COVID-19 is likely to result in more debt among the poor and higher savings for the rich, exacerbating global inequality
As the global economy emerges from the initial recessionary phase of COVID-19, attention has turned to its long-term implications. One such implication attracting further research is rising inequality.
We have analysed the trends in inequality leading up to the pandemic and the plausible outcomes from here to show how rising inequality could affect the real economy and financial markets.
Since the 1980s, a sharp rise in the incomes going to the top 1% has contributed to national debt levels approaching levels not seen since World War II. As earnings become more skewed to the top, the poorest households take on more debt in order to sustain essential consumption.
Figure 1: Advanced economy inequality and debt
Defining inequality and recent trends
Inequality is a broadly used term that can be analysed through various lenses, the most common being:
- Income inequality. How evenly the distribution of earnings is spread across the population.
- Wealth inequality. How evenly the distribution of total wealth is spread across the population. This is typically greater than income inequality as it includes all types of measurable wealth, such as property and investments.
- Consumption inequality. How evenly the consumption of goods and services is spread across the economy.
Consumption inequality is an important measure since spending is often smoothed over individuals’ lifetimes and can temporarily differ from income through borrowing, saving and transfers from governments in response to income shocks.
Income inequality has grown substantially since the 1980s in advanced economies, particularly in the UK and US, due to skill-based technological change and weaker trade unions. Between early 1980s and 2017, for example, the share of income owned by the top 1% had doubled from 11% in the US and 6% in the UK to 21% and 13%, respectively.
Net wealth in France, the UK and US has also become more skewed towards the top of the distribution over the past three decades. On average, the bottom 50% of the distribution only held 6% of total wealth in the mid-1980s; as of 2014 this figure has halved to just 3%. Conversely, the wealth of the top 10% has grown rapidly from 53% to 71% and even the very narrow top 1% have closed the gap on the 50-90% grouping (Figure 2).
Income inequality has profound short-term implications whereas wealth inequality results in an entrenching of the previous divide. Income is generated and often consumed within a family’s lifetime. However, wealth can be inherited and passed down through generations. This makes wealth inequality more self-perpetuating through time. For the purpose of focusing on debt, savings and interest rate implications, we will focus on income inequality as it is (a) easier to measure, and (b) more directly relevant for savings decisions.
Figure 2: The wealth of the top 1% has converged on the 50-90% since 1980 (simple average and range for France, the UK and the US)
How will inequality be affected by COVID-19?
The impact of COVID-19 will likely pass through every aspect of the global economy – from monetary and fiscal policy to global trade.
COVID-19 could exacerbate the rising inequality trend, at least in the short-term, owing to several factors.
Evidence from previous pandemics points to a rise in income inequality since the economic adjustment burden falls disproportionately on low-skilled workers.
The jobs that are most likely to be lost during this pandemic are those that cannot easily be ‘worked-from-home’, and these jobs are also typically lower paid.
Separately, job losses among the more poorly educated (and therefore likely least well-paid) have been greater both during this recession and the 2008-2009 Global Financial Crisis (Figure 3).
Figure 3: The least educated workers lost jobs quicker than college graduates during the GFC
The jobs that are most likely to be lost during this pandemic are those that cannot easily be ‘worked-from-home’ (for example, restaurants), and these jobs are also typically lower paid.
The unprecedented size of monetary stimulus in advanced and emerging markets has succeeded in achieving a V-shaped recovery for assets, which are majority owned by the wealthy. However, stock market fortunes are inevitably linked to employment of the lower paid.
Some reasons have been put forward to suggest why the pandemic induced global recession could decelerate or reverse these trends.
Our baseline assumes a decent V-shaped labour market recovery. Therefore, any temporary loss in earnings or employment will rebound quickly and could overshoot previous projections on account of government support.
We believe government policy will remain very supportive for the labour market until at least the end of 2020 and therefore suppress any huge surge in inequality. However, beyond 2021, we expect policymakers to withdraw support and therefore leave the poorest exposed to the forces that drive inequality post-pandemics.
Evidence from the US suggests incomes for the bottom 25% percentile have actually risen above their pre-pandemic earnings on average 87% . However, income support schemes are up for renewal, so this picture may change dramatically.
On balance, we believe government policy will remain very supportive for the labour market until at least the end of 2020 and therefore suppress any huge surge in inequality.
However, beyond 2021, we expect policymakers to withdraw support and therefore leave the poorest exposed to the forces described above that drives inequality post-pandemics.
What are the implications of inequality?
Some of the direct implications of growing inequality are on debt, savings, interest rates and electoral politics through growing disaffection.
Households at the bottom of the distribution have two responses to greater inequality – they can either reduce their consumption in line with earnings or take on greater debt to maintain the same spending. We find the latter is more likely since the proportion of essential spending is much greater for these groups than at the top of the spectrum. The fall in consumer spending in recent months has been much greater for higher-income groups as more of their spending can be postponed.
Consumers in high-income regions are still spending 11% below pre-COVID trends compared to -2% in low-income areas. This will also reflect the fact that high spenders will consume more on restaurants, recreation, and culture, among others. These sectors have faced greater constraints due to social distancing restrictions.
With higher inequality, individuals at the top end of the spectrum are likely to respond to greater income or wealth by saving more. This group already consumes to near maximum desire, so extra income will be used to protect future consumption through savings.
After the second major economic shock in just over a decade, it’s likely that keen perceptions of severe economic downturns will lead to a rise in precautionary saving across all income groups.
All else equal, higher savings by the private sector create excess demand for safe assets and therefore lower interest rates (through higher bond prices). Unfortunately, isolating this impact to prove an empirical link is difficult when the supply of safe assets are constantly adjusting.
Protests and populism
Our previous study of protests during the 2010s found longstanding wealth inequality was the only indicator that clearly separates protest-afflicted economies from other emerging economies.
Interestingly, studies have explored the gradual shift of left-wing parties in France, the UK, and the US to higher education voters. This leads to those with a lower income voting for populist parties to dismantle the fortunes of the elite.
Learning from the past
We have seen historically that pandemics can trigger a rise in inequality, even over medium-term periods. They damage consumer confidence in using in-person services, which disproportionately exposes low-skilled work to displacement.
According to our analysis, the COVID-19 pandemic is likely to exacerbate global inequality, leading to more aggregate debt among lower earners and higher savings for those at the top. A unique feature of this pandemic is that the ability to work from home is proving a key factor in determining job losses – those that can are typically in higher paid jobs.
This is a challenge for governments worldwide to deal with.
John Payne is an economist on the Global Macro Research team at Oxford Economics, specialising in macroeconomic modelling, scenario analysis and the outlook for the global economy. With nearly four years’ experience at Oxford Economics, John is also the company’s global forecast coordinator, ensuring the latest big picture views are reflected in the Oxford Economics baseline forecast, released every fortnight.
Liam Bradley is a research assistant on the Global Macro Research team at Oxford Economics, working alongside senior economists on regular research and analysis as part of a one-year industrial placement. Liam is part-way through a BSc Economics degree at the University of Surrey. He is also responsible for the forecasting and analysis of three small Latin American economies: Grenada, Guyana and Martinique.