Expanded union may come unstuck in Europe's regions

The enlargement of the European Union has developed an apparently unstoppable momentum. Austria, Sweden, Norway and Finland are set to join next year, Hungary submitted its application last week, and Poland, Slovakia and the Czech Republic should all come knocking on the door soon.

The process of enlargement has been painful for many of Europe's politicians, with John Major's embarrassing volte face over voting powers only the most recent upset. The applications of the former communist countries of Eastern Europe will further disturb the status quo. They will shift the EU's centre of gravity firmly on to German territory and diversify the range of political systems and aspirations it has to accommodate.

But the economic adjustments demanded by enlargement may prove still more significant and disruptive. The potential applicants from Eastern Europe are much poorer than current EU members on average. Hungary, for example, has an income per head of population around half that of Britain's. The Scandinavian entrants, in contrast, are generally better off than the European average, so the gap between rich and poor in the union will widen automatically, perhaps eventually threatening its social and political cohesion.

In theory, the opening of markets for goods and services - and the workers who produce and consume them - should narrow these regional differences as companies are attracted into areas in which labour is cheap and plentiful and in which returns to investment are higher. But past experience - at least since the oil price hikes of the 1970s - suggests that integration has done more to exacerbate national and regional inequalities than to reduce them. Firms in less prosperous areas have tended to react to greater competition by cutting wage costs, while those in better-off areas have tried to move their products upmarket.

SCRATCHING THE SURFACE

So each move to tie the EU's economies closer together has had to be accompanied by a more ambitious regional policy. About a quarter of the EU's budget is now spent attempting to ameliorate the inequalities between its rich and poor regions. More than ecu20bn ( pounds 15.4bn) was allocated to the EU's 'Structural Funds' in 1992, with the Edinburgh European Council meeting agreeing to raise this total by more than 35 per cent on top of inflation by the end of the decade.

But this is still less than half of 1 per cent of the EU's annual output of goods and services, and barely scratches the surface of the Continent's existing regional inequalities. Other EU programmes, such as the Common Agricultural Policy and support for research and development, also tend to offset the impact of the Structural Funds by helping already successful regions more than the less well-off.

Europe's regional inequalities remain striking. Incomes per head in the EU's 180 or so regions vary from 30 to 209 per cent of the European average, as the graphic illustrates. The 10 poorest regions - including areas in eastern Germany, Greece, Portugal and the French overseas departements - have incomes per head less than a quarter of those in the richest regions, which include Hamburg, London and Lombardy.

A study presented to last week's conference of the Royal Economic Society by Mick Dunford, of Sussex University, argued that regional incomes per head in Europe were clearly converging in the years up to 1976, (Winners and losers: the new map of economic inequality in the European Union, Mick Dunford, Sussex University). Rapid economic growth provided the resources to finance the development of less well-off areas, while convergence in turn reinforced growth by widening markets, improving human resources and easing inflationary bottlenecks.

But after 1976 incomes per head diverged between countries and regions. The earlier wave of investment in less developed areas dried up as productivity growth slowed and profitability fell. Rising unemployment in well-off areas also closed some routes of emigration.

For many years the European Commission summed up Europe's regional disparities as a conflict between the union's 'core' - the Benelux nations, northern Germany, Paris and South-east England - and its 'periphery' on the Mediterranean and Atlantic fringes. But this is now thought a misleading simplification.

As Bruce Millan, the commissioner responsible for regional policy, noted last year: 'Dramatic contrasts such as those between the centre and the outlying regions are being overtaken by a more complex pattern of territorial organisation. . . This diversification of disparities is generating a patchwork in which privileged areas border directly on depressed areas.'

The regional divergence after the mid-1970s did not simply unravel the convergence that preceded it, reassembling earlier patterns of economic geography. Some previously dominant areas lost ground while new areas of growth emerged. The same is likely to have happened when faster growth rekindled convergence in the late 1980s, before divergence resumed as the ERM imposed high German-style interest rates across the Continent.

Paul Cheshire of Reading University has attempted to identify why some regions have done better than others, (What made city-regions grow during the 1980s, Paul Cheshire, Reading University). He notes that city regions in backward agricultural areas and around coal fields and historic ports have all done consistently badly, confirming that pools of under-utilised labour are not sufficiently attractive to entrepreneurs to trigger regeneration via the marvels of the free market.

Michael Porter, the Harvard Business School management guru, argues that successful regions foster clusters of fiercely competing companies that thrive on high-quality labour, a network of related and supporting industries and buoyant demand from sophisticated consumers. This means that virtuous or vicious circles develop: the successful are rewarded by further success, but there is no guarantee that a failing region based on an out-of-date specialisation will be able to dig itself out of trouble.

Mr Porter's view is backed up by the fact that Europe's major cities - especially where business services flourish - appear to be winning the race, although the clustering of successful companies there may be more an act of defensive risk-avoidance than an active pursuit of higher productivity.

STOPPING SUBSIDY WARS

The enlargement of the EU, especially if the adoption of a single currency accelerates the process of market integration, will push regional policy even higher up the agenda of both Brussels and the national governments. They are well aware that a regionally imbalanced economy will run into inflationary problems before the resources off its less developed areas can be utilised fully.

There are already models of successful regional policy in Europe, with both Scotland and Wales having much to commend them. But their experience demonstrates that success will be expensive and slow in coming. An important challenge for Brussels will be to ensure that relatively wealthy countries do not enter into subsidy wars with each other to boost the fortunes of their less developed regions.

The training and education of underused workforces is an important route to regional regeneration, perhaps through grants to workers that only have to be repaid if they leave the qualifying area. More ruthless geographical targeting of state funding for university research and development may also help to germinate clusters of innovative companies.

But history suggests that a crucial determinant of the rich-poor gap in Europe will be the overall pace of economic growth across the Continent. Unwisely and prematurely locking Europe into a single currency with a bias to high interest rates and fiscal profligacy could do more harm to the development of an enduring European Union than its advocates are prepared to admit.

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