April 20, 2012
John Kenneth Galbraith, one of the 20th century’s most prominent liberal economists, made his initial mark in the academic world with a trenchant analysis of what went wrong during the 1929 stock market crash, which preceded the Great Depression. Over the past four years, his son, James K. Galbraith of the University of Texas, has followed in his footsteps.
In media appearances, speeches and articles lambasting the policy failures of the Bush and Obama administrations and the Federal Reserve, the Yale-trained economist has argued that the 2007-08 financial collapse that preceded the Great Recession could have been avoided. He has publicly chided President Obama and Treasury Secretary Timothy Geithner for failing to pursue adequate stimulus policies, which he says makes recovery impossible. He was prescient in warning that austerity in Europe would trigger renewed recession there and could undermine the global economy.
Now he has published a new book, Inequality and Instability: A Study of the World Economy Just Before the Great Crisis. Its controversial thesis – that income inequality and financial crises are inextricably linked – may end up on the placards of the Occupy Wall Street movement this summer. It’s doubtful it will be explored during one of next fall’s presidential debates.
But it’s definitely worth talking about. The Fiscal Times engaged in an email exchange with Galbraith to explore his latest thinking:
The Fiscal Times (TFT): Your new book says income inequality is tied to the financial crisis of 2007. How are they linked?
James K. Galbraith (JKG): The movement of inequality globally is very closely tied to financial events, including the breakdown of Bretton Woods in the early 1970s, the debt crisis of the early 1980s – which roiled the world in waves for two decades – and the peaking of the information technology boom in 2000. In the U.S., measured income inequality is very closely tied to the stock market.
Income Inequality is Hobbling the Middle Class
My argument here is not that inequality causes instability. It is that rising inequality and economic instability are the same thing. Inequality should concern us – in part – because radical instability is dangerous.
TFT: Why has income inequality increased in the U.S.?
JKG: Rising income inequality in the U.S. is driven, very substantially, by the movement of the stock market. One could be a bit more general and say "the credit cycle," but for most people the stock market conveys the correct idea. Income inequality is largely about how capital asset prices show up in recorded annual incomes.
This is because income is defined by tax law, and the most volatile elements of income are capital gains, stock options realizations and so forth, which are heavily concentrated at the top. The flow of incomes to salaries and wages is comparatively stable. So the movement of inequality is dominated by the movement of non-wage incomes.
TFT: Isn’t rising inequality a worldwide phenomenon?
JKG: Worldwide, inequality rose sharply from 1980 to 2000. This is a pattern you find in my data, which measure pay inequalities within countries, and also in measures of inequality between countries and in measures of the profit share in the rich countries. It's well-confirmed at this point. The pattern closely tracks the evolution of the global debt crisis: first in Latin America and Africa, then in Central and Eastern Europe, finally in Asia.
Worldwide, as in the U.S., the peak appears to have come in 2000. Since then, with lower interest rates and rising commodity prices, conditions have improved, especially in South America where inequality has declined quite a bit. Even in China we observe a peaking of inter-regional inequality in the mid-2000s, although inequality between sectors (for example, inequalities related to the rising power of the banks) continued to increase.
TFT: You note that certain types of political arrangements – European Social Democracy, for instance – lead to less inequality. Yet they don't seem to have escaped the effects of debt-fueled bubbles and financial crises.
JKG: A few countries with strong social democratic institutions have stayed egalitarian, or seen smaller rises in inequality than most of the world, but only a few. We notice this in Northern Europe, especially – for example in Denmark, Norway. It is surely true that robust wage-setting institutions also helped limit the rise of inequalities in other places, but the global, political, ideological and economic forces making for higher inequality have been very strong.
TFT: Could better regulation of the financial sector have reduced the impact or even avoided the recent financial crises? Or are we doomed to more crises until we tackle the underlying problem?
JKG: Yes and yes. Deregulation, de-supervision and a lax attitude toward massive criminality in the financial sector made things much worse.
I would dispute the notion that we face "more crises." We haven't recovered from the last one. It's still going on, as anyone who is upside-down on their mortgage knows. Until we deal with the toxic behavior of the banks, and until we stabilize the speculative movement in resource costs we're seeing right now, we will not – cannot – recover.