Info Service on Finance and Development (June12/05)
19 June 2012
Third World Network
vicious circle of instability and crises
Published in SUNS #7388 dated 13 June 2012
Geneva, 12 Jun (Kanaga Raja) -- Finance-driven globalisation, whose
defining features include unfettered capital movements, deregulation
of financial markets, regressive taxation and retrenchment of social
programmes, are contributing factors to rising income inequality in
both rich and poor countries over the past 30 years, the UN Conference
on Trade and Development (UNCTAD) has observed.
In its latest policy brief (No. 5, titled "Breaking the cycle
of exclusion and crisis"), UNCTAD said: "Even leaving aside
basic issues of social justice, experience shows that inequality often
goes hand in hand with macroeconomic instability and crises, undermining
growth prospects and, significantly, further augmenting inequality."
According to UNCTAD, breaking this vicious circle will entail a concerted
effort to foster inclusive and sustainable growth. Policy changes
will be needed at national and international levels, together with
strengthened multilateral support and coordination, it added.
The policy brief notes that even before the 2008 financial crisis
triggered the worst recession since the 1930s, it had become clear
that the prevailing pattern of economic growth was deeply unbalanced.
The share of profits and interest in national income had been increasing
everywhere over the preceding decades, and the Gini coefficient (measuring
inequality) had tended to rise in developed, developing and transition
economies, albeit with some variations, especially in recent years.
By 2007, says the brief, the richest 20 per cent of the world's population
was receiving 70 per cent of global income, while the bottom 20 per
cent was receiving only 2 per cent.
"Trade openness and technological changes have been offered as
possible causes, but these are, at best, partial explanations, because
they ignore the dominant role of finance in shaping economic outcomes
over recent decades."
Several features of finance-driven globalisation (FDG) have contributed
to growing inequality.
Firstly, said UNCTAD, the financial sector's share of national income
has grown almost everywhere, channelling larger profits and ever more
generous compensation packages to the wealthy. This helps to account
for the increasing proportion of income going to the top 1 per cent
of the population and, even more markedly, to the top 0.1 per cent.
Secondly, as returns on capital have grown, the share of wages in
national income has declined in most developed countries and has shown
significant volatility in the developing world.
Wages have lagged behind productivity growth almost everywhere, reflecting
greater competition in labour markets, weaker employment protection
legislation, and the weakening of labour unions. This has made it
harder to sustain the expansion of domestic demand and, consequently,
stable economic growth.
Thirdly, stressed UNCTAD, there have been huge increases in speculative
financial flows in search of quick gains. These have been fuelled
by rising debts contracted by governments, firms and individuals,
and by the liberalization of finance, capital movements and exchange
rates in most countries under FDG, which signalled policy support
for a financial free-for-all.
According to the policy brief, the features of FDG often reduced governments'
policy space, particularly regarding taxation and distributive measures.
In part to prevent capital flight through liberalized financial markets,
many governments have cut tax rates on high earners and on capital
gains, while relying on regressive measures, such as taxes on consumption,
to make up the shortfall.
"The growth of finance, the concentration of income and wealth,
and the movement of capital within and across borders have also been
linked to the increasing frequency of crises and shocks."
The policy brief notes that financial, balance-of-payments and exchange-rate
crises were common in developing countries in the 1980s and 1990s,
particularly in Latin America and East Asia. In all these cases, the
rapid liberalization of financial markets was an important trigger.
The pattern of accumulation under FDG, including declining investment,
weak demand, and boom-and-bust cycles, helps to explain the uneven
and generally slow economic growth rates in many countries over the
past 30 years, especially in those most firmly committed to FDG, said
UNCTAD, underscoring that the contrast with much faster and more stable
growth rates achieved in some countries, especially in Asia, can be
traced to the different development strategies pursued in the latter.
Several channels establish a two-way causal relationship between FDG
and inequality. After years of stagnating or slow-growing incomes,
those at the middle and lower end of the income spectrum increasingly
turned to "easy credit" to meet their aspirations for better
housing and improved living standards, fuelling a credit bubble based
on sub-prime loans, especially in the United States and the United
Kingdom but also in parts of the eurozone.
"This was facilitated by the rising incomes of the well-off,
whose frantic search for yield swelled the size of the financial sector
and provided the liquidity for loans to those on lower incomes. In
recent years, and principally in the advanced economies, these processes
were accompanied by the proliferation of opaque financial instruments,
such as mortgage-backed securities, which set up the conditions for
the 2008 crisis."
UNCTAD said that a significant body of evidence indicates that, since
those higher up the income ladder have a relatively low propensity
to consume, the skewing of income distribution can reduce aggregate
demand even as their spending habits prompt those on lower incomes
to increase their own spending, thereby reinforcing the pattern of
debt-driven growth. This, in turn, adds to the fragility of the financial
It underlined that when financial crises spread to the wider economy,
the inevitable rise in joblessness can also serve to aggravate inequality.
