Chapter 1. Rethinking regional development policies
This chapter argues that persistent economic inequalities across regions need to be addressed by place-based policies. It explains how productivity gaps across regions emerge and shows how uniform policies at the national level can have different effects across regions. The chapter argues that persistent regional inequalities have led to rising discontent with the economic, social and political status quo in lagging regions. In some cases, this discontent has been reinforced by growing cultural differences between economically successful urban regions and other regions that are lagging behind. Policy makers seeking to address this geography of discontent have to use place-based policies that target the region-specific factors behind persistent regional inequalities.
The statistical data for Israel are supplied by and under the responsibility of the relevant Israeli authorities. The use of such data by the OECD is without prejudice to the status of the Golan Heights, East Jerusalem and Israeli settlements in the West Bank under the terms of international law.
The OECD regional policy paradigm at 20 years
Regional policy as a distinct policy area developed in most OECD countries in the 1950s and 1960s, a period of relatively strong economic growth, fiscal expansion and low unemployment. It was motivated by widening regional disparities that emerged as a consequence of rapid industrialisation and urbanisation. When introduced, the principal objective of regional policy was greater equity and balanced development. Public interventions were supposed to facilitate the economic development of lagging regions by encouraging demand. The main instruments used were redistribution through financial transfers by the national government accompanied by large-scale public investments, especially in lagging regions (OECD, 2010[1]).
During the 1970s and early 1980s, successive economic shocks and changes in the global economy led to the emergence of geographical concentrations of unemployment in many OECD countries, and regional policy evolved rapidly to address this new challenge. The focus of regional policy was extended to not only to reduce disparities in income and infrastructure, but also disparities in employment. Policies aimed at affecting supply conditions and thereby influencing industrial location decisions, with respect to existing firms and new investments (OECD, 2010[1]). This brought a much stronger focus on subsidies to firms, either to support ongoing activities or to attract new jobs and investment to areas of high unemployment.
Until the late 1980s, regional policy focused predominantly on regional investment aid and infrastructure support, with policy interventions heavily targeting designated geographical areas that were often underdeveloped. In the European Union, Cohesion Policy also mainly focused on infrastructure development until the 1980s, assuming that infrastructure was a main bottleneck to regional economic convergence (OECD, 2010[1]).
However, in spite of sustained government efforts, regional disparities did not decrease significantly. Starting in the 1980s, growing pressure on public finances made large allocations for regional programmes politically unsustainable. In response to the poor outcomes of regional programmes, the idea of market failure was complemented by an argument of co-ordination failures that suggested a new approach to policy making. Regional policy evolved from top-down, subsidy-based interventions designed to reduce regional disparities into much broader policies designed to improve regional competitiveness (OECD, 2010[1]).
The new objective of regional policy necessitated a thorough rethinking of the policy instruments and tools that were used within regional policy. The recognition that a new paradigm for regional development was needed led to the creation of the OECD Regional Development Policy Committee (RDPC) in the late 1990s and its three working parties: the Working Party for Rural Policy, the Working Party on Urban Policy and the Working Party on Territorial Indicators. Its work complements the OECD Local Employment and Economic Development Programme (LEED) that exists since 1982.
An evolving consensus – 20 years of policy discussion within the OECD Regional Development Policy Committee
The RDPC was created in 1999 in recognition that changing economic and social conditions were giving rise to new regional development policies. Its first years focused on changing the paradigm of regional development policy from redistribution to regional competitiveness. It made clear that regional policy needed to rectify past mistakes to be more effective, mainly avoiding top-down policies based on large subsidies and the artificial creation of economic and technological hubs, disconnected from local assets. This shift included promoting investment to leverage regional opportunities as well as a focus on multi-sectoral approaches and multi-level governance, underpinning a dynamic vision to
(OECD, 2012[2]).promote growth in all regions
Regional development as a horizontal “policy of policies”
The 2008 financial crisis and its severe economic and social consequences marked an inflection point. The short-term need for counter-cyclical policies highlighted the role of public investment. Within the RDPC, it brought renewed attention to how regional development strategies can help to better target public investment. Notably, 57% of all public investment is made by subnational governments. Ultimately, these discussions helped pave the way for the development of the OECD Recommendation of the Council on Effective Public Investment across Levels of Government.
Why do regional development policies matter?
Regional development policy at the national level does not consist of a fixed set of policies. Rather, it consists of strategies to support the coherent implementation of various policies. These strategies depend on other elements: various sectoral policies (housing, transport, employment, economic development, innovation, energy, welfare, education, land use, etc.), the regional and local governments with whom they share policy competences, as well as the private sector and citizens themselves. In this context, the OECD Regional Development Policy Committee has helped to articulate the added value of regional development policies, and distilled high-level learnings on “what works”.
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People’s well-being is strongly influenced by where they live and work, and there are considerable differences across territories. In fact, the OECD’s Regional Well-being Database shows that regional gaps are wider when considering multidimensional measures of living standards instead of income alone. This diversity of local realities calls for a diversity of policy responses, delivered at the appropriate scale.
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Within OECD countries, the most productive region is, on average, almost twice as productive as the least productive region. And, while across the OECD a few large regions make outsized contributions to aggregate growth, the combined contribution of the remaining regions still accounts for approximately two-thirds of growth. Leveraging the growth potential of all places creates a double dividend of both increased aggregate productivity and inclusion. At the same time, an approach that values regional diversity is key for making our societies more resilient to future challenges.
