The New Indulgences

Mario writes*

According to Christian belief, every sin will be forgiven by God if the sinner has truly repented. Therefore, Medieval German clergy started to ask believers to finance charity and tributes to God as demonstration of their repentance and obtain forgiveness for their sins and for those of their loved ones in purgatory. This led to a market for forgiveness-certificates. To be forgiven, people were just required to buy an indulgence certificate, rather than making charitable donations and demonstrate their repentance.

The transformation of indulgences from earnest donation to market certificate led to a public outcry because this mechanism meant trading God’s forgiveness, stripping indulgences of their religious meaning, and incentivizing the wealthy to sin. This scandal eventually triggered the Lutheran Reformation.

Many carbon offset detractors argue that they are similar to Medieval indulgences, allowing a way of purchasing forgiveness for polluting instead of radically changing production processes and therefore reducing emissions (Cavendish 2019).

Are indulgence-like compensations inherently bad or an effective economic tool to price externalities and therefore reduce their effects? Bowles argued that economic compensations for bad behaviours can also be counterproductive, because if it is possible to pay for forgiveness, people can just account for them in their costs, much like indulgences. Indulgences made sinning easier by replacing moral with economic costs (Bowles 2016). Nevertheless, I would argue that payments for externalities that go to those harmed clears the slate.

Economic processes generally generate externalities (Laffont 2008). For example, when a factory produces goods, the pollution it emits is an externality, i.e., it can decrease air quality and harm other economic activities (e.g., tourism). An economy with unpriced costs is inefficient (Shepsle, 1997).

The problem’s size becomes clearer when the one who suffers is not only the individual whose business has been damaged, such as a hotel facing a tourism decrease, but the entire world suffers from large-scale environmental degradation.

Measuring externalities and identifying their origins is technically difficult. How can the hotel owner demonstrate that a firm’s pollution accounts for the loss of 30% of his customers and demand compensation? This is almost impracticable with contemporary tools so externalities are poorly integrated into costs.

Using new technologies, it is possible to measure and price externalities and then compensate those who are harmed. Generalized taxes, such as those on carbon, usually fail to efficiently compensate those who incur costs. Similarly, the problem of indulgences was that money went to the clergy rather than the poor. So the goal should not just be lower emissions but also compensation to those harmed by them.

Therefore, new financial and technological tools are needed to define the payer and the receiver, developing a mechanism which guarantees that these transactions benefit both parties fairly and constantly, i.e., the system should be able to assess how much the hotel is losing in profits and allow the firm to either compensate for those costs or eliminate them by reducing emissions.

From this foundation of local redistribution, it will then be possible to develop a global systems of redistribution to measure and fairly reallocate costs to improve market performance and get closer to climate goals.

Bottom Line: We need to measure and price externalities and then compensate those harmed by those externalities. This system will allow the New Indulgences (carbon offsets) to work as promised.

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

The CFA Franc(e) in Senegal

Noa writes*

It has been 60 years since Senegal officially became independent from French colonial rule, which lasted 300 years. To this day, however, French influence in the country is widespread, ranging from the education system to politics to the products being sold in the grocery stores and the use of French as the official language in a country where Wolof is the most widely spoken language.

Françafrique, literally “French Africa,” embodies neocolonialism for many, and Senegal is still influenced by its former colonial power, France. One legacy is the Communauté Financière Africaine (CFA) franc, formerly known as the French African Colonial franc, a currency created by France, and adopted in 1945 by fourteen West-African states, including Senegal. The CFA franc is pegged to the Euro, with a fixed exchange rate that has not changed since 1994. France guarantees the CFA franc’s unlimited convertibility into Euros, and in return requires that Senegal deposits at least 50% of its foreign exchange reserves with the French Treasury (Ministry for Europe and Foreign Affairs, 2019). The relationship between France and CFA-franc countries runs deeper. France is Senegal’s top trading partner and investor, French businesses account for 25% of Senegal’s GDP and tax revenues, and Senegal has received over €1.5 billion in aid from France (Ministry for Europe and Foreign Affairs, 2017).

In recent years, discontent with the CFA Franc and France’s socio-economic and political influences in Senegal have grown (Taylor, 2019). Proponents of the currency, as well as France itself, claim that the CFA franc has

  • Provided monetary stability thus encouraging foreign investment,
  • Controlled inflation thus keeping interest rates low, and
  • Facilitated trade with Europe by removing exchange rate risk (Economist, 2018).

