While almost no-one predicted the financial crisis of 2007, there’s been no shortage of people rushing to explain it with the benefit of hindsight. Amid all the competing explanations, one caught my eye: the idea that rising US income inequality somehow caused the financial crisis.
But while this conveniently slots into the ‘inequality-is-bad-for-everything’ narrative, is this really true?
I’m not an economist working on the financial sector, so I’m not going to pass judgement on this myself. (Any readers with more expertise and a strong opinion should get in touch and write a post!). But there’s an interesting conversation going on across the blogosphere that I thought I’d share.
The argument that inequality played a role goes something like this, as nicely captured by Kumhof & Ranciere, who argue that the same was true of the 1929 Crash. Rising income inequality was associated with squeezed living standards for Americans in the bottom half of the income distribution. Then:
“Borrowing and higher debt leverage appears to have helped the poor and the middle-class to cope with the erosion of their relative income position by borrowing to maintain higher living standards. Meanwhile, the rich accumulated more and more assets and in particular invested in assets backed by loans to the poor and the middle class. The consequence of having a lower increase in consumption inequality compared to income inequality has therefore been a higher wealth inequality.”
Some form of this view has been set out by a number of economists, including by Kumhof & Ranciere in a paper for the International Monetary Fund, and spawning a documentary called ‘The Flaw’ (by the creator of ‘Wife Swap’, no less).
Others, however, aren’t convinced. In this review of a number of posts by The Atlantic, they point out that (i) rising inequality in general doesn’t predict crises; (ii) inequality might be a symptom of a deeper problem, not a cause in itself. And this thoughtful post at The Economist points out that the main problem in the inequality-caused-the-crash explanation is one of timing:
The 50th (and below) percentile struggled most, he [Daron Acemoglu] demonstrated, in the 1980s. During the period in which this credit expansion was supposedly taking place, the bottom half wasn’t really falling behind the 90th percentile. Politicians reacting to that inequality would be targeting a phantom.
So who is right? While I have no special expertise here, the account on the Economist seems plausible – that inequality had a role to play, but within a highly complex, multi-causal picture of what led to the financial crisis (I recommend reading their long-ish post).
Either way, it’s fascinating stuff, and a reminder that inequality may have economic as well as social and ethical consequences.