General background

The problem of uneven geographical distribution of economic activities is a huge worldwide challenge. For the European Union (EU) regions this is shown by the deep differences within and across nations. According to the Eurostat regional yearbook 2010, the GDP per inhabitant of 67 EU-27 NUTS 2 regions, out of 271, falls below 75% of the average whereas that of 41 regions is above 125% of the average. The differences are even more marked considering the regions in the candidate EU countries (Croatia, Turkey and the Former Yugoslav Republic of Macedonia) and in the potential candidate EU countries (Albania, Bosnia and Herzegovina, Montenegro, Serbia, Kosovo under UNSC Resolution 1244/99 and Iceland).
Regional disparities are significant not only across but also within countries (especially Turkey, Slovakia, but also Italy, Germany and the UK) due to historical, economic and geographical reasons. Spatial inequalities are evolving through time following complex patterns – exemplified by the concepts of path dependence, cumulative causation, hysteresis, and so on – also determined by economic, financial, political, geographical,  institutional and social factors. For the period 2000-2007 growth trends in the EU show some overall catching-up at the country level but with remarkable differences at the regional level. The economic crisis in 2008-09 has slowed down the convergence process hitting some regions and nations more than others. Taking Eurostat data during the period 2008-2010, compared to a EU-27 average rate of income growth of - 0.67, in the
EU-15 Latvia (-7.83), Estonia (-5.54), Lithuania (-3.84) have been hit harder; Poland (3.52), on the other hand, enjoyed the highest growth rate. The economic recovery in Europe expected for the period 2011-2012 is also characterised by dissimilarities both at the national and regional level (IMF 2011 Regional Economic Outlook: Europe).
The complex nature of the distribution of economic activity across space and of its evolution through time require necessarily different levels and tools of analysis:

1. Geographical and territorial issues

In broad terms, the geographical distribution of economic activities across space is determined by what the literature denotes with “first nature” and “second nature” causes (Krugman, 1993). Second nature causes mainly refer to (human activity and) economic incentives. Economic activities tend to cluster together taking advantage of proximity to larger markets, scale economies, knowledge spillovers, lower transport costs and so on. Even starting from undifferentiated regions and large dispersion once the process is set in motion all activities tend to agglomerate. A fortiori, the concentration process is favoured by first nature causes determined by territorial topography, endowments of natural resources and geopolitical factors. Indeed EU core regions are typically more urbanised (capital regions are often the richest) and well-connected to the transport network hubs; whereas peripheral regions are often coastal, on borders or in rural areas, with a lower number of connections. The increase in the number and strength of territorial connections (transport
networks and so on) is at the centre of many EU policies aiming to intensify economic, social and territorial cohesion and to enhance competitiveness (Fifth European Commission Report on economic, social and  territorial cohesion).

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2. The role of institutions

Institutions at different territorial levels (EU, national, regional and local) play a crucial role in fostering growth and reducing regional disparities. At the EU scale the growing burden of sovereign debts and large national budget deficits may endanger economic and financial integration calling for better policy coordination among national governments and monetary authorities (esp. the European Central Bank). At the national level, as a consequence of the economic crisis, the share in national GDPs of public expenditure is rising. However, a marked process of decentralisation in public expenditure has taken place in the last few years (for example, two thirds of public investment is carried out, on average in the EU, by sub-national governments, regional or local). Moreover, there are categories of public expenditure that have a strong local impact (such as transport infrastructure and environmental policies) or may attract, through complementarities, private investment. A suitable territorial allocation can contribute substantially to the reduction of regional disparities.
Institutional capacities however are unevenly distributed across space. Improving the quality of governance (at the various levels) and developing better linkages and coordination between central and local governments and among local administrations become strategic issues.

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3. Financial and labour markets

The recent waves of financial turmoil have revealed once more the deeply interconnected structure of the international financial market. The financial system can be described as a global network (with also an European scale) within which a great amount of funds are managed by a few large centres. It has also a local dimension which stresses the existence of a local informational advantage enjoyed by financial intermediaries located in proximity of firms. If local fund managers are more inclined to prioritize local investments projects, the tendency towards a more equal distribution of economic activities is reinforced. Accordingly, a more internationalized financial sector could increase regional disparities. Nevertheless, with increasing openness some firms, especially large ones, may have access to credit from new sources.
The labour market has also a spatial dimension emphasised by the fragmentation induced by low labour mobility, which is in turn a consequence of language, territorial, cultural, gender, ethnic, age and other barriers across European communities.
Specific European programmes aiming to remove such obstacles, promoting social inclusion or access to finance, should take into account the specificities (i.e. skill endowments, microfinance opportunities) and needs which may significantly vary across countries and regions.