In parallel, the policy debate opened up to other stakeholders (international organisations, non-governmental organisations, the private sector, OECD partner countries) in recognition of their importance for regional development. Its scope also expanded to include issues such as innovation and entrepreneurship, climate change, skills, and demographic change. Regional development policy is therefore a “policy of policies”, mobilising multiple policy fields to support regional development together with the mission to “address the regional dimension of core issues that OECD governments are addressing”.
Putting people at the centre of inclusive and sustainable growth
By shining a spotlight on growing disparities, the 2008 financial crisis led to a greater emphasis on equity as an objective for regional development. In this context, there has been a debate on place-based versus people-based approaches, i.e. whether policies should target specific geographic territories or focus on groups of people without having an explicit territorial dimension. As will be discussed in the subsequent section, there is a need for both. In particular, targeting people is more effective if it is done at the appropriate scale and takes into account geographic specificities (OECD, 2011[3]).
The dual approach of targeting spaces and people has been visible in the subsequent work of the OECD. By highlighting regional well-being, people are placed at the centre of policy making (OECD, 2016[4]). In parallel, the question of geographic scale has been addressed through several streams of work, including ongoing statistical work to define functional urban areas in order to facilitate international comparisons of metropolitan areas and encourage policy making “at the right scale”. This has lead, for example, to the finding that administrative fragmentation carries a productivity penalty for metropolitan areas, and to the further work on urban-rural linkages.
What works for regional development?
The long-term vitality of communities depends not only on economic growth and competitiveness, but also on residents’ well-being, inclusion and environmental sustainability. A modern vision for regional development works across these objectives, leveraging complementarities and managing trade-offs as needed.
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In the face of geographic diversity, one-size-fits-all policies are doomed to fail. Building on endogenous factors of growth can help get communities on a long-term path of inclusive and sustainable growth. For example, the Regional Development Policy Committee (RDPC) has helped to modernise rural policy. It has shown which rural regions have been able to narrow the productivity gap with urban areas and helped to shift the logic of policy interventions in rural areas from a focus on agriculture to strengthening the inherent capacity of rural areas across economic sectors.
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Scale matters, and it is functional areas rather than administrative boundaries that are important for the implementation of many polices. The RDPC has empirically documented the productivity penalty that results from administrative fragmentation in metropolitan areas, and has shown that strengthening urban-rural linkages can generate economic, social and environmental dividends for both urban and rural residents alike.
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Subnational governments are responsible for 57% of public investment in the OECD. Effective multi-level governance mechanisms and adequate subnational capacities are essential not only for regional development policies, but also for policies with a place-based component, such as investment, infrastructure, land use, water, etc. The OECD Recommendation of the Council on Effective Public Investment across Levels of Government provides concrete guidance for how this can be done.
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Subnational data and governance indicators should underpin an evidence-based approach to diagnosing challenges, developing strategies and implementing policies at the right scale. The RDPC has helped to meet this demand through its Regional Database, Regional Well-being Database, Metropolitan Database, the delineation of comparable functional urban areas, the Observatory of Subnational Finance, the Metropolitan Governance Survey and the Water Governance Indicators.
The productivity slowdown and the impact of traditional structural reforms on regional productivity
One of the most important economic trends in OECD countries over the past decades has been the decline in productivity growth in most advanced economies. Across the OECD, annual labour productivity growth in the seven years after the crisis (2010-16) was 0.9%. This is only half the annual labour productivity growth of 1.8% during the seven years before the crisis and even further below historical averages in many OECD countries (OECD, 2018[5]). Furthermore, in many countries, this productivity growth was generated by only a few regions, whereas the remaining regions recorded no productivity growth or even declining productivity. The slowdown and divergence in productivity growth is problematic for several reasons: it reduces the rate of wage growth that is sustainable in the long term; if low productivity growth rates persist, it may also become harder to service public debts.
An important and long-standing pillar of OECD recommendations to address the productivity slowdown has been the call for reforms of structural policies. These policies have received their name because they provide the structure in which the economy operates. They concern a wide range of legal frameworks and regulations, such as tax policy, labour market policy, competition policy, education policy, trade policy and many other policy areas.
An overarching objective of structural policy is to set the conditions for long-term productivity growth and economic stability. The key focus lies on providing incentives to economic actors such as firms and workers that encourage them to engage in productive activities – that together maximise economic output and growth. Furthermore, structural policies try to prevent abusive actions and rent-seeking behaviour such as the creation of monopolies, and to limit activities with negative externalities. They also address equity concerns, such as income distribution. Last but not least, many structural policies target the public sector, for example to ensure that public budgets are sustainable, public spending is efficient and the public administration responsive to the needs of businesses. Table 1.1 provides an overview of structural policies that have been identified as targets for reform in the OECD’s Going for Growth work (OECD, 2018[6]).
Most structural policies affect supply-side factors in the economy. Since it takes time until businesses adjust to a new structural environment after a reform, the short-term effect of structural reforms on economic growth is often small or even negative. Therefore, structural reforms play only a secondary role in managing cyclical fluctuations of the economy. Yet, structural reforms have important long-term consequences, because they affect the long-term growth potential of an economy. Even if structural reforms increase annual growth only by a little, the cumulative effect of slightly higher growth rates over many years has strong consequences for income levels in the long term.
