How efficient are EU funds at creating growth?
Some economists say EU funds stop boosting growth after a certain level; but others argue that growth even spills back into richer EU members
Talks on the European Union budget for the 2014-2020 period collapsed late in November, with leaders due to reconvene early next year in an attempt to reach a deal on the nearly 1 trillion euros ($1.3 trillion) in spending over the period.
While paymasters Germany, the UK and Netherlands requested austerity, countries with needs for regional development such as Spain and Italy but also the new emerging European members such as Poland, Hungary or the Czech Republic want increased spending to catch up with richer EU peers.
A series of recent studies and research have shown that EU funds have contributed to growth and have given a boost to some of the bloc's poor regions, but more reforms are needed to ensure the money is spent efficiently.
Sascha Becker, a professor of economics at Warwick University, has conducted a study that shows that imposing an upper limit on the intensity of transfers of funds for the regional policy which makes up a third of EU spending as well as attaching some conditionality to the way the funds are spent would make them more efficient.
Transfers under the EU's regional policy should be limited to a maximum desirable level of around 1.3% of a recipient region's gross domestic product, because beyond that they fail to generate additional growth, the study shows.
It also shows that EU regions with a poorly educated workforce and those with low levels of government fail to convert transfers into additional growth, and thus the funds allocated to them do not fulfil their purpose.
"Based on economic theory you tend to say that the amount you can produce is a function of low skilled labour, highly skilled labour and capital and, typically, you say that the highly skilled labour and capital are working together more efficiently and that allows these regions to grow faster," Becker told Emerging Markets.
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The EU will have to rethink whether all the aspects of regional policy are financed efficiently, said Becker, pointing to the fact that member states have to pay money into the Brussels budget and then have to take some of it out for their own regions.
"It isn't clear why the money needs to first go to Brussels to then go back to Yorkshire; one can imagine that member states give lower contributions to the EU budgets but take on more of the regional policy themselves," he said.
Regions that continuously fail to make good use of the funds should probably see them cut, Becker said, but conceded that "these are politically extremely hot issues," so instead a higher degree of conditionality might be desirable.
"At present under Objective 1 [having to do with economic convergence] regions have a certain degree of flexibility on what they spend their money on, and one might ask them to spend more on education. It might not show immediate growth but it will help the region in the future to generate more additional growth," he said.
SUPPORT DURING THE FINANCIAL CRISIS
The positive effect of EU funds on growth is not limited to GDP; another economist argues that during the financial crisis they helped prop up emerging European countries' balance of payments.
"CEE countries enjoyed strong FDI inflows before the crisis and could run wide current account deficits," Dan Bucsa, an economist with UniCredit, said.
"The situation changed dramatically after 2009 but most CEE countries managed to replace missing FDI flows after 2008 with EU funds, cushioning their currencies and avoiding a stronger GDP contraction."
Foreign direct investment ranged between 3% and 20% of GDP for each country in CEE between 2004 and 2008, with the exception of Hungary and Slovenia which received big inflows of FDI in the 1990s, Bucsa said.
This FDI was a key source for financing current account deficits that ranged from 2.8% of GDP in the Czech Republic to 18% in Bulgaria during the same period.
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When Central and Eastern Europe was hit by the spillover from the financial crisis, FDI dried up. Bucsa said average annual FDI volumes to the 10 CEE countries halved between 2009 and 2011 compared to the 2004-2008 period.
The Baltics, Hungary and Poland turned inflows from the EU into "the most important source of non-debt creating external financing for their countries" as they managed to replace all missing FDI with EU funds and so enjoy better external financing levels than before the crisis, he said.
"At the opposite end, Romania failed to attract significant funds between 2007 and 2009 and to accelerate absorption thereafter," Bucsa added. "The Czech Republic and Bulgaria managed to increase EU fund intake in 2012, while Slovakia and Slovenia, eurozone members, run current account surpluses and are less dependent on external financing."
HELPING WESTERN EUROPEAN GROWTH
Another recent study, by the Warsaw-based IBS (Institute for Structural Research), showed that EU funds not only help economies in Eastern Europe.
Part of the funds return to Western European countries, as growing economies in the East are able to absorb more products and services from Western countries and companies in richer, donor EU states take part in contracts for modernizing infrastructure and regional development in the East.
The study looked at the effect of EU funds in the so-called Visegrad Group (V4) countries (the Czech Republic, Hungary, Poland and Slovakia) between 2004 and 2010.
"As a result of a number of EU projects the V4 countries experience faster economic growth, which creates additional demand for certain goods and services," the IBS study said. "The increase in demand leads to increased production not only in those countries but in other EU countries thanks to common rules facilitating trade within the EU."
Paymaster Germany has the greatest share of additional exports to the V4 countries, followed by Italy, the Netherlands, France and the UK.
The analysis of the shape and scale of the Cohesion Policy, its macroeconomic effects and the characteristics of the V4 countries in terms of import intensity and foreign trade inflows showed that on average, every net euro spent by the EU15 countries on the Cohesion Policy in the 4 countries resulted in 61 cents of additional exports from the West into the V4, according to the study.
"The value of the EU15 total benefits achieved through the implementation of EU programmes in the V4 countries constitutes more than half the total spending under the common regional policy in the V4 countries - exactly 53.3%," it concluded.