Wednesday, July 11, 2012

Structural reforms and regional convergence

by Natasha Xingyuan Che and Antonio Spilimbergo


July 11, 2012

A major cause of the Eurozone crisis is the difference in income and productivity between the core and the periphery. This column presents evidence suggesting that structural reforms can be instrumental in fostering the development of lagging regions within a country. It argues that this in turn can accelerate the rate of convergence across countries within a currency union.

The Eurozone crisis is at heart a crisis of failed regional convergence and lack of structural reforms. The euro was supposed to facilitate a rapid convergence in the level of income and, most importantly, of productivity across countries. The founding fathers of the euro saw the single currency as a necessary condition for a single market, which, however, turned out to be incomplete without structural reforms. While the focus has been on the financial and fiscal aspects of the crisis, structural reforms that facilitate more cohesion and growth are the key to a long-term solution to the Eurozone crisis.

Regional disparities in income are important. Countries that have higher regional disparity in output per capita are usually poorer (Figure 1).

Figure 1. Correlation between regional GDP dispersion and country GDP level

Within the neoclassical framework, relatively poor regions with less capital and lower productivity should attract capital from rich and capital-abundant areas. Capital would also facilitate the catching up of productivity, not the least by spreading new ideas and technologies from the advanced to the backward parts of the world. Although convergence can happen both across countries that use different currencies and across regions within a country, sharing a single currency should accelerate the convergence process, because capital and technology can move more easily within the area.


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