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Employment and Social Developments in Europe 2014
Box 4: Income distribution and international trade on impact, but returns to equilibrium
rather quickly.
In classical economic models, such as the Heckscher-Ohlin model, causality runs
from international trade to factor income distribution. In assessing the impact of Transmission of domestic
income distribution on international trade, a distinction has to be made between cyclical effects across borders
a scale and composition effect ( ).
1
The socioeconomic adjustments in the
The scale effect is related to differences in marginal propensity to spend income face of a temporary asymmetric shock
across the income quintiles ( ). As income earners in the lower quintiles have a described above (distributional effects,
2
higher marginal propensity to spend income, a re-distribution of income from low- hysteresis and product market feed-
to high-income earners will reduce aggregate demand, including imports. Moreo- backs) will not only affect economic
ver, when low-income earners face liquidity (or credit) constraints, cuts in their activity in the domestic country, but also
disposable income strengthen the fall in aggregate demand, including imports. the economies of its trading partners
The composition effect refers to the allocation of a budget across different goods through channels such as international
and services — whereby a distinction has to be made between necessities ( ) and trade, capital flows and migration.
3
luxuries ( ). A decrease in disposable income will decrease demand for luxuries
4
and increase demand for necessities. Hence, when the home country and trading Furthermore, as a temporary asymmetric
partners produce different types of goods, the change in income inequality will (negative demand) shock may increase
affect trade patterns. income inequality, this will in turn also
The quantitative impact of these channels depends largely on the structural charac- affect international trade (since demand
teristics of the economies. It is beyond the scope of this chapter to investigate this in elasticities vary between types of goods
more detail, but Chart 28 provides some indicative evidence of strong differences in (e.g. luxuries or necessities), as well as
trade openness of the Member States of the euro area. As the Chart shows, for exam- between income levels, while countries
ple, Greece has the lowest number of jobs (% of total business sector employment in often specialise in different catego-
the business sector) sustained by foreign final demand, while Ireland has the highest. ries of goods and services; see Box 4).
In addition, gains in national price and
( ) Assuming separability of preferences, i.e. in a first stage it is decided how much to spend and
1
how much to save, while in a second stage it is decided how the total spending will be allocated cost competitiveness also translate into
between the available goods and services. See, for instance, Deaton and Muellbauer (1986). losses in competitiveness of trading
( ) See for instance Parker et al. (2013). partners which can affect a significant
2
( ) Such as food and beverages which have a positive income elasticity below 1. share of employment (see Chart 28),
3
4
( ) Such as exotic travel which has an income elasticity above 1.
inducing a decrease in their exports and
an increase in their imports.
Chart 28: Jobs in the business sector sustained by foreign final demand Apart from these demand side effects,
(% of total business sector employment) several adverse hysteresis feedbacks on
the supply side have to be considered as
80 well, including the possibility of a perma -
70 1995 nent productivity loss. Indeed, when the
2008
rise in income inequality persists after a
60 temporary shock has waned, the domes -
50 tic country may experience a permanent
loss of productivity — which, in turn, has
% 40
a permanent adverse impact on its trad -
30 ing partners by limiting their opportuni-
20 ties to exploit comparative advantages
in world markets.
10
0 Furthermore, while international capital
EL ES UK FR PT IT PL DE FI NL DK AT SE CZ SI BE HU SK IE EE LU
flows have the potential to stabilise an
economy, these flows can be reduced if,
Source: OECD.
for example, borrowers cannot provide
sufficient collateral as a consequence
In short, the responsiveness of out- share will decrease, which may then of a shock and rising inequality.
put prices to changes in nominal unit trigger a further contraction in aggre-
60
labour cost (at the level of the econ- gate demand ( ). Nevertheless, the Finally, rising labour flows in the face
omy as a whole) appears to occur very pro-cyclical nature of wages is not of an economic downturn can affect
slowly. This is seen to be especially the observed across all euro area Member domestic wages which tend to start to
case in Germany, Portugal and Slove- States — in Slovakia, Estonia, Italy and rebound earlier (while domestic demand
nia, and to a lesser extent in Cyprus Finland, price adjustment overshoots can be boosted via remittances from
and Spain. Such lag between price and migrant workers), while at the same
nominal wage adjustment implies that ( ) Provided the marginal propensity to time, the increased supply of labour
60
real wages (i.e. nominal wage adjusted consume out of labour incomes is larger in the receiving country tends to put
than the marginal propensity to spend out of
for prices) and hence the labour income capital income. downward pressure on wages. However,
226
Box 4: Income distribution and international trade on impact, but returns to equilibrium
rather quickly.