Most structural reforms do not consider regional disparities in productivity
Most structural policies are place-blind. This means they apply uniformly across the entire territory of a country and do not change from region to region. Labour market regulations, for example, are usually identical throughout all parts of a country. They might depend on the characteristics of a worker, such as his or her job or income level, but they are independent from where a worker lives within a country. Exceptions to this rule exist primarily in some federal countries, where the federal states have authority over important dimensions of structural policy.
The place-blind nature of structural policies is often unavoidable and mostly desirable. Diverging product market regulations or large cross-regional differences in tax policies, for instance, would make it more difficult for firms to do business throughout a country. Thus, structural policies are for a good reason place-blind. However, the place-blind nature of structural policies limits their potential to address severe differences in economic outcomes across regions. Furthermore, it means that some structural policies set at the national level are not optimal for specific regional contexts.
Not all regions are equally affected by structural reforms
The fact that most structural policies are place-blind does not imply that they are also place-neutral. In other words, it does not imply that structural policies have the same effects on all regions of a country. This can be illustrated by an example. Many structural policies in recent decades aimed at liberalising trade. It is well-documented that trade liberalisation is in aggregate positive for a country, but not all regions benefit equally from it. In many OECD countries, trade liberalisation benefited cities that are providers of tradable services, but harmed regions with strong manufacturing profiles that faced new competition from abroad (Autor, Dorn and Hanson, 2013[7]).
Due to the one-size-fits-all nature of structural policies, it is difficult to use them to address concerns that exist only in some parts of a country. Given the sizeable differences in economic structure and economic performance across regions, structural policies that are a good fit for one part of a country might not be a good fit for another part of the country. For example, tax incentives to convert industrial brownfield sites could be an appropriate structural policy for regions that undergo industrial transitions. However, in booming cities, such tax incentives might only create windfall gains for landowners as the conversion of brownfield sites could be profitable without further incentives.
The fact that structural policies do not take regional conditions into account implies that further policies are needed to address regional disparities. As discussed in the following section, there are large differences in productivity levels and productivity growth rates in many OECD countries. Labour mobility, i.e. the ability of people to move from economically lagging to economically successful regions, is not enough to buffer the effects of regional imbalances. Place-based policies are required to respond to large and persistent inequalities across regions.
Productivity differences across regions are large and persistent
In most OECD countries, economic performance across regions varies strongly. On average, labour productivity in the worst performing region in an OECD country is 46% lower than labour productivity in the best performing region of the country. In some OECD countries, the difference between the best and worst performing regions is more than 60%. Likewise, unemployment rates usually differ by a factor of three or more across regions within the same country (see Figure 1.11).
Such differences would be less of a concern if they were temporary and regions that are lagging behind quickly caught up with more productive ones. However, differences are highly persistent. Figure 1.1 shows that in most countries, the ranking of regions by productivity levels in 2000 and 2015 was very similar. In most countries, the Spearman coefficient is above 0.7, which indicates that regions did not move up or down the productivity ranking much. Notable exceptions are Spain, and in particular the Czech Republic, which has a Spearman coefficient of less than 0.5, implying a significant degree of change in its regional ranking.
Notes: This graph shows the persistence of productivity differences across regions within a country. The higher the value, the higher the persistence in the ranking of regions by productivity level. Note that persistence in differences is not necessarily related to the overall magnitude of differences. Thus, even in countries that have a high degree of persistence in regional productivity levels, the actual differences across regions might be small.
Source: Calculations based on OECD (2019), OECD Regional Statistics (database), https://doi.org/10.1787/region-data-en.
Productivity growth in OECD countries tends to follow two growth models
When analysing how productivity has grown across regions within countries since 2000, two growth models become apparent. Seventeen out 31 OECD countries with available data have followed a regionally distributed productivity growth model (Table 1.2). Countries in this category had less than 50% of total productivity growth occurring in regions at the productivity frontier (i.e. in the most productive regions of the country accounting for at least 10% of employment). In these countries, differences in productivity growth rates across regions were usually gradual and no single region stood out. Moreover, among the regions with high productivity growth, there were often several with low productivity levels. As a consequence, regional productivity converged, or at least did not diverge further, countries with distributed growth models.
In contrast, 14 out of 31 OECD countries followed regionally concentrated productivity growth models. In these countries, regions at the productivity frontier contributed more than 50% to the overall productivity growth in the country. Thus, regional disparities in productivity levels widened in these countries. Table 1.2 provides an overview of the countries that fall in each of these two categories.
Figure 1.2 illustrates the difference between regionally distributed and concentrated growth models for six countries. Countries on the left-hand side of the figure follow a distributed growth model, whereas those on the right-hand side follow a concentrated growth model. Two patterns are notable. First, the defining difference between the two categories is easily visible. In countries with concentrated growth models, regions at the productivity frontier contribute disproportionally to aggregate productivity growth. Second, and perhaps more surprisingly, in countries with concentrated productivity growth, there is also a clear gap between the region with the highest contribution to productivity growth and all remaining regions. In contrast, productivity growth contributions in countries with distributed growth falls gradually across regions and few large gaps are visible.
One possible explanation for the differences in productivity growth could be differences in employment growth. At regional or national levels, there is often an inverse relationship between employment and productivity in the short term. For example, during economic downturns, average labour productivity increases while employment declines. Firms shut down less productive parts of their business and some firms with low productivity levels go out of business entirely. This process reduces employment, but at the same time the average productivity level goes up because some of the least productive firms and workers are not included in the average anymore. Likewise, average productivity can decline during booms when firms hire additional workers that are less productive than those workers already in employment.
