Inequality Aversion, Populism, and the Backlash Against Globalization ˇ astor ∗ Luboˇ s P´ and Pietro Veronesi ∗∗ ∗ University of Chicago, National Bank of Slovakia, NBER, CEPR ∗∗ University of Chicago, NBER, CEPR
Overview • Model motivated by the backlash against globalization in rich western democracies (Brexit, Trump, etc.)
Overview • Model motivated by the backlash against globalization in rich western democracies (Brexit, Trump, etc.) • Pushback against globalization emerges endogenously – Rational voters’ optimal response to rising inequality
Overview • Model motivated by the backlash against globalization in rich western democracies (Brexit, Trump, etc.) • Pushback against globalization emerges endogenously – Rational voters’ optimal response to rising inequality
Overview • Model motivated by the backlash against globalization in rich western democracies (Brexit, Trump, etc.) • Pushback against globalization emerges endogenously – Rational voters’ optimal response to rising inequality – Globalization carries the seeds of its own destruction
Economic Mechanism Global growth ⇓ ( heterogeneous risk aversion ) Inequality ↑
Economic Mechanism Global growth ⇓ ( heterogeneous risk aversion ) Inequality ↑ ⇓ ( inequality aversion ) Backlash
Economic Mechanism Global growth ⇓ ( heterogeneous risk aversion ) Inequality ↑ ⇓ ( inequality aversion ) Backlash • Backlash = Elect a populist, Globalization → Autarky – Risk sharing : Global → Local – Consumption ↓ but equality ↑
Economic Mechanism Global growth ⇓ ( heterogeneous risk aversion ) Inequality ↑ ⇓ ( inequality aversion ) Backlash • Backlash = Elect a populist, Globalization → Autarky – Risk sharing : Global → Local – Consumption ↓ but equality ↑ • Heterogeneous risk aversion: Within countries = ⇒ Inequality Across countries = ⇒ Imbalances
Empirical Evidence • Types of evidence – Across countries: Vote shares of populist parties + Surveys – Across individuals: Brexit + Trump voters
Empirical Evidence • Types of evidence – Across countries: Vote shares of populist parties + Surveys – Across individuals: Brexit + Trump voters • Evidence largely supports the model – Countries : More populist if they have ∗ Higher inequality ∗ Higher financial development ∗ Lower current account balance – Individuals : More populist if they are ∗ More risk-averse ∗ More inequality-averse
Model • Continuum of agents i ∈ [0 , 1] in countries k ∈ { US, RoW }
Model • Continuum of agents i ∈ [0 , 1] in countries k ∈ { US, RoW } • Preferences of agent i ∈ I k at time t ∈ [0 , T ]: C 1 − γ i � � � C it , V k = e − φt it U i t , t 1 − γ i where γ i = Risk aversion
Model • Continuum of agents i ∈ [0 , 1] in countries k ∈ { US, RoW } • Preferences of agent i ∈ I k at time t ∈ [0 , T ]: C 1 − γ i � � � � C it , V k = e − φt − η i V k it U i t , t t 1 − γ i where � � C it V k | i ∈ I k t = Var = Inequality in country k C k t γ i = Risk aversion η i = Inequality aversion ( ≈ anti-elitism, “envy of the rich”)
Inequality Aversion • Evidence – Experiments – Surveys
Source: Harvard Business Review
Model • Continuum of agents i ∈ [0 , 1] in countries k ∈ { US, RoW } • Preferences of agent i ∈ I k at time t ∈ [0 , T ]: C 1 − γ i � � � � C it , V k = e − φt − η i V k it U i t , t t 1 − γ i where � � C it V k | i ∈ I k t = Var = Inequality in country k C k t γ i = Risk aversion η i = Inequality aversion ( ≈ anti-elitism, “envy of the rich”)
Model • U.S. agents are less risk-averse than RoW agents – Interpretation: U.S. more financially developed than RoW
Model • U.S. agents are less risk-averse than RoW agents – Interpretation: U.S. more financially developed than RoW • Technical assumption: E I [ e x/γ j | j ∈ I RoW ] lim x →∞ = 0 E I [ e x/γ i | i ∈ I US ] Examples: 1. γ i < γ j for all i ∈ I US , j ∈ I RoW 2. U.S. risk tolerance 1 γ i ∼ U [ a, b ], RoW’s 1 γ j ∼ U [ a, c ], with b > c 3. Truncated normals for 1 γ i in both countries, same truncation points, same dispersion, higher mean in the U.S.
