INCOME INEQUALITY AND THE LABOUR INCOME SHARE: PATTERNS AND DETERMINANTS

CMTEA, 39th edition

Iaşi, 26 September 2008

EUROPEAN COMMISSIONDIRECTORATE GENERAL ECONOMIC AND FINANCIAL AFFAIRSDirectorate B: Economic Service and Structural ReformsUnit B3: Labour market reforms

INTRODUCTION

MOTIVATION

OUTLINE:

1. Income inequality patterns. - Distribution of H. disposable income

- Wage dispersion

2. Determinants of income inequality. - Labour income share

3. The relationship between the various concepts of inequality:

a unifying framework.

4. Policy implications.

PATTERNS (I): the distribution of household income

CROSS-COUNTRY DIMENSION

Gini Index on household-equivalent disposable income

0,00

0,10

0,20

0,30

0,40

0,50

0,60

Den

mar

k

Fin

land

Net

herla

nds

Slo

veni

a

Nor

way

Sw

eden

Aus

tria

Luxe

mbo

urg

Ger

man

y

Bel

gium

Fra

nce

Sw

itzer

land

Tai

wan

Can

ada

Japa

n

Aus

tral

ia

Irel

and

Italy

Gre

ece

Spa

in

Uni

ted

Kin

gdom

Isra

el

Por

tuga

l

Uni

ted

Sta

tes

Slo

vak

Rep

ublic

Cze

ch R

epub

lic

Rom

ania

Pol

and

Hun

gary

Est

onia

Rus

sia

Mex

ico

High-Income countries Middle-Income countries

Source: Luxembourg Income Study.

PATTERNS (II): the distribution of household income

0.2

0.25

0.3

0.35

0.4

0.45

0.5

0.55

NL AT BE GE LU FI GR FR IT PT IR SP DK EU15 SW UK

Market income disposable income confidence interval

CROSS-COUNTRY DIMENSION

Impact of public redistribution of income inequality Public redistribution and public expenditure: 1998

Source: Immervoll et. al (2005).

SP

IR

PTIT

FR

GR

FI

LU

GE

BE

AT

NL

R2 = 0.36

0.25

0.35

0.45

0.55

25.0 30.0 35.0 40.0 45.0 50.0

% reduction in the gini index due to redistribution: 1998

tota

l exp

endi

ture

of t

he g

ener

al g

over

nmen

t exc

ludi

ng

inte

rest

199

8(a

s % o

f GD

P)

UK

SEDK

EU15

PATTERNS (III): the distribution of household income

TEMPORAL DIMENSION: 20th century.

– Trend towards greater equality until the 1980s followed by increasing inequality thereafter.

– Strong equalising effect of public redistribution:

• Increase in income inequality tends to be larger in terms of factor income.

• Disposable income inequality smoother than factor income inequality.

PATTERNS (IV): wage dispersion

Source: OECD Earnings database.

90

95

100

105

110

115

120

86 88 90 92 94 96 98 00 02 04

DE

90

95

100

105

110

115

120

86 88 90 92 94 96 98 00 02 04

FI

90

95

100

105

110

115

120

86 88 90 92 94 96 98 00 02 04

FR

90

95

100

105

110

115

120

86 88 90 92 94 96 98 00 02 04

NL

90

95

100

105

110

115

120

86 88 90 92 94 96 98 00 02 04

SW

90

95

100

105

110

115

120

86 88 90 92 94 96 98 00 02 04

UK

90

95

100

105

110

115

120

86 88 90 92 94 96 98 00 02 04

P50/P10 P90/P10 P90/P50

US

PATTERNS (V): the labour income share

Preferred measure of the LS: Askenazy (2003).

