Redistribution Undermines Prosperity: Evidence from Italy

September 22, 2023 by Dan Mitchell @ International Liberty 

periodically explain that redistribution is bad for prosperity, mostly because it encourages sloth and dependency among recipients.

Though it is important to realize that the taxes needed to fund redistribution also are harmful (the magnitude of the problem can be viewed here and here).

I also periodically share new scholarly research on these issues.

And that’s our topic for today since the U.K.-based Centre for Economic Policy Research has published some new research about Italy.

The study, which looks at why Northern Italy is much more prosperous than Southern Italy, was authored by Jesús Fernández-Villaverde, Dario Laudati, Lee Ohanian, and Vincenzo Quadrini.

We’ll start by confirming there is a big difference in relative living standards. As you can see from this chart, this gap has existed ever since Italian unification in the 1800s and is bigger now than it was 100 years ago.

Here are some key findings, most notably the harmful impact of redistribution..

In a new paper (Fernández-Villaverde et al. 2023), we seek to identify the major drivers of the regional income differences in Italy using the macroeconomic approach based on the measurement of various wedges… The model consists of two integrated regions. The first is representative of the Northern and Central regions. The second is representative of the Southern and Island regions. …our goal is to understand which of the measured wedges are especially important for generating lower income in the South. …

We…find that inter-regional fiscal transfers contribute significantly to regional income differences (see Figure 2). The combined contribution of productivity differences and inter-regional fiscal transfers accounts for more than 70% of the income gap between Southern and Northern regions. The finding that inter-regional fiscal transfers contribute to regional income disparities is the most interesting finding, and the intuition is straightforward. First, inter-regional fiscal transfers are large. …In the counterfactual steady-state equilibrium without fiscal transfers, the output gap between the South and the North is reduced by one-fourth.

That’s remarkable. One-fourth of the gap between Northern Italy and Southern Italy could be eliminated simply by getting rid of redistribution.

Here’s the aforementioned Figure 2, which also is a good depiction of the dramatic difference between north and south.

There’s one other aspect of the study that is worth mentioning.

In their research on regional prosperity, the authors find that funds for “regional development” are not helpful.

And that is true regardless of whether the handouts come from Rome or Brussels.

Italy has invested large funds in regional development for decades. Were these monies well spent? …Nowadays, the European Structural and Investment Funds account for more than one-third of the whole budget of the EU, with a forecasted expenditure of €392 billion in 2021-2027. Will these funds make a difference? Our paper’s results cast doubt on the efficacy of these regional policies per se

I’m shocked, shocked.

P.S. The good news for Italy is that policy is not getting worse over time, but that also can be bad news since the country needs some shock therapy to avert a rather grim future (elaborated on here and here).

P.P.S. Not only does Italy provide some good evidence on the damage caused by redistribution, it also has led to research showing the harm of red tape.