Polarization of income distribution as a cause for the financial and economic crisis (2010)

Professor Engelbert Stockhammer
Project for the Chamber of Labour, Vienna, Austria

The financial crisis that began in summer 2007 has since turned into the worst economic crisis since the Great Depression. Its immediate causes are to be found in the malfunctioning of the financial sector: securitisation of mortgages allowed for a fast growth of credit and lowered credit standards as banks believed they had passed on credit risk; this fuelled a property bubble; statistical models, that turned out to be based on short time samples, were promised to reduce risk by constructing ingenious portfolios; well-paid rating agencies decorated the new assets with triple A ratings; banks shifted credit off balance sheets into structured investment vehicles; finally, capital inflows from Asian countries that wanted to accumulate reserves provided ample liquidity for this process. Obviously the financial system needs to be fundamentally overhauled. While these mechanisms were indeed important, this paper argues, they are only half of the picture. The focus on the flaws in the financial system may hide other causes of the crisis. The polarisation in income distribution, in particular, tends to get glossed over as a potential cause of the crisis. This is not to deny the importance of financial factors. The crisis erupted as financial crisis for good reasons. The underlying accumulation regime had financial expansion as one of its key building blocks. However, what is at stake is more than financial system. This paper will thus argue that the present crisis should be understood as a crisis of neoliberalism. Financial deregulation is one of the components of neoliberalism, the polarization of income distribution is another one; it is their interaction that provided the grounds for the crisis.

Project outline

The project will present empirical evidence on four channels through which the polarisation of income distribution has contributed to imbalances that erupted in the present crisis. Hypothesis 1: The polarisation of income distribution leads, other things equal to a decline in consumption demand as the consumption propensity of low income groups is higher and the consumption propensity of wage income is higher than that out of capital income. Hypothesis 2: External financial liberalisation has loosened balance of payment constraints on individual countries. As a result, two different growth models have emerged: In the Anglo-Saxon countries credit-led consumption growth has become the key variable to drive growth; in another group of countries growth of net export has become the main source of demand growth. Hypothesis 3: the increase of household debt in the USA has to some extent compensated for growth of wage income. Hypothesis 4: The increase in wealth inequality has increased speculation as richer household have a higher propensity to invest in risky assets. The project will evaluate these hypotheses empirically and discuss policy implications.

Project Output

Photograph of a torn Euro banknote