New York Times writer Louise Story recaps a bold thesis put forward by David Moss of Harvard Business School, namely, that high levels of income inequality stoke financial crises:
The possible connection between economic inequality and financial crises came to Mr. Moss about a year ago… A colleague suggested that he overlay two different graphs — one plotting financial regulation and bank failures, and the other charting trends in income inequality.
Mr. Moss says he was surprised by what he saw….
“I could hardly believe how tight the fit was — it was a stunning correlation,” he said. “And it began to raise the question of whether there are causal links between financial deregulation, economic inequality and instability in the financial sector. Are all of these things connected?”
Professor Moss is among a small group of economists, sociologists and legal scholars who are now trying to discover if income inequality contributes to financial crises. They have a new data point, of course, in the recent banking crisis, but there is only one parallel in the United States — the 1929 market crash…
Even scholars who support the inquiry say they aren’t sure that researchers will be able to prove the connection. Richard B. Freeman, an economist at Harvard, is comparing about 125 financial crises around the globe that occurred over the last 30 years. He said inequality soared before many of these crises. But, Mr. Freeman added, the data from different nations is difficult to compare. And Professor Freeman says he has found some places, like the Scandinavian countries, where there were crises without much inequality, suggesting that other factors, like deregulation, may be the best explanations…
Margaret M. Blair, who teaches at Vanderbilt University Law School and is active with the Tobin Project, the nonprofit organization Mr. Moss founded a few years ago to study issues like economic inequality….is researching whether financial workers promote bubbles and highly leveraged systems, even unconsciously. Ms. Blair said that because financial bubbles often lead to higher returns, financial workers have the potential to make more, and this pattern can influence their trading strategies and the policies they promote. Those decisions, in turn, drive even greater income inequality, she said.
Yves here. This is intriguing, but I am inclined to believe that income inequality is either a symptom of conditions that can produce bank crises (like excessive financailization of an economy) or a secondary contributor. If you simply look to Minsky’s theory of financial instability, a rise in what he calls speculative units and Ponzi units would benefit leveraged speculators, and shift incomes and wealth away from ordinary workers to those who can attach themselves to capital. Carmen Reinhart and Kenneth Rogoff similarly found a strong correlation between a high level of international capital flows and more frequent financial crises. It isn’t hard to imagine that large scale international capital flows would be associated with the prominence of large international ventures which again could distribute a lot of winnings to a comparatively small (in societal terms) number of beneficiaries. The article also mentions deregulation as a possible prime cause. The neoclassical experiments with radical deregulation, such as Chile and Russia, witnessed plutocratic land grabs, rising inequality, and economic upheaval.
I’m curious to get reader views on where income inequality fits among the factors that generate financial meltdowns.