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Tuesday, April 10, 2012

The folly of EU structural funds illustrated

Here are a couple of illustrative examples of why the EU's structural funds so badly and desperately need reform. The list seemingly never runs dry.

First, the Sunday Telegraph had a feature on Madeira’s economy, claiming that grants from the EU structural funds – which require match funding from local governments or business – have contributed to the local Madeiran administration now owing over €6 billion, nearly double the per capita public debt of mainland Portugal. Much of the EU cash has been spent on infrastructure (not least via the Cohesion Fund, which is earmarked for that purpose) for which there is no demand. As German Chancellor Angela Merkel put it, "There are many beautiful tunnels and highways [in Madeira]. But this did not contribute to competitiveness."

Meanwhile, the European Commission and Swedish local authorities have earmarked nearly £10m to subsidise Facebook – a company currently valued at around $100bn (£63bn) – under plans to build giant server halls in Lulea in Northern Sweden. You'd be aware that Sweden is one of the richest countries in Europe.

Now, the European Commission always has two standard responses to examples like these:
  • They've been taken out of context - and then gives a series of stats of how many jobs and how much growth the structural funds allegedly have created.
  • It's up to the local authorities in member states to select the projects anyway, the Commission merely facilitates the cash.

But these examples are very much symptomatic of the wider problems and flaws inherent in the structural funds (SF). As we set out in our recent report on the topic:

1) Conflicting aims: are the structural funds meant to be channelled to areas where the absolute return of capital is the greatest or where they can foster the greatest convergence between poorer and richer regions (a key stated aim of the funds)? The €10mn in EU funds earmarked for Facebook - a thriving company - surely could have come from private capital. It's probably a decent investment. So in fact, the €10mn could have served to ‘crowd out’ private investment that otherwise could have take place in Lulea, while channelling funds away from poorer regions where they can have the most comparative impact. The result is the opposite of convergence.

2) Opportunity costs: Related to this, both the Facebook and the Madeira examples illustrate the huge opportunity costs that the SF involve - spending diverted from other, more
comparatively productive economic opportunities. In the Facebook case, the funds duplicate economic activities in relatively wealthy states that would have taken place anyway, and in the Madeira case, they're spent on outright damaging projects (i.e. needless infrastructure projects that run up debt).

3) Pro-cyclical and unresponsive to changing needs: The Madeira case shows that the SF tend to be pro-cyclical as they can be sucked into areas of the economy where unsustainable growth or serious leveraging is taking place, with few ways of making adjustments (this was also the case in Spain for example). Remember, the funds are negotiated on a seven year basis, and come with fixed spending criteria (with some discretion to alter spending on a yearly basis). Co-financing also makes the funds pro-cyclical. Not wanting to forgo the potential opportunities presented by taking up structural funding, governments and local authorities feel obliged to spend the money on co-financing, even if this means running up massive debts. Again, hello Madeira.

4) No link between performance and spending: the absence of strong conditionality
and performance criteria in the allocation of funds meant that Madeira continued to receive funding despite the absence of results from the billions in funding that it has received. This also means that the focus is on getting money out of the door rather than spending the cash wisely.

And this is even before we get into the irrational distribution patterns of the funds, the added administrative costs, the absence of absorption criteria, the problem with accountability (falling in between member states and the Commission) and the fact that the Commission's models for evaluating the funds are hopelessly inadequate.

Do read our report for the full picture.

This policy simply has to undergo root-and-branch reform, starting by limiting funding to the poorest countries only, where it can have the greatest comparative impact.


blaiklock said...

Since 1998, EIB (the European Investment Bank) has lent (approx.):

Greece = Euro 15bn
Ireland = Euro 7bn
Portugal = Euro 23bn
Spain = Euro 88bn

............ all in support of "economic development".

Some, or most, of the above loans will still remain outstanding to be repaid at some date in the future.

Clearly, such economic development has not arisen yet, otherwise these countries could repay their debts.

Should not EIB declare a moratorium, or even be closed down until they can show that they can lend responsibly to developing economies?

Martin Blaiklock

Rik said...

The Swedish example is a bit one sided imho.
1. The North of Sweden has much lower per capita income than the average (and it is regions not countries).
2. Large companies take the goodies they get into consideration by determining the place of residence (and there are nearly always goodies). The system is rotten with lower ground prices, tax concessions etc, but that is how it works. Also and even especially for companies that do well like FB.
3. Looks highly uncertain that a company like FB will move to 'in the middle of nowhere', where it is night 3-4 months a year in a row and a lot of the people suffer from depressions and alcoholism.
4. It also is not certain that making investments in really poor areas (say Bulgaria) will have a higher return. Take the EZ probably the transfer from North to South is a misallocation (like the transfer from North to South in Italy).

The fund is rubbish imho but this is not really a good example and of course I mention only the more positive points. Imho it is only an example of the simple way most Europeans think. FB is rich so can pay for itself and can pay a lot of tax in the mean time. That might be fair but from an economic point of view total nonsense.