If countries with concentrated growth models were adding employment predominantly outside of their most productive regions, while countries with distributed growth models were adding employment predominantly in highly productive regions, it could explain the observed pattern. However, this effect does not seem to be the driving mechanism behind the observed pattern. First, the negative relationship between productivity and employment holds primarily in the short term. Countries with concentrated growth models had not only high productivity growth rates in their most productive regions, but also high employment growth rates.
Notes: Each bar represents the difference between the actual productivity growth in a country and the productivity growth rate of the country excluding the region. Black bars show the most productive regions of a country at the productivity frontier.
Source: Calculations based on OECD (2019), OECD Regional Statistics (database), https://doi.org/10.1787/region-data-en.
Is there a trade-off between high productivity and equally distributed productivity?
There is tentative evidence that productivity levels are higher in countries that have a regionally concentrated model of productivity growth than in countries that have a regionally distributed model of productivity growth (Figure 1.3)1. In the manufacture of goods and in the provision of market services (i.e. those services that are sold in a market for profit), TL2 regions2 in countries with concentrated productivity growth are 10% more productive (Figure 1.3, right panel). For non-market services, i.e. those produced by the public sector or other not-for-profit actors, there does not appear to be the same difference in productivity levels between the two groups of countries.
Notes: Data for 2016 or most recent year available. Labour productivity is gross value added in constant 2010 USD at constant PPPs divided by employment.
Source: Calculations based on OECD (2019), OECD Regional Statistics (database), https://doi.org/10.1787/region-data-en.
At this point, it is too early to judge whether there is a causal relation between the regional growth model of a country and its overall productivity level. The data suggest that there are important differences in productivity levels between the two groups of countries, but it cannot be ruled out that these differences are a coincidence that is driven by other factors or by chance. Yet, this is an important question for further analysis. If it turns out that productivity levels in countries with regionally distributed growth models are systematically lower, policy makers would need to find mechanisms to reduce this gap and to create productivity growth everywhere without incurring a productivity penalty.
Economic theory can only partly explain large and persistent productivity and employment differences across regions
Some differences in economic performance across regions within a country are expected and seem largely unavoidable. A key dimension in this respect is the difference between cities and less densely populated parts of a country. A higher density of potential customers, suppliers and workers as well as of various forms of infrastructure brings economic benefits that make firms in dense places more productive than firms in less dense places. This effect increases with population size. On average, firms in larger cities are more productive than firms in smaller cities. Moreover, cities, and especially large cities, tend to attract industries that are more productive than other industries, no matter where they are located. For example, firms that provide knowledge-intensive services are often highly productive and locate predominantly in large cities (OECD, 2018[8]). Such differences in the sectoral composition increase productivity differences between cities and rural areas even further.
The agglomeration economies created by cities can have advantages for the entire country. Cities have higher productivity levels than other parts of a country partly because they generate more innovations. This increases productivity growth in cities, but also benefits the rest of the country because innovations eventually spill over to other regions. Innovations that originate in cities can thus translate into higher productivity growth throughout the country.
Such benefits of cities are clearly documented, and economic theory can, in most cases, explain why they exist. Yet, many theories that explain productivity differences across regions also predict that the disparities between the most productive cities and lagging regions should not become too wide. The above-mentioned knowledge spillovers from highly productive places should raise productivity in less productive ones. Large differences in unemployment should be prevented by labour mobility that allows workers to move to regions where they find jobs (Rodríguez-Pose, 2018[9]). Capital mobility should ensure investment where it is needed. In such a world, urban agglomerations would push the productivity frontier forward, while other regions would keep pace without lagging too far behind.
In reality, regional disparities do not follow such a benign pattern. On average, productivity in rural areas is less than 80% of the average productivity in urban areas within the same country (Figure 1.4). As discussed above, the gap between the most productive regions and those lagging behind is growing in many countries. Moreover, regions hit by shocks such as the decline of a dominant industry often suffer from decades of economic depression. Often, productivity levels in lagging regions are low and unemployment rates above the national average (see Figure 1.11), indicating an underutilisation of regional resources. This is particularly a problem in remote rural areas. While rural areas close to cities could reduce some of the gap with urban areas, Figure 1.4 shows that no such convergence process has occurred in remote rural regions.
Note: Productivity is measured with the GDP per worker at place of work in TL3 regions, computed for 23 EU countries with predominantly rural (381 regions, in which 148 remote) and predominantly urban regions (365 regions). The productivity for each type is an average of the regions..
Source: Calculations based on OECD (2019), OECD Regional Statistics (database), https://doi.org/10.1787/region-data-en.
Cross-regional disparities imply a need for place-based policies
If economic performance across regions converged as expected by basic economic theory, there would be little need for regional development policies that go beyond structural policies. Policy makers could aim at optimising the overall policy environment through structural reforms without having to focus on specific places, because lagging regions would catch up automatically.
However, large gaps in economic performance and high persistence of inter-regional differences imply a failure of automatic convergence of regions. This raises the question of how policy makers can ensure the catching-up of lagging regions. Current disparities strain social cohesion and residents in lagging regions expect policy makers to provide solutions that do not require decades to be effective.
Place-based regional development policy provides a solution to help all regions use their full economic potential. The approach is motivated by the observation that regions differ not only in their economic performance, but also in the factors that are responsible for this performance. Each region has a specific set of strengths and weaknesses that makes it different from most other regions (see Table 1.3 for examples). The objective of place-based policy is to allow regions to use their strengths for endogenous economic development.
