Inequality and debt crises: A new twist on fictitious “human rights-debt” policy divide

Inequality’s unrelenting rise has been the subject of growing attention that has come, in the last few years, from unexpected quarters. As a recent example, an article appeared on the IMF’s Finance & Development journal, “Neoliberalism: Oversold?” put the spotlight on the negative effects that inequality has on the level and sustainability of growth. The article generated not only wide press coverage, but also a number of responses. Almost in sync with the article, the IMF felt the need to publish an interview with its Chief Economist, Mr. Maurice Obstfeld, clarifying that the policy rethink at the IMF did not represent revolution, but evolution. Needless to say, to many analysts who had closely followed IMF policies for years, the clarification was entirely unnecessary. In fact, critics were quick to comment that the article was only a mild departure from IMF doctrine, not reflected in actual IMF programs, and even reasserted points that continue to be the focus of contention such as the positive growth effects of trade liberalization, privatization and foreign direct investment. Nonetheless the article, reflected wider concern with inequality at an institution that until not long ago considered it an afterthought.

In a new report (“the Report”), the UN Independent Expert on Foreign Debt and Human Rights, Mr. Juan Pablo Bohoslavsky (“the Expert”), takes on one particular aspect of inequality, namely, its links with sovereign debt crises.

By way of introduction, the Expert reviews the basis for tackling inequality in international human rights law. There are economic and social rights –such as fundamental workers’ rights and the right to a fair remuneration – that recognize the duties of States to address and/or prevent inequality as a threat to human rights realization, and the principle of non-discrimination and equality can be found in all international and regional human rights treaties, applying in the context of socioeconomic disadvantages. “While human rights law does not necessarily imply a perfectly equal distribution of income and wealth,” he says, “it does require conditions in which rights can be fully exercised.” The level of distribution of resources should be such as to guarantee individuals an equal enjoyment of the realization of their basic rights without resulting in discriminatory outcomes. “When income inequality creates discriminatory outcomes, it becomes a human rights issue.”

This take echoes similar remarks by the Special Rapporteur on Human Rights and Extreme Poverty, who in a recent report said it did not advocate perfect economic equality but that economic inequalities, especially if they are extreme or begin at birth, are a significant obstacle to equality of opportunity, stating that “The problem in many societies is that poor people start the “race of life” at a disadvantage and will meet many more hurdles on their way than others.”

Mr. Bohoslavsky’s report also contains a summary of the impacts that sovereign debt crises have on inequality, a contribution to the human rights implications of inadequate action to address sovereign debt crises. Among these are the impacts of financial crises on declines in output, employment and growth in poverty. Weak labor market institutions can have a magnifying impact on the effects a crisis has on inequality. Research has also identified limitations in the social protection system in the country, as well as the level of public spending, which serves as an automatic stabilizer during a recession, can equally increase such impacts.

The reactions of governments to a crisis – as currently witnessed in fiscal consolidation programs across the world – are another element to take into account. The social impacts that a crises generates lead to the perpetuation or exacerbation of inequalities.

But it is worth noting that even the Sustainable Development Goals – which the Expert quotes at the beginning of its Report– contemplated the reduction of inequality as a Goal and include sovereign debt prevention and resolution as part of the Means of Implementation, a direction that seems to assume the causation runs from the latter to the former. It is, therefore, counterintuitive that the Report also delves into the opposite direction of the link, asserting that inequalities can, likewise, be a factor leading to sovereign debt crises.

To back up this assertion the Expert discusses the direct and indirect effects. As for the direct effects, he explains that increased levels of inequality mean that the income tax base of the State concerned is rather small, at least if income taxation is not progressive, which diminishes sovereign revenues and consequently makes the State more dependent on borrowing. Empirical studies point, in fact, to a clear nexus between inequality, income tax base and sovereign debt. One study he cites, using data from 50 countries in 2007, 2009 and 2011, found a negative correlation between income inequality and the tax base and a positive correlation with sovereign debt. According to other research, increased inequality is found to contribute to the degeneration of sovereign debt into sovereign debt crises.

There are at least two avenues, according to the Report, by which inequality can indirectly contribute to increased sovereign debt and consequently to sovereign debt crises. One of them is that high levels of inequality contribute significantly to the generation and increase of private debt. Booms in private debt have been found to be sometimes a more accurate predictor of financial stability and crises than the actual level of sovereign debt. In turn, private debt increases rapidly as private households try to maintain absolute or relative levels of consumption in the face of widening inequality.

The second avenue is that inequality adversely affects social and political stability. The impact on social and political instability creates disincentives for investment, disruptions in business activity, disunity, threats to property and policy uncertainty and may even raise the probability of coups and mass violence. These hamper growth and eventually affect both government revenue and spending. Moreover, in a recent study by IMF researchers the Report cites, they concluded “the income distribution itself matters for growth. Specifically, if the income share of the top 20 per cent increases, then GDP growth actually declines over the medium term, suggesting that the benefits do not trickle down.”

By shedding light on the debt prevention relevance of efforts to stem inequality, the Expert offers a new twist on the artificiality of trying to separate human rights and sovereign debt policy.

Read full report here.

By Aldo Caliari.

Source: RightingFinance.