Income inequality expected to rise due to financial crisis

Kanaga Raja

Income inequality, which grew dramatically in most regions of the world, is expected to further increase due to the current global financial crisis, according to a new study by the research arm of the International Labour Organisation (ILO).

In a report, ‘World of Work Report 2008: Income inequalities in the age of financial globalisation’, the ILO’s International Institute for Labour Studies also noted that a major share of the cost of the financial and economic crisis will be borne by hundreds of millions of people who haven’t shared in the benefits of recent growth.

The report said that while a certain degree of income inequality is useful in rewarding effort, talent and innovation, huge differences can be counter-productive and damaging for most economies, adding that “rising income inequality represents a danger to the social fabric as well as economic efficiency when it becomes excessive.”

“The ongoing global economic slowdown is affecting low-income groups disproportionately,” said the report, adding that “This development comes after a long expansionary phase where income inequality was already on the rise in the majority of countries.”

At a media briefing on October 16, the Director of the Institute Raymond Torres said that the main finding in the report is that income inequality has grown excessively and is expected to grow further as a result of the financial crisis.

He said that the bailout plans (recently announced in the US and Europe) are crucial to avoid another Great Depression. At the same time, he added, these plans show that the growth path has been uneven and highlight the problems that this represents. The cost of the rescue packages will be borne by all, whereas the benefits of the high growth period have gone mainly to some of the high income groups.

Reiterating that the bailout plans are for everybody and pointing to the need to avoid a situation where the financial crisis becomes a major economic crisis, Torres also noted that it raises a more structural issue of what caused the crisis in the first instance. One of the factors is imbalanced development - an imbalanced growth model.

Dynamism

As to what can be done, Torres pointed to the need to maintain strong employment dynamism that characterised the world economy at large since the early 1990s. There is also a need to avoid excessive volatility in financial globalisation.

When reforming the financial architecture, there is need to ensure that the solutions which are adopted reduce the volatility which is created by financial globalisation. “Volatility is bad for the labour market,” he said, adding that it introduces a lot of turmoil in the labour market. Low-income and vulnerable groups are disproportionately affected by this economic and labour market volatility.

As part of the reform of the financial architecture, Torres said that one needs to reflect on excessive executive pay trends. The report shows that these executive pay trends have not been related to firm performance, he added.

The report examined wages and growth in more than 70 developed and developing countries. It called for longer term action to put the global economy on a more balanced track, including promotion of the ILO’s Decent Work Agenda to link economic, labour and social policies to boost employment and improve incomes and income distribution.

The report said that as global employment rose by 30 per cent between the early 1990s and 2007, the income gap between richer and poorer households widened significantly at the same time. What’s more, compared with earlier expansionary periods, workers obtained a smaller share of the fruits of economic growth as the share of wages in national income declined in the vast majority of countries for which data was available.

Rapidly rising oil, food and raw material prices, as well as the global financial turmoil, have affected the world economy over the past year, said the report. Growth turned negative in a number of countries, including France, Germany, Japan and Italy, in the second quarter of 2008, and growth in emerging and developing economies is expected to slow down. To what degree this will happen will partly depend on how severe the situation in the advanced economies turns out to be.

The current economic slowdown has already had an immediate impact, bringing to a halt the strong employment growth enjoyed, with little or no interruption, by most advanced economies since the early 1990s. The US, for example, experienced negative employment growth in each of the first eight months of 2008. Moreover, employment growth in most countries of the Organisation for Economic Co-operation and Development (OECD) is expected to slow down over the remainder of 2008 and into early 2009.

Global employment growth, although still positive, is also expected to slow down in 2008, as employment gains diminish in developing economies. As a result, unemployment is expected to rise to 6.1 per cent in 2008, said the report.

In the context of the current financial crisis, it is also quite likely that the impact of these most recent developments has yet to be fully felt, said the report. In this respect, it will be important to monitor the extent to which low-income groups may be affected, especially in the developing world, where the recent steep increase in food prices has disproportionately reduced the purchasing power of poorer households.

Changes

These developments will likely intensify some of the changes that have characterised the world of work over the past two decades or so. First, as the advanced economies’ share of total employment has been in steady decline over the past decade, falling to just over 15 per cent in 2007, that of the developing economies has continued to rise. In fact, the world of work is evolving in such a manner that the regions of Asia and the Pacific and Latin America and the Caribbean now account for nearly two thirds of world employment, with Asia alone accounting for more than half.