Place-based regional development policy aims at using existing regional strengths productively for regional development while addressing specific weaknesses that form bottlenecks to economic development. It involves a wide range of actors from within the region and usually requires the implementation of several complementary policies in parallel. For example, a region that bases its development strategy on a culinary tradition might not only have to ensure that the infrastructure exists so that perishable goods can reach important markets on time, it also has to adapt its education system to train skilled workers in the food-processing industry. In parallel, it might have to offer advice and training to owners of small food producers on how to export; and it needs to foster the creation of business associations that can market food from the region nationally and internationally.
The example of developing a food-processing industry can also serve as an illustration of the various actors involved in place-based regional development policy. Major infrastructure is often provided by the national government. Adapting education policies within the region involves universities, various levels of government, employers and unions. Advice and training on how to export is often provided by business development agencies that are controlled by regional governments. Business associations fund and co-ordinate marketing campaigns. Thus, the successful implementation of such a hypothetical regional development strategy would require co-ordination among at least two levels of government, a governmental agency and three non-governmental actors.
Place-based policies are often designed for functional areas instead of administrative jurisdictions. In many places, administrative boundaries between regions do not correspond to the economic linkages throughout a territory. For example, there are important connections between core cities and their surrounding commuting zones, between rural and urban areas, and between neighbouring regions in different countries. In these cases, the boundaries of local, regional or national jurisdictions do not reflect these linkages. Effective place-based policies need to be co-ordinated across these administrative boundaries to target the entire functional area.
As discussed at the outset of this chapter, modern place-based regional policy does not imply persistent subsidies to lagging regions, nor does it emphasise any particular policy measure, such as infrastructure investments. Instead, it describes a set of co-ordinated policy measures that involves stakeholders from within and outside the region and is adapted to the specific conditions of a region. As highlighted by Iammarino, Rodríguez-Pose and Storper (2018[10]), equity is a major policy objective of modern place-based regional policy, but it is not aimed to be achieved through permanent transfers from productive to unproductive regions. Instead, the objective of modern place-based regional policies is to ensure equity by helping regions to utilise their economic potential by increasing employment and productivity. Modern place-based policies can also counteract a race-to-the-bottom among regions within a country. Rather than having regions trying to undercut each other, for example at the expense of tax revenues or environmental and labour standards, place-based policies offer regions a productive way to compete with each other while lifting the economic performance of the entire country. Table 1.4 provides an overview of the key characteristics of modern place-based policies for regional development.
Importantly, place-based policies are not a substitute for appropriate structural policies. Instead, they are a complement to structural policies. Place-based policies can provide the degree of regional specificity to economic policy that is needed to fully utilise the potential of all regions, but that cannot be provided by structural policies alone. However, place-based policies cannot replace a well-designed structural policy environment provided at the national level.
Finally, it should be emphasised that place-based policies for regional development are desirable not only from a regional perspective. Lagging regions have levels of economic activity that are well below their potential, both in terms of employment and productivity. This not only affects the regions themselves, but also has important consequences for national aggregates, such as national tax revenues. By using place-based policies in lagging regions, national governments have an important complement to structural policies that can contribute to increasing aggregate economic performance.
Reaping the benefits from globalisation requires place-based development strategies
Globalisation has reinforced the need for place-based policies. Increasingly mobile flows of goods, capital and information have led to an unprecedented integration of economies across the world. Yet, instead of eliminating differences across regions, the opposite effect has occurred. While aggregate effects from trade have been beneficial, the differences in outcomes across regions are substantial. In some regions, trade shocks have led to rising unemployment and prolonged economic decline (Autor, Dorn and Hanson, 2013[11]). These uneven outcomes have led to a backlash against globalisation that risks undoing many of the benefits of closer international economic integration. Only place-based policies can address the downsides from trade without threatening the benefits from trade.
The rise of exports from China
Globalisation is not a new phenomenon. Supported by improvements in transport technologies and infrastructure, global trade started to grow significantly during the 19th century (Federico and Tena-Junguito, 2017[12]). This trend was only halted by the onset of World War I and the Great Depression in the 1920s. Trade resumed a clear upward trend from 1970 onwards with higher growth rates than those achieved during the 19th century (Federico and Tena-Junguito, 2017[12]). Since 1980, world trade has grown on average nearly twice as fast as world production (WTO, 2013[13]). An increasing number of international trade agreements supported growing trade. Throughout the 1980s, less than 50 agreements where in place. By 1995, the World Trade Organization recorded 116 active agreements and a decade later the number had reached 240. With 485 active agreements in 2018, the number had more than doubled again.3 Figure 1.7 shows that this has benefited especially exports from low and middle income countries.
A major factor in the development of global trade in recent decades has been the rapid development of the People’s Republic of China (hereafter “China”) that lifted hundreds of millions of people out of poverty. Initially, China’s development was driven by products with low levels of technological complexity such as textiles or furniture, as well as tasks in the production of complex products that are less knowledge-intensive (e.g. final assembly). Chinese firms have not stopped as mere suppliers of intermediates and assemblers of final goods. There is a concerted agenda by both national and local governments to upgrade industries to become competitive at the global technological frontier. This is evident in places like Shenzhen, a small fishing village in the 1970s and today a megacity with more than 18 million inhabitants. The city became one of China’s first special economic zones in 1979 and has rapidly moved from providing assembly to being home to some of China’s most productive and innovative companies. In 2016, Shenzhen accounted for almost half of all China’s international patent applications and R&D spending in Shenzhen already accounts for 4.13% of gross domestic product (GDP), comparable to the R&D intensity of the top 5% of OECD TL2 regions.4
Source: Calculations based on Center for International Development (2018), Atlas of Economic Complexity, http://atlas.cid.harvard.edu (accessed on 20 November 2018).