Critics argue that

It is within the context of this growing discord that the Economic Community of West African States has suggested replacing the CFA franc with a new common currency, the Eco. The impacts of this new currency and timeline for its implementation are uncertain, but the CFA franc’s days are numbered.

Bottom Line: French influence in Senegal remains strong socially and politically, but especially economically. It is this degree of post-colonial influence that needs to be taken into account when analysing the extent to which Senegal’s plans to abandon the CFA Franc will give the country freedom to pursue its own goals.

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

Policies for the AI Revolution

Alexandra writes*

According to political economist and founder of the World Economic Forum Klaus Schwab, “major technological innovations are on the brink of fueling momentous change throughout the world – inevitably so.” He is referring to what some describe as the fourth industrial revolution. In the first industrial revolution, steam machines and railroads gave rise to mechanical production. The second one gave us electricity and assembly lines leading to mass production, which was later followed by the digital revolution brought about by the internet and increasing computing power.

The fourth industrial revolution is, among other things, is characterized by artificial intelligence (AI) and machine learning. AI has the potential to massively increase the efficiency of many processes and strongly increase economic growth, but could also be very disruptive [pdf] to economies and societies. Experts worn of risks [pdf] such as increased inequality, mass unemployment and the development of large monopolistic firms. In response to this foresight, people like Klaus Schwab have emphasized that we need to radically rethink our political, economic and social systems. In this blogpost I will present some of the ideas that people have come up with to mediate and/or prevent the 4th Industrial Revolution’s potential negative effects on equality, employment and income.

Robot tax

This could take form as either companies paying income taxes that would formerly have been paid by the replaced human workers, or as an increase in profit taxes if companies use robots that have increased their profits. The idea of taxing robots would help solve the problem of declining income taxes due to unemployment. With these robot taxes, governments could fund the much-needed social security system for all those who have become unemployed. It would also slow down the replacement of human workers with robots. The first (sort of) robot tax has been introduced in South Korea in 2017. However, a strong point of criticism against taxing robots is that it would slow down innovation and harm the economy by decreasing capital investment.

Universal Basic Income (UBI)

This would be an “unconditional transfer payment” to all citizens of a country. UBI would be one way of shaping a broader social security system, which is likely to be necessary with increased automation and the unemployment linked to that. Moreover, since this system would redistribute wealth, it would also help to decrease inequality. So far, no country has introduced a real UBI, but many pilots have been, and are being conducted. Moreover, this idea is gaining more and more traction. For instance, 64% of EU citizens were in favor of UBI in 2016 and this number has increased to 71% in 2020.

Universal Basic Dividend (UBD)

This is a variation on UBI, but rather than being funded by taxes, UBD would be funded through a government’s capital investments into companies. With UBD, corporations would have to have an X percentage of their shares held by the government. This would make sense considering that those corporations profiting thanks to technology (e.g. through the use of robots) are strongly benefitting from public investments into research. By transferring part of their profits to the public through the government-held shares, this free-riding problem would be solved. One example of UBD that has existed since 1976 is the Alaska Permanent Fund, which gives citizens part of its oil revenues. In 2019, Alaskan citizens received about $1,600 from the fund.

Bottom Line:: AI is bringing about the fourth industrial revolution, so it is time to radically rethink our political, economic and social systems to prevent mass unemployment, skyrocketing inequality and a weakened social security system. Robot taxes, UBI and UBD could be options.

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

The gravity of poverty in the U.S.

Thomas writes*

Poverty, when concentrated in a small neighborhood, can often lead such neighborhoods to become economic “dead zones” — cut off from investment due to the perceived risks and lack of profit potential to investors. In the long-term, this entrenches the disadvantaged position of residents as property values fall and poverty and crime rates rise in a positive feedback loop (Sánchez-Jankowski 1999).

But despite noticeable drops in both population and investment in such affected areas, the size of many “dead zones” seems to expand over time. This is because businesses and residences lying in the periphery of disadvantaged areas face exposure to many of the economic and interrelated social problems, such as higher crime rates, which increase insurance premiums among other costs, facing the center of the dead zone, and can therefore fall in with that center.

