Where are the limits of Europe?

For Branko Milanovic the limits of Europe are set by the inequality successive EU enlargements have enhanced.

Branko Milanovic

We know that there is such a thing as an ‘optimal currency area’, although it is possible that the framers of the Lisbon treaty were not aware of it. The Greek crisis has popularised the concept. As the name says, it puts limits to what should (ideally) be a single currency area.

Similarly, in the 1990s, when  at one end of the European continent countries like the USSR, Czechoslovakia and Yugoslavia dissolved, with their constituent member states applying to join the European Union, a like question was asked: why would you leave one union and join another, rather than keep your full independence? One of the answers came in a 1996 article, where I argued that there was a trade-off between independence in policy-making (say, full fiscal and monetary authority) and income. Countries such as Estonia and Slovenia were quite willing to give up monetary and (to a large degree) fiscal independence, in exchange for monetary transfers and the institutional framework provided by the EU.

But this reasoning still left the question: was there a point where a country might find the cost, in terms of forgone policy discretion, too onerous and so decide to stay out (thus placing a limit to the expansion of the union)? Perhaps Switzerland and Norway are such non-EU examples.

Limiting factor

Almost nobody looked at inequality as a limiting factor in the growth of a union. Yet there at least three reasons why it may be.

First, a union with member states at very different income levels requires large transfers form the richer to the poorer to function normally.

Secondly, a very unequal union is, by definition, composed of member states whose endowments of capital and labour are very different. Hence the optimal economic policy for a poor member may not be the same as the optimal policy for a rich member. (We find here echoes of the optimal currency area.)

Thirdly, and currently perhaps most importantly, if such a union implies freedom of movement systematic labour flows which then follow—with people moving from poorer to richer members—may be politically destabilising, if richer members are unwilling to accept migrants.

The third point may be largely responsible for ‘Brexit’. It could be argued that without the EU’s eastern enlargement there would have been no Brexit. Thus the EU, implicitly, faced a trade-off of its own: it could have the UK or eastern Europe—but not both. Through a succession of steps, and largely unaware of this choice, the EU picked the latter.

Income differences

Behind the movement of people are the underlying differences in income among countries. This is why Romania is estimated to have ‘lost’ almost 2 million of its citizens since it joined the EU. But how large are income differences within the union?

Let us start with the most simple and most important, ignoring differences in income within countries and looking only at those between EU countries (thus in effect assuming that every person in a given member state has the mean income or per capita gross domestic product of that member state). And let us take as the measure of inequality the Gini coefficient, which ranges from 0, at full equality, to 100, when the entire income is held by one person/entity.

The results are quite striking. In 1980, when the EU was composed of only nine member states, the between-country Gini coefficient was just three points. Combining the nine members into one group added to the total EU inequality (through their differences in development) an utterly negligible quantity. More than nine tenths of EU9 inequality was due to within-country income differences (that is, income differences between poor and rich people within France, within the Netherlands and so on).

A decade later, in 1990, the between-country Gini for the now EU12 had already doubled to six points. Fast forward 14 years more and, with the eastern enlargement, the number of member states went up to 25 and the Gini yet again more than doubled to 13 points. It has increased further, but slightly (to 13.5), with the additions of Romania, Bulgaria and Croatia.

Now, the estimates of interpersonal inequality (that is, between all citizens) in the EU range between 37 and 39 Gini points. This means that one third of overall EU inequality (13.5 out of 37-39) is now systemically built in, due to the underlying differences in income among the member states.

Compare the EU28 with the US50—the United States composed of 50 members (its states). Overall US50 inequality is higher than that for the EU28: the Gini for the US is in the lower 40s, whereas the European Gini is in the mid-to-upper 30s. But only about one tenth of that inequality in the US is ‘caused’ by inequality between states while, as we have seen, a third of inequality in Europe is caused by differences in income between the member states.

Hard to fix

European inequality (which thus decomposed looks very much like Chinese inequality, similarly driven to a significant degree by provincial income differences) is much harder to fix. It requires strictly geographic transfers of purchasing power from rich to poor member states. Since the population compositions differ, this translates into transfers from (say) the Dutch to the Bulgarians. But an EU budget of 1 per cent of total GDP is laughably small for such transfers.

The alternative solution is to let people migrate. This is what the EU has done, with political consequences which are obvious today.

We can then legitimately ask: are there limits to EU enlargement—limits imposed by the higher inequality arising from the accession of new and poorer members? If Turkey alone joined, the underlying Gini of a new union would be 17 points. If the western Balkans’ four candidate members joined as well, it would rise further to 17.5. This underlying inequality, which is not subject to domestic or EU-wide economic policies (the latter because the EU budget is so small), would then represent close to half of the overall inequality among 615 million citizens of the union.

It would be an unmanageable union.

This is why the EU should not continue with its unsustainable policy, which seems to offer candidate countries potential membership at the end a very long (or, rather, interminable) tunnel. That policy leads only to frustration on both sides. The EU should look at things as they are and create a new category of countries which will not be members for any realistic period of time.

Perhaps it could wait until such potential members become richer on their own, which means the EU should by all means encourage greater Chinese investment and involvement in those countries—the opposite of what it is doing now. Or perhaps it could wait until convergence of incomes within EU members and lower all-EU inequality permits another round of enlargement—which is unlikely to happen before the second half of this century.

This article is a joint publication by Social Europe and IPS-Journal

Branko Milanovic

Branko Milanovic is a Serbian-American economist. A development and inequality specialist, he is visiting presidential professor at the Graduate Center of City University of New York and an affiliated senior scholar at the Luxembourg Income Study. He was formerly lead economist in the World Bank's research department.