Atanu Ghoshray, Mercedes Monfort, Javier Ordóñez Open Seminar Eesti Pank 8 July 2019 - Tallinn

1. Economic integration, within- and
between-country inequality in Europe.
Atanu Ghoshray
Mercedes Monfort
Javier Ordóñez
Open Seminar Eesti Pank
8 July - Tallinn

2. Introduction:
Inequality has been rising over the past three decades in the vast majority of
OECD countries (OECD 2008, 2011, and 2015). Also, inequality has increased
both between and within member states of the EU (European Commission,
2014). Further, studies such as Bouvet (2010) argue that inequality between EU
countries has been a cause of overall inequality in the EU.
Inequality has moved to the top of the policy agenda in many EU countries.
There are worries that such persistently unbalanced sharing of the growth
dividend will result in social resentment, populism, nacionalism, europhobia,
xenophobia and protectionist sentiments all leading to political instability.
In fact, it is common for public opinion and national politicians to blame the
EU, and particularly the introduction of the euro, for the observed
development in inequality. The deep economic crisis of 2008-2009 triggered
further these sentiments.

3. Regarding the between-country component, one cannot simply assume that
economic integration would lead to convergence in income and wages, and a
consequent reduction in inequality between countries. There is a general
perception that the benefits of integration are not equally shared among the
participant EU countries, and this may threaten public support for the
integration process.
Within-country inequality in the EU is a matter of concern due to its effects on
welfare and growth, paving the way for social resentment.
It is important to assess whether these concerns are actually reflected in the
results of an empirical analysis of the data and to identify whether
institutional and economic events in the European economic integration
process can explain the observed changes in inequality trends in Europe.

4. Aim of the paper:
In this paper, we aim to estimate overall inequality trends for the EU as well as
within-country and between-country inequality trends in Europe.
Has inequality changed over time, and if so, at what rate?
Has this rate remained constant over time, or have there been structural breaks
that have caused the rates to vary?
Have these breaks occurred at roughly the same time, thus pointing to
institutional reasons as a cause of this change?
Which type of inequality has been more profound: has within-country or
between-country inequality contributed more to the overall trend?
And finally, is inequality persistent for the EU overall, as well as the within-
country and between-country components?

5. Changes in income distribution
What may caused these changes in income distribution?
1. Technological change: Murphy (1989), European Comission (2008).
2. Financialisation: ILO (2008).
3. The welfare state retrechment: Rehm (2016), OECD (2011)
4. Economic integration/globalization:
- globalization accentuates inequality: Firebaugh, 2003, Wade,
2004, Jayadev, 2007
- economic integration helps to close the inequality gap: Dollar
and Kraay, 2002

6. How economic integration affects inequality?
Bertola (2010) suggests three mechanisms:
1.Under economic and monetary integration, countries not only cannot
conduct an independent monetary policy but fiscal policy is also constrained
making difficult to stabilize economic activity.
2.Market integration can put in place new market forces and new sources of
shocks with potential distributional effects.
3.Economic integration can also affect the implementation of redistributional
policies.

7. The empirical literature on the effects of economic integration on inequality in
Europe is not conclusive (Bouvet, 2010).
Whether further integration lead to a deeper economic convergence has been
subject of much debate in both the theoretical and the empirical literature.
Ordóñez et al (2015) conclude that after years of ever-closer economic
integration EU countries have converged to different steady states in economic
efficiency (measured in terms of labour productivity), competitiveness (real
unit labor costs) and income (per capita GDP).
According to Monfort et al (2013, 2018), this lack of real economic convergence
is also present in terms of GDP per capita, inequality and unemployment.

8. Inequality trends:
The seminal work by Piketty (2001, 2003) led to a building up of interest in the
long-run developments of inequality and similar efforts of building data sets
spanning long time periods for many countries.
Main result: almost all countries present a declining trend along the twenty
century with an steady increase around 70s-80s (Piketty and Saez ,2014, Roine
and Waldenström, 2015, OECD, 2011).

9. This surprisingly homogeneous trended behavior of inequality, at least among
the developed countries, has been cast into doubt:
- the reversal of the downward trend after the 80s presents in fact great
variability despite of being observed in most developed countries, Roine et. al.
(2009)
- the results on the long-run trend behaviour of inequality have been mostly
based on a causal observation of the time series, which makes very difficult to
determine exactly where the breaks are located for a particular country and
the magnitude of the change in the trend (Ghoshray, et al 2018).

10. Ghoshray, et al 2018:
- no clear conclusion can be made on the common location of
inequality breaks.
- inequality is rather persistent
In this paper we analyze the trend behaviour of overall inequality and
between and within-country inequality to identify possible breaks at the time
of the major institutional and economic events in the process of convergence.

11. Data and results:
To measure inequality in Europe we consider the Theil index measure of
inequality based on quarterly GDP at constant PPP over the period 1960Q1 to
2017Q1.
The data covers 12 European countries: Belgium, France, Finland, Germany,
Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden and the
UK .
The data has been obtained from Main Economic Indicators Database, OECD.

12. Why the Theil index?
Theil index can be decomposed to analyze the trend behavior of:
- the between-country component, which corresponds to the inequality we
would observed if every citizen in a country would have the same income
- the within-country component, which corresponds to the inequality that we
would see if the average income of countries were all equalized.

13. Groups:
- euro-zone peripheral countries (Italy, Spain and Portugal)
- euro-zone core countries (France, Finland, Germany, Luxembourg and the
Netherlands)
- non euro-zone countries (Norway, Sweden and the UK).
Yes, a bit ad hoc but:
- Since the purpose of this paper is to ascertain whether the economic
integration process has had any effect on the between-country inequality, it
seems reasonable to distinguish between countries involve in deeper economic
integration (euro-zone countries) from those subject to a lesser extent
integration (non-euro-zone countries). Also, it seems reasonable to further
distinguish between cohesion (or later named peripheral countries) and non-
cohesion countries.
- This later classification is also supported by previous empirical results who
point out that peripheral and core countries convergence to different
equilibrium in terms of inequality (Monfort et al, 2018).

14. Why countries?
First, according to Bouvet (2010) between-country inequality shapes the
dynamic of overall inequality in Europe.
Second, most of the debate on the impact of the single market and the common
currency has focused on national economic conditions.
This paper adds to the literature on income inequality in Europe by making a
robust test for structural breaks and persistence in overall, within-country and
between-country inequality of twelve European countries.

17. First, we test for structural breaks in the series using robust methods
that are agnostic regarding the stationarity or nonstationarity of the
series.

18. Second, we test for the magnitude and sign of the trends.

19. Third, we test for the degree of persistence in the analysed series.

20. Concluding remarks
First, neither the economic integration process nor the economic crises
suffered over the last forty years caused a change in inequality of the
importance of the developments in the 70s.
Second, inequality can experience important compositional effects that,
despite its magnitude, do not cause a structural change in the overall
inequality. Specifically, the introduction of the euro was coupled with
important re-compositional effects in the within- and between-country
components of inequality that did not translate to a structural break in overall
inequality.
Third, shocks to inequality tend to persist and specific policy measure need to
be implemented both at national and EU level to cope with the negative effects
of rising inequality.