Growth effects of regional policy in Germany: Results from a spatially augmented multiplicative interaction model

Private investment subsidies are a key instrument for regional policy making to foster the economic development in lagging regions. In this paper, we analyze their effect on labor productivity growth for German labor market regions for the period from 1994 to 2006. A spatially augmented multiplicative interaction model based on neoclassical growth theory is used, which allows us to assess the marginal effect of regional policy proxied by overall payments of the main German regional development program on the region's convergence speed conditional on its initial income position as well as policy-related spillovers from its spatial neighborhood. Our results show a statistically significant positive effect of regional policy on labor productivity growth, which increases, the further away the supported region is from its steady-state income level, and the more grants are provided to its geographical neighborhood. The latter effect highlights the existence of positive spatial spillover effects from regional policy in Germany, which enhance the attractiveness of the whole macro region for private sector investments. The additional growth stimulus provided by a 1 % increase in the region's funding volume is thereby related to an up to 0. 3 % gain in terms of labor productivity growth. For regions with the highest initial gaps to steady-state income in the sample distribution, the regional policy stimulus accounts for almost 8 % of the regions' productivity growth performance.