The inequality of macroeconomic risk

Nick Galasso | 27 May 2013

Food price hikes, natural disasters, environmental degradation, and financial crises share at least two things in common: They’re on the rise, and they unequally burden the poor. 

Food price hikes, natural disasters, environmental degradation, and financial crises share at least two things in common: They’re on the rise, and they unequally burden the poor.

The growing risks associated with climate change, volatile commodity markets, and macroeconomic instability is a facet of global inequality hardly discussed. Yet, as a new Oxfam report rightly puts it, “inequality is hardwired into crises,” and the burden of risks are dumped on the poor.

Inequality is typically discussed through the lens of wealth and income. As we know, both are dangerously concentrated at the top in many countries. What’s less discussed is how risk is concentrated at the bottom. Not enough attention is given to this other, pernicious, form of inequality. In particular, the risks of macroeconomic instability are unevenly placed on the poor by financial elites and governments.

Spreading risk across society is not only fair, but may mitigate future disasters.

Let’s consider the interplay of government failure, economic risk, and inequality...

Political Capture, Macroeconomic Risk, & Inequality

The financial elite in the U.S. flood political campaigns with enormous contributions. This  influence over government policies has made this sector extremely wealthy in the last three decades. It also worsened income inequality and infused great risk into the economy. Yet, when the economy collapsed in 2008, the banks, firms, and CEOs represented by the financial lobby escaped sanction, laying the burden of recovery on millions of Americans.

The hold the financial sector has over government rulemaking is known as political capture. It means that instead of acting in the public interest, government advances special interests. Often, this occurs as regulatory capture, when agencies promote the discrete interests of the firms they’re charged to regulate.

For instance, the financial sector’s hold over government allowed them to make enormous amounts of money by taking advantage of the poor through predatory mortgage lending. Their influence to prevent regulation of derivative markets, and permit banks to become incredibly overleveraged, infused enormous risk in the American economy.

Credit default swaps and mortgage backed securities produced staggering wealth for investors and incredible profits for Wall Street (along with astronomical bonuses for traders and CEOs). On the other hand, millions of Americans were left out of this wealth creation. In fact, only about 10% of Americans own 80% of the stock wealth in the U.S. While many saw the value of their homes rise, that wealth resulted from an asset bubble driven by the same, risky financial products government failed to regulate. And as many can attest, that wealth has now vanished. Conversely, since recovery began in 2009, the stock market has broken new heights, creating enormous gains for major investors. The median wage, however, is declining, and therefore inequality is becoming worse. 

As the stock market races higher, millions of workers remain unemployed (or underemployed) because of the financial crisis. The loss of wealth from the housing bubble drove demand down by $1 trillion (residential construction alone fell by $600 billion). Government tax revenues fell significantly, and the deficit widened to cover growing unemployment insurance and food stamps. In Europe, the fallout has meant harsh austerity that’s punishing the poor. Since the poor rely more on government services, austerity means they must carry the burden for a crisis that is hardly their fault.

The financial crisis is a precise example of the inequality of risk, and government failure. Through political capture, the financial sector influenced the U.S. government to allow an enormous amount of risk in the economy. Risk meant great wealth for those at the top of the income distribution, and a bubble allowing homeowners to use their homes as an ATM. After the crash, homeowners were left underwater with debt and millions of jobs were destroyed.

On the other hand, the banks were bailed out in a near textbook example of moral hazard. Moral hazards are when actors take on risk because they believe the burden of their risky behavior will be borne by others. The risk of systemic, economic catastrophe inherent in subprime mortgages was spread to middle and low income Americans, while the economic rewards of such risk remained concentrated among top income earners. To be sure, the financial crisis hurt the portfolios of those at the top. However, the stock market has rebounded to unseen levels and the incomes of the very top are pulling ahead, while the median wage declines. In fact, since recovery began in 2009, the top 10% has captured 149% of the growth and the incomes of the bottom 90% have shrunk.

How to Build Resilience to Economic Risk

Fighting corruption: In many places, including the U.S., capture happens legally. The recent Citizens United ruling by the Supreme Court suggests the influence of moneyed interests over policymaking will continue. Regardless of legal status, it still remains a corrupting effect on representative government. Fighting corruption means greater transparency and accountability, and strengthening the rule of law so regulatory agencies are insulated from politics. In the U.S., it especially means campaign finance reform that levels the playing field. Only by reducing corruption can government act in the interest of all citizens.

Eradicating vulnerability: Building resilience to economic risk among the most vulnerable means more than curbing political capture. It’s also about enhancing poor peoples ability to weather crises. This is accomplished by moving them away from the vulnerability threshold through social insurance and more secure livelihoods. As seen in countries serious about poverty reduction, the most important ingredient to reducing vulnerability is political will. For example, Brazil’s minimum wage is constitutionally mandated to increase with inflation and cost of living. Its conditional cash transfers have provided a floor for people to become more secure and focus on moving out of extreme poverty. This kind of government intervention reduces inequality and brings citizens into social and economic opportunity networks, thereby enhancing their capacity to contribute to economic growth and the country’s future. It’s also a crucial component to reducing their vulnerability to crises.   

Photo credit main picture: steviep187