Consumers reap the biggest gains from globalisation
The strongest gains from trade accrue to consumers. However, the benefits are unevenly distributed and depend on the consumption baskets of different income groups. As richer households tend to consume more imported goods, any decrease in prices that stems from greater openness to trade creates larger benefits for them than for lower income households. For example, evidence from the opening of foreign supermarkets in Mexico shows welfare gains of around 6% of initial household income. The benefits are largely driven by foreign retailers charging, on average, 12% less for identical products than domestic stores, as well as offering five times the number of products. These gains were strongest for the richest income groups in Mexico, who gained about 50% more than the poorest as they switched more of their consumption to foreign retailers (Atkin, Faber and Gonzalez-Navarro, 2018[14]).
Since the 1980s, firms have started to break production processes into even smaller steps. Where before finalised goods were traded that were produced using local and imported raw inputs, today firms utilise local cost advantages to implement individual steps in different regions and countries (Grossman and Rossi-Hansberg, 2008[15]). This “trade in tasks” is captured by the concept of “global value chains” (GVCs), in which each place contributes part of the value added of a product. The focus thereby shifts from selling high value-added products to providing the tasks within the value chain that provide the highest value added.
Many fast-growing regions benefited from GVCs. Almost all regions that had annual growth rates in value added of more than 6% recorded growth in value added from GVCs that was even higher than their overall growth in value added (Figure 1.6). In contrast, no clear relationship between growth in value added from GVCs and overall growth in value added exists for regions with slower growth rates.
Notes: Nominal annual average growth in value added for European TL2 regions. The solid line indicates equal growth rates for value added in exports and gross value added.
Source: Calculations based on data provided by Los, B. and W. Chen (2016[16]), “Global value chain participation indicators for European regions”.
Global value chains increase the importance “governance” of production processes. The high degree of co-ordination across different actors, regions and countries requires sophisticated management of the value chain, which is typically within the hands of a multinational enterprise – the lead firm in the global value chain. Lead firms are those that govern their global-scale supplier networks, through combining products and services from subsidiaries (via greenfield or brownfield foreign direct investment) and contractual partners (Altomonte et al., 2013[17]).
To benefit from global value chain integration, regions must identify their advantages and build on them. This can be done by becoming hubs of knowledge and competencies, with sufficient institutional capacity to anticipate changes in global flows of production. It also involves setting the right framework conditions for development, in particular through four elements. First, the public and private sectors have to develop capabilities to adapt and integrate innovation and new technologies. Second, various stakeholders should aim at creating networks both within the region and, strategically, outside the region with places that have complementary capabilities. Third, engaging local stakeholders through participative governance mechanisms to ensure information sharing a common agenda within the region is essential. Fourth, it is important to ensure policy coherence across different policy fields, i.e. not just trade policy, but economic development, educational, investment, etc. and across levels of government (Labory and Bianchi, 2018[18]).
Gains from trade for consumers also have a spatial dimension. Households in larger cities spend a larger percentage of their income on local services and in particular on housing, and are hence less affected by the price of imported goods. The devaluation of the British pound in the run up and following the announcement and outcome of the referendum to stay in or leave the European Union has spurred price increases in the country. Inflation affected all income groups, but the effects were particularly strong for populations in less urban regions in the North of England and Northern Ireland (Breinlich et al., 2017[19]).
Notes: Growth for the period 1995-2017 or closest years available. Countries with no data before 2001 or after 2009 are excluded. The presented data and map are without prejudice to the status of or sovereignty over any territory, or to the delimitation of international frontiers and boundaries.
Source: Calculations based on IMF, “Export of Goods”, International Financial Statistics (Annual) (database), http://data.imf.org.
In the aftermath of the financial crisis, regions with strong export performance were doing better than most regions. The small number of regions that did not suffer any measurable economic setback from the 2007-08 crisis had, on average, an annual average growth rate in value added from exports that was more than 3 percentage points higher than the growth rate in overall gross value added. The average growth difference was about 2 percentage points for regions that returned to pre-crisis per capita income levels by 2011, 0.5 percentage points for those that recovered by 2015 and negative for the remaining regions that remained below pre-crisis levels in 2015 (Figure 1.8).
Notes: A region recovered from the crisis when real per capita GDP (in constant 2010 USD) was at least as high as in 2007-08. The box-and-whiskers plots show the difference in the annual average growth rate of value added in exports and gross value added (nominal values) between 2000 and 2010 for 243 European NUTS2 regions. The box shows the interquartile range, the long bar the unweighted average and the small “whiskers” the maximum and the minimum (excluding outliers).
Sources: Calculations based on OECD (2018[8]), Productivity and Jobs in a Globalised World: (How) Can All Regions Benefit?, https://dx.doi.org/10.1787/9789264293137-en; Los, B. and W. Chen (2016[16]), “Global value chain participation indicators for European regions”.
The finding that regions with a focus on exports weathered the crisis better than those where growth came mainly from internal demand might seem surprising. But regions that have a stronger link with global markets seem to be able buffer adverse shocks in some parts of their economy better than others. This is not only the case for economic output, but also for jobs. Regions with the smallest shifts in employment from tradable to non-tradable sectors before the 2007-08 crisis suffered fewer job losses in the aftermath of the crisis (OECD, 2018[8]).
