An econometric decision model for equalizing regional unemployment in West and East Germany

Reducing disparities among regions within European countries is the aim of European and national structural policies. In particular, a European grant contributes to the German governmental program for equalizing regional unemployment. The goal is to bring it down to the national average by creating new and/or by safeguarding existing jobs. In the given paper the distribution of available aid among 271 German labor market regions is considered as an econometric decision problem. At first, the dependence of the unemployment rate on the amount of aid is estimated for each eligible region. Using this dependence, the variance of regional unemployment rates is expressed as a function of the regional subsidies. The optimal aid distribution among regions is obtained by minimizing this variance subject to the total budget constraint and administrative restrictions. The optimal figures computed are compared with statistical data for 2000-2002. They show that the regional unemployment in West Germany could be equalized better (with variance 3.50 against the actual 4.40) and with a simultaneous decrease in the average unemployment in West Germany from 7.45 to 7.28%. In East Germany all regions are eligible, implying no administrative constraints and a high optimization flexibility. It enables almost perfectly equalize regional indices down to the variance 0.28 against the actual 9.76. Under the model assumptions, the actual results of the equalizing policy could be attained by half the budget granted. These underused possibilities explain the low efficiency of active labor market policies reported in empirical studies. To improve their performance, some tools for optimally distributing subsidies and predicting their effects are suggested.