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Monday, June 11, 2012

Inequality and the Crisis

Does inequality cause slower growth and instability?:

Inequality, the crash and the crisis: Part 1 “The defining issue of our times”, OECD Insights: Today we publish the first of three articles on inequality and the crisis by Stewart Lansley, visiting fellow at The Townsend Centre for International Poverty Research, Bristol University and the author of The Cost of Inequality: Why Economic Equality is Essential for Recovery... He was one of the speakers at the 2012 OECD Forum session: How Is Inequality Holding Us Back?
Does inequality trigger economic instability? A few years ago this was a issue that did not register on the political Richter scale. Nor did it attract much attention amongst professional economists. As James Galbraith ... has put it, those few working in inequality research were in an economics “backwater”. ...
There is one key reason for this lack of interest. For the last thirty years, the economic orthodoxy has been that inequality is a necessary condition for economic success. We can have greater equality or faster growth but not both. That orthodoxy emerged out of the global crisis of the 1970s when, it was claimed, the move towards more equal societies in the immediate post-war decades had gone too far and had led to economic sclerosis. What was needed to put economies back on an upward and sustainable path was a stiff dose of inequality.
Since the late 1970s that theory – for theory it was – has been put to the test in a real life experiment in both the US and the UK, and more latterly in a number of rich countries. ...
Not only has the rise in inequality failed to deliver on faster growth, history shows a clear association between inequality and instability. The great crashes of 1929 and 2008 and the deep-seated recessions that followed were both preceded by sharp rises in inequality. In contrast, the most prolonged period of economic success and stability in recent history – from 1950 to the early 1970s – was one in which inequality fell across the rich world and especially in the UK and the US.
Of course, association is one thing, causation is another. In part 2, we will look at the reasons why the link may run from inequality to crisis, at why economies that allow a small minority to colonize an increasing share of the economic cake hike the level of economic risk and the likelihood of implosion.

I'll be interested to see the evidence in part 2. There does seem to be an association between inequality and crises, but causality has been much harder to establish. It's easy to think of stories where this could happen, e.g. inequality leads to political power which spurs deregulation and causes a crisis. But it's just as easy to think of stories where a third factor causes both inequality and instability, and the evidence has not been sharp enough to allow us to choose one particular story over the others.

    Posted by on Monday, June 11, 2012 at 04:54 PM in Economics, Financial System, Income Distribution | Permalink  Comments (87)


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