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Can regional policy in a federation improve economic efficiency?

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  • Fuest, Clemens
  • Huber, Bernd

Abstract

In the European Union and in many federal and non-federal countries, the central government pays subsidies to poor regions. These subsidies are often seen as a redistributive measure which comes at the cost of an efficiency loss. This paper develops an economic rationale for regional policy based on economic efficiency. We consider a model of a federation consisting of a rich and a poor region. The economy is characterized by imperfect competition in goods markets and unemployment. Firms initially produce in the rich region but may relocate their production to the poor region. We show that a subsidy on investment in the poor region unambiguously increases welfare if labour markets are competitive. If there is unemployment in both regions, the case for regional subsidies is weaker.

Suggested Citation

  • Fuest, Clemens & Huber, Bernd, 2006. "Can regional policy in a federation improve economic efficiency?," Munich Reprints in Economics 20331, University of Munich, Department of Economics.
  • Handle: RePEc:lmu:muenar:20331
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    References listed on IDEAS

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    1. Huizinga, Harry & Nielsen, Soren Bo, 1997. "Capital income and profit taxation with foreign ownership of firms," Journal of International Economics, Elsevier, pages 149-165.
    2. Richter, Wolfram F. & Wellisch, Dietmar, 1996. "The provision of local public goods and factors in the presence of firm and household mobility," Journal of Public Economics, Elsevier, vol. 60(1), pages 73-93, April.
    3. Fuest, Clemens & Huber, Bernd, 2000. "Why do governments subsidise investment and not employment?," Journal of Public Economics, Elsevier, vol. 78(1-2), pages 171-192, October.
    4. Krugman, Paul, 1991. "Increasing Returns and Economic Geography," Journal of Political Economy, University of Chicago Press, vol. 99(3), pages 483-499, June.
    5. Markusen, James R. & Morey, Edward R. & Olewiler, Nancy, 1995. "Competition in regional environmental policies when plant locations are endogenous," Journal of Public Economics, Elsevier, vol. 56(1), pages 55-77, January.
    6. Sinn, Gerlinde & Sinn, Hans-Werner, 1992. "Kaltstart. Volkswirtschaftliche Aspekte der Deutschen Vereinigung," Monograph, Mohr Siebeck, Tübingen, edition 2, number urn:isbn:9783161459429.
    7. Horstmann, Ignatius J. & Markusen, James R., 1992. "Endogenous market structures in international trade (natura facit saltum)," Journal of International Economics, Elsevier, vol. 32(1-2), pages 109-129, February.
    8. Burbidge, John B. & Myers, Gordon M., 1994. "Population mobility and capital tax competition," Regional Science and Urban Economics, Elsevier, vol. 24(4), pages 441-459, August.
    9. Martin, Philippe, 1999. "Public policies, regional inequalities and growth," Journal of Public Economics, Elsevier, vol. 73(1), pages 85-105, July.
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    Cited by:

    1. Robert Fenge & Volker Meier, 2006. "Subsidies for Wages and Infrastructure: How to Restrain Undesired Immigration," CESifo Working Paper Series 1741, CESifo Group Munich.
    2. S. Bouayad Agha & Nadine Turpin & Lionel Védrine, 2010. "Fostering the potential endogenous development of European regions: a spatial dynamic panel data analysis of the Cohesion Policy on regional convergence over the period 1980-2005," Working Papers halshs-00812077, HAL.
    3. bouayad-agha-Hamouche, salima & turpin, nadine & védrine, lionel, 2012. "Fostering the potential endogenous development of European regions: a spatial dynamic panel data analysis of the Cohesion Policy," MPRA Paper 65470, University Library of Munich, Germany.
    4. Becker, Johannes & Fuest, Clemens, 2010. "EU regional policy and tax competition," European Economic Review, Elsevier, vol. 54(1), pages 150-161, January.
    5. Wegener, Stefan & Kiryluk, E., 2008. "Regional aspects of decision-making support for rural development in Poland," 2008 International Congress, August 26-29, 2008, Ghent, Belgium 43845, European Association of Agricultural Economists.

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