Inequality in Europe Inequality in Europe January 2018 Authors: Rocco L. Bubbico (ECON), Leon Freytag (CEPS) © European Investment Bank The authors would like to thank Debora Revoltella, Natacha Valla, Patricia Wruuck and Ilaria Nava for their feedback and support. The mission of the EIB’s Economics Department is to provide economic analyses and studies to support the Bank in its operations and in its positioning, strategy and policy. The Department, a team of 40 staff, is headed by Debora Revoltella, Director of Economics. Disclaimer The views expressed in this document are those of the authors and do not necessarily reflect the position of the EIB or its shareholders. i Table of Contents Executive Summary ................................................................................................................................. 1 Introduction ............................................................................................................................................ 2 1. Has inequality increased in the EU? .................................................................................................... 4 2. What is the relationship between inequality and growth? ................................................................ 7 2.1 A new empirical consensus ........................................................................................................... 7 2.2 Inequality and growth in developed countries ............................................................................. 9 3. Automation and Inequality ............................................................................................................... 11 3.1 Technological unemployment..................................................................................................... 12 3.2 The decline of the labour share: capital-biased technical change.............................................. 14 3.3 The platform economy: talent-biased technical change ............................................................ 16 3.4 The wage distribution: skill-biased technical change ................................................................. 16 4. Inequality of opportunity and some of its dimensions ..................................................................... 19 4.1 Geography ................................................................................................................................... 20 4.2 Education .................................................................................................................................... 22 4.3 Health .......................................................................................................................................... 24 5. Inequality, politics and policies ......................................................................................................... 26 5.1 Income inequality and redistribution policies ............................................................................ 26 5.2. The impact of the crisis on inequality trends ............................................................................. 28 5.3 The rise of populism: is income inequality a driver? .................................................................. 33 6. Conclusions: what can be done?....................................................................................................... 35 Annex – Fiscal policy measures and impact on income distribution: an overview .............................. 37 References ............................................................................................................................................ 39 ii Inequality in Europe Executive Summary • Tackling inequality in its multidimensional nature and reconciling it with growth and competitiveness strategies is a non-partisan choice, and a way to achieve higher and more sustainable economic development. • Concerns on inequality are high among scholars, policy makers and general public, but income inequality in Europe over the last decade has not increased. On the one hand, this reflects the progressivity of tax systems and the effectiveness of EU’s welfare systems. On the other hand, this is the result of conflicting trends, with diversified national growth trajectories and large variations in performance of welfare systems. Moreover, overall poverty has increased, those in the poorest income decile have lost share of total disposable income and still significant inequality of opportunity is observed in Europe. • There are several on-going factors that need to be considered as drivers of increasing market inequalities in Europe and in other advanced economies. In this paper we look in particular at automation and job polarization. By using automation technology data, we do not find an impact of robotics on wage and employment. Nevertheless, rapid advances in artificial intelligence might change this picture, as more professions and job typologies will be at risk. • Inequality of opportunity in Europe is still very high. In this note we look at geography, health and education, showing large differentials in basic services, well- being drivers and more generally economic opportunities across Europe and within Member States. • The strategy to contrast inequality must not be confined to fiscal measures, as it requires a larger and more complex policy mix. The literature and the evidence reported in this note call for action to enhance competitiveness, upgrade skills and reinforcing equality of opportunities. European Investment Bank Page 1 of 45 Inequality in Europe Introduction Income inequality has declined worldwide, yet it has become a crucial topic on policy agendas. Global inequality of incomes has declined significantly since 2000, but inequality is increasing within most countries, especially developed ones (Milanovic 2016; World Bank 2016). As a consequence, rising prosperity for lower and middle households has become a fundamental challenge for developed economies, given also the combined effect of the severity of the economic crisis, with stagnating wages and living standard for a prolonged period (Nolan 2016). Over the last years, inclusive growth has become a buzz word for governments and multilateral organisations, including IMF (Lagarde 2017), OECD (2016), World Economic Forum (2017) the European Commission1 and the Chinese Government2. At the same time, among scholars, the long-lasting debate on the relations between inequality and growth has been somehow eclipsed by the scrutiny on the distributional effects of political and fiscal choices of the last two decades, highlighting the underrated, adverse effects of neoliberal policies on both distribution of benefits of growth and long- term economic development. These analyses have reconsidered the distributive impact of popular policy trends before and during the crisis, in particular fiscal consolidation strategies (see Ostry et al. 2016; Ball et al. 2013), capital account liberalisation (Furceri and Loungani 2015) and growth-enhancing structural policies in low-income countries (Fabrizio et al. 2017). Contrasting the classic idea of a natural trickle-down from rich to poor households as a consequence of economic growth, these contributions have highlighted the negative spill- overs of policies that did not consider the vicious circle between distributional effects, inequality and lower growth. More importantly, the recent contributions have triggered a shift in policy recommendations for growth-enhancing policy measures, highlighting the role of inclusiveness to build more competitive and resilient economies (Ostry et al. 2016; Lagarde 2017). Concerns on inequality have been fuelled more by narrative than by evidence, reinforcing populist positions amid fiscal pressures on welfare policies. The rise of inequality as a topic of interest has been particularly significant in high-income countries and emerging market economies, where it has been connected with social stagnation and distress, before being linked more often to political populism (Inglehart and Norris 2016; Wolf 2017). Beyond economists and development scholars, this interest has also involved the general public, in particular during and in the aftermath of political events such the EU referendum in the UK and the US presidential elections. However, as recently shown, the perception of inequality in many contexts is way above its actual levels (Niehues 2014). Perhaps it is not incidental that the new wave of interest has emerged in times of stress for the European welfare 1 See the inclusive growth target identified within the Europe 2020 strategy. 2 As reported by Darvas and Wolf (2016), the 12th Five Year Plan has the objective to pursue economic growth sharing benefits among all people. Page 2 of 45 European Investment Bank Inequality in Europe systems, given ageing, migration and the fiscal consequences of the crisis. It is clear that beyond political consequences and its mere impact on growth, high inequality can imply the exclusion of large parts of population from the process of generating and enjoying economic growth. Clearly, beyond efficiency concerns, this is not sustainable from all possible policy angles. As argued in this note, tackling inequality in its multidimensional nature and reconciling it with growth and competitiveness strategies is a non-partisan choice, and a way to achieve higher and more sustainable economic development. This paper has the objective to review the rich debate on inequality