Regional inequalities, economic crises and policies: an international panel analysis

ABSTRACT

This paper examines the effects of economic downturns on regional inequalities. In a sample of 25 OECD countries for 1990–2014 period, we show that economic downturns are associated with a significant and long-lasting reduction in regional inequalities. Expansionary fiscal policy as well as higher share of the European development (cohesion) funds facilitate the response of lagging regions to negative nation-wide shocks, contributing to further stimulate the reduction in regional disparities. Additional evidence suggests that the effect of downturns tends to be larger in economies with a higher initial level of regional disparities in unemployment and human capital endowment.

KEYWORDS:

• Crises
• economic downturns
• fiscal policy
• european cohesion funds
• regional disparities

JEL CLASSIFICATION:

• E32
• O40
• R11
• R12.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

¹ See also the following VoxEU columns: https://voxeu.org/article/regional-inequality-europe; https://voxeu.org/article/monetary-policy-and-regional-inequality.

² Space is a source of advantages due to the cumulative nature of productive processes. Spatial proximity generates economies that reduce production and transaction costs (Capello 2010). Note that this explanation is also in line with the findings of the new economic geography theory (Krugman 1991), and endogenous growth theory (Romer 1986), that suggest a positive relationship between the process of regional integration and the degree of concentration of economic activity.

³ Conversely, Boldrin and Canova (2001) and Dall’Erba and Le Gallo (2008) find a non-significant effect.

⁴ We complement the OECD data with the European Structural and Investment Funds data provided by the European Commission. For descriptive statistics see Table A1 in the Appendix.

⁵ The results presented in Table A3 in the Appendix suggest that when differentiating between severe downturns (identified as those downturns with annual growth rates below the first quartile of the distribution of annual growth rates) and moderate downturns (all the others), the reducing effects of the former on regional inequality tend to be larger and longer lasting.

⁶ The estimates of the standard deviation on its own lags suggest that the standard deviation is an AR(1) process with autocorrelation coefficients equal to 0.8 for the first lag and about 0 for the second lag (see Table A4). This persistence can reflect structural impediments to convergence.

⁷ Another factor that may affect the response of regional inequality to economic downturns is price flexibility. Recent research (Furceri, Loungani, and Pizzuto 2020) shows how price flexibility is more important as a labour demand shock absorber in countries belonging to the Euro Area with respect to U.S. states. However, past research on selected countries (Obstfeld and Peri 1998) shows how intranational relative prices tend to fluctuate less than international relative prices. To the extent that the sensitivity of prices is different across regions, this may affect regional income inequality. Limited data availability on prices at the regional (NUTS 2) level prevented us to control also for this factor.

⁸ In particular, the estimation results are the following:

(4.98) $D_{i,t}=0.637I_{i,t}+{\epsilon }_{i,t}$(4.98)

with t-statistics in parentheses, and an F-statistics of 24.81 – well above the KleibergenPaap-rk-Wald-F statistic of weak exogeneity. In addition, the Hansen J statistic p-value for overidentification suggests that we can consider these variables to be strongly exogenous. Finally, the estimates of the effects of these instruments on regional inequality are not statistically significant once we have controlled for downturn dummy in country i.

⁹ As an additional exercise we re-estimated the IV model using the lag of our instrument, thus considering those downturns in trading partners which occurs just before the downturn in the national economy considered. The results presented in Table A12 in the Appendix, show very similar results to those presented in the text.

¹⁰ To further shed lights on the role of the Great Recession, we estimate equation (1) using growth as regressor for the entire period 1990–2014. The results of the first exercise confirm the reduction of regional disparities in the aftermath of economic downturns over the whole period (1990–2014). However, once we distinguish between pre – and post-2008, results seem to weaken in the period following the Great Recession probably due to the heterogeneous behaviour in the reaction to the crisis within each country.