International Investment Pushes Past and Present, Part 4: The European Union

By Tim Hirschel-Burns

This blog is part of a blog series on past large-scale international investment programs and the lessons they provide for the investment push needed for development and climate action today. You can read the introduction to the blog series here, part 1 on the Marshall Plan here, part 2 on South Korea here and part 3 on Jubilee-era debt relief here.

Among the major development projects of the last century, one of the largest and most successful is rarely seen as a development project: the European Union (EU). The EU’s Cohesion Policy accounts for around a third of the EU’s budget, which directs development investments to boost lower-income parts of the EU.

By some measures, these investments made some EU members among the largest recipients of development assistance in the world. For example, from 2007 to 2013, Poland received €58 billion from European cohesion funds. In that same time, similarly populated Kenya received the equivalent of only €13 billion euros in official development assistance (ODA). In that same period, European cohesion funding exceeding €250 per capita went to Czechia, Estonia, Hungary, Latvia, Lithuania, and Slovakia each year, about five times the ODA per capita going to low-income countries.

While it’s not the only cause of the impressive development experienced by emerging market EU members , these investments were important contributors to growth and social progress. This was seen first in lower-income EU members like Spain and Ireland and later in Central and Eastern European members that joined the EU in the 2000s. These advances in EU convergence precisely what the EU’s Cohesion Policy was designed to achieve: European policymakers agreed that deeper economic and political integration requires reducing inequalities between regions.

At a time when developing countries need an investment push financed in significant part by external resources, there is much to learn from this large-scale EU example that successfully supported European countries for decades. The EU has spent close to a trillion euros on these development investments, with funds focused particularly on infrastructure, delivered almost entirely through grants, and organized through structured and predictable mechanisms. By and large, it has worked.

The evolution and organization of the EU’s Cohesion Policy

The Treaty on the Functioning of the European Union provides the foundation of the Cohesion Policy, stipulating that, “In order to promote its overall harmonious development, the Union shall develop and pursue its actions leading to the strengthening of its economic, social and territorial cohesion. In particular, the Union shall aim at reducing disparities between the levels of development of the various regions and the backwardness of the least favoured regions.” As the EU has prepared for moments of deepened integration—including the launch of the single market in 1993 and the addition of 12 new members in 2004 and 2007—the urgency to reduce territorial imbalances has increased.

Following intense advocacy from Spain, the modern format of European Structural and Investment Funds emerged alongside the EU’s establishment in 1993. The Cohesion Fund and the European Regional Development Fund (ERDF) have formed the primary funds under the EU’s Cohesion Policy. Eligibility for the Cohesion Fund depends on a country’s income: member states with a gross national income below 90% of the EU average are eligible. Eligibility originally included Greece, Spain, Portugal, and Ireland but was then extended to the EU’s new members in 2004 and 2007. In contrast, the European Regional Development Fund’s focus is regional. Funding is primarily allocated towards poorer EU members as well as poorer regions of richer EU members, such as Sicily or East Germany. However, all EU regions are eligible for some funding.

Figure 1: European cohesion expenditures in lower-income EU members, 1994-2020

Source: Prota, Viesti, and Bux. 1994-2013 figures are expressed in 2015 prices, while 2014-2020 figures are expressed in 2020 prices. Cohesion Fund figures cover all Cohesion Fund spending, while ERDF figures only cover ERDF investments in countries eligible for the Cohesion Fund (GNI below 90% of EU average).

As shown in Figure 1, funding peaked in the 2007-2013 period as many new members had newly joined the EU, and more funding flowed through the ERDF than the Cohesion Fund. Funding operates through the Multiannual Financial Framework’s seven-year budgetary cycles, and programs are developed by national and regional authorities in dialogue with the European Commission.

Cohesion Policy spending is delivered almost entirely as grants, and it comes out of the general EU budget. Accordingly, countries that benefit from the ERDF and Cohesion Fund have also paid in to the EU budget, though poorer EU members are typically “net beneficiaries,” meaning that they receive more expenditures from the EU budget than they contribute to it. Figure 2 shows which countries have received the most ERDF and Cohesion Fund investments in recent decades.

Figure 2: European cohesion expenditures in poorer EU members, by country, 1994-2020

Source: Prota, Viesti, and Bux. 1994-2013 figures are expressed in 2015 prices, while 2014-2020 figures are expressed in 2020 prices. This includes combined Cohesion Fund and ERDF expenditures in all countries eligible for the Cohesion Fund.

Evaluating the success of EU Cohesion Policy

EU members benefiting from EU Cohesion Policy experienced impressive development. Ireland, Croatia, Malta, Lithuania, Poland, and Estonia all experienced growth above 6%. Growth in the EU was clearly tilted towards poorer members, helping advance the convergence that Cohesion Policy sought: except for Greece, every EU member that qualified for Cohesion Fund assistance grew faster than the EU members too rich to qualify for the Cohesion Fund.

