Economist's View: Did Inequality Cause the Crisis?: I've always been a bit uncomfortable with assertions that the income inequality causes bubbles. If there's a correlation between the two, it's not clear which way causality runs. It could be that bubbles cause inequality, not the other way around. And recent research by Michael Bordo and Christopher Meissner suggests even more caution in making such as claim (though one paper should not be considered the last word on the topic). However, Chris Dillow is not ready to concede…
Inequality & the crisis: The fact that crises are not often preceded by rising inequality does not disprove that inequality - along with other mechanisms - had a role in this particular crisis. And there are two other mechanisms…. Insofar as rising inequality in the 00s was correlated with a rise in wages in the financial sector relative to other industries, it attracted “talent” into banking. And this contributed to its downfall, because “talent” produces not stability but rent-seeking and overconfidence. Remember - banks survived for decades by employing doddering Captain Mainwarings but collapsed soon after hiring physics PhDs…. Top-down management structures produce bosses who combine domineering arrogance with ignorance. As Julian Birkinshaw has said (pdf), the management model in investment banks was one in which “Aggressive and intimidating behaviour is tolerated; effective teamwork and sharing of ideas are rare.” And even if inequality did not cause the crisis, it is correlated with it. The same growth of Asian economies that gave us an excess supply of cheap labour which depressed unskilled wages in the west also gave us the savings glut that produced the housing boom and malinvestments in mortgage derivatives.
But does it much matter whether income inequality contributed to the crisis or not? The Left argued that high inequality was a bad thing long before the crisis, for intrinsic as well as instrumental reasons. Those arguments are as strong (or as weak!) as they ever have been.
Yes, inequality is a very bad thing. Since social welfare is much better measured by the geometric mean of consumption rather than per capita consumption, higher inequality becomes very expensive for a society rather quickly.
I still find myself attracted to the idea that high inequality produces both high leverage (as the non-rich desperately scramble to keep up with the Joneses), high savings (on the part of the rich), and low interest rates. The first makes the collapse of bubbles damaging. The third makes the chance of bubbles higher.
But Bordo and Meissner are definitely leading me to think again...