New Report Examines Link Between Inequality and Financial Crises
This brief summarizes the Report of the Independent Expert on the effects of foreign debt and other related international financial obligation of States on the full enjoyment of human rights, particularly economic, social, and cultural rights
On Tim Tang, New Rules for Global Finance
A new Report of the Independent Expert from the Human Rights Council (published 12 January 2016) looks at income and wealth inequality in connection with financial crises. The Independent Expert looks at these two issues as interrelated, where either could be used to explain the rise of the other. Two distinct broad lines of argument are made; firstly, the Independent Expert looks at the ways “increased levels of such inequalities may contribute to increases in sovereign debt that may subsequently degenerate into financial crises”. Secondly, “he examines the reverse relationship by assessing the distributional impact of financial crises and points to severe adverse effects on the enjoyment of human rights”. The report concludes by proposing “a set of policy recommendations designed to target economic inequality as a pressing human rights issue and a factor contributing to the emergence of financial crises”. The report’s interest at looking at income inequality in conjunction with human rights comes from the underlying perspective of striving for non-discrimination and for individuals to enjoy at least “minimum essential levels” of living. This briefing summarizes the logic behind the Independent Expert’s arguments, and raises points for possible further exploration.
The Independent Expert’s first argument can be broken down into two elements; first, how does inequality cause an increase in sovereign debt? And second, how does greater sovereign debt lead to financial crises? The report examines this first element by discussing empirical studies that link inequality, income tax base, and sovereign debt. In countries that do not have a progressive income tax system, high inequality is likely to result in lower income tax revenues compared to countries with progressive tax systems and similar levels of inequality. With lower tax revenues, assuming all other factors remaining constant (e.g. government expenditures), the report argues that countries will be more likely to incur greater levels of sovereign debt. More indirect dimensions of this argument look at the link between inequality and private debt (with greater inequality, individuals are more likely to accrue private debt), the impact of macroeconomic policies conventionally used to address the issue of sovereign debt (reduced government spending broadly leads to unemployment and reduced economic output), as well as the socio-political aspect of income equality (income inequality leads to greater discontent, instability, thus lowering investors’ confidence and subsequently tax revenue as well).
The second half of this argument is that the more sovereign debt a country incurs without the means of financing it in the long-term, the more likely it is to end up in a financial crisis. Beyond the issue of inequality itself, the report asserts that the deeper problem is that many individuals cannot afford the minimum costs of living.
The Independent Expert’s second argument looks at the reverse causal relationship. Given that a financial crisis, by definition, is understood to involve a decline in economic growth, greater instability, and a decline in investment, the argument looks at how financial crises result in income inequality – in other words, why financial crises disproportionally affect low-income households. This argument is based on three distinct points: first, just like when faced with increased sovereign debt, governments tend to respond to financial crises by cutting spending. This may manifest itself in reduced public social assistance, which directly impacts the quality of life for its recipients. The report shares data that shows incomes are disproportionately affected and low-income households are impacted the most. Even in a hypothetical scenario where all income levels are affected proportionately following a financial crisis, the report finds that a reduction in social spending would translate to greater income inequality when compared to before. Secondly, the report establishes that financial crises tend to affect labor (typically on the lower end of income distribution) more than owners of capital (typically on the upper end) because financial crises cause individual unemployment, and thus the distribution share of income for labor in comparison to capital decreases. Thirdly, the unemployment that arises as a result of a financial crisis tends to disproportionally affect poorer and/or younger workers. These three points raise the questions: how should governments prioritize expenditures and the different programs they fund? And how can governments incentivize individual firms to develop strategies that reduce inequality in the event of a financial crisis?
Based on these inter-linkages between inequality, sovereign debt, and financial crises, the Independent Expert proposed several recommendations for “preventing and responding to financial crises and combating inequalities”: greater financial markets regulation in order to ensure debt sustainability, raising minimum wages and enforce increased standards for working conditions, introducing a progressive taxation system, tax reform with greater equality in mind, and developing financial crisis response plans with the aforementioned long-term consequences in mind (instead of cutting back on the development of skills, or programs that benefit the poor).
In conclusion, the three arguments laid out in this report seek to inform policymakers and other stakeholders of the depth of interconnectedness between income inequality and financial crises. A better understanding of this thesis should lead to the proposal of economic policies that reduce the occurrence of both phenomena, thus broadly benefiting society.
Work Cited
Report of the Independent Expert on the Effects of Foreign Debt and Other Related International Financial Obligations of States on the Full Enjoyment of Human Rights, Particularly Economic, Social and Cultural Rights (Advance Edited Version). Rep. no. A/HRC/31/60. Thirty-first Session. Agenda Item 3.1-22: Human Rights Council, 2016. Print. Promotion and Protection of All Human Rights, Civil, Political, Economic, Social and Cultural Rights, including the Right to Development