Cohesion and convergence.
 

James Mc Kenna *



THE ROLE OF THE STRUCTURAL FUNDS.

As we reach the end of the five period covered by the 1988 reform of the Structural Funds which was linked to the completion of the Single Market attention is turning to the next step in the process of European integration-Monetary Union.

This next stage launched by the Treaty on European Union (Maastricht) imposes a timetable and quantified targets for the achievement of convergence of national economies as a necessary pre-condition for moving to a single currency. The Treaty also stresses the need to strengthen economic and social cohesion.

This concept has been an important aspect of the ongoing process of European integration from the earliest days. The preamble to the Treaty of Rome contains the following text: "Anxious to strengthen the unity of their economies and to ensure their harmonious development by reducing the differences existing between the various regions and the backwardness of the less favoured regions."

This concern for reducing disparities between regions was reiterated in the Single European Act which laid the foundations for the Single Market. This is not* coincidental since each stage on the road to greater union brings with it the problem of ensuring that all members have the potential to benefit from the advantages to be gained or at least that weaker regions do not suffer as a consequence of the next stage of integration. This desire to achieve a fair distribution of the advantages of the union underlies the concept of economic and social cohesion. At the national level the primary means used to pursue this goal are financial transfers from rich to poor regions, the clearest instance being the German system of Financial Equalisation,"Finanzausgleich". This process is known as redistribution.

At the Community level the mechanism is not quite so clear cut since there is no explicit redistribution function in the E.C. budget but the method is similar. Poorer Member States (or regions) receive substantial transfers from the budget to help them adjust to new circumstances -the Single Market or Monetary Union-and in the process to assist them to catch up with the more developed Member States in terms of economic performance.

The policy instruments used to channel these transfers are the Structural Funds and the new Cohesion Fund. These budgetary grant instruments are reinforced by loans from the European Investment Bank.

The Structural Funds have been active for many years but in 1988 they were given a more coherent set of goals and increased financial resources in the run up to the completion of the Single Market. The aim was to improve the competitive ability of the less favoured regions(or countries) so that they could reap their fair share of the benefits.

The Edinburgh summit in December 1992 reinforced the role of the Funds by agreeing a further substantial increase in resources and setting up the Cohesion Fund with the main objective of helping the four poorer countries (Greece, Spain, Ireland and Portugal) to overcome the difficulties in making the move to Monetary Union. Although the Structural Funds are not exclusively devoted to these four countries, they are the prime beneficiaries and the Cohesion Fund is available to them alone (the "Cohesion countries").

In the cohesion protocol to the Maastricht treaty the EIB was asked to"devote the majority of its resources to cohesion" and "to achieve...a further expansion of lending in Member States benefiting from the Cohesion Fund and in Objective 1 regions of the Community". (Objective 1 regions are described as "Lagging behind the rest of the Community in development" and in addition to the "cohesion" countries include Southern Italy, the French overseas territories, Corsica and some regions in Belgium and the United Kingdom (chiefly N. Ireland).The ex-DDR länder in Germany are also included in this category).

Edinburgh also launched the Community Growth Initiative which aims to benefit the cohesion countries directly and indirectly. The new lending resources made available, some 7000 Mio ecu, are, in part, destined for these countries.
 

CONVERGENCE AND COHESION INTERACT.

Convergence is the process by which the Treaty on European Union aims to make the move to a common currency easier by reducing the risk of locking in unresolved tensions between the economies of the Member States which could cause problems later.

Convergence of national economies can be described as "real" or "nominal". Real convergence requires, for instance, that income (GDP per head) or welfare disparities be reduced while nominal convergence aims, inter alia, at reducing inflation and long term interest rate differentials to an acceptable level so as to foster stable exchange rates.

It is this latter definition which the Maastricht treaty has adopted as a necessary precondition for Monetary Union and lays down quantified targets and deadlines. The main targets are budget deficits and public debt; deficits are to be limited to 3% of GDP and general government debt to 60% of GDP with the deadline of 1999.

Apart from the value of these aims in terms of monetary stability the benefits of achievement will be felt in greater capacity for investment following reduced government borrowing and reduced fiscal pressure resulting from a drop in the cost of debt servicing (in the case of foreign debt the balance of payments will also benefit).

Real convergence and cohesion have the same aim: reducing income disparities but unlike "Maastricht convergence" they do not have quantified targets or a timetable. There will not be a moment when cohesion can be said to have been achieved in a quantifiable sense and real convergence is a long term process subject to the ups and downs of the general economic climate.

This is not to say that cohesion cannot be said to have occurred. If one accepts that the aim of the cohesion effort is to persuade less developed Member States to remain in the "club" in the belief that they will, at worst, not suffer from the next stage of integration then the completion of the Single Market can be seen as an example of the success of the cohesion process. Similarly, the achievement of Monetary Union will, in part, depend on the outcome of the renewed cohesion effort agreed on in Edinburgh. Cohesion is as much a state of mind as a matter of financial transfers or economic variables.