In classical economic models, such as the Heckscher-Ohlin model, causality runs
from international trade to factor income distribution. In assessing the impact of Transmission of domestic
income distribution on international trade, a distinction has to be made between cyclical effects across borders
a scale and composition effect ( ).
1
The socioeconomic adjustments in the
The scale effect is related to differences in marginal propensity to spend income face of a temporary asymmetric shock
across the income quintiles ( ). As income earners in the lower quintiles have a described above (distributional effects,
2
higher marginal propensity to spend income, a re-distribution of income from low- hysteresis and product market feed-
to high-income earners will reduce aggregate demand, including imports. Moreo- backs) will not only affect economic
ver, when low-income earners face liquidity (or credit) constraints, cuts in their activity in the domestic country, but also
disposable income strengthen the fall in aggregate demand, including imports. the economies of its trading partners
The composition effect refers to the allocation of a budget across different goods through channels such as international
and services — whereby a distinction has to be made between necessities ( ) and trade, capital flows and migration.
3
luxuries ( ). A decrease in disposable income will decrease demand for luxuries
4
and increase demand for necessities. Hence, when the home country and trading Furthermore, as a temporary asymmetric
partners produce different types of goods, the change in income inequality will (negative demand) shock may increase
affect trade patterns. income inequality, this will in turn also
The quantitative impact of these channels depends largely on the structural charac- affect international trade (since demand
teristics of the economies. It is beyond the scope of this chapter to investigate this in elasticities vary between types of goods
more detail, but Chart 28 provides some indicative evidence of strong differences in (e.g. luxuries or necessities), as well as
trade openness of the Member States of the euro area. As the Chart shows, for exam- between income levels, while countries
ple, Greece has the lowest number of jobs (% of total business sector employment in often specialise in different catego-
the business sector) sustained by foreign final demand, while Ireland has the highest. ries of goods and services; see Box 4).
In addition, gains in national price and
( ) Assuming separability of preferences, i.e. in a first stage it is decided how much to spend and
1
how much to save, while in a second stage it is decided how the total spending will be allocated cost competitiveness also translate into
between the available goods and services. See, for instance, Deaton and Muellbauer (1986). losses in competitiveness of trading
( ) See for instance Parker et al. (2013). partners which can affect a significant
2
( ) Such as food and beverages which have a positive income elasticity below 1. share of employment (see Chart 28),
3
4
( ) Such as exotic travel which has an income elasticity above 1.
inducing a decrease in their exports and
an increase in their imports.
Chart 28: Jobs in the business sector sustained by foreign final demand Apart from these demand side effects,
(% of total business sector employment) several adverse hysteresis feedbacks on
the supply side have to be considered as
80 well, including the possibility of a perma -
70 1995 nent productivity loss. Indeed, when the
2008
rise in income inequality persists after a
60 temporary shock has waned, the domes -
50 tic country may experience a permanent
loss of productivity — which, in turn, has
% 40
a permanent adverse impact on its trad -
30 ing partners by limiting their opportuni-
20 ties to exploit comparative advantages
in world markets.
10
0 Furthermore, while international capital
EL ES UK FR PT IT PL DE FI NL DK AT SE CZ SI BE HU SK IE EE LU
flows have the potential to stabilise an
economy, these flows can be reduced if,
Source: OECD.
for example, borrowers cannot provide
sufficient collateral as a consequence
In short, the responsiveness of out- share will decrease, which may then of a shock and rising inequality.
put prices to changes in nominal unit trigger a further contraction in aggre-
60
labour cost (at the level of the econ- gate demand ( ). Nevertheless, the Finally, rising labour flows in the face
omy as a whole) appears to occur very pro-cyclical nature of wages is not of an economic downturn can affect
slowly. This is seen to be especially the observed across all euro area Member domestic wages which tend to start to
case in Germany, Portugal and Slove- States — in Slovakia, Estonia, Italy and rebound earlier (while domestic demand
nia, and to a lesser extent in Cyprus Finland, price adjustment overshoots can be boosted via remittances from
and Spain. Such lag between price and migrant workers), while at the same
nominal wage adjustment implies that ( ) Provided the marginal propensity to time, the increased supply of labour
60
real wages (i.e. nominal wage adjusted consume out of labour incomes is larger in the receiving country tends to put
than the marginal propensity to spend out of
for prices) and hence the labour income capital income. downward pressure on wages. However,
226
