Regional aid displaces economic activity rather than creating more of it
A new study by VATT shows that the macroeconomic impact of regional aid measures may be minor or even negative. The study observed that employment grows in treated areas at the expense of untreated areas.
Moreover, the employment impact vanished entirely once the aid measures ended. The findings indicate that in terms of lifting overall employment regional aid measures are often a policy failure.
In many countries public money is directed at areas suffering from weak economic development and high unemployment. Regional aid measures, however, can have significant negative effects on untreated areas. In such cases the net impact of aid measures may be non-existent and the macroeconomic impact may even be negative.
The study, by Elias Einiö of VATT and Professor Henry Overman of the London School of Economics, investigated the impact on employment and entrepreneurial activity of regional aid measures in 30 disadvantaged areas with poor economic development across England in 2006–2011. These areas received £418 million in financing through the Local Enterprise Growth Initiative (LEGI). The study investigated changes in employment at the treatment area boundary by defining one-kilometre wide zones on either side of the boundary. Employment was monitored from the start to the end of the treatment.
The study provides evidence of spillover in local markets: when aid measures are directed at one part of the economy, the untreated part suffers. Einiö and Overman show the net impact of aid measures on employment to be negligible: improved employment in the treatment area was offset by worsening employment in nearby areas.
This impact was not long-term; it vanished as soon as the treatment ended. This finding is in line with previous research data showing that even large-scale regional aid measures do not have a long-term impact.
The study also demonstrates that the employment spillover effects mean that the impact of regional aid measures should not be evaluated by comparing the treatment area to its immediate neighbouring areas as this will yield over-optimistic impact assessments.
The study’s finding that large-scale regional measures in Finland, such as business and investment support in assisted areas, may be expensive and ineffective policy if the objective is to increase overall employment.
Senior researcher Elias Einiö, VATT, tel. +358 295 519 408
The (Displacement) Effects of Spatially Targeted Enterprise Initiatives: Evidence from UK LEGI
VATT Working Papers 71