In the long run, of course, it is hoped that the poorer Member States will become richer but this will be the result of a combination of continued efforts to promote cohesion and convergence, resulting in higher growth rates than the Community average.

Mention should be made of the Community Growth Initiative first proposed at the Edinburgh summit and followed up in Copenhagen in April 1993. The Growth Initiative calls for " measures to be adopted at national and Community levels to boost confidence, reinforce the fundamentals of economic growth and encourage the creation of new jobs."

The aim of the Initiative is to give a short term counter- cyclical boost to public investment and to encourage private investment especially in small and medium sized enterprises to produce a long term improvement in overall economic performance at the Community level. This should provide a further stimulus to growth in the less developed Member States since real convergence proceeds faster in a climate of general economic growth. It is difficult, if not impossible, for a less developed country to reverse a recessionary trend alone. Some external stimulus is required. This is particularly true when the convergence criteria on deficits and debt ratio limit a Member State's capacity to take independent action.

The combination of increased funding for cohesion (Structural and Cohesion Funds) increased lending from the EIB and the potential benefit from the Community Growth Initiative should provide an excellent opportunity for the less developed Member States to improve their position. However, they have to play their part and not rely on external assistance alone to achieve success. National policies must be geared to take advantage of the opportunities on offer.

As will be seen later, however, the availability of increased aid may cause problems in meeting the convergence criteria laid down in the Maastricht treaty.
 

THE PROBLEMS FACED BY THE COHESION COUNTRIES.

These fall into two categories, existing and potential.
 

Existing problems.

This article is not the appropriate place to give detailed country studies and the remarks which follow will be of a limited and largely general nature.

The first and most obvious problem is relative wealth. In terms of GDP per head all four are below 75% of the E.C. average (although Spain as a whole is above the average the Objective 1 regions are not) and contain some of the poorest regions in the Community.

Next in order of gravity comes unemployment where in two countries, Spain and Ireland, the rates are much higher than the Community average.

In addition to the economic disparities all four are on the periphery of the Community while two of the four, Ireland and Greece, are geographically remote from the rest of the Community.

All four are classified, for purposes of Structural Fund aid, as lagging behind the rest of the Community in terms of development (Obj.1) and as such qualify for higher rates of aid. In the case of Spain only the poorer regions are so classified.

The underlying difficulties facing these countries include:

- lack of a diversified industrial base;
- over-dependence on agriculture;
- relatively small market services sector which may be too specialised e.g. mass tourism which imposes great strains on infrastructure and the environment;
- underdeveloped infrastructure-transport, energy, water, telecommunications;
- high cost of upgrading industry or infrastructure because of local supply bottlenecks or compliance with environmental regulations.

Because of these primarily structural problems the Cohesion countries are apprehensive about the move to a common currency since they will lose a major tool of economic policy. Any disadvantages they now face may be made worse in a truly integrated European economy unless they can make the necessary adjustments before becoming "locked into" a less flexible system.
 

Potential problems.

Some of these results from the need to achieve "Maastricht" convergence within a relatively short time which in some cases e.g. Ireland where the level of public debt is equal to 9% of GDP, raises doubts as to the credibility of achieving the target. This is not to say that the target cannot be met but that investors and currency markets must be convinced that it will. Without this belief any attempt to increase investment in order to speed up growth and employment may fail.

Cutting public expenditure may be essential to meet the convergence criteria but in the case of under-developed countries it places at risk public investment which is intended to lay the foundations for productive private investment.

Ironically the Structural Funds themselves may cause some difficulties. Since the Funds operate by way of matching grants the beneficiaries may be forced to increase public spending in order to take up the extra aid available. The requirement that Fund aid be additional to national spending prevents governments from simply cutting their spending and substituting Community aid. Increased lending from the EIB can, in some cases, only be accommodated to a limited extent if the debt/GDP ratio is to meet the Maastricht convergence criteria.
 

THE COMMUNITY CONTRIBUTION TO COHESION.

The reform agreed on in Edinburgh will double (in real terms) the Fund resources (Structural Funds plus the Cohesion Fund) available to the cohesion countries by 1999 in comparison with the 1992 level. In total they will receive about 85000 Mio. ecu over the period 1993/1999, an average of 12500 Mio. ecu per year. The total amount will be shared out approximately as follows: Greece 23%, Spain 44%, Ireland 10%, Portugal 23% . The yearly average which represents some 2% of their combined GDP in 1993 shows that the sums involved are economically significant.

To this must be added the impact of the Community Growth Initiative and the potential of increased lending by the EIB.

