Regional investment incentives in Germany: Impacts on factor demand and growth

The aim of this paper is to analyse the effects of regional investment incentives - a main component of regional policy in West Germany on regional factor demand (investment and labor), growth and convergence of per capita income for the period 1978 to 1989. Demand for investment and labor arise from a model of cost minimization at given output with a putty-clay production function. The production function allows for regional technical efficiency. To model the output effect on factor demand an auxiliary output function is specified, In estimating the functions attention is given to the short-run dynamics and the long-run behaviour of factor demand by error-correction models, The empirical long-run relationships are then used to simulate the effects of regional investment incentives. In contrast to most studies for other countries the empirical results provide evidence that regional policy in Germany induces not only additional investment but also creates positive employment effects. However, the effects of regional investment incentives on growth and convergence of labor productivity are negligible.