Cross-national trends in permanent earnings inequality and earnings instability in Europe 1994-2001

Using a fully harmonized panel dataset across 14 European countries between the early- 1990s and 2001, the European Community Household Panel, we fill a gap in the literature with a cross-national comparative study which explores the trends in persistent inequality and transitory inequality across countries belonging to a common economic area, but with different systems and with different rates of adaptation to the economic reality of the 1990s. The covariance structure of earnings is estimated using minimum distance methods. We find a substantial degree of convergence in the overall inequality among the Mediterranean, the Continental and the Anglo-Saxon countries, which reflects a convergence in both permanent and transitory inequality. Among the Nordic/Flexicurity countries we find a strong divergence in the overall inequality, driven by a divergence in both permanent and transitory inequality. Pooling most countries in Europe, we find evidence of a strong convergence in earnings instability. The Nordic/Flexicurity countries have a lower overall inequality, a lower persistent inequality and a higher earnings mobility. These cross-national differences in persistent inequality and earnings instability across Europe can be partly explained by the labour market policies and institutions linked with the wage-setting mechanism. The stricter the regulation in the labour and product market, the higher the persistent inequality. The higher the unionization, the degree of corporatism, and the tax wedge the lower persistent inequality. Corporatist systems are associated with a lower earnings instability than decentralized ones.

Keywords: earnings dynamics; permanent inequality; transitory inequality

JEL classification codes: C23; D31; J31