Does Targeting Aid Help Poorer Regions?

Per capita income in the United State’s richest metro area, San Jose, California, was four times greater in 2021 than in the poorest, McAllen, Texas.

To address such inequality, some government leaders have enacted “place-based policies” designed to give designated areas an economic boost—but unintended effects can undermine the results, suggests a research paper that explores one such policy prescription in Turkey.

A group of researchers analyzed a 2012 attempt to combat income inequality in Turkey, which has long had an economic divide. Growing disparities were leading job-seeking residents to move from poorer regions in the southeast to urban centers in the west, one factor that prompted the Decision on State Aids in Investments, a policy targeting some businesses with subsidies, including lower corporate income tax rates, social-security payment assistance, and interest-rate subsidies on private loans

The policy divided Turkey into six regions, allocating the fewest subsidies to Region 1, which included the four most populous provinces (Istanbul, Ankara, Izmir, and Bursa), and the most support to Region 6, which in 2011 had a GDP per capita that was less than a third of Region 1’s. For example, projects in Region 1 were eligible for an investment tax credit of 15 percent, while a similar project in Region 6 received up to 50 percent. Within each province, only certain industries were eligible, primarily agriculture, mining, manufacturing, and wholesaling. Companies received subsidies until the approved investment projects were completed.

The researchers calculated the direct and spillover effects of the policy using company- and worker-level data on revenues, investment, and employment from the Turkish Ministry of Industry and Technology. The model they built also factored in data on subsidies awarded, migration, and buyer-supplier relationships. The study covered companies with 20 employees or more and included only workers in the formal economy, who pay into the social-security system and at the time represented about two-thirds of workers.

For every 5 percentage point increase in the investment tax credit subsidy rate, companies’ revenues rose on average by about 16 percent, employment grew about 9 percent, and marginal costs fell by about 3 percent, the study finds. Even companies that didn’t receive this same tax break—but whose suppliers and customers did—got a boost: for instance, companies that had half of their customers receive subsidies saw their revenues rise 7 percent and employment increase by 6 percent on average, the researchers find.

Despite these influences on companies’ activities, the subsidy program was only partially successful in decreasing regional wage inequality. The policy reduced regional income inequality by about 7 percent in 2020, but the researchers’ model projects only a modest long-term impact: it predicts that number will drop to about 5 percent in 2026 and to less than 4 percent in 2036. This diminished effect is due to two side effects of the program, the first being its influence on migration. Turkey’s poorer regions had seen considerable population outflows toward its richer urban regions, but the subsidies slowed and in some cases even reversed these flows. Thus, even though employment rates rose, additional competition for jobs kept wage growth from rising as fast.

The second side effect, per the researchers, was that the benefits of subsidies spread through buyer-supplier networks, creating spillovers in other geographic areas. If a subsidized company in a poor region had customers or suppliers in Istanbul, for example, some of the effects of the subsidy showed up in the city, despite not having been directed there. This reduced the differential effect of the subsidies across relatively poor and wealthy regions.

Together, these two effects mitigated the program’s influence on income inequality. As the researchers note, “Absent both domestic trade flows and domestic migration, the impact would be nearly seven times larger.”