Economic Events, Crises, and Income Inequality

Introduction

• Highlights of recent economic events, based on Blanchard et al, European 4th edition, 2021 Chapter 1.

A Historical Perspective

• A chart comparing all major powers by GDP from the year 1 AD to 2017 shows the share of GDP of world powers like China, India, Japan, Russia, Germany, Italy, Spain, United Kingdom, France, and the United States.

GDP of Major Economies (2017, PPP)

• United States: $23.2T, 18.3% of world GDP

• China: $19.4T, 15.3% of world GDP

• EU GDP (2017 PPP): 15.6% of world GDP

• Rest of the World: $51.3T, 40.4%

• Japan: $5.4T, 4.3%

• Germany: $4.1T, 3.3%

• United Kingdom: $3.9T, 3.1%

• France: $2.9T, 2.3%

• India: $2.8T, 2.2%

• Italy: $2.3T, 1.8%

• Canada: $1.8T, 1.4%

• Demonstrates significant growth for China since 2010.

World GDP per Capita

• Graph showing World GDP Per Capita (1990$) from year 1 to 2000.

Economic Progress and Innovation

• For thousands of years, economic progress was largely linear and linked to population growth.

• Innovations in technology and energy led to the “hockey stick” effect.

• Initially occurred in Western Europe and North America, now happening globally.

• Economies like China and India are making a comeback due to technological advancements evening the playing field.

Recent Economic Crises

• 2008-2012: Financial crisis followed by sovereign debt crisis (one of the worst recessions since the Great Depression).

• 2020-2021: COVID-19 pandemic (worst global sanitary crisis since the 1918 Spanish flu), causing extensive lockdowns and economic standstill.

• February 2022: Russia's invasion of Ukraine, causing energy price shock in oil, gas, wheat, minerals, and fertilizers.

• These events created economic crises differing from previous recessions over the past 80 years.

Economic Indicators

• Euro Area and Malta GDP Annual Growth Rate (%) from 1995 to 2022.

• Euro area/Malta inflation rate 2015 to 2024.

• Labour productivity: Euro area - Malta (2015 = 100), data from 1995 to 2022.

• Unemployment rate Euro Area/Malta, November 2024, showing data from 2001 to 2022.

Outline of Topic

• An International Perspective

  • The Financial Crisis & Sovereign Debt Crisis of 2008-2014

  • The United States

  • The Euro Area

  • China

  • Looking Ahead

The Financial Crisis

• 2000-2007: Sustained expansion of the world economy.

• 2007: U.S. housing prices declined, leading to a major financial crisis.

• Falling stock prices, declining trade, and increasing unemployment worldwide.

• The U.S. crisis became a world crisis through trade and financial channels, leading to the sovereign debt crisis in the Euro area from 2010-2014.

The United States

• Output: Approximately $29 trillion in 2023 (about 25% of world output).

• Population: 340 million.

• Output per capita: $63,000 in 2023 (among the highest in the world).

• Main economic indicators in 2004:

  • Output growth: 2.7%

  • Unemployment rate: 4.1%

  • Inflation rate: 2.9%

The European Union

• Output: Approximately $18.4 trillion in 2023 (about 15% of world output).

• Population: 448 million.

• Output per capita: Approximately $47,000 in 2023.

• Main economic indicators at the end of 2024:

  • Output growth: 0.9%

  • Unemployment rate: 6.3% (end Nov 2024)

  • Inflation rate: 2.3% (end Nov 2024)

The Euro Area

• 1999: EU formed a common currency area called the Euro area.

• 2002: National currencies replaced with the euro.

• 2008: Malta joined the euro.

• Today: 20 countries are members.

• Population: 350 million.

Challenges in the Euro Area

• Economic disparities among member states:

  • Stronger economies (Germany, etc.): high productivity and low unemployment.

  • Weaker economies (Italy, Spain, Greece, Portugal, etc.): low growth, high unemployment, and high debt to GDP ratios.

• Monetary policy is centralized, while fiscal policy is decentralized.

• Interest rate and Euro exchange rate must be appropriate for all member states.

