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"The Impact of Financial Crises on Labour Markets, Household Income and Poverty: A Review of Evidence”

Peter R. Fallon and Robert E.B. Lucas

IED Discussion Paper 103, March 2000

Recent years have witnessed a series of financial crises in a number of developing countries. Although these crises usually prove to be relatively short-lived, the associated drops in income have been substantial and perceptions of these declines have been particularly acute because of prior rapid growth in most cases. Concerns regarding the impact upon poverty and distributional issues both during a crisis and also over the longer run are therefore quite real. In their paper, Fallon and Lucas review evidence from East Asia, the Tequila crisis and Turkey concerning the impact of such crises on labor market conditions, poverty and inequality of incomes.

The predominant impact on labor market outcomes has been a fall in real wages. Indeed, cross-country evidence suggests a positive association between the depreciation of the local currency and the fall in real wage. The available evidence also suggests a trade-off between declining real wages and the decline in employment levels. Whereas employment levels were by and large unaffected,

massive churning of the labor force has occurred as workers accepted lower pay in alternate jobs to maintain family incomes. In the aftermath of a crisis, living standards of landless agricultural laborers frequently worsened due to increasing food crop prices. These laborers also face increased competition from returning urban migrants. Some families managed to smooth their incomes partially by increasing labor force participation and increasing private transfers. However, except in Indonesia, consumption smoothing was not observed in the aggregate. Even in Indonesia, only those who were better off prior to the crisis managed to smooth consumption. Tightened monetary policy typically exacerbated the problem.

Fallon and Lucas also examine the potency of various poverty alleviation programs that arose in the aftermath of these crises. Most of these suffered from severe targeting problems due to the lack of regional correlation between pre-crisis poverty and additional poverty. Moreover, while public works programs have often proven cost-effective, they are usually hampered by eligibility criteria which preclude newly laid-off workers. The authors conclude that if poverty alleviation programs happen to be cost-effective, they are worth mounting in more normal times rather than incurring the start-up costs during the initial phases of a crisis.