Date created: 3/5/07
Last modified:3/5/07
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John Quiggin

Add to CV: bankruptcy

John Quiggin Australian Financial Review

20 July 2006

Although the consequences of the recent IR reforms and broader changes in the labour market remain to be worked out, international experience suggests that an inevitable consequence of such changes is an increase in wage variability and inequality. Both the United Kingdom and New Zealand experienced large increases in wage inequality as they moved from regulated and unionised wage-setting systems. to largely deregulated systems based on individual contracts, and the same will no doubt happen here. A more surprising, but very likely consequence is the emergence of bankruptcy as a normal life experience for Australians.

The experience of the United States illustrates this. Although there was never much formal regulation of US labour markets, an implicit social contract emerged after World War II in which companies shared much of the surplus arising from US economic dominance with their workers. The result was that even unskilled workers (particularly those employed by large manufacturing companies) enjoyed high wages and relatively secure employment.

The US social contract unravelled during the economic crises of the 1970s. Wage and income inequality rose dramatically in the 1980s and, after a brief pause, is now rising again.

In view of how unequally the benefits of economic growth have been distributed, one might expect that political parties would be advocating radical policies of redistribution towards the poor. This is evidently not the case. The current dividing line in US politics is between the Bush Administration, which wants radical redistribution towards the wealthy and the Democrats, who largely support the status quo.

Explanations of this apparent paradox often focus on ideological factors such as the prevalence of the idea (not supported by empirical data) that social mobility is higher in the US than elsewhere and therefore that the poor can hope to become rich themselves. A more plausible analysis is one that switches attention from income to consumption.

It turns out that inequality in consumption has not grown nearly as much as inequality in income. Since living standards depend, at least in the short run, on consumption rather than income, this may help to explain the limited political impact of rising income inequality.

A recent paper presented to a meeting in Alice Springs of the Econometric Society of Australia by the Society’s President, Professor Richard Blundell of University College London showed that a disconnect between income and consumption inequality has been common in countries where wage inequality has grown rapidly in recent decades. Blundell explored a range of potential explanations for this disconnect, of which improved access to credit was one. Credit markets can be seen as a social device for managing risk.

One of the important, but relatively poorly understood, institutions associated with credit markets is that of bankruptcy. Although we take bankruptcy for granted nowadays, it was a radical government intervention in the developing credit markets of the 19th Century, marking the first time that the state stepped in to manage economic risk and implicitly rewrite credit contracts. It was bankruptcy that put an end to the Dickensian institution of debtor’s prison. The idea that easy credit and access to bankruptcy offset the political impact of growing inequality is supported by political science studies which find that US states with generous bankruptcy laws have less redistributive taxation systems.

If bankruptcy is seen as a social institution for managing income risk we would expect to see it used more as risk and variability increase and this is precisely what has happened. The number of bankruptcies in the US has risen from around 300 000 per year in the early 1980s to more than 1.5 million per year in 2004.

Since most bankruptcies are joint filings by couples, the number of people affected each year is over 2 million. Strikingly, Americans are now more likely to go bankrupt in any given year than to get divorced.

Since the bankruptcy boom is comparatively recent, the number of people who have ever been divorced is much larger than the number who have gone bankrupt. But if the rising bankruptcy trend stabilises at its current level, around half of all Americans will experience bankruptcy at some point in their lives, and many will go bankrupt more than once.

Other countries, notably the UK and New Zealand, are following a similar path, with a lag of a decade or so, and it seems inevitable that the same will happen in Australia. While the prospect of bankruptcy as a normal life experience seems alarming, society has adjusted to widespread divorce and will no doubt do the same for bankruptcy.

John Quiggin is an ARC Federation Fellow in Economics and Political Science at the University of Queensland.

John Quiggin is an Australian Research Council Federation Fellow in Economics and Political Science at the University of Queensland.

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