Rich Europe, Poor Europe

From its earliest days, the European Union has aimed for balanced economic development across its many regions. The Maastricht Treaty contains the striking phrase “overall harmonious development.” But, however admirable this sentiment may be, there is no “scientific truth” about the “right” level of disparities and the correct speed of convergence.

Nevertheless, it is useful to compare economic disparities in the EU with those in the United States to assess regional convergence in Europe – bearing in mind, of course, that the US has been a nation-state for more than two centuries, while the EU is best seen as a confederation of 27 states under a supra-national structure.

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Let us first take a historical look at the western part of the EU. In 1960, disparities in what later came to be known as the EU-15 were about twice as large as those between US states. Today, they are comparable with American income disparities. Income disparities have halved both in nominal terms when expressed in euros and in real terms when taking into account differences in purchasing power.

Western Europe first saw a period in which real incomes converged, followed by a period of converging prices. In the 1960’s and early 1970’s, disparities in purchasing power declined by about 40%, then stalled, while nominal income disparities fell by a similar margin from the mid-1970’s to 1990. With the introduction of the euro, and with falling inflation, nominal convergence and real convergence have grown similar, both making gradual progress since the mid-1990’s.

The average population of the EU-15 is about 25 million, many more than the six million in the average US state, which more closely resembles the average population of EU regions, such as Bavaria, Wallonia, Île-de-France and the Canary Islands. So perhaps it is more useful to compare the 50 US states with the EU’s 72 regions.

The convergence trend in the EU at the country level is reflected in the regions. But income disparities in the regions are still substantial in western Europe when compared with American states. It is true that poorer EU countries tend to outgrow richer ones, but poor regions do not necessarily outgrow rich regions or even the country average. So regional disparities may persist or even grow, posing a challenge for policymakers concerned with stimulating economic growth and regional cohesion.

And what about wealth disparities in today’s EU of 27 members? With the accession of 10 new states in 2004 and another two at the beginning of 2007, the Union’s membership now spans central and eastern Europe. In the 1990’s, these ex-communist countries had to face temporary income slumps as most of their industrial production became virtually made obsolete overnight. New production capacity has now been created and new markets conquered, but the catching-up process is still far from complete.

Unsurprisingly, then, regional disparities in income are much greater across the enlarged EU’s countries than across the US states. In 2005, average income disparities were twice as high within the then-EU-25 as within the American states. But they have come down by nearly one-third over the past 12 years. As with the EU-15, income convergence for the regions again turns out to be slower than convergence between countries.

Recent empirical evidence suggests that the central and eastern European regions benefiting most from EU membership are those around the country’s capital city or sharing a border with one of the 15 countries. But as long as poorer member states grow faster than their richer counterparts, one should not be overly concerned about temporary increases in intra-national disparities.

In fact, a temporary increase in intra-national disparities may be a good thing. Globalization and technological change are reshaping production throughout Europe, leading to the decline of traditional industries and rapid growth of high-technology manufacturing, banking and finance, scientific research, and business services. The fact that companies in these sectors benefit from operating close to one another may boost economic development at the expense of peripheral regions.

In the US, successful convergence in economic conditions across regions relies strongly on labor mobility. Internal migration is the main driver of income convergence, helped by a common language and all the other factors that foster mobility in America, such as comparatively easy access to housing and education.

By contrast, labor in the EU is largely immobile. Despite populist speeches about the threat posed by “Polish plumbers,” net migration flows between regions are generally insensitive to differences in unemployment rates among regions.

Of course, Europe’s labor immobility is partly caused by linguistic and cultural differences – barriers that cannot easily be removed. But other barriers can be overcome by reforming housing policies, reducing the cost of moving, and revising social-welfare policies in order to end fears of losing long-term benefits.

Reducing the labor supply in economically depressed areas of Europe and increasing it in booming regions would do much to reduce differences in wages and unemployment rates. It’s time to start thinking seriously about how to make Europeans move.