From the financial crisis to the world economic crisis – The role of inequality and the German debate

Policy Study

A central cause of the crisis, which the public debate has taken little notice of so far, is the rapid increase of income inequality in many industrialised countries, but also in some emerging economies (IMK 2009). In the USA many private households have reacted to stagnating real incomes by increasingly extending their borrowing. This was facilitated by a deregulated financial system. Only thus could private consumption become the main pillar of economic growth in the USA for years. The opposite holds for Germany: here the weak wage dynamics and social spending cuts have induced consumption restraint rather than higher debt, thus causing an extended period of weak domestic growth. High capital exports and a strong (and risky) foreign market involvement of the banking sector (cf. also Horn et al. 2009 for an analysis of the relationship between the economic crisis and global imbalances) were the flip side of the extreme export hikes of the German economy, which were enhanced by weak wage increases. In the current financial crisis the limits of these opposite growth models become evident: both are based on the necessity to compensate the sluggish trend resulting from an increasing income inequality with other sources of demand. These consisted either in increased household borrowing (USA, UK, Spain) or in export-led growth (Germany, Japan, China).

The importance of a growing income inequality for the explanation of the global economic crisis is increasingly emphasised by internationally renowned economists (cf. Fitoussi/Stiglitz 2009). At the same time the growing economic disparity is interpreted as the result of a shift in the political power structure, which has to be reversed in favour of lower income groups (cf. Krugman 2008). The German debate, by contrast, is still characterised by demands for further wage restraint, social spending cuts and increases of the international competitiveness (cf. Sinn 2009a, Schmidt 2009, Dreger 2009), which would signify merely a continuation of the pre-crisis strategy. In the light of the current crisis better-founded research on the potentially negative repercussions of an unequal income distribution on the economy as a whole is an important challenge in macroeconomics. This Report sketches some hypotheses on this issue; it is the third in a series on the causes of and remedies for the economic crisis (IMK 2009, Horn et al. 2009).

Read the contribution elaborated in the frame of the collaboration between FEPS and IMK (Hans Böckler Stiftung, Germany) by Gustav Horn, Katharina Dröge, Simon Sturn, Till van Treeck, Rudolf Zwiener