The Structural Funds (Regional, Social and Agricultural) will continue to co-finance the same types of programme as at present but some additions to their scope should be noted as they are of special importance to the cohesion countries.

The most significant changes are:

- Investment in health and education
- Greater emphasis on research and development
- A specific stress on the completion of Trans-European Networks

While the latter two are not new the emphasis on them has been strengthened in the new regulations with particular reference to Obj.1 countries.

The addition of investment in health and education as eligible categories in Obj.1 areas is further recognition of the role played in regional development by the provision of higher basic welfare levels than the local economy can supply. Furthermore, improvements in the provision of education and training are vital components of the aim to improve the competitivity of backward regions.

A further benefit of including these categories is to increase the absorptive capacity of the countries concerned which, as will be seen later, is essential to help them take up the increased level of aid.

The Cohesion Fund has very specific targets in that it will be used exclusively to co-finance transport infrastructure as part of the policy to improve Trans-European Networks (TEN) and environmental investment.

The new lending facilities introduced as part of the Edinburgh Growth Initiative (EIB temporary lending facility and the European Investment Fund ) are also targetted on TEN and projects have already been approved in Spain,Ireland and Portugal.

The establishment of TEN for transport and energy are of special importance to the cohesion countries as they are all, to some extent, peripheral to the "core" of the Community and thus suffer cost disadvantages both in access to markets and energy supplies.

Aid for environmental investment is of particular interest to the cohesion countries in that it improves the possibilities for attracting new investment by reducing the load on existing facilities (water treatment and supply) and removes constraints on tourism which places a great strain on supply infrastructure.
 

CONVERGENCE AND COHESION A POSSIBLE CONFLICT

Convergence programmes, which are the medium-term economic strategies designed by the Member States for achieving a sufficient degree of nominal convergence so as to be able to participate fully in the third stage of EMU, are a requirement of the Maastricht Treaty. Implementation of these programmes is a purely national responsibility with the Commission having only a monitoring role.

For the cohesion countries, however, successful implementation of their convergence programmes will be a condition for continued receipt of financial support from the Cohesion Fund. This element of conditionality is an innovation in Community structural aid and demonstrates the link between cohesion and convergence. The Community will provide some financial help towards achieving cohesion but only if this forms part of overall national economic policy. This conditionality allows the Community to exert an indirect influence on national policies central to convergence which otherwise would be beyond its reach such as taxation and social security benefit levels which, apart from their impact on public finance, also influence the labour market. This element of conditionality applies only to the Cohesion Fund and not to the Structural Funds themselves.

Another distinction is that the Edinburgh Council decided that additionality in the strict sense of the Structural Fund regulations would not apply to the Cohesion Fund. The beneficiary countries are simply required to give an undertaking that they will not substitute Community aid for national spending.

As already stated the convergence criteria laid down in the Maastricht Treaty may cause problems for the cohesion countries since they will face an increase in available Community aid at a time when they may be seeking to cut public spending.

The general principle of additionality requires that they cannot reduce their spending plans by the amount of aid they receive. The minimum requirement is that they maintain national (i.e. exclusive of Community aid) expenditure on structural development in real terms at a reference level. This level has not yet been defined but will probably be the average of 1989/1993. To partly offset this problem the maximum aid rates in the cohesion countries for the period 1994/1999 have been increased, in the case of the Structural Funds, from 75%

to 80% of the total cost of the investment and to 85% for the most peripheral regions and the outlying Greek islands. The Cohesion Fund maximum aid rate is also set at 85%.

The widening of eligibility for aid to include health and education increases the absorptive capacity of the beneficiaries without calling for additional expenditure.

Another factor which will limit the extent of this problem is that the 3% deficit target refers to General Government and thus semi-state or privatised utilities are excluded and these are in many cases large investors in infrastructure such as telecommunications and energy. Further privatisation of public enterprises will allow an increase in development expenditure without affecting the budget deficit. Another avenue which could be explored is opening the provision of, say,roads to private enterprise as is the case in France. The combined effects of increased aid for cohesion and the beneficial side effects of convergence itself will be to increase growth in the cohesion countries thus providing more room to increase development spending in the future.
 

CONCLUSION.

The current economic climate is not favourable to economic and social cohesion, which advances more in times of general economic growth. The Community has, however, put in place new or reinforced aid instruments, which if exploited effectively by the cohesion countries, as part of an economic strategy designed to foster sustainable growth should enable them to increase the benefit they derive from the Single Market, increase their growth rates relative to the rest of the Community and move more confidently to the next stage of European integration-Monetary Union.
 
 

11-10-1993
 



* The author is on the Staff of the Directorate-General for Economic and Financial Affairs, DG II B/2, Commission of the European Communities, rue de la Loi, 200 - 1049 Brussels. The views expressed in this article are those of the author alone and do not necessarily represent those of the Commission.