Rising inequality as a structural cause of the financial and economic crisis (2013-16)

Professor Engelbert Stockhammer
Funded by the Institute of New Economic Thinking

The financial crisis that began in summer 2007 has since turned into the worst economic crisis since the Great Depression. Its causes are usually sought in the malfunctioning of the financial sector leading to a real estate bubble and rapidly rising household debt. Among the macroeconomic factors that have attracted attention international imbalances have featured prominently: capital inflows, in particular from Asian countries that wanted to accumulate reserves, provided ample liquidity for this process. While all these financial mechanisms are indeed important, this project argues that, they may only give half of the picture. The project will investigate the hypothesis that rising inequality has contributed to the macroeconomic imbalances that erupted in the present crisis.

This project, financed by the Institute for New Economic Thinking, proposes to interpret the present crisis as an outcome of the interaction of the effects of financialization with the effects of rising inequality. We thus do not deny the importance of financial factors, but argue that they have to be seen in conjunction with increasing inequality. A dramatic shift in income distribution in all OECD economies has been one of the major socio-economic changes since the early 1980s. This has taken different forms in different countries. In the Anglo-Saxon countries a polarisation of personal income distribution has occurred. In the continental European countries it is functional rather than personal income distribution that has shifted dramatically. These changes in income distribution are historically extraordinary. They mark a clear break with the relatively egalitarian income distribution of post-war capitalism. In the USA income inequality is at its most extreme for a century! Given these dramatic changes one would expect macroeconomic effects.

Project Outline

The project furthers our understanding of how rising inequality has contributed to the macroeconomic imbalances that erupted in the present crisis. This is done based on a Kaleckian macroeconomic model. We suggest that the present crisis should be understood as an outcome of the interaction of the process of financialization with the effects of the polarization of income distribution. The project will explore three channels through which rising inequality has contributed to the crisis.

  • Channel 1: The decline in the wage share has a negative effect on domestic demand and has thus contributed to stagnation tendencies.
  • Channel 2: The deregulation of international capital flows has loosened the balance of payments constraints for individual countries and has thus allowed the emergence of two growth models: one group of countries has relied on debt-led consumption growth—typically implying capital inflows; another group has relied on net exports growth, which implies capital outflows.
  • Channel 3: Rising inequality, in particular stagnant wage growth, has contributed to rising household indebtedness in the USA.
Photograph of a torn Euro banknote