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An Old Theory vs. Complexity – Federalism, transfer system and (non)growth

For a long time, economic literature (theoretical and empirical) suggested that one of the best performing countries (in terms of innovativeness, productivity, growth, democracy, decreasing inequality etc.) are those having highly decentralised system, the so called fiscal federalism and the associated transfer system. Germany is one of those countries.
The apropos of this short rudimentary post is the recent evidence about the inefficient and ineffective work of the famous Finanzausgleich transfer mechanism across German Länder. The cited study has analysed empirically the effect of inter-governmental transfers on economic growth with a panel of West German states over the period 1975-2005. The findings suggest that transfers do not foster economic growth, presumably because the recipients use them to subsidize declining industries.
This finding seems to signal that our theory might be wrong. I do not by any means emphasise that the theory might be wrong, instead I would go for a ’it does not necessarily apply all the time across techno-economic paradigms’ argument.
Let me just underline intertwined phenomena that have been evolving in parallel and constituting a socio-economic configuration that makes it more difficult for such a theory to be held for a very long time. Our line of thinking here is as follow:
1) There is a dynamic pattern in the innovation ecosystem: our techno-economic paradigm has been changing gradually since the 1970s, a new service oriented knowledge economy has been ever more evolving by contributing to the Digital Age, the so-called digital economy.
2) We have a growing budy of evidence today to question the thesis on the high productivity-increasing potential of digitalisation because (still with the caveats with measurement) there is a secular decline in productivity growth in developed countries, like Germany;
3) This is why the premium of high-skilled, creative workers has been increasing and they are regularly syphoned away to growth poles by worsening the absorptive capacity of the poorer regions when it comes to efficiently absorbing transfers;
4) Not to mention the development of industry 4.0, the so-called fourth industrial revolution, when the spread of smart factories (equipped with sensors, robotics, ICT-based integrated production, logistic lines with cyber-physical systems, 3D printing, AI, Internet of Things etc.), is primarily expected in richer regions since declining industrial players in poorer regions face gargantuan problems: not having enough talents and skilled workers, and the high front load investment need cannot smoothly tackled;
5) In this configuration, having a bias – as the cited study emphasised – towards declining industries (and their context – education & training system, and other public services shaping the given innovation ecosystem) with the consequence of not sparking enough growth in statistics can be an acceptable option, because in this way the likelyhood of the full detachment and divergence of poor regions from the richer ones can be dampened – as, by the way, the statistics in case of German Länder show. Bremen, Saarland are stagnating but not declining, while Thüringen, Sachen-Anhalt are on growing trends in terms of gross domestic product at current market prices (see Eurostat, by NUTS 2 regions [nama_10r_2gdp]). In addition: poverty risk had declined not only in the city-state of Berlin, but also in the poorer states like Mecklenburg-Vorpommern. The situation is not clear-cut, of course, since the rate of people at risk of poverty across Germany is still a huge problem: In the 1980s, the risk of falling from the middle income milieu into poverty had been around 12 percent.  Since 2005, the risk had risen to 16 percent.
In parallel, new and old complex challenges (climate change, migration, demographic, broken harmony between the parasitic financial sector and the real economy etc.) are making governance and economic policy ever-more limited to easily demonstrate to the wide public that ’we can manage’. Under these circumstances, not letting poor regions to diverge even more rapidly is per se an achievement. But, of course, institutions matter together with good governance, lowering the rentier-culture etc. to breed a fertile ground to offer equability, and thus a better life for all.
It is important for economists to admit the limits of our knowledge because we have to address issues developing in time in a non-linear and complex system. We have to cultivate our ability to adjust public statements and policies not only to what we can know and what might be the unknown unknowns, but also to what we should really cheris is qualitative growth.
Olivér Kovács Ph.D is a Hungarian economist specialised in the research fields of sustainable development, fiscal sustainability, innovation and innovation policy.

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