Human Development Research Paper 2011/06 Economic Crises And
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Human Development Research Paper 2011/06 Economic crises and Inequality A B Atkinson and Salvatore Morelli United Nations Development Programme Human Development Reports Research Paper November 2011 Human Development Research Paper 2011/05 Sustainability in the presence of global warming: theory and empirics Humberto Llavador, John E. Roemer, and Joaquim Silvestre United Nations Development Programme Human Development Reports Research Paper 2011/06 November 2011 Economic crises and Inequality A B Atkinson and Salvatore Morelli A B Atkinson is a Fellow of Nuffield College and Centennial Professor at the London School of Economics. E-mail: [email protected]. Salvatore Morelli is a D Phil student in the Department of Economics, University of Oxford. E-mail: [email protected]. Comments should be addressed by email to the author(s). Abstract Sustainability for a society means long-term viability, but also the ability to cope with economic crises and disasters. Just as with natural disasters, we can minimize the chance of them occurring and set in place policies to protect the world’s citizens against their consequences. This paper is concerned with the impact of economic crises on the inequality of resources and with the impact of inequality on the probability of economic crises. Is it the poor who bear the brunt? Or are crises followed by a reversal of previous boom in top incomes? Reversing the question, was the 2007 financial crisis the result of prior increases in inequality? Have previous periods of high inequality led to crises? What can we learn from previous crises – such as those in Nordic countries and the Asian financial crisis? How far can public policy moderate the impact of economic crises? Keywords: Economic crises, Poverty, Inequality. JEL classification: D310, E300, I300 The Human Development Research Paper (HDRP) Series is a medium for sharing recent research commissioned to inform the global Human Development Report, which is published annually, and further research in the field of human development. The HDRP Series is a quick- disseminating, informal publication whose titles could subsequently be revised for publication as articles in professional journals or chapters in books. The authors include leading academics and practitioners from around the world, as well as UNDP researchers. The findings, interpretations and conclusions are strictly those of the authors and do not necessarily represent the views of UNDP or United Nations Member States. Moreover, the data may not be consistent with that presented in Human Development Reports. 1. Introduction1: Sustainability, crises and inequality Sustainability for a society means long-term viability but also the ability to cope with economic crises and disasters. Just as with natural disasters, we can seek to minimise the chance of them occurring and can set in place policies to protect the world‟s citizens against their consequences. Both avoidance and protection are essential. Indeed, in the case of economic crises and disasters, the balance is more favourable to avoidance than with natural phenomena. Economic crises typically concern the institutions created by humans and, in principle at least, are more subject to influence by governments and international organisations. Historically, economic crises have often led to changes in these human institutions, such as the introduction of Social Security in the United States in the 1930s. The paper is concerned both with the impact of economic upheavals on the inequality of resources and with the reverse direction of causality: the impact of inequality on the probability of economic crises. These are two related, but different, questions. The first question asks how far economic crises lead to rising inequality in access to resources. Is it the poor who bear the brunt? Or are crises followed by a reversal of a previous boom in top incomes? Or do both occur? The period prior to the 2007-8 financial crisis did see rising income inequality in a number of countries, notably 1 This paper develops the analysis of financial crises reported in Atkinson and Morelli (2010), a study carried out with the support of the International Labour Organisation. The research forms part of a project undertaken in the Institute for New Economic Thinking at the Oxford Martin School. The paper is based on a data-base for 25 countries covering 100 years described in Atkinson and Morelli (2011), which draws on earlier research by Atkinson (2003), Brandolini (2002) and by the authors of the country studies in the top incomes project published in Atkinson and Piketty (2007 and 2010). None of these institutions or authors should be held responsible for the views we have expressed. 1 an increased share of total income accruing to those at the very top. Has the current crisis reversed this trend? What can we learn from past crises? The answer will depend not only on impact of the initial crisis but also on the policy responses of governments and monetary authorities, as is illustrated for the case of financial crises in Figure 1. The consequences depend on whether the financial crisis is followed by a deep recession. These different factors may work in different directions. The impact of bankruptcies and falling asset prices may have greater impact on the better-off, but an ensuing recession may hit hardest those at the bottom. It is for this reason that we look, not only at financial crises, but also at macro-economic disasters. As we shall see, they do not necessarily come together. But are the effects of a crisis today the same as those in the past? In the US, is the recent crisis like that of 1929? Some crises may be “defining moments”, leading to a permanently changed level of inequality or to a change in direction of its trend. Such change may, like US introduction of Social Security, or like increased financial regulation, work to increase the level of protection for individuals and their families and reduce inequality. The recent study by Roine, Vlachos and Waldenström using data covering the period 1900-2000 for 16 countries concluded that a banking crisis would permanently reduce the share of the top 1 per cent by about 0.2 percentage points for each year of the crisis2 (2009, Table 7). But change today may work in the opposite direction. Pressures for fiscal consolidation may lead to a permanent scaling-down of the welfare state. Put the other way round, the avoidance of economic crises may be necessary to ensure the sustainability of the social institutions we have developed to keep 2 Morelli (2010) undertakes a similar study focusing entirely on US and using a different methodology. 2 inequality in check, such as the welfare state and the stability of democratic political governance. (In this paper, we focus on inequality within countries, but the same issues apply in the case of global inequality.) The second question approaches the issue the other way round and asks how far inequality has increased the probability of crises. Was the recent financial crisis the result of the prior rise in income inequality? Have previous periods of high inequality led to the increased risk of economic crisis? The last 100 years has seen a broad pattern where inequality within countries was high before the Second World War, was lower and, in some cases, falling, over the next 35 years of the “Golden Age”, and then rose in the latter part of the century. Banking crises, as we shall see, almost all occurred before 1945 or after 1980. Is there then a “smoking gun”? On the other hand, we shall see that economic crises in the form of sharp falls in consumption or output are spread more evenly over the century (abstracting from wartime). Is inequality causally linked with financial crises, but not directly with collapses in consumption? The two causal processes can be mutually self-reinforcing. Increased inequality may have increased the probability of a crisis, and the crisis may have had distributional effects that have strengthened the link. This may have happened if the underlying mechanism is a political one, where money buys influence, for example to secure the liberalisation of previously regulated financial markets, which in turn increased earnings in the financial sector (Philippon and Reshef, 2008). It has been argued that liberalisation increased the probability of financial crises: “the number of banking crises per year more than quadruples in the post-liberalisation period” (Kaminsky and Reinhart, 1999, page 476). On a political economy explanation, the crisis strengthens the hand of those in 3 control of the financial sector, giving them political influence, and allowing them to protect their earnings, transfer the cost of crisis-resolution to the taxpayer, and resist the re-introduction of regulation. On the other hand, it is possible that we have a case of co-incidence, rather than causality. The common experience of crises and inequality may be due to a third causal mechanism. Liberalisation and rising top incomes may be a common result of a rightward shift in political thinking, as has been argued by Krugman (2010) and Acemoglu (2011). If that is the case, then there may be an intermediate path, where market de-regulation is combined with effective progressive taxation to secure social justice. In examining these questions, the paper takes a long-term perspective, drawing on data for the past hundred years from 1911-2010. A long-run view is essential since crises are, fortunately, relatively rare events. As was noted by Reinhart and Rogoff, the study of financial crises requires a much longer run of years: “a data set that covers only twenty-five years simply cannot give one an adequate perspective” (2009, pages xxvii and xxviii). The paper considers the history of crises over the 100 year period in 25 countries.3 Looking across countries is valuable for several reasons.