Employment growth has also occurred alongside a redistribution of income away from labour. In 51 out of 73 countries for which data are available, the share of wages in total income declined over the past two decades. The largest decline in the share of wages in GDP took place in Latin America and the Caribbean (-13 points), followed by Asia and the Pacific (-10 points) and the advanced economies (-9 points).

The period 1990-2000 offers the most comprehensive snapshot of income inequality and patterns over time by region and country, said the report, adding that over this period, more than two-thirds of the 85 countries for which data are available experienced an increase in income inequality, as measured by changes in the Gini index.

The wage gap between the highest 10 per cent and lowest 10 per cent earners has also tended to increase. An examination of existing data for OECD countries and micro-data for Brazil, China and India reveals that inequality has risen in 18 of the 27 countries since the early 1990s for which data are available. The highest wage dispersion occurred in Brazil, China, India and the US, and the lowest in Belgium and the Nordic countries.

The report noted that the rise in executive pay, which is sometimes regarded as a driver of income inequality, has attracted considerable attention over the past few years but especially so in the context of the recent financial crisis. An examination of executive pay in 2007 for the 15 largest companies in six selected countries shows that chief executive officers (CEOs) earn, on average, between 71 and 183 times more than the average employee. In the US, the CEOs of the 15 largest companies earned 520 times more than the average worker. This is up from 360 times more in 2003.

While some developments in the global economy have clearly benefited those in the highest income brackets, others have made the poorest worse off. This is particularly the case of rising food and commodity prices - particularly fuel prices, said the report.

The peculiarity of food and fuel is that they have virtually no substitutes. An increase in their price does not, therefore, generate a large decrease in consumption, so any increase in food prices affects households’ purchasing power. Moreover, low-income households are likely to be more adversely affected, in that they spend a large proportion of their income on such goods. In India, since 2006, food prices have grown by 9 per cent , compared with 6.3 per cent for non-food prices. This is predicted to have a negative effect on the purchasing power of all urban households.

Financial

The report observed that financial globalisation has accelerated since the early 1990s, with advanced countries investing financial assets in international markets amounting to several times their GDP. However, despite these substantial capital flows around the globe, financial globalisation has failed to improve global productivity or employment growth. This stands in stark contrast to the benefits brought by domestic financial development.

Moreover, said the report, despite accelerating financial globalisation, less developed economies are not receiving their share of global savings. On the contrary, savings continue to flow from less to more developed economies, in contrast with theoretical predictions.

Partly through the lack of proper regulation or an adequate supervisory framework, the frequency of financial crises has increased in both developed and emerging economies as a consequence of financial globalisation. Worldwide, systemic banking crises have been 10 times more likely throughout the 1990s than during the late 1970s, which was hardly a period of calm economic activity.

Such increased instability has come at a steep cost to inequality, as low-income households have been particularly affected by repeated boom-bust cycles. Low-income households do not seem to have benefited from improved access to financial markets to insure themselves against shocks. As a consequence, global inequality has, at best, remained constant, while inequality within countries seems to be rising, regardless of their level of economic development.

The report also noted that financial globalization has led to a depression of the share of wages in GDP, reinforcing the downward trend recorded in most countries. This effect is over and above any trend decline in the wage share that may have resulted from sectoral shifts, rising labour demand elasticities from trade openness or changes in labour market regulations and institutions.

Now that the recent financial market turmoil in the US has turned into the ‘first global financial crisis of the twenty-first century’, however, the labour market fallout from such crises deserves renewed interest, said the report. The spillover of US financial market stress to other developed and emerging markets, in the form of interest rate hikes and the loss of liquidity, has demonstrated yet again that events in international financial markets can have a substantial impact on domestic economic and social development, with adverse consequences for employment growth and income opportunities.

The report said that the current dynamics of financial globalisation have prevented a further convergence of wealth both across and within countries, with income inequality in low-income countries remaining unaffected by financial openness. This is in marked contrast with the sanguine predictions of some proponents of financial globalisation.

Noting that prospects are for a continuing increase in income inequality in the course of the present economic situation, the report said that excessive income inequalities could also be associated with higher crime rates, lower life-expectancy, and in the case of the poor countries, malnutrition and an increased likelihood of children being taken out of school in order to work.

“Already now, there are widespread perceptions in many countries that globalisation does not work to the advantage of the majority of the population,” said the report. “The policy challenge is therefore to ensure adequate incentives to work, learn and invest, while also avoiding socially-harmful and economically-inefficient income inequalities.”

- Third World Network Features