Model • Global output: D t = D US + D RoW . Its log, δ t ≡ log( D t ), follows t t dδ t = µ δ dt + σ δ dZ t where µ δ > 0 ⇒ output trends upward
Model • Global output: D t = D US + D RoW . Its log, δ t ≡ log( D t ), follows t t dδ t = µ δ dt + σ δ dZ t where µ δ > 0 ⇒ output trends upward • For simplicity, also assume (relaxed later): D US t = U.S. population share D t • Agents share risk in complete markets – Interpretation 1: Financial contracts (stocks, bonds) – Interpretation 2: Labor contracts (risky, safe jobs)
Model • Two possible regimes: 1. Globalization : Cross-border trade allowed Global risk sharing 2. Autarky : Cross-border trade not allowed Local risk sharing
Model • Two possible regimes: 1. Globalization : Cross-border trade allowed Global risk sharing 2. Autarky : Cross-border trade not allowed Local risk sharing • Both countries hold elections at known time τ ∈ [0 , T ] 1. Mainstream candidate: Keep globalization 2. Populist candidate: Move to autarky – Elections decided by the median voter
Model • Two possible regimes: 1. Globalization : Cross-border trade allowed Global risk sharing 2. Autarky : Cross-border trade not allowed Local risk sharing • Both countries hold elections at known time τ ∈ [0 , T ] 1. Mainstream candidate: Keep globalization 2. Populist candidate: Move to autarky – Elections decided by the median voter • Expropriation not allowed – Can’t move to autarky if other country suffers consumption loss
Optimal Consumption • Complete markets = ⇒ Agent i in country k solves �� T �� T � � � � C it , V k π k { C it } E 0 max U i t , t dt s.t. E 0 t C it dt = w i 0 0 where π k t = state price density, w i = initial endowment
Optimal Consumption • Complete markets = ⇒ Agent i in country k solves �� T �� T � � � � C it , V k π k { C it } E 0 max U i t , t dt s.t. E 0 t C it dt = w i 0 0 where π k t = state price density, w i = initial endowment • Result : C ∗ it = f ( γ i , π k t ) – High- γ i agents choose consumption less sensitive to shocks
Equilibrium under Globalization i ∈I C it di . Solve for π t = π US = π RoW � • Market clearing: D t = . t t
Equilibrium under Globalization i ∈I C it di . Solve for π t = π US = π RoW � • Market clearing: D t = . t t • Result: Low- γ i agents grow disproportionately rich – Their consumption shares grow with output C it ↑ in δ t iff γ i < γ k ( δ t ) C k t – Benefits of growth accrue increasingly to “elites”
Equilibrium under Globalization i ∈I C it di . Solve for π t = π US = π RoW � • Market clearing: D t = . t t • Result: Low- γ i agents grow disproportionately rich – Their consumption shares grow with output C it ↑ in δ t iff γ i < γ k ( δ t ) C k t – Benefits of growth accrue increasingly to “elites” • Result: Fraction of agents who grow richer declines with output ⇒ γ k ( δ t ) ↓ δ t ↑ = – The ranks of elites are shrinking
A. US Consumption Distribution 0.6 Global log GDP = 1 Global log GDP = 1.5 0.4 Global log GDP = 2 Global log GDP = 3 0.2 0 0 5 10 15 20 25 30 35 40 B. US Consumption Share Distribution 1.5 Global log GDP = 1 Global log GDP = 1.5 1 Global log GDP = 2 Global log GDP = 3 0.5 0 0 1 2 3 4 5
Equilibrium under Globalization • Result: Inequality V k increases, without bounds, as output grows. So does the skewness of consumption shares. = ⇒ Inequality grows with output, driven by elites’ consumption Panel A. Inequality in US Panel B. Inequality in RoW 0.6 0.6 0.4 0.4 Variance Variance 0.2 0.2 0 0 0 1 2 3 0 1 2 3 Global log output t Global log output t Panel C. Skewness in US Panel D. Skewness in RoW 3 3 Skewness Skewness 2 2 1 1 0 0 0 1 2 3 0 1 2 3 Global log output t Global log output t
Equilibrium under Globalization • Result: U.S. runs a current account deficit, RoW runs a surplus. � � i ∈I US C it di > D US i ∈I RoW C it di < D RoW , t t 60 US RoW 50 40 Percent of local GDP 30 20 10 0 -10 -20 0 0.5 1 1.5 2 2.5 3 Global log output
Equilibrium under Autarky • Market clearing: D k � t = i ∈I k C it di , for k ∈ { US, RoW } ⇒ Solve for π US � = π RoW = t t
Equilibrium under Autarky • Market clearing: D k � t = i ∈I k C it di , for k ∈ { US, RoW } ⇒ Solve for π US � = π RoW = t t • Result: U.S. inequality is lower under autarky than under globalization. The opposite is true for RoW. Panel A. Inequality in US Panel B. Inequality in RoW 0.6 0.6 Globalization Globalization Variance Autarky Variance Autarky 0.4 0.4 0.2 0.2 0 0 0 1 2 3 0 1 2 3 Global log output t Global log output t
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