Desperation by Consent: Inequality and Financial Crises

Abstract

The recent financial crises were preceded by a prolonged and sharp increase in inequality. This brought to the fore the possible relationships which may exist between the distribution of income and instability. As financial crises are typified by excessive risk-taking behaviour, we will argue that for a crisis to ensue, this excessive risk-taking should be done by those who are more likely to default: the poor. The obvious remedy to this would simply be a redistribution of income. However, for modern economics, there are two difficulties in both aspects of the argument. Firstly, excessive risk-taking, which is a departure from rationality, is not something for which the theory accounts for, or associates with, income distribution. Secondly, the system of competitive decentralization has lost its freedom with regard to income distributions since the problems of incompleteness in uncertainty have limited ownership structures and, hence, income distributions which are consistent with efficiency. Therefore, correcting income distribution for the sake of stability may contradict the inequality required for efficiency.