Demographic distribution and change in an African-American area in Detroit 1989-1995, field observations by Martin Sánchez-Jankowski

A core neighborhood where poverty has concentrated can therefore damage the potential for growth in a far wider area over time as an increasingly large area is divested from. But beyond pulling peripheral areas in, such expanding poverty-stricken areas also make it increasingly difficult, or at least less appealing, for residents to move elsewhere — for more than just financial reasons.

Pre-existing conceptions of identity and entrenched local social support networks within these neighborhoods play an important role incentivizing one to remain where they are in order to preserve proximity to those valued social networks (Krysan & Farley 2002). The expansion of “dead zones” also facilitates searches for cheap housing, as more buildings integrate with the ghetto, or encourage previous residents to return after having suffering economic setbacks, both because of cheaper cost of living and proximity to family networks (Sánchez-Jankowski 1999).

In some cases, cheap housing can attract wealthier outsiders looking for cheap accommodation — in turn driving up housing costs and leading to gentrification. In the United States, at least, such influxes are far less likely to happen in predominantly African-American neighborhoods since Whites, who make up the vast majority of the gentrifying, yuppy class, are far less likely to move into or remain neighborhoods with a significant number of African-American households. They do not, however, seem to have a general bias for or against predominantly Asian-American or non-Black Hispanic neighborhoods.

Bottom Line: Concentrated, underprivileged neighborhoods manage to preserve their identity and expand their presence over time. They can manage to consume neighboring areas, retain residents in the long-term, and discourage investment which might change the neighborhood. This is evidence of a kind of self-preservation on a neighborhood block scale.

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

More crops and less poor in Peru

Jan writes*

Poverty is largely a rural occurrence around the world and Peru is no exception. In 2004, 40% of rural population in Peru lived in extreme poverty compared to 8% in urban areas (World Bank 2005). Improving the income of poor rural households is therefore a critical step in poverty eradication efforts. In this blogpost, I will first offer a brief overview of the current state of agriculture in Peru and the income sources of the poor rural households. Then I will point out possible trends that could increase the income of the rural poor and zoom in on the possibility of increasing productivity, explore the required steps to increase it, and assess the capacity of the poor to take such steps.

Peruvian agriculture can be divided into its main sectors: high-value export products and staple crops for domestic consumption. The high-value export products grow primarily in the Costa (coast) and also in the Selva (rainforest) and consist of crops such as coffee, mango and avocado. Peaks in prices in international markets have boosted the growth of this sector (Flachsbarth, 2018). The staple crops, on the other hand, mainly encompass potato and maize, which are grown in the Sierra (highlands) and are targeted for domestic consumption. Most poor rural households, located in the Sierra, earn their income by growing staple crops. Recent increases in prices and gains in productivity have raised the farm-income of these households and reduced poverty (Flachsbarth, 2018).

There are three possibilities that have the potential to further raise income for poor rural households:

  1. Shift to high-value export crops
  2. Become employed in the non-farm sector, and/or
  3. Raise staple crops with higher productivity.

The high prices of high-value export crops motivates poor farmers to grow more of those crops. Similarly, the rise in employment in non-farm sector, particularly in the food-processing and tourism sectors, can be a profitable source of income for the rural poor. Finally, further increases in productivity of staple crops reduce costs of production and offer higher farm incomes (Flachsbarth, 2018). I will further explore this third alternative by looking at what is necessary to increase productivity and what is the capacity of the rural poor to do it.

Conventionally, increases in productivity require the adoption of technology. This mainly refers to the adoption of improved varieties of seeds, chemical fertilizers and pesticides and machinery for harvesting, transport and storage (Dethier & Effenberger 2012). An alternative view argues that increases in productivity can result from the adoption of sustainable practices such as natural pest and weed control, organic improvements to soil health and efficient water use (Pretty et al 2002).

Picture from elEconomista, 2018 

The capacity of poor farmers to increase productivity through adoption of technology is, nonetheless, heavily constrained. They face three main challenges: insufficient education, insufficient access to financial capital, and risk-averse behaviour aimed at avoiding failures. The rural poor often lack skills and knowledge necessary to use material technology (Ruttan and Hayami 1973). Furthermore, the costs of inputs such as seeds and fertilizers tends to be high, and poor farmers may have difficulties in accessing credit sources to acquire such inputs (Rahman 1999). This problem is accentuated due to higher-than-ideal costs that result from protectionism of domestic chemical industries (which prevents international competition) and limited infrastructure networks (which raise transportation costs). Finally, poor farmers tend to shy away from adopting technology because of the risk it involves. The potential negative trade-offs of risk-taking could be starvation and loss of land (Weeks 1970). Therefore, poor farmers hesitate to adopt new technologies.

