Income distribution and economic crises

• Date: 01 December 2018
• Published date: 01 December 2018
• DOI: http://doi.org/10.1111/infi.12135

DOI: 10.1111/infi.12135

ORIGINAL ARTICLE

Income distribution and economic crises

Bilin Neyapti

Department of Economics, Bilkent

University, Ankara, Turkey

Correspondence

Bilin Neyapti, Department of Economics,

Bilkent University, Ankara 06800,

Turkey.

Email: neyapti@bilkent.edu.tr

Abstract

This study presents an original empirical analysis of the

relationship between income inequality and recession

severity, measured by the length and depth of recessions.

For this purpose, an extensive panel data set was

constructed, whereby each observation corresponded to a

recession episode. The empirical analysis yielded two novel

findings. First, pre-recession inequality and recession

severity are weakly related to each other, as a negative

and statistically significant relationship is only observed

for middle and high levels of income and governance.

Second, the relationship between recession length and

post-recession income inequality is positive and highly

significant in low- and middle-income countries. This

relationship is insignificant in high-income countries due,

possibly, to their high capacity to accommodate for the

impacted low-income groups.

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INTRODUCTION

Income growth has been volatile around the world since the 1970s, interrupted by recessions of varying

degrees of severity.

1

While economics research has focused overwhelmingly on growth and efficiency

especially during that period, the relationship between sustainable growth and inequality has been

insufficiently explored.

2

Income and wealth inequality may, to some extent, be attributed to historical and structural

factors. It is also likely that these factors facilitate the formation of special interest lobbies that engage

in rent-seeking activities and build extractive institutions to strengthen their socio-economic

positions.

3

Extractive institutions lead to allocational and distributional inefficiencies and may result in

institutional sclerosis

4

that eventually dominates macroeconomic outcomes. Consequently, recessions

or crises are usually associated with—besides poor economic management—inefficient institutions

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that, in turn, may also be closely linked to socio-economic inequality.

5

Volatility in economic growth

since the 1980s may, therefore, be associated with increasing relative and absolute income inequality,

6

and declining collective bargaining power of workers, commonly measured by the rate of

unionization.

7

In an effort to mitigate the widespread effects of the Great Recession (GR), which originated as a

financial crisis in the United States in 2008, most developed countries adopted large-scale

unconventional policy measures that were mainly tentative remedies, rather than substantive reforms.

8

Piketty and Saez (2013) and Piketty (2014) noted that the post-GR recovery in the United States has

been experienced mainly by the top decile of the population, whose income shares have already been

on an upward trend during the last four decades.

9

The expanding size and influence of the financial

sector in the U.S. economy,

10

coupled with the decreasing lobbying power of the wage-earners, may

help explain this unequal impact of GR across different income groups.

11

Low preference of the

political elite for progressive taxation in many countries may have also contributed to increasing

income inequality around the world.

12

Morlino and Quaranta (2016) and Gründler and Köllner (2017)

showed, however, that democratic quality, extensive political rights, and strong middle classes in

advanced economies have helped overcome the negative effects of crises. Gründler and Köllner (2017)

also noted the negative effect of top income groups on redistribution. While interest group dynamics

thus appear important to understanding the relationship between economic crises and income

distribution, exploring their role in this relationship is beyond the scope of the current study. This study,

instead, simply focuses on the association between the severity of recessions and income inequality.

The relationship between economic crises and high and persistent income and wealth inequality has

recently drawn considerable research interest, in view of the widespread effects of GR. The focus in

many of these studies, however, is on the relationship between financial crises and income distribution,

with an emphasis on crisis prediction (see, e.g., Atkinson & Morelli, 2010; Bazillier & Héricourt, 2014;

Bellettini & Delbono, 2013; Bordo, 2012; Kumhof, Rancière, & Winant, 2015; Perugini, Hölscher, &

Collie, 2013; Piketty & Saez, 2013; Rajan, 2010; Van Treeck, 2014). Considering that not all financial

crises overlap with a recession episode, however, the possible relationship between economic

downturns and inequality remains to be investigated.

The novel contribution of the current study stems from the empirical analysis of the relationship

between income inequality and recession severity, measured by the length of the recessionary

episodes and the resulting cumulative output loss. The main hypotheses tested in this work are thus:

(i) pre-recession income inequality may be related with recession severity; and (ii) post-recession

income inequality may be related with the severity of foregoing economic recessions. High and

persistent purchasing power gaps usually imply unequal access to markets, quality education, and

healthcare. Economies with high income inequality are more likely than others to suffer from payment

problems and restrained demand that hamper economic activity. While not all recession or inequality

phenomena imply inefficiency,

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recessions—when coupled with high income inequality—may also

be associated with increased potential for socio-political unrest that is harmful for economic prospects.

These arguments form the basis of the first hypothesis.

Severe recessions are, in turn, likely to lead to organized demand for institutional reforms that

target elimination of economic inefficiencies.

14

Whether or not such reforms are implemented usually

depends, however, on both the political power of the disadvantaged groups and the will and the ability

of policy makers, which are dynamically interconnected.

15

Hence, an improvement in income

distribution following a recession is conditional on various structural and institutional factors, besides

crises severity. This premise has guided the development of the second hypothesis tested as a part of

this investigation. When inefficiencies are not overcome, inequality may persist or escalate over time,

and may pave the way for further recessions.

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NEYAPTI