Public Policy for Regional Development

Jorge Martinez-Vazquez, Francois Vaillancourt

• Publisher: Taylor & Francis
• Year: 2008
• Print ISBN: 9780415775762
• eBook ISBN: 9781135972592
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

This book draws on the expertise of both North American and European specialists of regional economics, evaluating the impact of economic policy in certain regions and considering alternative policies to foster regional economic development and improve the employment and income of the residents of these regions.Martinez-Vazquez and Vaillancourt hav

1 Regional development

Challenge for public policy

Jorge Martinez-Vazquez and François Vaillancourt

Introduction

The desire to develop one’s region is strongly shared by voters, politicians and even some investors across the world. Various reasons explain this desire. In the case of voters, it can be explained by factors that bring about both psychic and financial rewards. Psychic rewards are associated with civic pride and personal identity, living in one’s birthplace, admiring its natural beauties, and so on. Financial rewards result from employment opportunities and the continued use of an existing stock of capital. Politicians may genuinely desire greater levels of development for their regions and they also need to respond to their constituencies’ desires and how they vote. Politicians will often attempt to implement development policies, for example, by spending in their districts money raised by taxes, preferably paid by other individuals than their own voters, to attract investment. This may be done through a variety of means such as offering tax breaks and direct subsidies to investors, offering new or improved public infrastructure such as road access or serviced lots and offering a better trained labor force through both investor-specific training programs and more generally investments in the human capital of residents of their region.

Economists usually frown upon regional development spending, considering that it attempts to counter the market forces at work in a larger setting – several regions together or the country as a whole – and that the natural adjustment mechanism of labor mobility should be allowed to play itself out. However, as Luger and Maynard (this volume) argue, among many others, market failures, of which they list several examples, can justify government intervention. Another way to justify government development policies is to argue that full reliance on natural adjustment mechanisms and labor mobility neglects the existence of social capital with various externalities (linguistic, ethnic, religious) that may make labor mobility less efficient than capital mobility. But, of course, this interpretation begs the questions of who should subsidize such mobility of capital and how it should be done. For example, spending the same amount on building a site-specific physical facility such as a port or railroad or on improving the human capital of a labor force by offering more post-secondary training to the inhabitants of a region does not have the same consequences in terms of regional labor market flexibility or, if needed, labor mobility. And yet, the total absence of physical infrastructure will significantly impact regional development. These are some of the compelling questions asked and addressed in this volume.

Independently of what economists say the optimal policies are, it is quite likely that politicians will continue devising different approaches to the development of their regions. Given that regional development policies have been, are, and will continue to be implemented in many countries of the world, the main purpose of this book is to present new research on these activities. The studies resulting from this research, written by a selected group of scholars, address one fundamental question. What are the best possible uses of public funds and the most effective strategies for regional development? The answers and perspectives, though written with the rigor of academic research, are at the same time accessible and relevant to policy makers.¹

The chapters in this book fall into three categories, preceded by a discussion of the importance of regional disparities and the potential for economic convergence, a main reason for the interest of policy makers in the subject of regional development. The first set of chapters examines the tools generally available to policy makers for pursuing regional development objectives, and how they have been applied in the United States and Ireland, two countries with very vibrant regional economies. The second set of chapters reviews specific empirical findings of considerable relevance to regional economic policy makers in terms of developing human capital and attracting investment flows from outside the region. The third set of chapters examines several methodological issues which must be recognized in the process of regional policy formulation and which, in some ways, will need to be approached in future research in this area. Let us now turn to a more detailed discussion of the contents of the book.

The first chapter by José Manuel González-Páramo starts off by stating that ‘the issue of how to deal with heterogeneity in a diverse single currency area has been an issue at the heart of the debate in Europe all along the road to deeper economic integration’. This issue is important for many countries, whether they are federal or unitary, geographically large or small. The issue is probably exacerbated in the European context by the fact that the EU is a young association of economic regions, each with a tradition of full sovereignty. But in the United States, the issue of how to deal with differences in the economic development of states is also important, with states deciding on their own policies to attract investment and thus employment. Even within small countries such as Belgium, regional development is an issue. In developing and transitional countries, such as China and India, the problem of regional economic and other forms of heterogeneity poses significant policy dilemmas for the governments of those countries. Having described the differences in inflation and growth rates between countries in the euro area, González-Páramo looks for explanations. He finds that a growth accounting exercise indicates that differences in the evolution of total factor productivity plays an important role in explaining differences in regional growth. This role for differences in factor productivity is not unique to the euro area; examinations of differences in growth between the richest members of NAFTA, the United States and Canada shows that factor productivity differences also matter in that economic area. In closing González-Páramo argues that greater flexibility in the labor market is the most important structural reform that euro area members must implement to allow them to adapt to economic shocks in the absence of their own monetary policy. This emphasis on labor which embodies human capital is a theme taken up in chapters in the following two sections of this book.