The barriers between poor farmers and new technology need to be addressed by government initiatives or collective action if productivity is to rise in Peru. Perhaps low cost, sustainable practices can help? Higher incomes can also reduce risk aversion, so it may also be useful to increase rural incomes by encouraging the shift to export products or off-farm employment

Bottom Line: Poor rural households in Peru face different opportunities to increase their income. It is necessary to identify what prevents them from harnessing those opportunities. This will allow us to propose sound policies that can assist poverty eradication.

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

The dangers of greenwashing

Lotte writes*

In March 2021 Tariq Fancy, the previous chief investment officer in the department of ESG investing at BlackRock (the largest asset manager in the world), published an opinion article in which he essentially stated that ESG investing is “little more than a marketing hype.” (ESG stands for “Environment, Sustainability and Governance.”) He exposed parts of the industry by claiming that some companies who label themselves as ESG actually do not act sustainably, and some even invest in fossil fuel companies and other polluting industries. His piece caused a flare-up in discussions around ESG investing and the greenwashing that it has caused.

Greenwashing happens when funds present themselves to be sustainable when they are not to attract more investors. The rise of greenwashing amongst funds has risen because of the rising profits in the ESG market. ESG funds and ETFs are becoming increasingly profitable, reaching record-breaking heights last year. This increased attractiveness of ESG is reflected by a large increase in funds rebranding themselves as ESG. However some of these rebranded funds are not as green as they want others to think. Firms are able to greenwash without repercussions because concrete rules and checks are lacking, allowing them to publish incorrect or manipulated data.

One might think that because there are no current regulations, greenwashing can’t be that harmful. However this is a dangerous assumption considering we are nearing a point of no return with climate change. Greenwashing presents a problem because of two reasons: First, it causes a barrier for investors to integrate an ESG framework into their decisions, meaning that the potential that ESG investing has in changing consumption goes lost. Second, it puts up the façade of a positive change happening in big firms, when realistically they are still irresponsible producers. Fancy emphasizes the last issue in a call for action addressed to the government, as we are running out of time to take climate action, and we cannot afford to not take action.

The solution to greenwashing seems obvious: a clear set of regulations for what is defined as sustainable and what is not. Luckily it seems that governments and multigovernmental institutions like the EU have also been noticing the issues with the current rules around ESG investment and sustainability labels. On March 10th the EU issued a new set of rules to help define the difference between sustainable and non-sustainable products. The US government also took notice and announced the creation of a Climate and ESG taskforce, which will “proactively identify ESG-related misconduct.” Hopefully the implementation of these regulations will be effective so that ESG investment can keep on expanding in a way that actually makes progress rather than standing still.

Bottom Line: Greenwashing is presenting itself as an big issue in ESG investing. This issue needs to be solved as soon as possible, and the best solution seems to be government regulations.

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

Altruism and development

Diego writes*

In the West, we have tended to focus a lot more on the outside (external) rather than the internal. This has brought amazing outcomes in the material dimension of things: revolutionary technology, high living standards, etc. At the same time, this overly focus on the external has left an untapped potential for developing the internal. This area of inquiry has been left to religions and spirituality to take care of, and it has been seen as separate (or tried to be separated) from economy and politics. But, as we will see, the internal and external are deeply connected.

There are huge untapped potentials for focus and investment in the internal development of individuals because of the huge benefits it can bring to individual wellbeing, societal wellbeing, and the productivity and capabilities of individuals (human capital) in the long term, which is pretty much all we care about.

Of all the areas of internal development/growth, one that receives close to no attentions is that of motivations. We assume that people’s motivations are self-arising and unchanging. For example, in the field of political economy, motivations are taken as extrinsic (given). When creating a model using methodolocial individualism you take preferences, believes, environemnt to model individuals’ and groups’ decisions, but it is never considered that it might be possible to manage/change preferences (motivations). But they can be affected.

