Cohesion policy and inequality dynamics: Insights from a heterogeneous agents macroeconomic model

• Model-based analysis of mechanisms driving the effectiveness of EU cohesion policies. • A multi-region heterogeneous agents model with empirical micro-foundations is used. • Consideration of evolution of inequality within and between regions. • Influencing firms’ technology choice in target region is key for fostering convergence. Regions within the European Union differ substantially not only with respect to per capita GDP, but also with respect to income inequality within the regions. This paper studies the effects of different types of technology-oriented cohesion policies, aiming at the reduction of regional differences, on the convergence of regions and the dynamics of income inequality within regions. In particular, policies are analyzed using a two-region agent-based macroeconomic model – the Eurace@Unibi model – where firms in the lagging region receive subsidies for investment in physical capital. It is demonstrated that the short-, medium- and long-term effects of the policies on per-capita output and between- as well as within-regional inequality differ substantially. Effects depend on how successful the policy is in incentivizing firms to choose best available capital vintages and on how flexible labor markets are in the targeted region.