The Rich World's Rust Belts Aren't So Unequal

(Bloomberg Opinion) -- The political upheavals of our current populist era have often originated in the "forgotten lands" of the rich world. It was the rust belt that propelled Donald Trump to the White House; the Midlands and the North of England that pushed Britain out of the EU; and the French countryside that generated the "yellow vest" revolt against Emmanuel Macron.

So how big are regional inequalities, and what should be done to address them? A new study by the International Monetary Fund suggests that they may in fact be less significant than we have recently assumed. Furthermore, the right policy response hinges on ensuring that labor markets work effectively, rather than splurging public money on a depressed area in the hope it will rekindle growth.

There is little doubt that regional disparities in advanced economies have increased over the last three decades. The IMF finds that real GDP in regions at the 90th percentile is on average 70% higher than in regions at the 10th percentile — an increase of more than 10 percentage points from the late 1980s. In some countries, such as Italy and Canada, real GDP in some of the richest regions is more than double that of some of the poorest.

Yet it would be wrong to overstate the role that regional disparities play in determining overall levels of inequality. The IMF finds that the regional component accounts for only about 5% of overall inequality in household disposable income within advanced economies. There are some significant differences: For example, in Italy, eliminating regional disparities would bring inequality levels back to where they were in the early 1990s. But even in this case, income inequality would only fall by around 15%.

The IMF study also looks into the question of whether some regions in rich countries have suffered disproportionately from globalization. Looking at a broad sample of advanced economies, it finds that competition from external markets do not have any significant effect on regional unemployment. But technological change does: unemployment rates in regions vulnerable to automation rises steadily over the four years after a shock, such as a significant drop in the cost of machinery and equipment capital goods.

For policy makers concerned about regional inequalities, the most relevant question remains what to do about it. The temptation is to chuck money at the problem, offering tax incentives or higher spending to laggard regions via what is called in jargon "place-based fiscal policy." These policies appear to be second best. The most important course of action is to ensure that labor markets work effectively and that workers can move across a country to fill vacancies wherever they exist.

Unfortunately, there are often cases where this does not occur. A good example is Italy: Tito Boeri, Andrea Ichino, Enrico Moretti and Johanna Posch, a group of economists, have looked at the impact of collective bargaining agreements in Germany and Italy. While Germany has moved toward a more flexible system that allows for local bargaining, Italy exhibits very limited geographic wage differences, which are often completely unrelated to productivity. This essentially means that workers in Germany have an incentive to move to where wages are higher and jobs are more plentiful, while workers in Italy do not. Moreover, German companies have an incentive to move where wages are cheaper, creating more jobs, while Italian companies do not. 

The result is that the Italy’s poorer south enjoys higher real wages (because the cost of living is lower than in the richer north), but also much higher levels of unemployment. The researchers find that if Italy adopted the German bargaining system, aggregate employment and earnings would increase by 11% and 7.5% respectively, because of the better allocation of workers across the country.

There are indeed cases in which money from the central government can help a region that is lagging behind. Benjamin Austin, Edward Glaser and Larry Summers, three economists, find that targeted hiring incentives can be effective in creating jobs and growth when aimed at regions with higher unemployment rates. But such place-based measures can create issues of horizontal equity: Why should poor households in high-income regions be penalized just because they do not live in a deprived area?

Most importantly, there is no reason to let artificial obstacles get in the way of the functioning of a labor market — particularly within the same country where there are few or no language or institutional barriers. Money alone will not rescue the forgotten lands.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Ferdinando Giugliano writes columns on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.

©2019 Bloomberg L.P.

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