Regional policy in a multiregional setting: when the poorest are hurt by subsidies

Regional policies that seek to reduce economic inequalities between regions are common. These policies normally involve subsidies or transfers to the poorest regions. Over any given short-term horizon such subsidies serve to reduce inter-regional inequalities, but as they also affect migration patterns the long-term effects are less clear. This paper demonstrates using a three-region general equilibrium model that subsidising the poorest region may be to the detriment of the periphery as a whole and even to the very region that receives the subsidy, if the subsidy draws firms away from a nearby region that would function better as a production centre. If the subsidy does not attract a sufficient number of firms to the subsidised region, then the long-term effect on the residents of that region would be negative. Though further research is needed to isolate the conditions under which such an effect would arise, this result has potentially important implications for the design of regional policy.