Perpetuating regional asymmetries through income transfers

ABSTRACT

This paper studies the effect of income transfers on the distribution of economic activity through a modified FE model. The model incorporates some key features of the Dutch disease literature: sectorial mobility and non-tradable goods. If foreign competition is high (high trade openness), transfers could cause a Dutch disease in the short and long runs. For intermediate levels of foreign competition, Dutch disease appears only in the short run. And, for low levels, the recipient region always benefits from the income transfers. Additionally, when economies of scale are large, the transfers could perpetuate a core–periphery structure.

KEYWORDS:

• New Economic Geography
• Dutch disease
• income transfers

JEL:

• H30
• R12

DISCLOSURE STATEMENT

No potential conflict of interest was reported by the author.

Notes

1 According to Eurostat definitions.

2 The first versions of the FE model were developed independently by Ottaviano (2001) and Forslid (1999).

3 The Dutch disease or de-industrialization in the short run could occur in our model as a result of the economic configuration of the regions. The bigger the non-tradable sector and the higher the competition, the higher the probability of ending up in a de-industrialization scenario. However, in Moncarz et al. (2017), Dutch disease always takes place in the short run, and is not a result of the economic configuration.

4 Alternatively, if the non-tradable services were also an input for industrial production, all the results derived in this paper would remain unchanged.

5 Besides of avoiding wage equalization, the assumption of a different regional agricultural good is more empirically accurate, as pointed out by Fujita et al. (2001).

6 Examples of non-tradable sectors are, mainly: the construction sector, some finance and real estate services, and public services. Piton (2017) estimates that, on average for the period 1995–2014, the weight of the non-tradable sectors in the total production for the EU is > 40%.

7 For the derivation of equation (26), see the supplemental data online.

8 This channel can be shut down by setting ${\mu }_2=0$. In this case, all expenditure goes to tradable goods.

9 This channel can be shut down by making $\phi =1$.

10 Another way of interpreting this is by focusing on the agricultural sector. Increasing ${\mu }_2$ while holding constant ${\mu }_1$ is equivalent to a reduction of proportion of disposable income devoted to agricultural consumption ($1-{\mu }_1-{\mu }_2$). Because this proportion is relatively small, the contraction of the supply will have a larger effect on the other sectors of the economy, which makes the industrial sector more likely to shrink.

Additional information

Funding

The author acknowledges the support given by COST Action IS1104: ‘The EU in the New Economic Complex Geography: Models, Tools and Policy Evaluation’. The study was partially supported by the Ministerio de Economía y Competitividad, Gobierno de España [grant number ECO2017-82227-P].