Policy tools

Four chapters are grouped under this theme. The first one by Michael Luger and Nicolas Maynard presents policy tools broadly while those by Ann Markusen and Roy Green and Johanna fahy focus respectively on the proper scope of regional development policy (industrial or occupational) with specific examples for California and on the role of innovations in regional development with a focus on Ireland. The fourth by Santiago Lago-Peñas addresses the potential tradeoffs and complementarities between fiscal equalization and regional development. The relevance of equalization policies for regional development lies in the fact that poor regions which are perhaps in greatest need of regional development policies are also those that can least afford to pay for them out of their own resources.

Luger and Maynard begin their chapter by providing a simple yet appropriate definition of regional development as ‘efforts to enhance employment, income, wealth, and/or opportunity within a defined geographic area’; these authors note that government action to achieve this has four components: planning, financing, regulating, and managing. An important point made in this chapter is the reminder that the process of regional development will see regions going through different phases of development along a continuum with each phase or level requiring different inputs from governments. Hence regions at an earlier stage of development may require more physical capital than more advanced regions to allow them to access markets and knowledge/ideas. This explains in part the past focus in countries such as the United States on physical investments for regional development; such a need may have changed but institutional inertia makes the focus on these investments still important. For Luger and Maynard, regional development should not only be about attracting new businesses (business recruitment) in a score sheet type approach but also about a more balanced approach with the success of existing businesses mattering as much, if not more. This is often a forgotten point. ² Luger and Maynard then examine three current policy tools used for regional development. The first one is tax incentives. They show that the evidence on the impact of these incentives is mixed; some authors conclude they have little impact while others argue they do. The main point from a policy maker perspective is that one should at least be aware of the cost of such incentives and thus make informed choices as to their use, given the competitive environment a region finds itself in. ³ The second policy tool is cluster based planning; here the authors endorse its use but sagely note that:

Of course, if the cluster planning process is not likely to pick the right winners and losers, and the policy process fails to identify the proper amenities and services to provide … A place then may be better off not changing much.

Finally they examine the use of innovation systems, which link universities and more generally research generating bodies (laboratories, …) as idea generators to regional development. In their view, the resistance of traditional regional development authorities to such an approach is interesting when linked to the next two chapters in this volume. This theme is picked up in the following chapter by Ann Markusen.

The chapter by Ann Markusen also addresses the issue of the proper tools of regional development but from a different perspective. After recalling the links between growth theory and regional development policies, Markusen argues that past regional development policies have focused too much on physical capital, noting issues such as import penetration and boom and bust cycles associated with building transport infrastructures, for example. She raises the issue of not only the efficiency and cost but also of the regulation of tax incentives. Markusen then argues that the use of an industry-based approach for regional development is not as desirable as an occupation-based approach:

Accepting the industry/firm/establishment framework as the skeleton of a regional economy means shaping economic development practice around firm priorities. Implicit in this approach is a vision of economic growth that favors physical capital as the key input, rather than technology or human ingenuity and labor.⁴

Thus, Markusen argues that looking at regions as groupings of workers as opposed to industries provides a more useful and generally better perspective. In particular, this perspective focuses efforts on redeploying resources rather than saving plants when an industrial downturn threatens a region. Hence one can use a cluster-based approach with occupational clusters. ⁵ Markusen then puts forward specific policy recommendations. Of particular interest in a context where many regions are facing an aging shrinking work force is the recommendation that regions market themselves to individuals and not to employers since firms will follow the workers. A practical step to do this can be found in her recommendation that incentives to employers, if one uses them, be based on their use of target occupations.

In their chapter, Green and Fahy devote considerable attention to two of the tools enumerated by Luger (clusters and innovations systems) and also to the role played by foreign direct investment; how public policy can best attract it is the topic examined in a later chapter in this book by Goodspeed, Martinez-Vazquez and Zhang. In their chapter, Green and fahy begin by reviewing what clusters and innovation systems are and by showing the links between the two concepts. In that context, they raise the issue of the ‘embeddedness’ of foreign investment, that is, the nature of its relationship with the local economy. Green and Fahy then turn to the discussion of the causes of why the medical technology sectors in Galway have emerged as a world class player in the field. They then raise a fascinating question: what next? They argue that:

explanations for Ireland’s success are multi-faceted, but include strategically targeted FDI attraction, an effective social partnership framework, low corporate tax, development of the skills base and policy-relevant use of EU Structural Funds … However … Ireland finds itself in a serious dilemma … (that) … lies in the fact that Ireland has become a world leader in the export of high-tech products … without being a significant innovation generator … the current structure inherited from the ‘Celtic Tiger’ period is weighted largely towards externally generated R&D, leaving control of the key technology drivers outside domestic influence.

This raises, in the context of a specific region, the issue of the success of existing businesses already flagged by Luger and Maynard. More importantly, Green and fahy conclude that there is a need to build innovation capacity in Ireland; innovation systems that take innovations from elsewhere are incomplete.

