Current Account Imbalances, Income Inequality, and Financial Instability: Asian Experiences

ABSTRACT

From Asian experiences in financial crises of 1997–08 and 2007–09, this study finds that higher income inequality can worsen current account imbalances and exacerbate external vulnerability. Capital flows, volatile though they are, are the effect, not the cause, of variations in economic fundamentals. We show that credit-based growth with the aid of foreign financing is prone to financial fragility while export-oriented growth on the basis of domestic saving is good for financial stability. Given the rising international political tensions, our result suggests that Asian emerging markets should reduce inequality and boost demand to achieve sustainable credit and balanced growth. By doing so, Asia can effectively help alleviate global imbalances and lower financial risk.

KEYWORDS:

• Income inequality
• current account
• financial crisis
• growth strategy
• Asia

JEL:

• E20
• E25
• E51
• N1

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1. Given the nature of low-frequency data (such as Gini indexes), we use long enough yearly samples up to 2017 to extract maximum information from available datasets; there is no similar work in the literature. We resort to alternative estimators/methodologies for reliable results, multiple regression specifications for result robustness checking, and more than one measure of a regression variable for more precise estimation. We not only conduct regression analyses but also perform statistical inferences to judge and ensure the significance and accuracy of our estimation results.

2. However, one more thing that cannot be handled by any regression but needs our serious attention is that the external environment for any economy to grow has changed greatly since the Trump administration, especially since the outbreak of the COVID-19 pandemic. Export-led growth, albeit financially less risky than investment- or consumption- led growth, can no longer be sustained any more under intensified trade wars, economic decoupling of the West from China, and persistent international political confrontations (Jasper, Kamin, and Yoldas 2021; Marques 2022). Therefore, surplus economies in Asia and deficit countries in the West should both lower their income inequality in order to increase the scale of domestic or regional demand, reduce the imbalances of current accounts, promote the sustainability of economic growth, and lower the risk of financial crises.

Additional information

Funding

The work was supported by the Guangdong Higher Education [UICR0400014-21].