Book Review: 'Inequality and Instability,' by James K. Galbraith

Inequality and Instability:
A Study of the World Economy Just Before the Great Crisis
By James K. Galbraith
Oxford University Press; 336pp; $29.95
 

Should we be worried that in the U.S. the top 1 percent claim 21 percent of the national income? Should we be more concerned that the middle is lagging, or that the very top is soaring? Until recently, economists mostly ignored such questions. The exceptions were generally of leftish tilt—that is, they favored more equal distribution. James K. Galbraith, an economist at the University of Texas at Austin and son of the famous John Kenneth, fits that pattern. Inequality and Instability, his latest book, is the product of years of study in a field that was, he laments, a “backwater.” It rejects the conventional view that inequality is the justifiable price that societies pay for flexible markets. Rather, Galbraith points a finger at the financial sector for broadening the income gap and thereby destabilizing the economy. (He posed for his author’s photo in Zuccotti Park during last year’s Occupy Wall Street campout.) With President Obama proposing a millionaires’ tax and even Republicans haranguing Mitt Romney for the sin of getting rich, his timing is certainly good: Inequality is shaping up to be a defining theme of the election year.

This book stakes out a simple task—to determine whether inequality leads to higher, or lower, levels of growth for society overall. But the answer is anything but simple. For example, countries that are “unequal” in terms of income do not look the same as those that are unequal in terms of consumer expenditures. And two workers may earn the same wages but have unequal stock portfolios. Does one type of inequality matter more than the other?

Drawing from a rich array of data, Galbraith wonders whether democratic institutions promote equality and finds that in general they do not. He doesn’t so much refute arguments that flexible markets can benefit society as simply declare them null and void. By inference and tone, he posits that nearly every rise in inequality is to be regretted—even in Cuba, as it limps out of Stalinist torpor.

According to Galbraith, the North American Free Trade Agreement (NAFTA) “greatly increased economic inequality between northern Mexico and the rest of the country.” He seems to mean that the north got richer; is this bad? Surely not: A widening income gap can merely reflect a transitioning economy—for better or worse. Galbraith acknowledges as much when he tells us that inequality in the U.S. declined as the auto industry collapsed, because there were fewer relatively high-paying auto jobs. Galbraith notes, “This is of course not good news, and it sounds a caution against regarding any inequality statistic as per se an indicator of social welfare.”

Galbraith argues that contrary to the standard view, prosperity and equality go hand in hand. He finds supporting evidence, namely that employment tends to rise as pay scales are compressed. (Which is cause and which is effect is unclear, a hazard of such studies.) Scandinavia is Galbraith’s shining example, since it is both egalitarian and prosperous. The U.S. is an exception since our “prosperity is associated with rising income inequality.” But even this exception Galbraith dismisses because in America, inequality didn’t broadly rise through society; it was caused by the narrow slice with a stake on Wall Street.

“An American resident in Ohio or Georgia,” Galbraith says, “saw very little of this directly.” Pay scales in the U.S. were relatively stable. Inequality, he says, was the fruit of stock ownership; it literally tracked the Nasdaq. “Few noted that the two phenomena were, in fact, identical,” says Galbraith. Blaming all on the stock market, he discards the popular notion that incomes have risen because in a global economy, skills command higher pay. The author sees “no reason to dwell on” that notion. Nor does he dwell on the lawyers, university professors, and athletes whose earnings have soared independently of the market.

There are few solutions in this book, aside from what is suggested by Galbraith’s fondness for state involvement. In general, he finds that inequality varies with the level of development. Thus, “all agrarian feudal societies, all advanced technological economies … will resemble each other more than they resemble other countries.”

This leads him to critique the global financial institutions he blames for nurturing inequality worldwide. Galbraith targets the European unification project, which he says coincided with rising unemployment. He targets the “anti-inflation monomania of the European Central Bank.” He targets Thatcherism, Reaganism, and the shriveling of the welfare state that those isms brought about. He targets “aggressive high-interest rate policies … beginning in the early 1980s.” The interest-rate critique is misleading; after first rising sharply, interest rates in the U.S. and elsewhere began to tumble in the early 1980s, and continued to fall through the financial excesses of recent decades, which Galbraith calls a “superbubble.” Nonetheless, he is hardly wrong to point out that, with the encouragement of central banks and other official bodies, the financial industry now captures a far higher share of total income than before. And this increased financialization of world economies is, I believe, the crux of Galbraith’s complaint.

“Increasing inequality,” he writes, “is a warning sign that something is going wrong.” What might that something be? His thesis is that the inequality of the past three decades—driven by the stock market and the rising role of finance—led inexorably to instability. And chaos and instability or, if you will, bubbles and crashes, were clearly on the rise during that period, and this the author cannot abide. He likens recent business cycles to “waves, whereby certain sectors and areas ride the peaks before crashing to the shore,” leaving innocent victims in their wake. The creative destruction of which capitalists are proud is, to Galbraith, all destruction.