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Reducing or aggravating inequality? Preliminary findings from the 2008 financial crisis

Citation

Fiorio, Carlo V. & Saget, Catherine (2010). Reducing or aggravating inequality? Preliminary findings from the 2008 financial crisis. International Labour Office Working Paper no. 95.

Abstract

Why would we expect the 2008 financial crisis to change earnings and income distribution? Was this a usual outcome from past financial crises? Is there evidence of a change in earnings inequality in some of the most early affected countries e.g. the United Kingdom and the United States? Have deep changes in pay practice been observed at the company level? Are changes in inequality likely to be permanent or transitory? The main objective of this paper is to provide a tentative answer to these fundamental questions. Indeed, rising inequality raises questions of its own, in particular when it is due to a deterioration of low earnings relative to higher earnings such as potentially severe social consequences (low standard of living, poorer health, increased social tensions and crime...). In addition, a substantial part of the increase in earnings inequality observed over the past 20 years in OECD countries can be traced to an increase of top earnings relative to other earnings and especially in banking, e.g. the sector where the crisis initiated. In some countries, declining earnings for low paid workers would have prompted households to increasingly rely on credit to maintain their living standards. Major economic shocks (financial crises, hyperinflation) are sometimes associated with changes in the earnings distribution. For example, earnings inequality deteriorated permanently in countries most affected by the Asian financial crisis of 1998 and after the hyperinflation period of the 1990s in some of the CIS countries. In contrast, a common feature of other financial crises in Europe, Northern American, Latin American countries was to exhibit an increase in inequality before the crisis. As far as the present 2008 crisis is concerned, transmission mechanisms from crisis to inequality may be informative of the outcome. Besides total or partial closures, bankruptcies and job losses, the crisis is also forcing some firms to introduce work-sharing arrangements or review their pay practice. The combination of these three factors: job losses, reduction in work hours and changes in pay rates affect the distribution of monthly earnings in a fairly direct way. Turning to the income distribution, the crisis has also affected capital income and social protection system. These two other transmission mechanisms from crisis to income inequality are also addressed in this paper. The empirical evidence of this paper focuses on the United Kingdom and the United States as examples of labour markets most affected by the crisis but they have also been chosen because of earnings data availability. However, the paucity of data precludes from analysing various dimensions of aggregate inequality. The results show that there is very small evidence in favour of rising earnings inequality. Regarding the top of the distribution, there is anecdotal evidence of an equalizing effect through legislative limits and non-regulatory “self-discipline” on the remuneration of highly paid executives, especially in the financial services industry. This equalizing effect is not reflected in our results. Turning to income inequality, preliminary analysis support the view that it has increased during the crisis, largely driven by increases in the incidence of unemployment among low-earnings individuals. The structure of the paper is the following. This paper starts in Section 2 by reviewing the theoretical and empirical literature on the relationship between financial crises and income inequality before discussing the special case of the impact of inflation. It also discusses the way labour market institutions and social protection policies may mitigate these results. New empirical evidence on earnings and income inequality in the United Kingdom and the United States is then presented in Section 3. Section 4 concludes with a summary of the main findings, outlining the transitory nature of the observed changes in inequality.

URL

http://staging2.ilo.org/wcmsp5/groups/public/---dgreports/---integration/documents/publication/wcms_145082.pdf

Reference Type

Journal Article

Year Published

2010

Journal Title

International Labour Office Working Paper no. 95

Author(s)

Fiorio, Carlo V.
Saget, Catherine