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As the aftershocks of the financial crisis continue to reverberate through real economies and government budgets (particularly in the West), it is becoming increasingly clear how the gap between the extremely rich and the poor is playing a major role in the crisis. Economists from the International Monetary Fund (IMF) now acknowledge that, while dysfunctional financial markets caused the crisis in an immediate sense, its deeper cause was inequality.
Banks took on financial assets whose risk they had no real way of assessing correctly. At the heart of these assets were mortgages in the so-called 'sub-prime' market – basically high-risk mortgages made to poor people with insecure and low-paid jobs. When these people started to default on their mortgages in large numbers in 2008, the whole complex (and fraudulent) system of securitised risk unravelled very quickly and dramatically.
An underlying question is why the sub-prime market arose in the first place, and the answer in part lies in the stagnation of incomes in the bottom half of the income distribution in the US (and also in the UK) since the early 1980s. A number of factors drove this, including the introduction of new technology. New technology (e.g. IT) has nearly always been targeted at cutting costs and getting rid of manual labour (increasing unemployment and squeezing wages), instead of using it to free up staff and unleash their (untapped) potential to continuously innovate and grow. (NB the former is a blunt application of Poweromics, whilst the latter is a good example of Leanomics ... it's also worth noting that very few enterprises, or economies, will successfully find they 'cut their way to sustainable success').
Michael Kumhof and Romain Rancière, the authors of the report Inequality, Leverage and Crises, pick up the theme of stagnant incomes at the bottom, but link these to the huge increase in earnings at the top, which provides the other half of the story. By 2006, the top 1 per cent of taxpayers in the USA received almost one quarter of all income in the US (see chart below).
The wealthy needed to invest their money somewhere, and in Kumhof and Rancière go on to say: 'The key mechanism is that investors use part of their increased income to purchase additional financial assets backed by loans to workers. By doing so, they allow workers to limit their drop in consumption following their loss of income, but the large and highly persistent rise of workers’ debt-to-income ratios generates financial fragility which eventually can lead to a financial crisis'.
As a consequence the size of the financial sector, as measured by the ratio of banks’ liabilities to GDP, ballooned*, with the crisis characterised by large-scale household debt defaults and an abrupt output contraction (as in the U.S.)
During the build up to the 2008 financial crisis, the worlds of the rich and the poor were connected, but through the need to lend on the one hand and the need to borrow on the other, and IMF paper argues that the extreme gap between rich and poor was an underlying cause of the crisis (with its obvious parallels to the late 1920s - when the Roaring 20's was followed by the Great Depression) - see chart of Male Annual Earnings in the US below.
The paper goes on to explain how 'the crisis is the ultimate result, after a period of decades, of a shock to the relative bargaining powers over income of two groups of households, investors who account for 5% of the population, and whose bargaining power increases, and workers who account for 95% of the population' and argues 'because crises are costly, redistribution policies that prevent excessive household indebtedness and reduce crisis-risk ex-ante can be more desirable from a macroeconomic stabilization point of view than ex-post policies such as bailouts or debt restructurings'.
The paper concludes by suggesting 'Restoration of poor and middle income households’ bargaining power can be very effective, leading to the prospect of a sustained reduction in leverage that should reduce the probability of a further crisis.' and warns of "disastrous consequences" for the world economy if workers do not regain their "bargaining power" against rentiers.
The International Monetary Fund (IMF) also warns that "dangerous" imbalances have emerged that threaten to derail global recovery and stoke tensions that may ultimately set off civil wars in deeply unequal countries (nb we can see this already starting to play out today**).
Despite all the rhetoric and spin, in reality the UK (and US) Government chose to bail out the banks with tax payers money (allowing the rich bankers to profit heavily from gambling once again), whilst passing the cost of the bailouts onto poor and middle income households, in the form of job losses, higher taxes and reduced services ... Indeed, worse still, in the UK we have the Tory Government trying to suggest the way out recession is to cut the top rate of income tax to the rich ... and to restrict the rights of ordinary people to strike ... both quite the opposite of what the IMF suggests in its report ... unless they're trying to promote civil war that is!
* The situation was also made worse by Fractional Reserve Banking, with bankers pushing to increase lending in order to profit from money (created out of thin air)!
** With the current unrest in Egypt, it was interesting to hear the potential hypocrisy in which the UK/US told Egypt's leaders to return the internet/mobile communications to its people, and to respect these as basic human rights ... as I understand both Governments' have similar strategies planned if they face similar levels of unrest!
