DP8133 Interregional Redistribution and Regional Disparities: How Equalization Does (Not) Work

Author(s): Anke Kessler, Christian Lessmann
Publication Date: December 2010
Keyword(s): Interregional Transfers, Redistribution Evidence, Regional Disparity
JEL(s): H71, H73, R58
Programme Areas: Public Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8133

Do inter-governmental transfers such as equalization grants reduce interregional disparities? This paper studies both theoretically and empirically the impact of interregional redistribution on interregional inequality. We set up a model with residential choice and equalization grants between regions, and show that interregional transfer payments prevent convergence promoting migration. We test our model in using cross-country data and panel data for 22 highly developed OECD countries. The evidence suggests a positive relationship between interregional transfers and regional disparities both across countries and over time from 1982 to 2000. In the cross-section data, we find that countries with higher levels of interregional redistribution in the past show a subsequent increase in interregional disparity, while countries with lower levels of grants and transfers show less divergence or even convergence. The panel reveals a similar picture: countries who have increased their sub-governmental transfers and grants have experienced more divergence (less convergence) over time than countries who have lowered their transfers.