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4. Local interactions and networks

Decisions which impact on population well-being (labour migration movements, households residential choices as well as firms location decisions) may also be affected by lower scale interrelations: the number and strength of social ties could explain differences in occupational opportunities and wage outcomes; residential choices have a clear spatial dimension (characteristics of local housing markets, accessibility, neighbourhood quality) involving individual preferences but also linked to households interactions; firms compete in local as well as in international markets, where larger firms are involved with more aspects of strategic interactions.
Firms may also interact on a cooperative basis creating bilateral or multilateral links (i.e. building the so-called innovation networks, or other types of inter-firm networks). The existence of local links enhances substantially the importance of local administration quality and interventions.
To tackle properly these issues this Action has to undertake the following steps:

  1. reformulate the theoretical economic modelling envisaging the EU as an evolving trade network with a specific topology determined by the number and strength of national, regional and more local links;
  2. enhance interdisciplinary networking combining recent approaches in economics with the most advanced mathematical and computational methods for analysing complex and non-linear systems;
  3. assess and design of economic policies (especially, EU Cohesion policies) taking explicitly into account this pervasive network structure and the role and specificities of economic, geographical, institutional and social factors.

Cost represents the best framework to achieve the goals described above, since it provides prenormative cooperation for the development of EU regional policies contributing to Europe’s competitiveness, socioeconomic development and welfare.

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Current state of knowledge

The theoretical approach concerning spatial issues adopted within economics, the so-called New Economic Geography (NEG) paradigm, initiated by the 2008 Nobel Prize laureate Paul Krugman (with his contribution in 1991) typically describes an economy with two regions (or two nations) in which at least one sector is characterised by imperfect competition, increasing returns and product differentiation. Regions are related via migration of labour, human and physical capital, technological spillovers and commodity trade; they are separated by (a simplified representation of) trade costs. A parametric change involving these costs, such as improvements in transport infrastructures or trade agreements, activates opposite agglomerative and dispersive forces (i.e. clustering in proximity to the larger markets or, contrariwise, spreading across space to avoid
competitive pressures) that may disrupt the initial distribution of mobile inputs across locations and the initial sectoral composition within regions moving the economy towards a radically different configuration. The basic dynamic process is modelled as a simple continuous time evolution involving only a few aggregated variables (Fujita, Krugman and Venables, 1999). The design and evaluation of EU regional policies have often been inspired by such a theoretical framework (Midelfart, Overman, Redding and Venables, 2004). Several contributions within this approach have recently focused on the effects of public policy on industrial location and on regional inequalities brought about by different types of public intervention, such as public consumption, subsidies, tax competition, infrastructures and the provision of productive services (P. Martin and
Rogers, 1995; Trionfetti 1997, 2001; Dupont and P. Martin, 2006; Baldwin and Krugman, 2004; Baldwin and P. Martin, 2004).
The main result obtained within this NEG literature is that policy interventions may have a positive impact provided that specific conditions are fulfilled, as the following examples show:

  • public investment in transportation infrastructure in a less advanced region encourages business location within the region itself when the associated infrastructure improvements are intra-regional, while it may cause leakage of business when the improvements are interregional;
  • subsidies may, in some circumstances, produce perverse effects. A subsidy directed at firms located in a less developed region may exacerbate the unequal distribution of income across regions when the share of capital owners that resides in the developed region is larger;
  • public purchases of locally manufactured goods may counterbalance the increase in regional imbalances induced by economic integration depending on the expenditure financing choices and on the composition of public expenditure;
  • tax competition between regions does not necessarily lead to a "race to the bottom". Regions with an agglomerated industrial sector enjoy an agglomeration rent which allows the setting of higher local tax rates without losing industrial activity.
  • where the geographical proximity between firms promotes the spatial dissemination of knowledge, redistribution of industrial activity across regions may reduce efficiency and competitiveness.

Standard NEG models have been criticized because of their simplifying assumptions (R. Martin and Sunley, 2011). Here the following ones are highlighted: a) a small number of symmetric and identical locations; b) simplified descriptions of agents (firms, households, workers) mobility decisions and interactions; c) no consideration of network structures; d) scarce attention at different institutional set-ups and at the impact across locations of policy decisions; e) overlooking of the geographical aspects of financial and labour markets. By relaxing these assumptions (for example, by simply increasing the number of regions, Fujita and Thisse, 2009) the results of the NEG literature do not necessarily hold.
By reformulating NEG economic modelling, this Action addresses the issues concerning the effectiveness of EU Cohesion policies aiming to reduce regional unbalances, increase welfare and enhance competitiveness. The EU is envisaged as complex evolving system with different territorial levels (with similar topological properties of the world trade web as those studied by Serrano and Bogñá, 2003). At each level agents take decisions by interacting with each other and with the institutions. Networking structures are present at various scales. The modelling of this complex and fractal structure requires a multidisciplinary approach and the development of specific tools drawing from several areas of competence such as economics, mathematics, physics, computational theory and network analysis.

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