present, widening of the EU has only increased disparities substantially.

The examples discussed reveal the astonishing divergences between European regions and give an idea into the extent of the problem. To tackle the aforementioned regional differences; the EU uses cohesion policy. The main aim of cohesion policy is to diminish economic well-being gaps between less favoured regions and more affluent ones. Policy makers agree this is a key concern continue to commit to tackle it with increases in the 2007-2013 budgets for cohesion policy by “3.2% to reach over €42.5bn P.A” (ec.europe.eu, 2010). Nevertheless, in spite of the budgetary increases for cohesion policy, regional disparities continue to grow within the EU and billionaire expenditures are yet to show real progress in addressing and realigning regional divergences. In fact, “a number of studies have demonstrated that inter-regional disparities have grown since the 1980s” (Esteban 2000; cited in Farole, T 2009: 3)

To understand why there are regional disparities, we must address the fundamental question of why certain regions’ growth is higher than others. A range of economic growth theories attempt to explain the growth of economies and thus the causes of regional disparities. These growth theories are split into two schools of thought; convergence and divergence school. However, it is widely accepted that these theories have their flaws and there isn’t one theory alone that can be used to explain economic growth and the cause of regional disparities single handily.

The convergence school, led by Solow’s Neo-Classical Growth theory (1956), is considered one of the major theories used to explain economic growth. The fundamentals of the theory state that per capita incomes of different regions converge in the long run due to diminishing returns to scale of labour productivity. It assumes a steady economic growth rate is achieved through varying the ratios of each of the inputs; capital, labour and technology. Through this method, an equilibrium state is achieved that is optimal for economic growth. Investment is translated into input of capital per worker and as this rises, returns steadily decrease and constant or decreasing returns to scale are realised leading to a decline in the marginal product of capital and an automatic dispersion of per capita income across regions. Thus, the theory states that gradual convergence in economies will occur.

The convergence school and neo classical theory has some, if narrow, support from growth figures within the EU. In particular, the growth that has been present in such countries as Greece, Spain, Ireland and Portugal in the period 1994 – 2006 supports convergence. From the European Union’s Fourth Cohesion Report (2007: 5) we can see that “Greece reduced the gap with the rest of EU-27, moving from 74% to reach 88% of the EU-27 average in 2005. By the same year, Spain and Ireland had moved from 91% and 102%, respectively, to reach 102% and 145% of the Union average”. However, “in spite of this progress, absolute disparities remain large” and contrary to these results, there is generally a very limited amount of support available for the convergence school. Although support is limited, the focus on convergence is understandable given that it is the basis of what the EU aims to achieve with the cohesion policy.

Convergence school, led by the Neo-Classical theory is flawed by its failure to take into account key mechanisms for economic growth. Factors such as; entrepreneurship, institutions facilitating economic growth and geographical differences are ignored. Although Solow’s model provides a strong base to explain economic growth, it has various downfalls and the “conclusions of Solow model were not fully proven by long-term world economic development” (Nedomlelova, 2007: 3). It is unrealistic to expect regional disparities to be completely diminished as convergence school suggests, therefore, cohesion policy has and will always play a key role within the EU’s policies.

The opposing divergence school of thought consists of many theories but has strong basis from Myrdal’s theory of cumulative causation (1957). Myrdal claims growth is spatially selective and that a cumulative “virtuous cycle” exists in developed countries and a “vicious cycle” in underdeveloped countries which, through a spiral effect, increases disparities. Myrdal emphasised the essential need for the “welfare world”, which today can be seen as the EU’s Cohesion Policy. The divergence school has several supporting theories including; core-periphery model, institutionalist theories, the endogenous growth model and new economic geography model.

