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Inequality, recession and the robustness of Social Models

Speech of Jörg Asmussen at the "Treasury Talks"-Conference

Dear Ladies and Gentlemen,

it is a pleasure for me to be here with you today and talk about the relationship between inequality, recession and the robustness of Social Models.

If we take the long view and look back at the two decades from the Fall of the Berlin Wall to the global financial and economic crisis, interpersonal inequality worldwide decreased for the first time, after basically rising for the previous 150 years.

A number of observers, chief among them François Bourguignon, have identified this as a "turning point in [economic] history". Income growth in emerging nations has produced huge gains in human welfare, lifting hundreds of millions of people out of poverty and giving them a chance for a better life.

Christoph Lakner and Branko Milanovic have recently described these fundamental changes in the global income distribution: Most importantly, populous Asian countries such as China, India and Indonesia, have “graduated” from the bottom ranks, modified the overall shape of the distribution in the process, and essentially created a global “median” class. Truly a success story!

The other "winners" were top income earners across the globe, which you have heard about during the first panel, while the “losers” were, broadly speaking lower and middle class households from North America, Europe, and Japan, who saw their real household incomes grow slowly or even stagnate for the better part of the past two decades.

Presumably, this was not just the effect of "globalisation", but also of technological changes that would have put pressure on the “blue-collar” working class in mature economies even in the absence of increased global competition. Looking ahead, the likely “inequality impact” of our current processes of digitalisation, which affect the very nature of work, is essentially still an open question.

But back to the retrospect, what we have observed was a long-term rise of inequality within most richer countries. This is worth bearing in mind before one look at the effects of recessions: income inequality increased even while countries were going through a period of sustained economic growth from the mid-1980s to the 2008/09 economic crisis.

Moreover, effects of economic downturns on income distribution and inequality are ambiguous as well. One might think that recessions generally tend to increase income inequality. But actually, in most European countries strongly affected by the recent crisis, income inequality remained stable or, looking at risk-of-poverty rates, even decreased.

There are two points worth mentioning with regard to this observation. First, OECD data shows that market incomes inequality – that is, excluding the mitigating effects of the Welfare State’s tax and transfer system – has in fact increased by more over the three years from 2008 to 2010 than in the previous twelve. Welfare States, and the fiscal stimulus policies in the immediate aftermath of the crisis, were able to absorb most of the impact on inequality and alleviate some of the pain involved.

Secondly, with respect to measures such as the risk-of-poverty rate, recall that those are calculated with respect to the median. Now, the crisis put a strong downward pressure on median incomes in many countries, including Southern Europe, the Baltic States, as well as Ireland and UK. In such a context, a stable or declining risk-of-poverty rate can occur even if poorer households are de facto worse of in terms of their disposable income. The measure then merely indicates that poorer households are not affected disproportionally compared to middle class ones. But of course they have a much harder time compensating for losses in income, and they invariably suffer most from a continued economic and particularly labour market slump, such as we are still dealing with in much of Europe.

Summing up, over the past two, two and a half decades, income inequality has decreased globally – both between countries and between people – but often increased within countries, particularly in the richer part of the world. Unlike Germany, where income inequality grew strongly between 1985 and 2005 (and has been stable since), France is an exception here in that inequality initially fell, and then rose much less markedly since the mid-1990s.

Moreover, taking the long view, the impact of recessions on inequality is not straight-forward, but it is quite obvious that prolonged stagnation and high unemployment will be particularly harmful to medium- and lower income households, and at the same time put growing pressure on Welfare States.

At this point, please allow me a small detour.

As most of you know, prior to my current assignment I held a position at the European Central Bank, and I would like to shortly touch upon the connection between monetary policy and inequality.

For a long time, this was not a topic monetary policy makers usually talked about. You will be hard-pressed to find more than a handful of speeches by Central Bankers mentioning distributional effects of monetary policy before 2008. That has changed somewhat since, as both the issue of inequality (and its macroeconomic effects) and Central Banks’ role in the post-crisis environment have received substantially more attention.

My friend and former colleague Benoît Cœuré has been looking into the matter as early as 2012. More recently, Yves Mersch gave a concise account of the ECB’s reading of the theoretical and empirical links.

On the very face of it, monetary policy obviously impacts on distribution, both directly and indirectly. Working, as it does, through numerous channels – among them current and expected interest rates, credit expansion, asset prices, monetary policy most definitely will not impact everyone in the same way.

How precisely it affects different households will depend on a variety of socio-economic factors, among them households’ income and wealth status, their employment, and their housing situation.