Trade-related tensions
In many OECD countries, there is a growing scepticism concerning the benefits from trade that has been described by the OECD Secretary-General:
[…] there seems to be a growing apprehension about opening up, which, in some cases, is evidenced in a backlash against globalisation. On the political side the response seems to be a wave of populist movements and a call for protectionist measures that threaten to unravel decades of international co-operation that have lifted more than a billion people out of extreme poverty, fostered cultural diversity, and facilitated the fastest convergence of per capita incomes in history.5
Different factors contribute to the backlash and the rise of “trade-related tensions”. In some cases, they are tangible, as sectoral change threatens the jobs of people who might not be able to move into new jobs in growing sectors; other aspects are not related to tangible changes, but to the perception that challenges might arise. In some cases, the challenges are not recent, but build on a legacy of poverty, economic decay and lack of opportunities (Rodríguez-Pose, 2018[9]).
A flurry of recent academic studies have highlighted the negative effects of trade shocks on some regions. Local labour markets in the United States where manufacturers competed directly with Chinese imports experienced an increase in unemployment, lower labour force participation and a decline in wages. At the same time, benefits payments for unemployment, disability, retirement and healthcare rose sharply (Autor, Dorn and Hanson, 2013[21]). This impact had lasting effects on the local labour markets. Even a decade after the initial shock, wages and unemployment remain adversely affected (Autor, Dorn and Hanson, 2016[22]). Similar regional effects from import competition occurred also in regions in many other countries. They have been documented in Germany, Norway and Spain, among others.
Even severe geographically confined job losses in one sector would not pose a major problem if workers could easily find jobs in other sectors within the same region or in other regions. Yet, laid-off workers in affected regions struggle to find other jobs because affected regions lack dynamic sectors, which create jobs that offset the job losses from trade. As a consequence, unemployment rates remain persistently high over long time periods in regions that suffered from negative trade shocks (Autor, Dorn and Hanson, 2016[22]). Similar results are found for Spain, where regions affected by import shocks suffered job losses in sectors affected by import competition that were of the same magnitude as in the United States (Donoso, Martín and Minondo, 2015[23]).
Addressing the geography of discontent calls for a place-based approach
In a context of persistent economic stagnation in many regions, a growing discontent with the political and economic status quo has become apparent in recent years. It is reflected, for example, in the 2016 referendum in favour of the United Kingdom leaving the European Union. This amounted to a public rejection of one of the most important political institutions of the United Kingdom. Trust in the EU is also low in many eastern and southern European countries, such as the Czech Republic, Greece and Slovenia (European Commission, 2017[24]). Other indications of discontent include growing political polarisation, for example in the United States (Boxell, Gentzkow and Shapiro, 2017[25]), growing political fragmentation (e.g. in Germany), as well as the collapse of established political parties and the surge of new parties from across the political spectrum (e.g. in France and Italy). Discontent with existing institutional arrangements is also reflected in policy decisions, such as threats to upend the global trading system through the introduction of large-scale tariffs.
Many indicators of political discontent show that there is a distinct Geography of Discontent – a distinct geographical pattern of unhappiness with the status quo (Los et al., 2017[26]). Discontent is high in regions that have seen long-term economic decline and is particularly strong in former manufacturing regions that struggle unsuccessfully with industrial transitions (Becker, Fetzer and Novy, 2017[27]).
The challenge to respond to public discontent becomes clear when the effects of the financial crisis are considered. Figure 1.9 shows the time it took regional economies to recover from the effects of the financial crisis. In 2015, eight years after the crisis, a large number of regions had still not regained the per capita GDP levels they had before the start of the crisis. Notably, even countries such as the United States, whose aggregate per capita GDP levels recovered quickly from the crisis, had several regions where per capita GDP levels were still below pre-crisis levels after eight years.
Source: OECD (2018[8]), Productivity and Jobs in a Globalised World: (How) Can All Regions Benefit?, https://dx.doi.org/10.1787/9789264293137-en.
Public discontent in economically stagnating regions is reinforced by the contrast with economically successful, often urban, regions. In several OECD countries, the capital region (which is often home to a country’s largest city) created more than 50% of all new net jobs. In most other countries, capital regions were responsible for at least 25% of new net jobs (Figure 1.10). Capital regions were also much less affected by job losses during and after the crisis. Ten OECD countries lost net jobs between 2006 and 2016. However, over the same time period, only three capital regions recorded net job losses.
Notes: Capital regions in Portugal, Slovenia and Spain lost jobs over the 2006-16 period. Due to data availability, the values for Chile, Israel and Mexico cover the 2006-14 period.
Source: OECD (2018[28]), Job Creation and Local Economic Development 2018: Preparing for the Future of Work, https://dx.doi.org/10.1787/9789264305342-en.
More generally, employment outcomes differ dramatically within countries. In Italy and Turkey, the highest regional unemployment rate is more than seven times higher than the lowest regional unemployment rate. In most other OECD countries, unemployment rates between the top and the bottom regions vary by a factor of at least two to three. Thus, there are sometimes dramatic differences in economic opportunities across regions within a country.
Notes: The top diamond represents the region with the highest unemployment rate, the bottom square corresponds to the region with the lowest unemployment rate in the country. The horizontal bar shows the national average.
