Economic Insecurity: A Problem Beyond Poverty and Inequality

Cite: Petrov, D., & Romaguera-de-la-Cruz, M. (2024). Measuring economic insecurity by combining income and wealth: an extended well-being approach. Review of Economics of the Household, 1-27. 

Economic insecurity is one of the major challenges of modern societies, alongside poverty and inequality. It affects not only those at the lower end of the income distribution but also middle-class households and even some segments of the wealthier population. Living with the uncertainty of not knowing whether you will be able to maintain your standard of living in the future has profound consequences, from reducing the willingness to take risks (such as investing in education or changing jobs) to impacting mental and physical health. Moreover, economic insecurity can influence crucial decisions, such as having children or participating in political life. In short, it is a phenomenon that affects not only individual well-being but also the functioning of the economy.

How Do We Measure Economic Insecurity?

Traditionally, income has been used as the primary indicator. However, this approach has limitations, as it does not capture families’ ability to cope with future economic shocks. Wealth, on the other hand, can serve as a financial cushion but may also be a source of uncertainty due to fluctuations in asset prices. In a recent article published in the Review of Economics of the Household, we propose an extended measure of well-being that combines both income and wealth to more comprehensively capture exposure to economic risk.

What Do We Do in the Article?

Our approach consists of converting wealth into a potential income flow and adding it to households’ current income. This allows us to estimate the total economic resources a family could use to smooth consumption in the event of a negative shock. We then measure economic insecurity as the probability of experiencing a significant loss in this extended well-being (EW). We use data from the Panel Study of Income Dynamics (PSID) for the United States between 1999 and 2019, which enables us to analyse how economic insecurity evolved before, during, and after the Great Recession.

Key Findings

Figure 1 highlights a key finding: economic insecurity varies significantly depending on the measurement approach. When considering only income, the average probability of experiencing a significant loss is 22%. However, this probability increases to 33% when both income and wealth are combined and rises to 43% when focusing solely on wealth. This discrepancy stems from the greater volatility of assets like real estate and stocks compared to labour income, which tends to be more stable.

Mechanisms Behind Economic Insecurity

What drives economic insecurity? Our analysis suggests that declines in household income and the value of illiquid assets (such as real estate and pensions) are the main factors explaining greater exposure to economic risk. The most vulnerable families—those with a higher probability of experiencing losses—suffered significant declines in these components, especially after the Great Recession. In contrast, less vulnerable families managed to maintain or even increase the value of their illiquid assets, allowing them to diversify risk and reduce their exposure to economic insecurity.

Another relevant factor is mortgage debt. The most financially insecure families reduced their mortgage payments after the crisis, which could be interpreted as an improvement in their financial situation. However, it could also reflect difficulties in accessing homeownership, limiting their ability to protect themselves against economic shocks.

Public policy implications

Economic insecurity is a complex phenomenon that extends beyond the poorest households. Our extended measure of well-being, which combines income and wealth, provides a better way to capture exposure to economic risk and offers valuable insights for designing more effective public policies. Thus, if policymakers are able to anticipate households’ future economic risks, they can more effectively design targeted ex-ante interventions to prevent declines in household well-being. This strategy represents an advantage over ex-post action against inequality and poverty when well-being losses have already materialized. For example, authorities could study the impact of an increase in interest rates on economic insecurity through higher mortgage expenses and develop mechanisms to mitigate this source of financial stress. Proactive measures in this regard would help reduce the adverse effects of macroeconomic shocks on household stability and overall economic resilience.