It is fiendishly difficult, though, to disentangle and quantify the various effects and their overall impact empirically. Still, I believe a rather broad consensus of economists would hold that “standard” monetary policy should neither systematically dampen nor intensify economic inequality.

The story with “non-standard” measures – such as we have become progressively used to since the global financial and economic crisis – is arguably a different one. There is justified reason to believe that large-scale balance sheet expansions through financial asset purchases by the Central Bank might in fact increase income inequality.

One principal reason is that it may raise corporate incomes and capital gains more than wages. While most low- and medium-income households rely primarily on labour earnings, wealthier households have increasingly higher shares of capital income. Those households will therefore tend to benefit disproportionately from non-standard monetary policy, leading to higher income inequality.

A second argument points to the higher activity and stronger connectedness of wealthier households with financial markets, which allows them to exploit profit opportunities opened up by highly expansive Central Bank policy more effectively than more risk-adverse middle class households, which – in this environment – typically hold their financial savings in low-risk, (increasingly) low-return assets.

This is a kind of criticism the ECB is currently confronted with, not exclusively – I may add – in Germany. My own take is that in the situation we are currently facing, the ECB sees such unintended distributional side-effects of unconventional measures as a kind of collateral damage that has to be tolerated, faced with much greater dangers connected with a do-nothing approach in the face of a clear violation of the ECB’s price-stability target.

In fact, you could well argue that if it is successful, monetary policy pursuing its primary aim of maintaining price stability, and boosting economic activity in the process, will help avoid further increases in inequality. That is a) because very low inflation, on average, benefits creditors rather than debtors, and b) because a failure to re-start growth will disproportionally hurt wage-earning households, who continue to be faced with high unemployment.

Let me wrap up. Does inequality matter? At the end of the day, as I see it, we have a number of economists’ views on if and how income inequality matters. Some will argue we should focus on restoring economic growth rather than worry about how its gains are distributed – why would you even care about that? Others never tire of portraying income inequality as the engine of growth, because it makes the poor try harder.

On the other hand, recent work by the IMF [which was also a prime focus of the first panel] argues that keeping inequality in check is important to ensuring stable economic growth and reducing the risk of financial crises. However, there is no general agreement in the economic literature.

But I have a clear political position: For me, as European Social democrat, inequality matters. Rising inequality is a major challenge for European societies and for our ‘European Social Model’.

This European Social Model is a fundamental part of what Europe stands for. As a result of the global financial crisis, and its still ongoing economic repercussions, people are losing faith in our Social Model, and to me, that is equal to saying they are losing faith in Europe.

As you all know, over the past couple of years dealing with the crisis, a huge number of national structural reforms have been devised and implemented across Europe. It is imperative to recognize the substantial efforts that have been made, often at great sSpeech of Jörg Asmussen at the "Treasury Talks"-Conference ocial and political cost.

We now have to make them count; to make sure a great number of people in our societies actually get to reap benefits from these reforms.

In this context, another important argument – one the IMF has been stressing more recently – is that the developed world "inequality experience" of the past two decades makes it harder for governments, or societies more generally, to make difficult but necessary choices faced with longer-term economic challenges.

Of these challenges, I believe we can agree there are quite a number. But dealing with them politically will be hard as long as a majority of people feel that the typical result course of events with “reforms” is them making sacrifices, and the already-better-off in society pocketing the gains.

With this, let me conclude by coming back to the European Social Model. There are a few competing definitions, but following Anthony Giddens, its whole point should be to combine economic dynamism with social justice. As I see it, this would always include targeted anti-poverty strategies, deployed to cope with embedded forms of poverty and social exclusion. But above and beyond that, the focal point of the European Social Modell has to be the equality of opportunity. And in our contemporary European societies, I would argue, equality of access to education and training is at the very core of equal opportunities.

These are no mere normative arguments. Equal opportunities are basic building blocks for unlocking the future social and economic potential of our societies. Of course, that is not an entirely new thought. In 1835, the French political thinker and historian Alexis de Tocqueville wrote in « De la démocratie en Amérique »

"Parmi les objets nouveaux qui, pendant mon séjour aux États-Unis, ont attiré mon attention, aucun n'a plus vivement frappé mes regards que l'égalité des conditions. Je découvris sans peine l'influence prodigieuse qu'exerce ce premier fait sur la marche de la société".

("Amongst the novel objects that attracted my attention during my stay in the United States, nothing struck me more forcibly than the general equality of conditions. I readily discovered the prodigious influence which this primary fact exercises on the whole course of society")

On that note, let me close my opening remarks and thank you for your kind attention.