For example, rapid de-leveraging by companies and households reduces
tax receipts and consumption and fuels the public debt, and, in recent
experience, triggers regressive shifts both in taxation and in social
provision, further widening income inequality.
"The outcome of these overlapping processes is a vicious circle
in which FDG fosters inequality, which contributes to crises which,
in turn, perpetuate or even heighten inequalities," it cautioned.
Income gaps can also widen across regions within countries, as is
evident in the growing rural-urban split in several fast-growing developing
countries and in many developed countries, where the recession has
widened regional inequalities.
"Given the proven track record of public policies in reducing
regional disparities across countries and over time, today's austerity
policies do not bode well for convergence within countries."
These vicious circles of financial instability, inequality and crisis
have long-term implications and may store up difficult challenges
for the future.
UNCTAD pointed out that slow wage growth and insufficient aggregate
demand increase the risk that the global economy will suffer a prolonged
stagnation and deflation. Persistently low investment and employment
creation, especially of full-time, permanent and decent jobs, wastes
human resources and risks excluding many people, especially the young
and women, from the benefits of economic growth.
Finally, and despite the marginal tightening of financial regulations
after the global crisis, if the disproportionate flow of income to
the top is maintained, the conditions that triggered the crisis could
"It is possible to break these cycles of inequality, economic
instability and under-performance through a coordinated drive within
and across countries to promote inclusive development. There is an
important role for multilateral institutions in providing policy advice
supporting these efforts to ensure that national policies are mutually
reinforcing and driven by those countries with stronger fiscal and
balance-of-payments positions, rather than conflicting with each other
or burdening the weakest countries disproportionately," says
A more balanced, inclusive and stable pattern of growth will require
boosting demand in a sustainable manner, through real wage increases
and improved social security provision, rather than through speculation
or bubbles in credit and asset markets. This should be the bedrock
sustaining a virtuous circle of long-term sustainable investment,
rising productivity, higher wages and consumption, and job creation,
While no single policy prescription can secure the transition onto
this trajectory, several economic and social policies can work together
to make growth more sustainable and inclusive, fostering a form of
globalization that is development-centred rather than finance-driven.
"This policy shift will require paying as much attention to employment,
income distribution, social protection and environmental sustainability
as to inflation, efficiency, and the interests of creditors. In this
respect, the experience in Latin America during the last decade is
Since the start of the new millennium, several countries have managed
to reduce inequality and sustain faster and more inclusive growth
through the deployment of more equitable social, taxation and economic
These include counter-cyclical fiscal policies, lower interest rates,
and higher public investment and social spending, supported by more
progressive taxation, and labour-market policies that help to raise
wages and improve social protection.
In turn, says the brief, enhanced income support, higher pensions
and improved healthcare have helped to ensure that disposable income
is channelled back into the economy, especially in poorer regions,
alleviating poverty and boosting regional convergence.
In Brazil, for example, inequality has declined sharply since the
new millennium, with the Gini index falling by more than 5 points
since 2000. This has been associated with a significant reduction
in poverty and in the share of income going to the wealthiest 1 per
cent. Between 2000 and 2009, average annual GDP growth accelerated
by two percentage points compared with the previous decade.
"This break with the past reflects a policy mix that has included
substantial growth in the minimum wage, increased spending on education
and a range of innovative social programmes, the best known of which
is Bolsa Familia (family allowance, a Brazilian social welfare programme),
and a rising share of taxes as a percentage of GDP, which are subsequently
channelled back into the economy," said UNCTAD.
Experiences of wage-led growth in Latin America can offer important
lessons for those developing economies where creeping financialisation
and precarious social protection have driven household savings to
excessive levels, fostering a distorted and, ultimately, unsustainable
modality of growth.
According to UNCTAD, efforts are also needed to encourage investment
in fixed capital, developing and incorporating sustainable technologies,
and to strengthen the employment component of growth. Linked to these
priorities is the need to address the failure of wages to grow in
tandem with productivity.
Several policy instruments are available in this regard, including
industrial policies, income and labour-market policies, and public-sector
investment. Other structural and self-reinforcing aspects of inequality
must also be addressed, including unequal access to education and
technology, and exclusion due to gender, ethnicity and age.
"Without such policies, and a decisive break with FDG, developing
countries risk replicating the regressive and destabilizing growth
pattern of the developed countries," the brief stresses, adding
that this danger is especially evident in fast-growing Asia, where
income inequality has widened markedly in the last 20 years.
A recent report by the Asian Development Bank estimates that, if inequality
had remained stable in those Asian economies where it has increased,
the growth rates achieved in 1990-2010 would have taken 240 million
more people out of poverty.
The rising trend in inequality under FDG, and its economic and social
implications, is increasingly of concern to policymakers, researchers
and international bodies. Growing realization of the dangers of inequality
should elicit policy analyses and recommendations tailored to the
needs of individual countries, said UNCTAD.
"However, if such policies are to succeed in breaking the cycle
of inequality and creating inclusive development, they must be part
of an integrated approach combining economic and social goals, with
effective support and coordination at the international level,"
the policy brief concludes. +