Justice and the Great Recession: Has the financial crisis increased inequality?

Have a few thousand bankers made the world more equal than it had been for a hundred years? In this blog post, I will investigate the distributive impact of the 2008 financial crisis and show that today’s inequalities are more complex than we think: if political philosophers want to understand the repercussions of the crash, they need to team up with economists and track down the hidden divides in post-crisis societies.

It was on 14 September 2007 that the general public first noticed that something was wrong. Hundreds of desperate customers queued in front of the branches of mortgage lender Northern Rock, fearing that their savings were already gone. Britain’s eighth-largest bank was a very early, but clearly not the last corporate casualty of the Global Financial Crisis: One year later, the acclaimed investment bank Lehman Brothers went bust and the insurer AIG was nationalised. This shock plunged the entire financial system in a panic that lasted 28 days – and whose repercussions are still with us today.

World trade contracted more quickly than during the Great Depression of the 1930s. $60,000 to $200,000 billion were lost in economic output and 10 million Europeans and US Americans found themselves unemployed. More than an estimated 10,000 people in Europe and the US committed suicide because of the downturn. Elsewhere, it threw 2 million Bangladeshis and 1.4 million Filipinos from a lower-middle-class life into poverty.

But how exactly has the shock of 2007/08 changed the distribution of income and wealth? As it turns out, the effects are more complex and harder to spot than we think.

A first, surprising point is that the 2008 Global Financial Crisis has made the world as a whole more equal than it had been for more than a century. In 1988, global income inequality dropped for the first time since the Industrial Revolution and has kept falling ever since. A recent World Bank study shows that the repercussions of the financial crisis have even accelerated this trend towards global income convergence.

Is that good news? Not quite. The inequality-reducing effect of the crisis mainly materialised because the Great Recession has disproportionally affected the industrialised West. At the same time, population-rich countries like India and China continued growing largely unimpeded. In other words, the incomes of the rich and the poor converged more quickly because of two trends: the poor continued to catch up (not because, but despite the crisis), and the downturn dealt a huge blow to the by global standards richest part of the world population. Hence, the impact has been what Larry Temkin termed “levelling down”: it reduced inequality without benefitting anyone, by disproportionately dragging down the best-off.

This teaches us to be cautious about aggregate inequality indicators like Gini coefficients and the Theil index in times of economic crisis. Several commentators keep casting the narrowing income gaps as evidence that “the system is working”, as a success of laissez-faire policies. In the case of the Global Financial Crisis the opposite is the case: The accelerated convergence should rather be seen as an indicator of system failure. The “levelling down” of the best-off simply obscures how the least well-off are faring. In addition, let us not forget that the polarisation of incomes within countries has grown explosively since the 1970 and is at its highest level since then. The financial crisis has possibly slowed this increase temporarily, but not substantially affected it either way.

Hence, to grasp the normative implications of the 2008 crisis, political philosophers need to dig deeper into the statistical findings. In fact, tucked away in the data, the recession and the ensuing policy responses have produced another series of developments that deserve critical attention.

Here are two examples:

(1)   Regional inequalities: The crisis has strongly accentuated inequalities between regions. This can be seen in the case of France. In the sixteen years between 1993 and 2007, the largest discrepancy in average annual growth between two regions was between Corsica’s +2.8 percent and Picardie’s +1.3 percent growth rate. In the first four years after the crisis, however, the maximal gap between two regions doubled! While Corsica’s economy expanded with +1.9 percent, Bourgogne’s shrunk by -1.2.

A similar pattern emerges from UK data. Here, despite modest, but robust aggregate growth figures, only two regions actually had a higher per-capita GDP in 2015 than in 2007, London and the South-East. By contrast, in Yorkshire and Humberside it has shrunk by 6 percent. Northern Ireland remains 11 percent below its pre-crisis peak. “Whose recovery?”, asks the Bank of England’s Andrew Haldane. “To a significant extent, those living in London and the South-East of the country”.

(2)   Intergenerational inequalities: Moreover, think about these three developments that have characterised the crisis and its aftermath: (1) First-time job seekers and unexperienced workers had a particularly hard time in the labour market. (2) Billion-dollar bailouts limited the losses of savers and institutional investors and were funded by the money of (future) taxpayers. (3) Thanks to ultra-low interest rates and quantitative easing, the prices of financial assets and real estate have sharply rebounded. Now, it is important to see that assets and tax burdens are not evenly distributed over the demographic pyramid. Broadly speaking, older people tend to own more assets, while younger workers shoulder the lion’s share of tax payments.

The upshot? In some countries, these differences have drastically inflated intergenerational inequality. The Bank of England finds that in the UK “all of the £2.7 trillion rise in wealth since 2007 has been harvested by those over the age of 45, two thirds by those over the age of 65. By contrast, those aged 16-34 have seen their wealth decline by around 10% over the period.” Again, the question “Whose recovery?” appears more important than asking about aggregate growth rates.

The examples of intergenerational and regional inequalities show: Even if macroeconomics shocks affect all of us, they do not affect all of us equally. There are significant differences in how vulnerable people are to them. Intersectional feminist theory teaches us that it is especially the co-occurrence of such structural disadvantages that is problematic: it can have a major impact on fair equality of opportunity.

Why don’t we do more to combat such vulnerability differentials? Part of the reason is that they do not fully feature in customary inequality metrics. The described inequalities are “local”, i.e. they do not generically make the rich richer and the poor poorer, but instead discriminate among people across income and wealth classes, for example in virtue of features like age or geographical location. This makes it harder to detect and track them.

Thus, in my view, we should draw two practical conclusions from the above:

1. Inequality is more complex than we think. In the aftermath of large economic shocks, standard inequality metrics are an unreliable guide to how just a society is. This is because “levelling down” tends to obscure the struggles of the least advantaged. Furthermore, many relevant inequalities are local and do not fully feature in headline inequality metrics. This explains why the crisis has reduced many inequality indicators – and yet made things worse.
2. Scrutinise inequality statistics in detail. Political philosophers should not be satisfied with customary indicators like the Gini coefficient or the Theil index to determine how just a society is, but dig deeper into the data. We need to talk to economists and jointly figure out: what kinds of statistics do we need to detect current and avert future injustices? Only by taking these steps can we succeed at fully appreciating the impact of the 2008 financial crisis. Ten years later, the challenge is still on.

(picture: Sao Paulo Stock Exchange, by Rafael Matsunaga)