Inequality & the crisis

Was inequality to blame for the financial crisis? A paper (pdf) by Michael Bordo and Christopher Meissner suggests not. They point out that, in developed countries since the 1920s, the sort of credit booms that lead to crises have not generally been associated with rising inequality. This casts doubt upon Raghuram Rajan’s idea that rising inequality led to the crisis by encouraging lax regulation of lending to low-income households; though he is not alone (pdf) in suggesting such a link.

One can question the relevance of Bordo and Meissner’s evidence. The fact that crises are not often preceded by rising inequality does not disprove that inequality - along with other mechanisms - had a role in this particular crisis.

And there are two other mechanisms through which inequality might have precipitated the crisis:

- Insofar as rising inequality in the 00s was correlated with a rise in wages in the financial sector relative to other industries, it attracted “talent” into banking. And this contributed to its downfall, because “talent” produces not stability but rent-seeking and overconfidence. Remember - banks survived for decades by employing doddering Captain Mainwarings but collapsed soon after hiring physics PhDs.

 - One contributor to bank collapses was inequality of power. Top-down management structures produce bosses who combine domineering arrogance with ignorance. As Julian Birkinshaw has said (pdf), the management model in investment banks was one in which “Aggressive and intimidating behaviour is tolerated; effective teamwork and sharing of ideas are rare.”

And even if inequality did not cause the crisis, it is correlated with it. The same growth (pdf) of Asian economies that gave us an excess supply of cheap labour which depressed unskilled wages in the west also gave us the savings glut that produced the housing boom and malinvestments in mortgage derivatives.

But does it much matter whether income inequality contributed to the crisis or not? The Left argued that high inequality was a bad thing long before the crisis, for intrinsic as well as instrumental reasons. Those arguments are as strong (or as weak!) as they ever have been.

Comments

[CharlieMcMenamin]

"...banks survived for decades by employing doddering Captain Mainwarings but collapsed soon after hiring physics PhDs."

I think that's my favourite sentence on the subject to date. By some distance.

[BT]

"And even if inequality did not cause the crisis, it is correlated with it."

Bingo.

The correlation between US Gini index and US private sector debt:GDP ratio is extraordinary.

This can't just be due to GATT/globalisation pushing down US wages or the 'asian savings glut' pushing dow US interest rates. It's also the 2% inflation target, which falls on wages but not asset prices.

Rising asset prices over average income means that those incomes at the very top rise the most, because they benefit most from asset price rises (Finance, Insurance, Real Estate, Lawyers).

[Tomboktu]

Anthony Atkinson gave a presentation in Dublin in January on work done by Atkinson and Morelli on whether there is a link between banking crises and inequality, drawing on 72 banking crises in 25 countries between 1911 and 2010. Their conclusion: "No".

Paper treatment here:

http://isites.harvard.edu/fs/docs/icb.topic457678.files/ATKINSON%20paper.pdf

[ThomasW]

BTW: That's where Deutsche Bank is now heading to: Kicking out the last Captain Mainwarings and replace them by the physics PhDs. It is already happening.

[Dipper]

"...banks survived for decades by employing doddering Captain Mainwarings but collapsed soon after hiring physics PhDs."

"Top-down management structures produce bosses who combine domineering arrogance with ignorance."

JP Morgan, Goldman, and Barcap all have loads of PhD's and whilst I have no experience of these organisations it would seem that the description of management would apply to these as much as other banks. These banks didn't go bust.

Did Bradford & Bingley have loads of quants? Did HBOS's corporate loans department, recently plastered all over the papers, have lots of quants?

This article is a case of post hoc ergo propter hoc?