Economic disasters and inequality: a note

Abstract

This paper analyzes the dynamic effects of economic disasters, captured by cumulative decline in output of at least 10% over 1 or more years, on disposable income inequality of a sample of 99 countries over the annual period of 1960–2017. Based on impulse response functions derived from a robust local projections method, we find that economic disasters increase inequality by 4%, with the overall effect being statistically significant and highly persistent over a period of 20 years following the shock. When we repeat the analysis by categorizing the 99 countries based on income groups and regions, we find that the strongest effects are felt by high-income countries (8%), and in Europe, Central Asia and North America (16%) taken together, as primarily driven by ex-socialist economies. Though of lesser magnitude, statistically significant increases in inequality are also observed for low-, and upper-middle-income economies, and the regions of Latin America and Caribbean, Middle East and North Africa (MENA) and South Asia, and to some extent also for Sub-Saharan Africa. Our findings have important policy implications. Our findings suggest that the avoidance of economic crises is of paramount importance to ensure the sustainability of the welfare state, which in turn would allow for sound redistributive policies to reduce inequality, which can also help in indirectly reducing the negative impact of rare disasters on asset markets. In other words, our results have both economic and financial implications.