Figure 3: Growth under EU Cohesion Policy

Figure 3 displays compound annual growth rates for countries eligible for Cohesion Fund assistance, from the start of their eligibility (generally when they entered the EU in the mid-2000s) until 2024 (or in the case of Ireland and Spain, until they graduated from Cohesion Fund eligibility). Source: World Bank. GDP figures used constant US $. “Richer EU members” refers to the 1992 to 2024 growth in the total GDP of EU members that were never eligible for the Cohesion Fund (including the UK from 1992 until 2024).

It is difficult to assess exactly how much of these development gains are attributable to the benefits of Cohesion Policy funding. Countries that entered the EU also gained access to the single market, benefited from the free movement of people within the EU, and harmonized labor and regulatory standards. EU members also had access to finance through the European Investment Bank, which is by some measures the world’s largest multilateral development bank. Still, numerous studies have sought to measure the impact of Cohesion Policy funding on growth. While results differ based on methodology, results generally suggest that Cohesion Policy finance caused meaningful increases in growth. Cohesion Policy funding also served as a stabilizer during the financial crisis of the late 2000s and early 2010s.

Despite the methodological difficulties of attributing growth impact, Cohesion Policy funding was clearly central in enabling investment, particularly in infrastructure. For example, from 1986 to 2006, European financing funded 40% of Spain’s eight-fold increase in highways and 38% of its new rail infrastructure. From 2007 to 2013 in Hungary, 94% of railways and 54% of road investments were financed by cohesion funding. For some countries, EU cohesion funding has accounted for more than half of government capital investments.

Comparisons with similarly situated countries that lacked such support suggest that Cohesion Policy funding played an important role in advancing development. For example, when Lithuania entered the EU in 2004, Mexico had a higher GDP per capita, but now Lithuania’s GDP per capita is twice as high as Mexico’s. Mexico was also part of a major free trade zone with advanced economies through NAFTA, but NAFTA did not include development financing. Likewise, Türkiye and Poland had similar GDPs per capita in 2004, and both are geographically proximate to richer European countries. However, Poland enjoyed the benefits of the EU while Türkiye did not, and Poland’s GDP per capita is $9,000 higher today. Still, the impressive growth of some non-EU countries in Eastern Europe underlines that cohesion funding was not the sole driver of development.

How successful has the Cohesion Policy been in benefiting the EU’s richer member states? Its original rationale understood convergence to represent mutual gain: reducing territorial imbalances would amplify positive-sum growth and prevent destabilizing movements of people and economic activity. Much of this story has borne out. Convergence has meaningfully advanced, it has contributed to reduced emigration, and an estimated 15% of the growth attributable to Cohesion Policy has taken place through positive spillovers to EU members other than the member receiving the direct investment.

To be sure, Cohesion Policy has also suffered from shortcomings. It has funded some inefficient projects, and the challenges of aligning project preparation with the intricacy of program requirements has meant that absorption of funds has often lagged behind initial allocations. It has also achieved less success in advancing economic development in poorer subnational regions than it has in developing poorer member countries.

Lessons for today’s investment push

At a minimum, EU Cohesion Policy shows the potential of large-scale international finance. Net beneficiaries received EU finance on a scale similar to that needed to meet development and climate goals in developing countries today, and many of those countries ended up among the fastest developers of similarly situated emerging markets. In the absence of EU support, these countries would have likely faced the choice that so many developing countries do today: forgo critical investments or risk debt distress by financing investment through expensive market borrowing.

EU Cohesion Policy bears the most direct lessons for economies pursuing close integration, particularly those in free trade areas. Almost no other trade integration mechanisms have included a significant development finance element, and developmental disparities between members can contribute to labor arbitrage and rapid and destabilizing shifts in employment. In contrast, the EU deliberately sought and meaningfully advanced convergence between members.

Still, the question remains how the EU achieved a political economy that allowed unusually large and grant-based transfers of resources towards lower-income countries. The EU’s federated structure played a key role, enabling an institutionalized funding system and allocation mechanism that proved more stable than ODA’s general reliance on recurring appropriations in national budgets. A sense of shared European identity also likely helped, enabling a system that resembles progressive national taxation and expenditure policies more than international aid to separate polities.

However, interconnection is hardly unique to EU members. While shared EU membership may have amplified the importance of cohesion and convergence, many other countries share close trading relationships and large potential migration, not to mention a climate crisis that is fundamentally global. In these cases, addressing the barriers to investment in development would generate significant benefits for richer countries—and the EU’s Cohesion Policy provides promising precedent for how it could be achieved.