The chapter by Santiago Lago-Peñas raises several important issues in the practice of interregional fiscal equalization and regional development strategies. Equalization is a national policy that can affect the development opportunities of even very similar regions. For example, two poor regions with the same financial needs (revenue potential and expenditure needs) may not receive the same support from their central government. If region A,adjacent to B, offers the same location advantages as B but cannot offer the same public infrastructure or quality of labor, then it will be hard put to develop at the same pace. Conversely, two rich regions, C and D, may face different demands by the central government on their tax base for equalization programs. In this case, the issue is the maintenance of a comparative advantage. These issues are relevant in both countries with explicit or implicit equalization programs; their salience will depend on the importance of equalization in economic terms which will in turn depend on political forces, as analyzed by Lago-Peñas. There is a also a converse side to the issue of equalization and regional development. As he puts it:

… regional policy may be seen as a subtle way of equalization. If it succeeds in promoting economic growth in poorer regions, it reduces disparities in future tax capacities and then will make easier the equalization issue. Moreover, political communities from poorer regions will probably be more pleased about a solution that improves their economic performance and make them less dependent in the future.

An important message of this chapter is the importance of being aware of the relevance of regional development to equalization and vice versa. However, these two sets of policies (regional equalization and regional development) are typically designed separately from one another and also by quite different political actors (for example, the national Ministry of Finance versus the national Ministry of Economy or the regional authorities themselves).

Empirical studies

The next three chapters in the volume address new empirical evidence on the effectiveness of different development policies. The first by Varvara Rakova and François Vaillancourt examines the impact of human capital on productivity; the second by Timothy Goodspeed, Jorge Martinez-Vazquez and Li Zhang compares the roles of public sector governance and spending versus taxes in attracting foreign direct investment; and the third by Luiz de Mello examines the availability and use of foreign sources of borrowing as tool for economic development.

Rakova and Vaillancourt examine the impact of an increase in the amount of human capital in a region on the productivity of both high and low education workers in that region. In fact, this study can be seen as providing an empirical measure of the existence of human capital clusters emphasized as playing a key role for regional development in the previous chapter by Markusen. In this chapter, Rakova and Vaillancourt review the existing empirical evidence for the United States and present new evidence for Canada’s metropolitan areas for the year 2000, calculated using micro data from the Census with four different measures of education. Leaving aside the technical details of their estimation, we see that these authors arrive at three key findings of relevance to policymakers. First, the existence and importance of human capital externalities show a positive and significant impact on wages and productivity at the metropolitan area level but they are not as clearly present for large areas; therefore, human capital externalities may dissipate in the case of larger geographical areas, such as provinces or regions. Second, the choice of the measure of human capital matters. Results obtained using the share of holders of graduate degrees show a greater impact than those obtained using all holders of university degrees. Hence Rakova and Vaillancourt note

the importance of the effect associated with the share of graduate degree holders both for other workers and for themselves. It no longer suffices for a region to have a university educated labor force; one needs a well-educated university labor force with advanced degrees and thus specialized training to compete.

Third, the impact of the clustering of human capital is larger in the private than in the public sector. Overall, the findings by Rakova and Vaillancourt support the view put forward in the preceding section that investing in human capital is an appropriate and effective policy to further regional development.

The chapter by Goodspeed, Martinez-Vazquez and Zhang focuses on the role of fiscal policies in attracting external private investment into an area. While, traditionally, the literature on the determinants of ‘foreign direct investment’ has focused on the potential role played by tax incentives, Goodspeed, Martinez-Vazquez and Zhang emphasize the potential role played by good governance and public services in attracting and retaining ‘foreign direct investment.’ These authors use cross-country and within-country regional data for several countries to test the relative impact of the roles played by taxation levels and a variety of public service and governance measures in attracting foreign direct investment. The main conclusion Goodspeed, Martinez-Vazquez and Zhang draw from their empirical work is that:

… the adequate provision of public services in a broad sense, and not just low taxes, would seem to be an important policy principle for regional and central governments that want to attract FDI. These governments need to offer a package of public services that generate benefits that are commensurate with the taxes that the beneficiaries will pay.

The chapter by de Mello examines the impact of greater economic integration and globalization on the financing constraints of regional governments. De Mello, indeed finds that greater integration of neighboring countries, with increases in trade and financial flows, leads to a higher reliance on foreign rather than domestic sources of budget financing; however, the lack of regional data prevents the author from carrying out estimations at that level. Nevertheless, his results remain quite relevant for the focus on regional development of this volume for two reasons. First, one can think of European countries as regions of Europe, particularly in the case of the members of the euro area and thus these results apply to ...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• List of figures
• List of tables
• List of contributors
• 1 Regional development: challenge for public policy
• 2 Regional divergence in the euro area
• 3 On the government’s role in regional economic development
• 4 Human versus physical capital: government’s role in regional development
• 5 Regional innovation systems and public policy: Ireland’s medical technology cluster
• 6 Unbalanced development and regional governments: how much to equalize and how to equalize?
• 7 Human capital externalities and regional development: evidence for Canada – 2000
• 8 The role of public services and taxes in attracting ‘foreign’ direct investment
• 9 Regional economic integration and budget financing: looking towards international markets?
• 10 Do new highways attract businesses? A new microeconometric methodology
• 11 Regional growth and environmental regulation: friends or enemies?
• 12 Methodological dilemmas in regional strategy building
• 13 Conclusion: what advice for policy makers?