Investment additionality and job creation: evidence from reforms to regional development funding in Germany

Abstract Spatially targeted investment subsidies are a central instrument of regional policy to stimulate economic activity in lagging regions. We study the employment effects of Germany’s largest regional policy program (GRW) over the period 2007–2020. Our identification strategy exploits exogenous variation in maximum funding rates across space, time, and firm-size classes as the result of EU-wide and national institutional reforms. Using reduced-form fixed effects (FE) and two-stage least squares (2SLS) estimates, we document a robust positive relationship between firm-level investment and job creation in eligible municipalities. Instrumenting firms’ investment intensity with changes in maximum GRW funding rates, a significant policy channel linking public funding and firm investment can be identified. Comparing 2SLS and FE estimates, we find stronger employment response to policy-induced variations in investment intensity in the 2SLS estimations, which we interpret as evidence of investment additionality. Micro and small firms respond most strongly to subsidy variation, underscoring their key role in driving GRW effectiveness. We further document asymmetric regional effects. The negative response to declining funding rates in initially high-subsidized firms in East German regions exceeds the positive response to increasing funding rates in initially low-subsidy West German regions, highlighting the importance of funding rates in absolute terms alongside changes in funding conditions. In the context of moderately shrinking overall GRW budgets since the mid-2000s, the results reported here point to diminishing overall employment effects of German regional policy.