policymakers demonstrate

352 Stef Proost and Jacques-François Thisse
and labour are mobile, and vertical linkages are accounted for using regionalized
international input-output matrices. The model is implemented for the
267 NUTS 2 regions of the EU and used to assess the effect of investments that
reduce trade costs. The properties of this model are tested by simulating the
impact of planned Cohesion Policy investments in infrastructure, whose main
targets are the poorer, peripheral regions. The aim of the exercise is to isolate
the effect of the different economic mechanisms identified in Section 8.3, for
which three scenarios are simulated.
Scenario 1: Isolating the Effect of Capital Mobility
By switching capital mobility on and off, allowing savings in one region to be
invested in other regions, the authors find that the tendency toward the equalization
of the rates of return on investments spreads the growth effects of the
transport investments more equally. This is the home-market effect at work:
although the poorer (peripheral) regions received a larger share of the transport
investment, the relocation of capital leads to more growth in other EU regions.
Scenario 2: Isolating the Effect of Labour Mobility
By switching labour mobility on and off, allowing workers to relocate where
their real wages are higher according to estimated elasticities, the authors find
that the region receiving the initial investment will benefit from a lower cost
of living. This attracts more workers and increases the size of the region, its
production, and its consumption, which should foster agglomeration. However,
since consumer tastes are calibrated in each region based on the observed
trade flows in the base year, the growing regions also demand more from the
peripheral regions, which bids up prices and prevents a strong agglomeration
effect. The cost-of-living effect is found to be stronger than the labour marketcrowding
effect, thus magnifying the beneficial effect of local investments and
making the lagging region better off, but the effect is very localized.
Scenario 3: Isolating the Effect of Vertical Linkages
By switching interregional consumption of intermediates on and off, it can be
noted that higher demand for intermediate goods in regions with improved
accessibility attracts producers of intermediate goods, which lowers the production
costs for the producers of the final goods. In the absence of vertical
linkages, the benefits of Cohesion Policy investments are more localized. However,
when vertical linkages are allowed, the productivity improvements in one
region spread to all the regions using its output as an input in their productive
processes. Therefore, the benefits of allocating resources to a region are felt
beyond its borders.