Surprise! The EU Pisses Our Money Away

The aim of regional support funds is that – for some unknown reasons perhaps – some part of the European economy are less productive than others. Productivity being the key to all economic wealth and advance. So, send off some helpful little sums of money to those less productive peeps in less productive areas and we’ll all get richer. That is the EU justification for those regional funds. Except, they give the money to the already more productive, something which doesn’t raise their productivity at all. That is, the EU is spending out money to no gain. Also known as pissing it away. And Jeebus, aren’t we all surprised?

Making the best of EU regional support funds to boost productivity: Firm-level analysis
Naomitsu Yashiro, Konstantins Benkovskis, Olegs Tkacevs 06 May 2019

EU cohesion policy aims to narrow gaps in economic development through large regional support funds. This column presents new research on the impact of such funds on firms’ performance, focusing on the experience of Latvia, one of the largest recipients relative to its size. The findings indicate that larger and more productive firms are more likely to receive support funds, but it is not clear if their productivity improves as a result. Access to such funds must be facilitated to allow smaller and less productive firms, which have a great need for investment and a larger room for productivity catch-up, to be included in the pool of potential recipients.

Over the programing period 2014-2020, the EU will have spent €351.8 billion on cohesion policy, which aims to narrow gaps in regional development via several EU structural funds (henceforth “EU funds”). Although EU funds are considered to have contributed to the economic development of lagging regions, they have been subject to several criticisms, such as crowding out national fiscal spending and various inefficiencies in their implementation (OECD 2018).

Many EU member states that have achieved higher income levels expect a smaller allocation of EU funds in the next programming period. It is therefore important to understand whether and how EU funds improve economic performance, so that member states can make best of EU funds.

Identifying the effects of EU funds on regional development has been complicated, as they are often tangled up with other forces acting, such as income convergence of lagging regions towards advanced regions (Hagan and Mohl 2010, Fratesi and Wishlade 2017).

In a new paper (Beņkovskis et al. 2019), we assess the impacts of the EU funds on the performance of recipient firms, thereby avoiding such complexity. Latvia is a suitable country for our analysis, as it is one of the largest recipients of EU funds in relative terms. Among various EU funds, we focus on the European Regional Development Fund (ERDF), which is specifically intended to boost the economic performance of lagging regions through improved entrepreneurship and business innovation.1

Larger firms are much more likely to obtain the ERDF

We match the dataset on the recipients of the EU funds with a large dataset on the financial statements of Latvian firms. We employ a propensity score matching to control for the possibility that firms with initially superior performance obtain ERDF co-financing. Indeed, we find that Latvian firms that are initially more productive, larger and more capital-intensive have a higher probability of launching ERDF co-financed projects.

Firm size is a particularly important determinant. In fact, the largest Latvian firms are twice as more likely as those in the second largest decile to obtain the ERDF, while small firms have little or no chance (Figure 1). This indicates the existence of non-negligible fixed costs associated with launching ERDF co-financed projects, which can only be born by large firms.2

Figure 1 Larger firms are more likely to obtain the ERDF

The contribution of the ERDF to productivity is complex

After accounting for the self-selection discussed above, we conduct a difference-in-difference estimation to identify how much launching ERDF co-financed projects improves the productivity and other performance of Latvian firms. We find that it increases the recipient firm’s capital stock per employee by 14% in the year of launch, and by 32% in the third year (Figure 2). Similarly, it boosts employment by 7% in the first year and by 16% in the third year.

The immediate surge in capital intensity is not surprising, as the ERDF is largely intended to finance investment activities. Also, a firm’s capacity to expand employment was one of the implicit criteria when the national authority selected the recipients of the EU funds in the aftermath of the crisis.

The impact of the ERDF on productivity, on the other hand, is ambiguous. Although launching ERDF co-financed projects seems to boost labour productivity and total factor productivity (TFP) of recipients by 11% and 10% in the third year, the estimated effects are not statistically significant.

The absence of significant improvement in the productivity despite the capital deepening is a puzzle. One possibility is that Latvia’s small domestic market is constraining the use of increased production capacities. Indeed, we find that the ERDF does not increase the export intensity of Latvian firms, even through some of programmes it finances are explicitly targeted at expanding their export markets.

Figure 2 The ERDF boosts capital and employment but the impact on productivity is ambiguous

Note. The light blue colour indicates statistically insignificant values whereas the dark blue colour denotes values that at least 10% statistically significant.

Another possibility is that effect of the ERDF on productivity is determined by the recipient’s room for productivity catch-up. To test if this is the case, we compute the average treatment effect on labour productivity for each decile of initial productivity levels.

We find that recipients with initially very low productivity levels enjoy the largest productivity gain (Figure 3). This may be because the ERDF finances the investment needed for those firms to initiate productivity catch-up. Yet, in practice the ERDF is allocated more toward firms that are already productive and large, and therefore would benefit little from the ERDF. This may explain the weak overall treatment effect on productivity.

Figure 3 Initially less productive firms benefit most from ERDF co-financing

Note: The light blue colour indicates statistically insignificant values whereas the dark blue colour denotes values that at least 10% statistically significant.

Improving access to the ERDF by small laggard firms

The contribution of the ERDF to productivity can be enhanced by targeting it towards small firms that are lagging behind in productivity levels. In order to facilitate the access to ERDF co-financing by those firms, the application procedures and administrative burdens associated with the management of EU funded projects need to be streamlined.

Rigorous efforts by both the European Commission and the authorities in receiving countries are warranted. For example, the Commission should consider reducing the scope of indicators it requires member states to report in relation to EU funded projects. The number of such indicators increased dramatically during the programme period 2014-2020 (European Court of Auditors 2017).

The authorities should also simplify the application procedures and provide widely accessible technical assistances on EU funded project management. They can also include face-to-face interviews with entrepreneurs in the project selection process, as done in Poland, to identify innovative firms (OECD 2019).

The granular empirical evaluation of regional support programmes like the one in our paper is useful for improving the design of the EU funded projects. Admittedly, our findings on the ERDF may not be directly applicable to other EU funds. Nevertheless, accumulating granular evaluations at the level of recipients for each type of the EU funds is a promising alternative to previous assessments that bunched all EU funds and were confined to a region-level perspective.

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