Source: OECD (2018[28]), Job Creation and Local Economic Development 2018: Preparing for the Future of Work, https://dx.doi.org/10.1787/9789264305342-en.
Yet, among social scientists, there is a growing debate to what extent economic factors alone can explain the degree of discontent. There is evidence that cultural factors, and in particular a backlash against a changing cultural consensus, also play an important role in explaining the geography of discontent.
The cultural dimension of the geography of discontent is not necessarily identical to the economic dimension. Goodhart (2017[30]) distinguishes two stylised groups of people: those who have built portable identities that allow them to thrive socially and economically in various places and those whose identity is rooted in a particular place. Whereas the former group tends to be comfortable with cultural change, the latter is more resistant to change. In many respects, this divide corresponds to the divide between economically successful cosmopolitan-minded groups in cities and localist-minded population in economically struggling regions.
Gordon (2018[31]) argues that individual attitudinal factors are more important than personal economic conditions in explaining geographical patterns of discontent. He shows that there are pronounced regional patterns in the distribution of attitudinal factors that explain the geography of discontent. Rodriguez-Pose (2018[9]) makes a related point by arguing that inter-regional inequality is much more important in explaining discontent than inter-personal inequality. Where these economic patterns of inter-regional inequality overlap with the above-mentioned cultural and attitudinal factors, feelings of economic neglect and cultural concerns reinforce each other up to the point where large shares of the population reject the dominant political consensus.
Considering the cultural dimension of the geography of discontent together with its economic dimension is important for policy makers. It provides an argument against a regional development policy based only on persistent cross-regional subsidies to residents. Increasing living standards through transfers can address the material needs in struggling regions, but it will not change the perception of cultural loss in communities where work has been a source of pride and cultural identity (Ulrich-Schad and Duncan, 2018[33]). Furthermore, persistent transfers also threaten to increase the cultural divide within countries by negatively affecting public opinion towards struggling regions in regions that are net contributors.
Cultural and social factors are also a reason why a sole focus on increasing labour mobility will not be sufficient to address the geography of discontent. Many people in economically struggling regions are rooted in their local community and prefer to stay even if this brings economic disadvantages. As highlighted by Cass (2018[34]), historically a majority of the population stays even in severely depressed regions instead of migrating to regions with better opportunities. Moreover, an element of the geography of discontent is the rejection of an urban/cosmopolitan lifestyle that has become a culturally dominant narrative in many OECD countries in recent decades. Social groups that define themselves partly through this rejection will not be enticed to move to economically successful cities by small reductions in barriers to labour mobility.
Policies to address the geography of discontent
The geography of discontent is a symptom of an underlying policy failure. Too many regions are left behind by policies that are not adequate for their situation. Only if policy makers address this fundamental issue will they be able to deal with the cause behind the geography of discontent.
To address geographical patterns of discontent, a place-based policy for economic development is thus indispensable. Residents in all regions must have the possibility to contribute productively to society. While economic change is unavoidable, it is important to manage it in order not to overwhelm the societal capacity for change, nor to create persistent regional disparities that spur resentment. Appropriate public policies need to combine a mix of policies to do so. They need to involve measures to facilitate labour mobility for those who are willing to move, but also include the provision of economic opportunities for those who are not able to move. As discussed in the previous section, this requires complementing structural policies with place-based policies that generate economic development at the regional level.
Many successful place-based policies build on the existing strengths of a region, which are often influenced by its industrial history. Such policies have the dual advantage that they not only provide a strategy for economic development, they are also aligned with a cultural desire for continuity because they follow an evolutionary model of economic development in which the future strengths of a region are built from today’s assets. Existing skills within the population are valorised and economic traditions are updated or reinvented instead of disappearing completely.
Without a change towards policies that are more sensitive to regional conditions, regional disparities will most likely only get worse. The subsequent chapters show that global megatrends related to new technologies will increase the importance of knowledge-intensive services that are predominantly located in cities. In contrast, jobs in regions with low productivity levels will be threatened by automation. However, the subsequent chapters show that new technologies also offer opportunities to overcome many of the challenges that regions are currently facing. Yet, the potential benefits of new technologies will not materialise automatically. It will require policies that link the specific problems within a region with its potential solution.
Thus, inaction is not an option. Without changing course, regional imbalances will grow and public discontent will get worse. The sooner policy makers act, the easier it will be to prevent increasing regional inequality. When a new economic shock, either from automation or from a cyclical downturn, will hit regions, it will be those with the lowest productivity that will fare the worst. By postponing action today, it will be even harder to address the geography of discontent in the future.
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Notes
← 1. Market services are defined as those services produced for sale on the market at a price intended to cover production costs and to provide a profit for the producer.
← 2. 2. Territorial Level 2 are larger regions that correspond tin most cases to the principal subnational unit of government (states or provinces).
← 3. A large part of the proliferation of regional trade agreements since the 1990s has been agreements between developing economies rather than between developed or developed and developing economies. Calculations based on World Trade Organization, “RTAs in force and inactive, 1948-2018”, Regional Trade Agreements Information System (database), https://rtais.wto.org/UI/charts.aspx (accessed 21 November 2018).
← 4. OECD (2019), “Regional Innovation”, OECD Regional Statistics (database), https://doi.org/10.1787/1c89e05a-en.
← 5. Remarks by the OECD Secretary-General Angel Gurría on “Challenges and Solutions for Globalisation” (Beijing, People’s Republic of China, 12 September 2017).