Arguments for and against the Euro

• Supporters argue:

  • Economic advantages: no exchange rate changes between member states, lower transaction costs.

  • Positive contribution to a large economic block with a single currency and stable inflation.

• Others argue:

  • Drawback of a common monetary policy.

  • Loss of the exchange rate as an adjustment instrument.

China

• Often in the news due to the trade war with the U.S.

• Population: More than four times that of the United States.

• Output: $14.2 trillion (about 66% of the United States).

• Output per person: Roughly 29% of that of the United States in 2018.

• Rapid growth for over three decades, recently slowing down.

• Challenges: financial sector and increasing difficulties in exports.

United States vs China by GDP

• Graph comparing US (Nominal & PPP) and China (Nominal & PPP) GDP from 1960 to 2020; China has overtaken the U.S. in output when using Purchasing Power Parity (PPP) adjustment.

• China's GDP per capita is still much lower than that of the U.S. due to its large population.

Looking Ahead - Questions to Explore

• What determines expansions and recessions?

• Can monetary and fiscal policies prevent a recession?

• How will the euro affect the eurozone, and what monetary policy has been used by the ECB in the recent inflation scenario?

• Why did inflation accelerate two years ago? Why was it so low in the previous ten years?

• Why do growth rates differ so much across countries? Why has productivity declined in the last decade?

Fundamental Question

• Does the pursuit of self-interest promote the social interest (unintentionally)?

• Adam Smith’s “invisible hand.”

• Yes, but with serious qualifications.

• Qualifications: Externalities, tendency towards monopoly, market imperfections, information problems.

• Market economy may allocate resources efficiently but produce very unequal distribution of income.

• Fairness as another criterion.

Income Distribution

• Economic performance relates not only to productivity, economic growth, and low unemployment but also to how income is distributed.

• Significant changes have been occurring in recent decades, especially in advanced countries.

Income Inequality Statistics

• Income inequality in OECD countries is at its highest level in the past half-century.

• The average income of the richest 10% is about nine times that of the poorest 10% across the OECD (up from seven times 25 years ago).

• Wealth inequality is twice as large as income inequality.

• The top 10% of people in the income distribution received 24% of total income.

• The top 10% of households in the wealth distribution held, on average, 52% of total net wealth (OECD).

Gini Coefficient

• A measure of income inequality, ranging from 0 (perfect equality) to 1 (perfect inequality).

• In several OECD countries, the Gini coefficient is higher now than in 1980 by 3 percentage points.

• In the US and UK, it is 10 and 7 percentage points higher respectively.

• Increasing income inequality has a negative effect on economic growth and its sustainability (Recent IMF studies).

• $G = A/(A + B)$

Income Inequality - Gini coefficient

• Income Inequality Gini coefficient, ranging from 0 = complete equality to 1 = complete inequality (2021 or latest available).

• Income Inequality Gini coefficient, ranging from 0 = complete equality to 1 = complete inequality (2022 or latest available).

Gini Coefficient - World Bank

• Graph showing a range of Gini coefficients.

Kuznets Curve

• In economics, the Kuznets curve illustrates the hypothesis that as an economy develops, market forces first increase and then decrease economic inequality.

• First advanced by economist Simon Kuznets in the 1950s and 1960s.

Kuznets Curve Explanation

• Early in development, investment opportunities for those who have money multiply.

• Influx of cheap rural labor to the cities holds down wages.

• In mature economies, human capital takes the place of physical capital accrual as the main source of growth.

• Benefits are distributed widely.

• While the Kuznets curve seemed to be holding until the early 1980s, income distribution has worsened in recent decades.

Question on Growth and Income Inequality

• Is the economists’ post-war paradigm that “growth is a rising tide that lifts all boats” still valid today?

• The overwhelming evidence points to a worsening situation since the early 1980s, with income inequality increasing and threatening the well-being of society.

• In the past 40 years, there has been a deterioration in income growth of a significant proportion of the populations in advanced economies.

• This coincided with slower productivity growth, increased automation, and globalization.

OECD Secretary-General on Inequality

• We have reached a tipping point. Inequality can no longer be treated as an afterthought.

• We need to focus the debate on how the benefits of growth are distributed.