Basic measure:

1st refinement Adjust by the labour income of the self-employed:

2nd refinement Impute to each self-employed compensation per employee of its own activity branch:

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PATTERNS (VI): The labour income share

.4

.5

.6

.7

.8

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04

Austria

.4

.5

.6

.7

.8

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04

Belgium

.4

.5

.6

.7

.8

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04

Germany

.4

.5

.6

.7

.8

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04

Denmark

.4

.5

.6

.7

.8

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04

Euro Area

.4

.5

.6

.7

.8

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04

Greece

.4

.5

.6

.7

.8

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04

Spain

.4

.5

.6

.7

.8

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04

Finland

.4

.5

.6

.7

.8

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04

France

.4

.5

.6

.7

.8

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04

Ireland

.4

.5

.6

.7

.8

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04

Italy

.4

.5

.6

.7

.8

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04

Luxembourg

.4

.5

.6

.7

.8

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04

Netherlands

.4

.5

.6

.7

.8

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04

Portugal

.4

.5

.6

.7

.8

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04

Sweden

.4

.5

.6

.7

.8

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04

United Kingdom

PATTERNS (VII): The labour income share

• In the policy debate, declining LS are often interpreted as reflecting episodes of wage moderation.

• It is generally wrong to interpret movements in the LS as exclusively stemming from wage moderation/acceleration.

• Shift-share analysis:

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PATTERNS (VIII): The labour income share

1996-2004

-1,50%

-1,00%

-0,50%

0,00%

0,50%

1,00%

EA13 EU15 BE DE IE EL ES FR IT LU NL AT PT FI DK SE UK SI

Share of employees remuneration in value addedEmployment composition Sectoral composition Overall change in the aggregate labour share

-0.08%

-0.09%

-0.07%

-0.25%

-0.20%

-0.15%

-0.10%

-0.05%

0.00%

0.05%

0.10%

0.15%

0.20%

Sectoral composition Employment composition Share of employeesremuneration in value

added

Agriculture Manufacturing Market services Construction Total

PATTERNS (IX): The labour income share

• What if the sectoral and employment composition were kept constant at their 1970 levels?

Euro area

.50

.55

.60

.65

.70

1970 1975 1980 1985 1990 1995 2000 2005

ALS: constant sectoral and employment compositionALS: varying sectoral and employment composition

DETERMINANTS: Common trends

• Globalisation

• INEQUALITY IN DISPOSABLE INCOME:– Capacity of the state to redistribute

• WAGE DISPERSION:– Trade specialisation (Stolper-Samuelson)– Off-shoring of intermediate inputs– Immigration

• Skill-biased technological change

• Country-specific features

– LABOUR MARKET INSTITUTIONS: Levy and Temin (2007), Gordon and Dew-Becker (2008), and Checchi and García-Peñalosa (2008).

A UNIFYING FRAMEWORK

• Appealing work (C&G-P, 2008): Gini Index is expressed as a function of the unemployment rate, wage dispersion and the LS.

higher unemployment rate increases inequality

LMIs higher wage dispersion increases inequality

higher LS reduces inequality

• Main uses:

1. Elaborate a stylized story to account for income inequality patterns.

2. Examine the effect of LMIs on overall income inequality.

A UNIFYING FRAMEWORK TO INEQUALITY

1. Elaborate a stylized story to account for income inequality patterns.

CASE STUDY: the UK

2. Examine the effect of LMIs on overall income inequality.

• Empirical evidence is mixed.• Wage-setting institutions more effective at reducing income inequality than EPL.

-2.5-2

-1.5-1

-0.50

0.51

1.52

2.5

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

Unemployment rate P90/P10 Labour share

POLICY IMPLICATIONS

SOURCES OF INCREASED INCOME INEQUALITY • Labour shares:

– They have not been declining everywhere in EU15 economies.– Where they were, this is not necessarily due to wage moderation.

• Wage dispersion:

– Overall wage dispersion has increased almost everywhere.– Cross-country differences in contributions of dispersion at the top and the bottom.– SBTC accounts for changes in wage dispersion.

• LMIs have an impact on income inequality through the LS, the UR and the wage dispersion, the sign of which is ambiguous a.t empirical evidence…

• … except for what concerns the choice between EPL and wage-setting institutions and the tax wedge.

• Public redistribution has a strong equalising effect in mature economies. Current debate is on principles to enhance efficiency of redistributive policies.