Curse or Blessing. The implementation of the European Monetary Union and its impact on the income distribution in Europe

Contents

List of figures

List of tables

Abbreviations

1. Introduction

2. Theory and literature

3. Empirical Evidence
3.1 Income inequality between EMU countries
3.2 Income inequality on the national level

4. Why has the EMU no significant positive effect on income distribution?

5. Concluding remarks

6. References

List of figures

Figure 1: Development of income inequality: Euroarea12 compared to EU15 (from 1995 to 2012) and Euroarea17 compared to EU27 (from 2004 to 2012)

Figure 2: Income quintile ratios for the Euroarea12 countries and the Euroarea12 aggregate from the year 1995 to 2012

List of tables

Table 1: GDP per capita in PPS (2002 to 2013) and net national income per capita based on current PPP (1999 to 2001) of the Euroarea12 countries and Denmark, Sweden and the UK

Table 2: National Gini indices from 1995 to 2011 of the Euroarea12 countries and Denmark, Sweden and the UK

Abbreviations

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1. Introduction

In recent years there has been a growing concern about inequality in Europe among politicians, economists and the population. (Economic Papers, 2008, Introduction page) In 2013 in her speech at the World Economic Forum in Davos, Christine Lagarde underpinned the importance of equal distribution by saying that "Excessive inequality is corrosive to growth; it is corrosive to society. I believe that the economics profession and the policy community have downplayed inequality for too long. Now all of us - including the IMF - have a better understanding that a more equal distribution of income allows for more economic stability, more sustained economic growth, and healthier societies with stronger bonds of cohesion and trust." (Atkinson, 2013, p.1)

Due to the severe consequences which persistent income disparities can have, reducing regional disparities has been one of the most explicit goals of the European Union (EU) and an increasing share of its budget was devoted to reduce this disparity. (Bouvet, 2010, p.2) Unequal distribution and unequal economic growth is especially dangerous for the EU since the EU is characterized by a much higher cultural and political fragmentation, compared to other common currency areas for example, to the USA. Accordingly, unequal distribution and unequal economic growth across and within the European member states can result in growing suspicion against the EU. In fact, due to the lack of mutual cultural and political bonds, this could result in the collapse of the EU. (Mongelli, 2008, p.22) Therefore, one of the three main priorities of the Europe 2020 strategy is inclusive growth for the EU and one of the headlines targets is 20 million less Europeans in, or at risk of, poverty and social exclusion by 2020. In 2010, there were 120 million such individuals. (Fredriksen, 2012, p.4) The Economic and Monetary Union (EMU), whose implementation was finalized in 1999 and was characterized by the introduction of a common currency, the Euro, aims at reducing those economic differences between the member states and thus contributing to an more integrated Europe. (European Commission 1, 2014) The EMU currently comprises 18 out of the 28 EU member states. (European Central Bank, 2014)

The interesting question which arises is whether the implementation of the EMU actually contributed to a more equal income distribution in Europe or, on the contrary, stimulated and assisted unequal distribution. What are the reasons for this development? Moreover, what are the consequences and what measures could be implemented to overcome income inequality within the EMU?

In order to elaborate these points, I will firstly give an overview of the theory and the respective literature - see (2). In the next point, I shall present statistical evidence in order to answer the issues at stake if the income distribution in Europe has become more equal or unequal since the implementation of the EMU - see (3). Thirdly, I shall set forth the reasons why income distributions have developed in a particular way (as presented in section three) and the consequences which may ensue from this development - see (4).

Finally, I shall summarize my findings and seek to provide a satisfactory answer to the question of whether the implementation of the EMU has contributed to a more equal income distribution in Europe (5).

2. Theory and literature

Economic theory suggests conflicting concepts, whether further economic and monetary integration leads to the disappearance of regional disparities. The Neoclassical precept suggests that income disparities vanish due to diminishing returns to factors of production. In poorer countries and regions, factor endowments are lower, therefore the concept of diminishing returns to factors of production imply that these returns are higher. Accordingly, factor endowments and output grow faster in poorer countries, and this leads to a decrease in income disparities between countries. Especially, in the open-economy version of the neoclassical model, convergence should be faster (compared to the closed-economy version) because the initial misallocation of resources will be reduced due to free movement of factors of production. Further integration leads to a more efficient allocation of resources, to factor price equalization, and therefore to lower income inequality. (Bouvet, 2010, pp.3-4) Free movement of labour and services between the EMU member countries is a major component of the EMU policy towards a more economic integrated Europe. (European Commission, 2014) Therefore, income disparities should decrease between the EMU member countries according to the neoclassical model.

