Sustainable interregional transfers: lessons from Belgium

1. Sustainable interregional transfers: lessons from Belgium Erik Buyst VIVES and Center forEconomic Studies

2. Structure • What are interregional transfers? • Roots of the problem. • Policy responses. • Efficiency of interregional transfers. • State reforms. • Conclusion.

3. What are interregional transfers? • Public financial flows. • For every geographical entity we calculate the: • revenues from taxes and social security contributions to finance common public expenditures. • spending flows from the federal government and the (federal) social security system to a certain geographical entity. • difference = interregional transfer. • what geographical entity is a net contributor?

4. 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). • from late 1950s: coal mining crisis in Wallonia. • Flanders benefits from breakthrough of oil: refineries, chemicals, car assembly. • oil crises of 1970s hit Walloon economy disproportionally hard.

5. Roots of the problem • Is it just an asymmetric shock/bad luck? (De Grauwe, 1980) • unit labour costs in Wallonia are 10% higher than in Flanders. • Wallonia unattractive for (foreign) investments, no modernization. • existing firms focus on labour saving technologies. • wage cost problem important cause of interregional transfers. • first blow to legitimacy of transfers in Flanders.

6. Roots of the problem • Origins of unit labour cost problem (Buyst, 2011)? • high salaries in coal mining demonstration effect. • 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.

7. Policy responses • Even sharp increase in unemployment after 1974 does not generate wage moderation in Wallonia. • national wage agreements. • generous unemployment benefits, unlimited in time. • Walloon public opinion: • entrepreneurial failure - holding companies (SociétéGénérale). • demands economic autonomy - public initiative .

8. Policy responses • Late 1970s and early 1980s Belgium as a whole faces serious competitiveness problems. • 1982: devaluation of BEF. • national policy of imposed wage moderation. • but regional gap in unit labour costs remains (Planning bureau, 2008).

10. Policy responses • Economic recovery in late 1980s much weaker in Wallonia than in Flanders. • Walloon unemployment rate remains stubbornly high. • In Flanders shortages in certain segments of labour market. • rapid rise in wages. • regional wage gap decreases, but in wrong direction.

12. 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) • redistributive transfers – income taxes and social security – slow down relocation of production factors. • less pressure on wages. • no incentives to commute. • generate little or no regional convergence. • hurt economic growth of the country as a whole.

13. Efficiency of interregional transfers • Alternative: • investment in transport infrastructure: outcome uncertain. • investment in human capital. • Empirical test: 140 geographical units in 9 Eurozone countries (Persyn & Algoed, 2009, 2011) • confirm theoretical predictions. • simulate effects of reduction of transfers to Hainault by one third (Persyn, 2010). • first disposable income falls, but afterwards better off.

14. Efficiency of interregional transfers • Other case study: former East Germany (Marcolin, 2012) • in 1990s same mistakes as Belgium. • 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.

15. Efficiency of interregional transfers • Today Flanders faces its own challenges: • ageing hits Flanders relatively more. • deindustrialization. • labour productivity advantage is eroding. • high energy costs. • share of exports to emerging economies still too low. • Flanders cannot afford to finance the transfers much longer. • phasing-out program is necessary.

16. State reforms • From 1970 series of state reforms. • Did not affect interregional transfers. • social security system remained federal. • solidarity mechanisms between regions. • Transfer issue is only top of iceberg. • Structure of the Belgian federal model as such faces severe sustainability problem.

17. State reforms • Several construction flaws. • 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. • Belgium: • no hierarchy between the two levels. • retirement benefits of regional civil servants are paid for by federal government.

18. State reforms • Austerity programs and ageing problem will put additional strain: • federal level has to pay retirement benefits. • federal grants to regions are fixed by law. • regions & communities responsible for infrastructure and education. • requires intense cooperation between various governments in a context of regional parties and asymmetric coalitions.

19. 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”.