Open Europe blog team said...

Thanks Rik - always good to read your very interesting thoughts and insights. But here, I think you miss the point slightly.

First, Luleå is still a wealthy place by EU standards and, in any case, Sweden can most certainly afford paying for its own regional policy and with much lower deadweight, opportunity and admin cost at that (all of which would be reduced should the funds no longer be routed via Brussels). So whether FB would have moved there regardless is besides the point, the funding still represents a misallocation of resources.

Making investments in poorer areas will almost never have higher absolute returns than investments in richer ones. That's precisely our point. As we explain in our recent report on the topic:

"If the aim of the SCF is to foster growth, then the funds should be channelled to areas where each invested euro can generate the greatest absolute return – where the so-called Marginal Product of Capital (MPK)
is the highest. If it is to foster “regional convergence”, then the funds need to go to areas which struggle to attract private investment, often areas where MPK is relatively low.

The areas with the highest growth prospects tend to be in richer member states and regions which benefit from good administration, developed infrastructure and a range of other factors. However, targeting such areas runs in direct conflict to the aims of convergence and cohesion, as this would allow them to soar further ahead of poorer regions.

Therefore growth based on MPK alone is not a valid way of assessing the effectiveness of the SCF. Instead, we must look at the comparative impact that the funds can have in one region over another. If we can discern that the MPK is higher in more developed regions, then it is clear that markets and private capital will as well. Since the aim of any public funds should be to avoid replicating what the market can already provide, it becomes absolutely clear that spending the funds in richer member states and regions is not
the best use of scarce resources.

At worst, SF could serve to ‘crowd out’ private investment that otherwise had take place in richer regions while channelling funds away from poorer regions that need them the most. The result is the opposite of convergence."

Rik said...

Huge problems to send earlier much longer reply.

Nobody is pushing away investments in Lulea. Neither the real poor parts of Europe and Lulea will under normal conditions been invested in. For different reasons may be but still no investments.
A miss the difference between what is basically welfare in another form (like Lulea) and normal getting something of the ground (creating the normal conditions for investments (like a proper infrastructure) or a start up subsidy). I doubt btw if Europe can afford (even rich Sweden) more welfare.

Another problem I have is that it clearly looks like 'making a society' is much more difficult than the EU seems to think. The room to create convergence is much smaller than a lot of these measure seems to be based upon (part of the reason they don't work) unless of course it becomes an often expensive form of welfare.

Anonymous said...

Where is the data backing up the claim that Luleå is a wealthy place? What is the average after-tax income?

This part:
"The areas with the highest growth prospects tend to be in richer member states and regions which benefit from good administration, developed infrastructure and a range of other factors. However, targeting such areas runs in direct conflict to the aims of convergence and cohesion, as this would allow them to soar further ahead of poorer regions." leads me to the conclusion that the authors believe that regions with BAD administration should get (be rewarded) with EU funds. Virtue is its own reward for the virtuous, the rest get free money :-)

I agree that having EU administering funds where there were no obvious reason for the funds detour to Brussels seems inefficient. The logical conclusion seem to be that if rich countries should be excluded from receiving EU funds then the EU budget should be cut accordingly.

Open Europe blog team said...

Thanks anonymous. Luleå is ranked 54 out of 290 Swedish councils in terms of average income, http://www.e24.se/karriar/kommunerna-som-har-hogst-och-lagst-medelinkomst_33619.e24 - so relatively well off also by Swedish standards.

The problem with bad administration in recipient regions can be off set by additional absorption criteria and linking funding to results - we set out how in our report.

"I agree that having EU administering funds where there were no obvious reason for the funds detour to Brussels seems inefficient. The logical conclusion seem to be that if rich countries should be excluded from receiving EU funds then the EU budget should be cut accordingly."

Exactly - which is also what we argue in our report!

Anonymous said...

Thanks for the reply.

Everything is relative so I suppose it is possible to claim that Luleå is wealthy. However, the average income in Luleå is lower than the average income in Sweden ;-)

An issue with SCF is that either it goes relatively unchecked (possibly gobbled up by bad administration) or it'll have to come with a lot of absorbtion criteria combined with careful audits of results (comes with high costs of EU administration (probably the costliest administration in Europe)).

SCF into regions with bad administration is simply a bad idea. But I suppose if the locals trust their administration, with the proof of trust being their willingness to pay taxes, then SCF might be worthwhile. Subsidiarity principle for verifying quality of administration :-)

Anonymous said...

I live in Madeira. We cannot understand why people do not know the importance of roads! Imagine living without any utilities, eg sanitation, electricity etc. Waiting 2 hours for an ambulance to reach you and 2 hours to reach the central hospital in Funchal. This is the problem with everyone trying to rule over everyone else in the disasterous 'one size fits all' EU. I welcome its disappearance under the increasing debt mountain and we will be free from the unelected dictators. The more they go for forced convergence, the more it will split up.