For example, in the Buddhist tradition there are practices to influence our motivations. The simple explanation is the following. We are motivated by our emotions and thoughts, so if we are able to feel more of a certain emotion, we will be more motivated by it. Certain Buddhist practices, like one from the Tibetan tradition called “Tonglen”, work to make certain wholesome emotions (love and compassion) more accessible and for individuals to feel them more often. It has been found that feeling works like a muscle, the more you feel it, the more accessible is this experience (as with gratitude, for example). So, the Tonglen practice works by simply triggering these emotions time and again so that they become more accessible to us.

These practices not only can make us better human being overall (think relationships and teamwork), and improve our wellbeing, but, as we are strengthening our motivations, these practices can make individuals more productive and therefore bring about better economic outcomes. Bettering our motivations can definitely better society as they bring huge positive externalities to all of society. So maybe, just maybe, government should incentivize it, and, for example, subsidize organizations sharing these practices and make it part of the school curriculum.

Bottom Line: There is huge untapped potential in the area of internal development. Practices for generating more altruistic motivations have the potential to create a better society for all. These practices improve personal wellbeing and society as a whole.

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

The bright side of the black market

Menno writes*

The black market is not as bad as many policymakers believe. It provides a lot of otherwise unemployed individuals with labor and income. Formalization of the economy is vital since it allows for more development through taxation, which is especially the case in countries with a huge informal market such as Bangladesh. However, this does not mean the informal economy is only bad news.

Informal businesses collectively employ fully half the world’s workers. Often, the black market is considered to be harmful to a country’s development. However, small, illegal, off-the-books businesses collectively account for trillions of dollars in commerce. These enterprises are essential for entrepreneurialism, innovation, and self-reliance. Furthermore, black markets have grown during the international recession, adding jobs, increasing sales, and improving the lives of hundreds of millions. Thus, black markets offer more than meets the eye.

The reason the informal market troubles a lot of policymakers is because it is associated with low productivity and poverty. It is generally believed that the primary solution to a large informal economy is economic growth. More formal employment leads to more taxation, which can then lead to better education, which can help people transfer from informal to formal labor. The figure below shows that an increase in GDP is associated with a lower share of informal employment. However, this trend does not occur in all countries.

In Bangladesh, specifically, the informal economy has grown to a vast size. It currently accounts for 89% of the total labor force, constituting 64% of the country’s GDP. The informal market has grown despite a steady rate of economic growth for the last three decades. The increase of the informal market is driven by the large population, the dominance of young age groups, and an increase in female participation in the labor market. Furthermore, Bangladesh’s economy is witnessing a significant growth of service sector jobs ahead of manufacturing jobs, forcing a lot of people to work in the black market.

Institutional restrictions, harassment, illegal extractions by local touts, and general hostility in society significantly limit the full potential of the black market in Bangladesh. Furthermore, informal businesses enjoy less institutional support than their formal competition. Often, informal employees work under challenging conditions, with more harassment and less job security.

Since economic growth decreased the size of the informal economy, Bangladesh requires a different approach. First of all, I believe, since the informal economy plays such a significant role, Bangladesh should focus on improving productivity within the sector instead of threatening it. Policymakers should remember that, even though the formal economy is more efficient, the informal economy still provides a large number of jobs and contributes to economic growth. Thus, instead of attempting to lower the size of the informal market through institutional restrictions, I believe it should be incorporated into the formal economy by providing job security and benefits.

Second, policymakers need to shift from promoting service sector jobs to providing industrial employment and investing in education. Often people are informally employed, not because they want to but because they have to. By providing these individuals with jobs and education, they could transfer into the formal market, where there can work under better conditions for a better wage.

Bottom Line: Productive work is helpful, formal or not.

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

Not-so-special economic zones

Sam writes*

Ever wondered where that iPhone of yours came from? Who put it together? And how are so many can be made each year? For years we have used a neat trick in order to keep up with this type of demand, most particularly in electronic devices.

Special Economic Zones (SEZs) are that neat trick. They offer “tax efficiency” and loose regulations to attract industry that will export to the world. China loves them — establishing over 60 SEZs since the 80s — and that’s how you get the iPhones you know and love.

