Inequality and efficiency – a post crisis view from European perspective FES round table debate Zagreb 7. April 2011 Béla Galgóczi

2 Equality and efficiency: the context ● critical review of the equality-efficiency trade-off assumption ● highlighting its limits > pointing to the different manifestations and origins of inequality in various forms of market economies. ● Some stylised facts on the development in income inequality in Europe to show that the current crisis has much more to do with the lack of equality, than with two much of it. ● Lessons from the crisis show us that decades long accumulation of inequality backed by irresponsible financial practices was one of the major causes of the deepest economic crisis in the post Word War world and led to an unprecedented loss of efficiency.

3 Equality and efficiency: the context The equality-efficiency trade-off assumption comes from Arthur Okun (Okun, 1975): ● `Equality undermines incentives, pro-equality policies distort market allocation and economic performance can only be improved at the expense of a less equitable distribution of income`. ● This interpretation looks at the relation of equality and efficiency in a very narrow context and the generation of inequality (before social transfers) is not addressed at all ● Polanyi (1957): `embedded markets perform better`; Esping Andersen (1990): more equality through `decommodification` ● Okun`s `trade-off` is partially true for free market economies (if we assume, markets are perfect)

4 Equality&efficiency ● To avoid misunderstanding – this does not that mean full equality in form of egalitarian societies would be desirable ● Inequality based on performance and skills-bonus is needed as incentives ● Redistribution is needed to the extent of managing a cohesive society ● Redistribution needs to be targeted and efficient ● Our point here is: recent history tells not about inefficiency caused by too much equality, but about inefficiency caused by excessive inequality

5 Stylized facts on progressive inequality in Europe and the world ● At the time of increased capital mobility and globalisation, when cca. 1 billion workers got integrated in the world economy (China, India, eastern Europe) – the previous balance between labour and capital has shifted ● Wage moderation is characteristic for most EU15 countries for the last 10 years ● Wage shares in GDP are falling ● Wage differentials are growing ● The danger of a downward spiral is real

6 Sustainability/ Equality Economic Social Environmental Trilemma: Different dimensions of sustainability have also an equality dimension

7 Features of equality/efficiency/sustainability In the basic scenario, one can pursue economic efficiency to the detriment of social and environmental aspects - This is what happened in the last decades: balance between capital and labour was shifted as the share of labour within the accumulated wealth (GDP) has shrunk in all major economies; depressed wages were substituted either by credit based consumption (US, UK, IE, ES, Baltics) or export driven growth (Germany) where exports were largely financed by debt (exception: China). - Environmental resources were seen as external factors that are free and unlimited (irreversible climatic processes with a catastrophy scenario, source for new inequality )

8 Income inequality – the background ● Decent pay – as basic principle – make work pay – a basic function of the European Social Model ● BUT: increasing wage differentials ● Background: large low pay sector in Europe (20 million employees on law pay in Europe), precarious jobs ● Segmented labour markets ● lack of proper bargaining coverage in several sectors/countries ● Labour migration – migrant workers` wages and labour conditions ● Freedom of services (Vaxholm case)

9 Shrinking wage share – a long term perspective Note: Compensation per employee as percentage of GDP at market prices per person employed.

10 Inequality among employees: Average real annual pay growth in the US ( )

11 Inequality in Germany > Divergence /inequality/ in the Eurozone

12 Inequality in Germany > Divergence /inequality/ in the Eurozone

13 Wage moderation in Germany ● Germany is the model case of wage moderation in Europe ● Employees have a continuously sinking share in the wealth produced ● Low wage sector expanding (7-8 Mn employees in Germany) ● Result: low domestic demand > export offensive ● Sinking unit labour costs in Germany pushes the rest of the Eurozone `into the corner` (Spain, Greece, Portugal, Italy) ● These countries have no other option then to cut wages, as well

14 Growing inequality in some EU countries and the US: the Gini coefficient

15 Armut in der Arbeit – Armutsrisiko Alleinerziehender, 2008 Data Source: Eurostat Survey of Income and Living Conditions. Notes: 2008 Figures except IE, IT, UK, and EU27

16 Effekte der Krise auf die öffentlichen Dienste

17 Unsustainable economic growth: household debt and income inequality

18 Conclusions ● While inequality justified by performance and skills is not being questioned, limits of inequality appear within the concept of a `cohesive society` ● Redistribution definitely needs to be targeted and efficient with some scope for efficiency – equity trade-off ● What we are facing in the current world is too much inequality that also detrimentally effects efficiency ● This is even more true for South-East Europe (and transformation economies in general) ● There are additional factors of inequality (corruption, in certain regions even criminal economy) and the inequal participation at the reallocation of resources during transformation (e.g. privatization and its transparency).