Europe is the land of generous social programs with not as much inequality as in the U.S., right? It is fair to say that low interpersonal inequality in general remains fundamental for most Europeans, while part of the American dream is to pursue social mobility based on entrepreneurship and equality of opportunities rather than income. Nevertheless, if the European Union (EU) is taken as a single country, economic data show that the EU and the U.S. have similar levels of inequality.
As Branko Milanovic points out in the latest edition of the World Bank’s Inequality in Focus series, the overall income inequality in the EU and the U.S. has reached similar levels, with a Gini coefficient in both just above 40, as measured in 2007 when Bulgaria and Romania became members of the former. (A Gini coefficient of zero expresses perfect equality while one of 100 expresses maximal inequality–a situation where one person has all the income). If any, the direction of change since then has not been one toward smaller gaps.
Of course, the structures – and explaining factors – of income gaps are different. As Branko puts it: “In the United States, inequality is a matter of individuals or social classes; in the European Union, it is a matter of location or countries”. In the U.S. inequality is based on the gap between the rich and the poor regardless of the state they live in, whereas in Europe the gap is more pronounced among countries and regions. So if you are an American living in New Hampshire, the richest state in per capita income, the ratio between the average income in your state and that of someone living in the poorest state (Arkansas) is only 1.5. However, the inequality within states is much larger.
In Europe the situation is very different. The poorest five percent of the population in Luxembourg, the richest country in the world, has a much higher income than the richest five percent of population in Romania. Likewise, the poorest people in Denmark are richer than 85 percent of Bulgarians. In fact, if we were to compare European high-inequality countries like the U.K. with American states, as Milanovic does, it turns out the 2012 Olympics host would rank as the sixteenth most equal state in the U.S.
Reducing economic disparities between EU countries was exactly the major rationale for fiscal transfers to help poorer members converge with richer ones. Those policies, combined with the pattern of regional economic growth that followed suit, led to a process of intra-EU income convergence, at both interpersonal and inter-country dimensions. When Portugal joined the EU in 1986, its GDP per capita was 45 percent below that of the EU then. Twenty years later, its GDP per capita was only a third smaller than that of the EU average. Such an income convergence was a key component of the EU political construct. The remaining wide gaps in 2007 only expressed the half-way stage of that endeavor.
The problem now is that the pre-crisis pattern of pro-convergence EU regional growth has shown to be unsustainable in several regards. Labor productivities in poorer countries did not rise as fast as it would have been necessary to underpin the apparent income convergence. In fact, higher growth of poorer EU countries took place in tandem with real estate asset bubbles, high current-account deficits, and household and/or government debt. The unraveling of the finance of those has been the central feature of the most recent phase of the global financial crisis.
Furthermore, shifts in political opinion within richer countries regarding fiscal transfers have led to cross-country political bickering throughout the crisis. On the other hand, strengthening the EU as a political entity, with some key government functions being assumed at a supranational level, is seen by many as ultimately the only way out of the EU economic crisis.
But then the issue of (inter-country) income inequality will remain at the fore. Paradoxically, income inequality may become an even more pressing issue in Europe than in the U.S.
First appeared at World Bank Growth and Crisis blog, Roubini EconoMonitor, and Huffington Post