Endogenous growth theory proposes that growth is a result of the regions’ available resources, more specifically, human capital and innovation. Opposing the convergence school, endogenous theory assumes that there will be increasing returns to knowledge and this will drive economic growth. Therefore, the more human capital a society has accumulated, the higher the productivity of each single member will be which increases the regions’ productivity and enables further economic advancements. Paul Romer (1986: 1003), an endogenous theory expert, dismisses the Neo-Classical assumption that countries eventually converge asserting that “the level of per capita output in different countries need not converge; growth may be persistently slower in less developed countries”. This theory has strong application in today’s global economy which displays an ever present and ongoing shift from a resource based economy to a knowledge based economy and in particular, ever increasing economic growth for those areas fostering knowledge based economies. Within the EU, support for this theory can be seen through the relative contrasts when comparing Regional Expenditure in R&D displayed in Appendix: figure 2, with Geographical Eligibility for Structural Fund Support as seen in Appendix: figure 1. Consequently, regions with low R&D expenditure are those eligible for structural fund support and, they are entitled to programs such as the SPEED WM Program in the West Midlands which aim to re-align the regions’ R&D.

“In order to catch-up, a less developed country is well advised to invest in its education system and infrastructure and to try to get closer to the frontier of technological knowledge by providing incentives to domestic firms to imitate and innovate and by encouraging FDI of technologically advanced firms” (Kruz and Salvadori 2010: 5).

The EU evidently views human capital investment as a key element to reduce regional disparities, therefore, 30% of structural funds is spent on strengthening education and training systems (Martins, P. 1997). During 2000-2006, the EU also set guidelines for its Regional Competitiveness programmes; “priority will be given to developing human resources and promoting innovation” (Europe.eu, 2010). This is in line with the Lisbon Strategy, agreed in 2000, which aims to increase investment in education as well as trying to increase R&D spending of member states up to at least 3% of GDP. Thus driving the EU forward to become “the most competitive and dynamic knowledge-driven economy by 2010” (euractiv.com, 2004). According to endogenous growth models, intervention from government will “raise the level of efficiency in the economy” (Mundschenk, S. & Stierle, M, 2006: 3). This approach is supported by Heckman & Jacobs, “all available evidence shows that welfare state dependency in Europe is heavily concentrated among unskilled persons” (Heckman & Jacobs, 2009: 4). Dependence on welfare systems is concentrated in regions that have collections of unskilled labour, caused by innovation and technical advances in human capital focused regions. The GNP per capita of the unskilled regions will be reduced and, in terms of the EU measurements, that region is eligible for cohesion fund support when it drops below 75% (Europa.eu, 2009).

If the EU aims to decrease the divergences between regions and “redistribute towards the poor”, then “human capital policy is more urgent than ever to avoid increasing dependency on welfare states” (Heckman & Jacobs, 2009: 5) In theory, according to endogenous growth, EU policies that increase human capital capabilities in relatively poorer regions will reduce regional disparities. However, this depends heavily on the capacity of the region to manage the human capital, innovation and technology; undoubtedly developed countries have a higher capacity to utilise technology than less developed countries.

Hashemzadeh (2003: 1177) believes we must consider other dynamic processes that hinder convergence and “thwart the equilibrating effects”. Even though sustaining a skilled, trained and educated labour force with the ability to relocate within the EU to support division of labour is an extremely important factor to achieve growth in today’s modern and pioneering global world; other factors are recognised as being extremely important. The Institutional environment, geographic conditions, agglomeration factors and a region’s initial conditions amongst others will all act as catalysts to EU regional divergence.

New Economic Geography theory (NEG), for example, claims that it is the “role of clustering forces that generate uneven distribution of economic activity and income across space” (Venables, 2005: 1). Within the EU, speific regions that have been affected by clustering forces creating a greater concentration of activities in one area and allowing those areas to benefit from “greater levels of accessibility and as a result attracting a higher volume of activities” (Limao & Venables, 2001). There is evidence of this occurrence in Appendix: figure 1 (European Commission, 2005), those regions that are eligible for structural fund support, such as parts of the Wales, are located in relatively un-clustered locations. London on the other hand, an extremely clustered area, has 334.2% of average EU GDP per capita. Inner London has the highest volume of activities in the UK and the GDP of that region clearly reflects the positive effect this has, confirming Venables’ previous point. Even though the EU spends 30% of structural funds on infrastructure (Martin, P. 1997) to aid geographical differences, the issue that the EU has is that as NEG theorists assert; clustering occurs because of spatially concentrated increasing returns to scale (Venables, 2005: 2). In isolation, this is one of the toughest problems to tackle. Firms are encouraged to relocate into and invest in the cluster of activity and at the same time those firms located in the clusters have no incentive to diverge from the central location causing the central regions to have positive reinforcement in the form of a “virtuous cycle” (Myrdal, 1957).