• There doesn’t have to be a trade-off between growth and equality.

• The opening up of opportunity can spur stronger economic performance and improve living standards across the board!

Income Inequality: Europe and the United States (1900 to 2020)

• From 1980 onwards, top 10% income shares started increasing, while bottom 50% income shares started declining.

Global Income Inequality

• Interpretation: Between-country inequality, as measured by the ratio T10/B50 between the average incomes of the top 10% and the bottom 50% (assuming everybody within a country has the same income), rose between 1820 and 1980 and has since strongly declined.

• Within-country inequality, as measured also by the ratio T10/B50 between the average incomes of the top 10% and the bottom 50% (assuming all countries have the same average income), rose slightly between 1820 and 1910, declined between 1910 and 1980, and rose since 1980.

Focus on Malta

• In Malta, the only increase in wealth was for the top 5%, whose share increased from 33% to 40% (Eurofound 2021).

Share of Total Net Wealth in Malta

• Graph showing the share of total net wealth in Malta by net wealth percentiles from 2010 to 2017.

Malta - Gini coefficient of equivalised disposable income

• The Gini Coefficient has been on an increasing trend from 2013, with a significant jump upwards from 2021.

Why Does Inequality Matter?

• Some income inequality is inevitable due to different capacities of individuals.

• Otherwise, excessive inequality may:

  • Reduce individual motivation.

  • Slow economic growth.

  • Lower risky and innovative investment.

  • Reduce opportunities to develop further, leading to inequality of opportunity.

  • Slow potential economic growth due to underdeveloped human resources.

  • Lead to socio-economic decay, divide society, distort the political environment, and reduce political participation.

  • Reduce Government revenue, leading to declining investments in public goods (health, education), and poor environmental protection.

Tools to Combat Income Inequality

• Inequality is an urgent problem with damaging repercussions on society.

• Governments must act more forcefully through focused policies.

• Taxes and spending programs need to be more progressive.

• More focus on programs that benefit the lower and middle classes (education, healthcare).

• Novel, data-driven approaches should be considered to confront complex problems.

Pope Francis and Franklin Roosevelt on Inequality

• “So there may not exist that tragic inequality between those who have too much and those who have nothing.” - Pope Francis 2018

• “The millions who are in want will not stand by silently forever while the things to satisfy their needs are within easy reach.” - Franklin Roosevelt 1932

Voluntary Support

• The upper-income groups need to recognize that they can also do something to soften the increasing income and wealth inequality.

• Increased willingness to share their income and wealth to help charities.

• Charities should not only provide immediate support but enable those marginalized or at risk of becoming marginalized to stand on their own two feet.

• Increased awareness that more needs to be done, and that this cannot be left completely in the hands of governments.

Regional Income & Wealth Inequality

• Bottom 50%, middle 40%, and top 10% income shares across the world in 2021.

• In Latin America, the top 10% captures 55% of national income, compared to 36% in Europe.

Wealth Inequality Across the World

• The richest 10% own around 60-80% of wealth. The poorest half typically owns less than 5% of wealth.

• The top 10% in Latin America captures 77% of total household wealth, compared with 1% captured by the bottom 50%.

Global Carbon Inequality

• The emissions of the top 10% are 3 to 4.5 times greater than the bottom 50%.

• In rich countries, the bottom 50% is already below the 2030 per capita target.

• Increased emissions reductions efforts need to be made by the top half of the income distribution.

• In the US, the top 10% must cut their emissions by close to 90% to reach the 2030 per capita target.

The Great Gatsby Curve

• High inequality tends to mean low mobility across generations.

• More inequality is associated with less mobility across generations

Intergenerational Earnings Elasticity

• The coefficient $\beta$ indicates the degree to which earnings are “sticky” across generations within the same family.

• The percentage difference in child earnings for each percentage point difference in parental earnings.

• The higher the value of $\beta$, the more that knowing a parent’s place in the earnings distribution will tell us about where we can expect the child’s place to be.

Kuznets Curve and Restrained TFP Growth

• Note: In the US Ronald Reagan was elected President in Nov. 1980 until 1

The Rise and Fall of American Growth (R.J.Gordon)

• To explore these changes, highly respected economist R.J Gordon explores further the productivity and growth changes taking place in recent decades.

