INCOME INEQUALITY AND THE LABOUR INCOME SHARE: PATTERNS AND DETERMINANTS CMTEA, 39 th edition Iaşi, 26 September 2008 EUROPEAN COMMISSION DIRECTORATE GENERAL ECONOMIC AND FINANCIAL AFFAIRS Directorate B: Economic Service and Structural Reforms Unit 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 Source: Luxembourg Income Study.

PATTERNS (II): the distribution of household income CROSS-COUNTRY DIMENSION Impact of public redistribution of income inequality Public redistribution and public expenditure: 1998 Source: Immervoll et. al (2005).

PATTERNS (III): the distribution of household income TEMPORAL DIMENSION: 20 th 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.

PATTERNS (V): the labour income share Preferred measure of the LS: Askenazy (2003). Basic measure: 1 st refinement Adjust by the labour income of the self-employed: 2 nd refinement Impute to each self-employed compensation per employee of its own activity branch: ti ti k i ti ti t ti datatoral t E TE va CE GVA va LS,, 1,,, sec **A )3(    t t t t dataaggregate t E TE GVA CE LS*A )2(  t t dataaggregate t GVA CE LS  )1(

PATTERNS (VI): The labour income share

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:

PATTERNS (VIII): The labour income share

PATTERNS (IX): The labour income share What if the sectoral and employment composition were kept constant at their 1970 levels? Euro area ALS: constant sectoral and employment composition ALS: 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 dispersionincreases inequality higher LSreduces 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.

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.