It must not be forgotten that historical context matters. A region’s initial conditions play a significant role in determining their development. Less endowed regions or poorly led regions have more and larger challenges to overcome than those more favourable regions. For example, the manner in which Eastern European countries overcame their communist regimes has been a significant factor to their future success. According to path dependency, a regions’ historical context matters, in this case communism and the period following communism in Eastern Europe has been a “major force at play in shaping divergent democratic and development outcomes” (Glaser, C. 2010: 109). Poland for example has been one of the more successful regions following communism. Poland had a positive exit from communist regime; it was ended swiftly and peacefully due to high political competition. In contrast, Romania had weak political competition and struggled to overcome communism and since has not been as successful as other communist regions. Presently, Poland is predicted to achieve the highest annual GDP growth forecast in the EU as shown in the Appendix: Figure 4, whereas Romania’s latest GDP is the second worst in the EU shown in the Appendix: Figure 3 (Economist Online, 2010).

In addition to the divergent factors that work against regions’ convergence within the EU, the spending practices of the EU have come under fire. The case of Twinning’s is a prime example, Twinning’s the quintessentially English tea brand has been at the centre of an EU cohesion funding scandal. The tea maker was given £10 million in Euro grants for a new factory, which they decided to build in Poland. Because of this, the factory in North Shields, UK will close in September 2011 causing the loss of 250 jobs in an area that is entitled to EU funds. North Shields is the type of area that EU structural funds are intended for. It is a fund that is meant to revive industry and support new jobs, both desperately needed in North Shields (Dispatches, 2010). Replacing jobs with cheaper workers will not aid convergence between regions within Europe. When considering the poor use of EU structural funds, this is just the tip of the iceberg. Tremendously rich multinational companies; IBM, Coca Cola and Nokia have all received funding from the EU, supposedly with the aim to improve ‘economic, social and territorial cohesion’. This undermines the value of the fund and raises questions about whether the EU is allocating the funds a beneficial manner and whether the current regulations governing the fund are effective. The Financial Times has even launched a website to ‘track every penny distributed through the EU’s Structural Funds to date’ (Financial Times, 2010).

Divergence amongst EU regions is still persistent and there is a torrent of evidence to suggest that successful regions in the EU are continuing to grow while less successful regions continue to decline, even though the EU’s cohesion fund has attempted to tackle divergence with billion euro policies. From the evidence presented, I believe that successful regions will continue to grow while less successful regions will continue to decline. Divergence is a result of a range of factors that are mutually supportive and one single theory cannot be exclusively used to explain the complex process that causes regional disparities, therefore attempting to tackle disparities will involve a range of multifaceted policies. The EU must treat each region independently and take into account the huge differences between regions and their independent economic circumstances. Artelaris, Arvanitidis and Petrakos (2008) suggest that convergence and divergence theories are both present in the EU but at different stages depending upon a regions’ development. “Both neoclassical and the endogenous growth theories receive empirical support, although their explanatory power seems to be stronger in different stages of development” therefore, “this mix of convergence/divergence forces changes, as the development levels of countries change”. During the divergent stage of development, as Myrdal (1957) stated, developed countries will experience a “virtuous cycle” whilst developing countries experience a “vicious cycle” increasing disparities. If this is accurate, as the evidence seems to suggest, uncertainty is cast on the prospects for the future convergence of EU regions and the aim to reduce disparities between successful and less successful regions. The regional differences within the EU and the theories understood to be behind the growing differences have been addressed, this includes their limitations and the policies now used to tackle them. The inadequacies of the EU have been considered and recommendations made based on evidence presented. However, as Ralph Waldo Emerson famously said, “Some will always be above others. Destroy the inequality today, and it will appear again tomorrow”. This is becoming increasingly clear within the EU.