Labour Productivity Components

• Gordon splits up the increase in labor productivity into three components:

  • Education

  • Capital deepening

  • Technology or Total Factor Productivity (TFP)

• He identifies three distinct time periods of distinct developments.

Average Annual Labour Productivity Growth Rate per Hour and its Components in the US

• Rising ratio of capital input to labor hours is called capital deepening.

• TFP is total factor productivity – proxy for effect of innovation and technological change.

Annualized Growth Rates of Total Factor Productivity (TFP), 1890 – 2014

Industrial Revolutions and TFP

• The first industrial revolution of the mid-1800s: steam engines, railroads, steamships, transition from wood to metal.

• The second industrial revolution: invention of electricity and the combustion engine.

• Rapid TFP growth during 1920-1970 reflects the dynamics of the industrial revolution that created the modern economy.

• These gains in productivity have also resulted in lower inequality.

Digital Electronic Third Industrial Revolution

• The gains are reflected in the productivity upsurge of 1996-2004.

• This surge in TFP is depicted by the narrow dark bar, indicating that the benefits of this third revolution were short-lived compared to the benefits gained from the second revolution.

Productivity Growth

• “Followed by mediocre productivity growth in the decades after 2004”.

• The benefits from the Internet and web revolution have been largely absorbed by 2004, and the methods of production have been little changed over the past decade.

• The benefits of the digital revolution often cannot be easily adopted across the whole income spectrum as they require an element of advanced human capital that the lower income groups often lack.

Growth Rate of Real Income in the US

• Weak growth in real incomes mirror the Kuznets curve and the restrained growth in TFP – especially the bottom 90%.

Human Capital and Education

• Human capital is the foremost channel of inequality: education attainment has become less accessible, and the consequences of not attaining education are aggravating.

• “The cost of a university education has risen since 1972 at more than triple the overall rate of inflation” (Gordon).

Wage Inequality

• Wage inequality has risen sharply in the United States and other industrialized economies over the last four decades.

• The real earnings of men without a high-school degree are now 15% lower than they were in 1980.

Tasks, Automation, and Wage Inequality

• A theory that shifts against less skilled workers result from technologies that automate.

• Between 50% and 70% of the overall changes in the U.S. wage structure over the last four decades were driven by automation.

Automation Impact

• Automation reduced the relative, and in some cases real, wages of workers specializing in routine tasks in industries undergoing rapid automation.

• Worker groups that were not displaced from their tasks, such as those with a post-graduate degree or women with a college degree, enjoyed wage gains.

Change in Earnings in the UK Since 1977

• During the last decade, earnings in the UK stagnated for all income groups except the top 10%.

• The relative earnings of people in the top half of the earnings distribution have grown between 1977 and 2014, while the relative earnings of people in the bottom half have fallen.

Inequality and Social Dysfunction

• “Inequality seems to make countries socially dysfunctional across a wide range of outcomes”.

Rising Inequality and Growth

• A higher Gini coefficient and therefore higher income inequality tends to be associated with a lower GDP per capita.

• A number of IMF studies have also found that income inequality (as measured by the Gini coefficient) has a negative effect on growth and its sustainability.

Conclusions

• Recent technological improvements have not had the same persistent impact on improving income distribution as in the past.

• As lower productivity growth appeared, we also see worsening income distribution.

• There is evidence of socio-economic decay.

Impact of Automation

• The impact of automation has worsened wage inequality.

• Acemoglu and Retrepo (2022) conclude for the US that there is a strong association between task displacement and wages.

• In their baseline regressions, direct task displacement explains 50–70% of the changes in wage structure across groups between 1980 and 2016.

Factors Affecting Wage Structure

• The relationship between task displacement and wages is unaffected when they control for other potential determinants of industry labor shares and earnings.

• Their estimates are driven by automation and not by other forms of technological progress or capital deepening.

• Offshoring-induced task displacement has similar effects on wages, though offshoring accounts for a smaller share of the observed changes in task displacement and the wage structure than automation.