Sustainable interregional transfers: lessons from Belgium

Erik BuystVIVES and Center for Economic Studies

Structure

• What are interregional transfers?

• Roots of the problem.

• Policy responses.

• Efficiency of interregional transfers.

• State reforms.

• Conclusion.

What are interregional transfers?

• Public financial flows.

• For every geographical entity we calculate the: o revenues from taxes and social security contributions to

finance common public expenditures.o spending flows from the federal government and the

(federal) social security system to a certain geographical entity.

o difference = interregional transfer.o what geographical entity is a net contributor?

Roots of the problem

• Flanders becomes a net contributor from the mid 1960s (Dottermans, 1997).

• In 1970s and early 1980s transfers from Flanders to Wallonia increase rapidly (Van Rompuy & Bilsen, 1988).o from late 1950s: coal mining crisis in Wallonia.o Flanders benefits from breakthrough of oil: refineries,

chemicals, car assembly.o oil crises of 1970s hit Walloon economy

disproportionally hard.

Roots of the problem

• Is it just an asymmetric shock/bad luck? (De Grauwe, 1980)o unit labour costs in Wallonia are 10% higher than in

Flanders. o Wallonia unattractive for (foreign) investments, no

modernization. o existing firms focus on labour saving technologies. o wage cost problem important cause of interregional

transfers.o first blow to legitimacy of transfers in Flanders.

Roots of the problem

• Origins of unit labour cost problem (Buyst, 2011)?o high salaries in coal mining demonstration effect.o when mines disappear downward rigidities prevent

wage adjustments.

• From late 1950s: loss of private sector employment in Wallonia largely compensated by early retirement and rise in public employment.

• No incentives to correct unit wage problem.

Policy responses

• Even sharp increase in unemployment after 1974 does not generate wage moderation in Wallonia. o national wage agreements.o generous unemployment benefits, unlimited in time.o Walloon public opinion:

• entrepreneurial failure - holding companies (Société Générale).• demands economic autonomy - public initiative .

Policy responses

• Late 1970s and early 1980s Belgium as a whole faces serious competitiveness problems. o 1982: devaluation of BEF.o national policy of imposed wage moderation.o but regional gap in unit labour costs remains (Planning

bureau, 2008).

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

60

62

64

66

68

70

72

74

76

78

Wage share (% of value added), 1980-2010

FlandersWallonia

Policy responses

• Economic recovery in late 1980s much weaker in Wallonia than in Flanders.o Walloon unemployment rate remains stubbornly high.

• In Flanders shortages in certain segments of labour market. o rapid rise in wages.o regional wage gap decreases, but in wrong direction.

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2

4

6

8

10

12

14

16

18

20

Unemployment rate, 1980-2011 (in %)

FlandersWallonia

Efficiency of interregional transfers

• In Belgium long term interregional transfers do not produce economic convergence.

• Recent economic theory skeptical about efficiency of transfers (Dupont & Martin, 2006; Padovano, 2007)o redistributive transfers – income taxes and social

security – slow down relocation of production factors.• less pressure on wages.• no incentives to commute.

o generate little or no regional convergence.o hurt economic growth of the country as a whole.

Efficiency of interregional transfers

• Alternative: o investment in transport infrastructure: outcome

uncertain.o investment in human capital.

• Empirical test: 140 geographical units in 9 Eurozone countries (Persyn & Algoed, 2009, 2011)o confirm theoretical predictions.o simulate effects of reduction of transfers to Hainault by

one third (Persyn, 2010).• first disposable income falls, but afterwards better off.

Efficiency of interregional transfers

• Other case study: former East Germany (Marcolin, 2012)o in 1990s same mistakes as Belgium.o Hartz reforms of 2003-2005.

• reduction of redistributive transfers.• more labour market flexibility.• larger regional wage differences. • revival of economic growth.

• French-speaking economists in Belgium.

Efficiency of interregional transfers

• Today Flanders faces its own challenges:o ageing hits Flanders relatively more.o deindustrialization.o labour productivity advantage is eroding.o high energy costs.o share of exports to emerging economies still too low.

• Flanders cannot afford to finance the transfers much longer.o phasing-out program is necessary.

State reforms

• From 1970 series of state reforms.

• Did not affect interregional transfers.o social security system remained federal.o solidarity mechanisms between regions.

• Transfer issue is only top of iceberg.

• Structure of the Belgian federal model as such faces severe sustainability problem.

State reforms

• Several construction flaws.

o vertical gap: mismatch between competences to spend – regions and communities – and competences to tax – federal government (Escolano et al., 2012).• provides incentives to regions to spend as much as they can.• moral hazard: bail out, cf. Spain. • spill-over effects: hike in interest rates.

o Belgium: • no hierarchy between the two levels. • retirement benefits of regional civil servants are paid for by

federal government.

State reforms

• Austerity programs and ageing problem will put additional strain:o federal level has to pay retirement benefits.o federal grants to regions are fixed by law.o regions & communities responsible for infrastructure

and education.o requires intense cooperation between various

governments in a context of regional parties and asymmetric coalitions.

State reforms

• Serious risk that at some point in time it will prove impossible to reach an agreement.

• For those who believe that the 2011 agreement was the last state reform:

• “You ain’t seen nothing yet”.