So that answers the “where” question, but what about the “who” and the “how”? As it turns out, Apple workers in Chinese SEZs have some of the worst working conditions imaginable. Minimum wages are barely higher than the living wage [pdf], working shifts can exceed 16 hours (oh and there’s no overtime pay), and conditions require workers to meet quotas as they attach tiny wires and chips all day. The stress has led to alcohol abuse, divorce rates are 3 times the national average, and suicides so regular that factories have have councilors on site.

How are companies allowed to do this? Article 22 of the National Chinese Labor Act states that workers have the right to fair pay and healthy working conditions but not in SEZs (remember those loose regulations). Since trade unions are not permitted in China, workers are not likely to see improvements in their conditions.

Photo Courtesy of Steve Jurvetson, CC-BY-2.0 [pdf]
Apple’s relationship with China was worth over $43 billion in 2019, with 217 million iPhones produced (and some sold) in the country. SEZs allow rich companies to profit from cheap labor in exchange some technology transfer. SEZs are popular everywhere, but especially in rapidly developing countries such as China and India that have abundant labor. In places without a labor glut, like in the United Arab Emirates, labor is imported [pdf] to work in their “Free Economic Zones”.

Bottom line: Global competitiveness means firms need fast, efficient, accessible places to produce their products. Countries with SEZs benefit from growing industries, FDI, and new technologies, but is this the best route to development? Worried that workers are losing? Don’t. Your nice new iPhone created jobs, even if they are poorly paid.

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).

Corruption and EU Cohesion Policy

Pieter writes*

Roughly a third of the European Union’s budget is spent on Cohesion Policy. Through this, the EU invests in sub-national regions with the aim of “converging” their quality of life upwards, to EU averages. This is done by fostering economic growth, business competitiveness, sustainable development, and supporting job creation in the poorer regions of Europe. Three different types of funds are used: First, the Cohesion Fund is used to ameliorate the economic and social situations of the regions of Member States with a GNI per capita that falls below the threshold of 90% of the EU’s average. Second, the European Regional Development Fund (ERDF) aims to induce competitiveness and create regional jobs. Third, the EU invests in educational opportunities and combats unemployment using the European Social Fund (ESF).

Over the past decades, many studies have analysed how effective Cohesion Policy has been in converging the regional economies of the EU. Numerous studies have found that transfers from the different Cohesion Policy funds effectively stimulated economic growth in underperforming regions (Becker et al., 2012; Becker et al., 2018; Medeiros, 2013). However, most of the studies analysing this subject mention a variety of drawbacks. First, studies found that the EU was not effective in all goals that it claims to pursue with Cohesion Policy. To exemplify, research has suggested that it has not been very successful in reducing unemployment (Becker et al., 2010). Second, although immediate results are promising, progress often stops or reverses when funding stops (Becker et al., 2018). Third, Cohesion Policy effectiveness depends on institutional quality, which is largely outside the EU’s sphere of influence (Marzinotto, 2012 [pdf]).

Although institutional quality can be approached from several perspectives, a crucial component is the level of corruption within the institutional structures of Member States receiving transfers. Corruption reduces Cohesion Policy effectiveness through two (interacting) mechanisms. First, in a corrupt administration much of the resources made available will be allocated to ‘rent-seeking’ activities, as opposed to ‘productive’ activities; this will thus inhibit the extent to which the goals of Cohesion Policy can effectively be pursued (Ederveen, 2003). Second, once the European Commission establishes that funds are used in a corrupt manner, it can decide to withhold further funds. To exemplify, Bulgaria was entitled to roughly a billion euros from the European Regional Development Fund in the period from 2007 to 2009. However, because the Commission was unsatisfied with responses to fraud and corruption cases, so Bulgarian regions received only 30% of the initially allocated funds (Pop, 2009).

Analysing the relationship from a different perspective, it can be theorised that there is also a causal mechanism between Cohesion Policy and corruption, originating from Cohesion Policy itself. In other words, Cohesion Policy can induce corruption in the regions that it aims to support. Fazekas (2013 [pdf]) analysed Central and Eastern Europe and showed that although the EU provides extra resources, often it fails to balance this out by putting sufficient controls for corruption in place, leading to increased rent-extracting behaviour.

Bottom line: Although the European Union’s Cohesion Policy has helped helped sub-national regions grow, it may not work if corruption diverts funds and may exacerbate corruption if implemented without controls.

* Please help my Economic Growth & Development students by commenting on unclear analysis, alternative perspectives, better data sources, or maybe just saying something nice :).