The Role of Additionality in the EU Cohesion Policies: An Example of Firm-Level Investment Support

Abstract

Additionality is one of the key principles driving the functioning of the EU cohesion policies (ECP). The present paper studies how additionality affects the impact of firm-level investment support on firm investment behaviour in differently competitive markets. We find that the investment additionality and the level of competition importantly affect the firm investment behaviour. Imposing additionality on the ECP investments in perfectly competitive markets causes distortions in the capital market and leads to lower welfare levels. In contrast, without the enforcement of additionality, the distortions are zero and the investment support fully benefits the firms. In an imperfectly competitive environment, the firm-level investment support may increase investment and may be welfare increasing with and without the enforcement of the investment additionality.

Acknowledgements

The authors acknowledge Ben Gardiner, Enrique Lopez-Bazo, Fabio Manca, Giuseppe Piroli, Alessandro Rainoldi, EcoMod and IER conference participants in Istanbul and Smolenice as well as seminar participants at the European Commission for their helpful comments. The authors acknowledge the EU Project “System of regional model for impact assessment of EU Cohesion Policy” for the financial support. The authors are solely responsible for the content of this paper. The views expressed are purely those of the authors and may not in any circumstances be regarded as stating an official position of the European Commission.

Notes

In general, three types of ECP additionality can be identified: project-level additionality, programme-level additionality and MS-level additionality. In this paper, we consider the additionality at the project (firm) level, but the results can be generalized to any implementation level of the ECP.

See Art. 3(2) of the General Regulation.

For an overview of these objectives, see European Commission (2007, pp. 10–26).

www.cc.cec/dgintranet/regio/documents/20072013/a_sf_reg2007_2013/corrigendum_commission_reg.pdf

See Art. 15 and Annex II(7) of the General Regulation, respectively.

See Annex III, General Regulation.

See Art. 55(2), General Regulation. It is worth noting that the funding gap does not apply to investment projects whose financing is classified as State aids (see Art. 55(6)).

This ratio is the complement to one of the funding gap and it is given by the ratio of discounted net revenue to discounted investment costs.

European Commission, Art. 15 of Regulation (EC) No 1083/2006.

From the baseline specification, the SFA-receiving firms are also allowed to interact with explanatory variables in the model through various ways, such as (i) composite dummy effects (multiplication of the SFA dummy with employment, capital stock, etc.), to investigate whether firms which received SFA might operate using different technologies compared with non-supported firms, (ii) interaction terms between the SFA and firm age and ownership structure, and (iii) disaggregation of the SFA into capital grants and all other ECP support.

f_K and f_KK are the first and second derivatives of the production function with respect to capital, respectively.

For illustrative purpose, we assume that the economy is small and open, which implies that the output price is fixed.

For example, if δ = 0, then the capital good is undepreciable such as land.

This is consistent with the short-run modelling of capital market, where firms adjust capital quantities as a response to a policy change. Other effects, such as changes in prices and/or quantities of other inputs, will take place in the medium- to long-run perspective. Usually in firm investment literature, variable inputs are assumed to change in the short run, whereas capital is assumed to change in the long run. Because our objective is to analyse the effect of investment support, the change in firm capital is a short-run effect of the policy. Then in the long run, adjustment of other inputs and/or prices follows as a reaction to policy-induced capital change. Furthermore, note that when incorporating this partial equilibrium approach into a general equilibrium framework, all price and other input effects are accounted for (Kielyte, 2008).

This assumption is not strictly needed to obtain the results. The interest rate i represents the income to capital owners. If one would consider firm-owned capital, then the interest rate i would represent opportunity cost of capital.

This is a more realistic assumption, because the actual budget for the ECP is limited and is subject to competition, implying that not all capital benefits from the support. We assume K _max sufficiently low, less than the equilibrium quantity of investment in the absence of support (see below).

We consider the case when the support affects only the firm interest costs. In general, this is consistent with the implementation of the firm-level investment support. The support finances the purchase costs of capital. The depreciation costs (δR) are not eligible for the support.

Similar one can be shown for the imperfectly competitive demand, D_ic .

Note that in the case shown in Figure 2, the eligibility constraint K_s  ≤  K _max is binding, λ > 0. This does not hold in general. For a sufficiently high maximum eligibility threshold, the firm may not exploit the investment support possibility in full.

Note that this is not a general result. If the mark-up is not sufficiently large, then the net effect of the investment support could actually lead to a welfare loss.

Note that in a general equilibrium model, tax distortions and other inter-sectoral and inter-regional distortions need to be accounted for to obtain total welfare effects of the investment support.

Note that K _max < K _lc* also implies that K _max < K _pc *.

The intuition behind this result is that with perfect competition firms can exploit all profitable investment opportunities even without the support. Providing investment support to firms (such that K _s < K _pc *) does not alter investment opportunities available to firms. Firm optimal behaviour is to use the same quantity of capital with and without the support.

Note that this does not hold in general, but only for the cases when the mark-up is sufficiently large as shown in Figure 1.