The optimal currency area (OCA) theory was developed in 1961 by Robert Mundell. (Mundell, 1961, pp.657-665) It stresses that monetary and economic integration leads to both advantages and disadvantages. Lower transaction costs provide more price transparency and less exchange rate uncertainty, which leads to economic growth in the EMU. The EMU could improve the economic performance of less competitive countries by inducing relative-price deflation. This would result in a decrease of inequality between countries. However, in the absence of independent exchange rate and monetary policy, national governments are not able to tackle national and regional asymmetric shocks. Asymmetric shocks may emanate from a variety of reasons. They can be caused by actual asynchronous shocks like earthquakes but they are also caused by structural differences between the member countries. EMU member countries have for example different magnitudes of trade volumes with third countries. (Weiß, 2010, p.24) If the trade volume of a specific EMU country with a third country significantly decreases, this country cannot depreciate its currency anymore in order to stimulate trade because the European Central Bank (ECB) is the only institution which is allowed to depreciate respectively to appreciate the Euro. (Kater, 2009, p.8) These shocks could lead to increasing income inequalities between countries. (Bouvet, 2010, pp.4-5)

According to the new economic geography (NEG) theory, deeper economic integration will create new opportunities of economies of scale, activity specialization and economic agglomeration by enhanced trade and factor mobility. Consequently, regional disparities in growth, factor accumulation and income are the results. Moreover, the NEG theory argues that gross domestic product (GDP) grows faster in core than in peripheral regions, and this results in growing inequality. Additionally, the EMU might increase the risk of asymmetric shocks and exacerbate income inequality between regions and countries by stimulating deeper industrial specialization. (Bouvet, 2010, p.4) Literature does not provide a consistent answer to the question whether the EMU, or respectively deeper economic and monetary integration, leads to a more equal income distribution. (Bertola, 2007, p.5)

3. Empirical Evidence

In the preceding chapter I surveyed the extent to which current literature may provide a satisfying theoretical framework in addressing the question whether the implementation of the EMU is a curse or blessing for income distribution across and within the EMU member states. However, there is no consensus in the literature as to whether further economic and monetary integration leads to a more equal income distribution. Therefore, in this part I turn to empirical evidence to answer the issue at stake. I will focus on the eleven initial members of the EMU plus Greece which joined in 2001 since positive, or respectively negative impacts of the EMU on its member countries are more likely to observe the longer the country is an EMU member.¹ Firstly, In point 3.1 I will set forth how income distribution has developed between the EMU member countries. Point 3.2 deals with the question in how far within- country inequality has been affected by the implementation of the EMU. I chose 1995 as the starting point since the second stage of the implementation of the EMU started on 1st January 1994. The second stage set a milestone in economic integration in the EU since it introduced binding economic convergence criteria for the founding states of the EMU (as set by the Treaty of Maastricht 1992) and introduced the European Monetary Institute, which is a forerunner of the ECB. (Keil, 2012, pp.65-66)

3.1 Income inequality between EMU countries

To measure the development of the cross-country income distribution, table one takes the distribution of the GDP per capita in purchasing power standards (PPS) measured by Eurostat into account. The volume index of GDP per capita in PPS is expressed in relation to the EU28 average set to equal 100. EU28 means the 28 current member states of the EU. If the index of a country is below 100, this country's level of GDP per head is below the EU average and vice versa. By expressing the GDP variable in PPS meaningful volume comparisons of GDP between countries is possible due to the fact that PPS is an artificial common currency that eliminates the differences in price levels between countries. (Eurostat 1, 2014) Eurostat publishes the GDP per capita in PPS index since 2002. Therefore the period between 1999 and 2001 is covered by the net national income per capita index based on current purchasing power parities (PPP) measured by the OECD. The measurement is slightly different from the Eurostat methodology and the OECD index is expressed with respect to the OECD area = 100. However, the tendency of the results equals the Eurostat results and therefore the OECD measure can be used complementary. (OECD, 2009)² The green boxes mark the highest and the red boxes the lowest point of each country's GDP per capita in PPS. Because the OECD measure yields on average lower numbers these numbers are not taken into account in this consideration.

Table 1: GDP per capita in PPS (2002 to 2013) and net national income per capita based on current PPP (1999 to 2001) of the Euroarea12 countries and Denmark, Sweden and the UK.

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Source: Eurostat, OECD.³

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¹ The eleven initial member states which joined the third stage of the EMU in 1999 are: Belgium, Germany, Ireland, Spain, France, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland. Greece followed in 2001. In 2007 Slovenia joined the EMU, 2008 Cyprus and Malta, 2009 Slovakia, 2011 Estonia and in 2014 the currently latest member of the third stage of the EMU, Latvia joined. (European Commission 2, 2014)

² For more details concerning the OECD method see: http://www.oecd-ilibrary.org/sites/soc_glance-2008- en/04/01/index.html?itemId=/content/chapter/soc_glance-2008-5-en.

³ Data: Eurostat 2, 2014. GDP per Capita in PPS. [online] Available on:
<http://epp.eurostat.ec.europa.eu/portal/page/portal/national_accounts/data/main_tables> [Accessed 5 July 2014]; OECD 1, 2014. Net national income per capita, OECD = 100. [online] Available on: <http://www.oecd- ilibrary.org/economics/data/oecd-national-accounts-statistics_na-data-en> [Accessed 5 July 2014].