Depressing Dependence? Transfers and Economic Growth in the German States, 1975-2005

Most countries pay substantial intergovernmental transfers to poor regions. Since these transfers are often paid with the aim of achieving regional convergence, they should have a positive effect on economic growth. However, it is equally possible that transfers perpetuate under-development by diminishing regional incentives to implement growth-enhancing policies. In this paper, we study empirically the effect of intergovernmental transfers on economic growth using the German federation as an institutional laboratory. Our findings, which are based on a panel dataset covering the West German States over the period 1975-2005, suggest that transfers are irrelevant or possibly even harmful for economic growth. The results of our analysis of transmission channels are consistent with the notion that transfers fail to foster growth because states use them to subsidize declining industries.