Inequality: A few comments from the front lines
James K. Galbraith

The publication this year of The Price of Inequality by EPS Trustee Joseph Stiglitz and of my own Inequality and Instability has helped to deepen our understanding of this issue, and perhaps also to raise its profile as a policy question.

Stiglitz's new book is a work of art and passion, a cry from the head and the heart that America confront inequality as its greatest economic challenge. Joe wastes no time and few words in stating the nub of his case. He writes, “The simple story of America, is this: the rich are getting richer, the richest of the rich are getting still richer, the poor are becoming poorer and more numerous, and the middle class is being hollowed out” (page 7). Further, as if this were not bad enough, Stiglitz argues that the Great Crisis has made matters even worse, especially by reducing the buffers protecting the middle class from distress and penury later on.

Meanwhile, as a political matter, inequality empowers the rich, disenfranchises the poor and weakens the middle class. Unemployment insurance is reduced, health and education deteriorate, people are forced to withdraw from community life. One consequence ultimately is the erosion of democracy itself, as the political classes come to depend on the very wealthy — alone — for their campaign funding as well as for their future employment. Accordingly, they align with those interests as surely as the sunflower follows the sun.

Joe also writes with great conviction that inequality is damaging to the economy, and therefore unnecessary. In some ways, his core argument restates the case made long ago by Adam Smith: inequality arises from monopoly, which arises from the abuse and manipulation of government power (a case I also made a few years back in The Predator State). Inequality that arises from rent-seeking and from abusive financial practices cannot be defended as necessary for economic dynamism and progress. On the contrary, the economy would work better, and maybe even grow faster, if such inequality were controlled.

Inequality and Instability
is a different sort of book. Where Joe Stiglitz is concerned mainly with making the case that inequality in America must be reduced, my chief purpose is more prosaic. I'm mainly concerned with working out what the facts actually are, and in checking whether certain economic relationships — such as between inequality and income, or between inequality and growth — actually exist. My focus is as much on the world at large as it is on the United States.

I have been working with measurements of inequality around the world since the mid-1990s, and supervising research students in the field. One great constant of that experience is the weakness of the previously available data. It's an odd situation, where practically every data point — every measure of inequality that we have for every country since the 1950s — has been assembled at great expense and with the best procedures known at the time. It's impossible not to admire this work, and also the effort that has gone into bringing them all together. However, the resulting compilations, the data sets that researchers try to mine, are still not up to the job. The observations are too few, and are often too different in what they attempt to measure (sometimes income, sometimes expenditure...) to be consistently comparable. As a result, the numbers are sparse in some places, comparisons are implausible in others, and the whole business is very, very noisy.

We did find that although there exist many collections of data that can be used to compute measurements of inequality, they had never been used for this purpose. Geographic statistics, industrial statistics, sectoral statistics, and international comparative data sets of income and population or payrolls and employment by country and year can be employed, so long as some fairly simple conditions are met. The resulting inequality measures aren't perfect, but they are dense, consistent, and fairly closely related to existing income inequality measures, taken from surveys. The advantage is that there are so many more of them; and as they are far less noisy, one can develop a much clearer statistical picture.

Examination of that picture makes me a bit cautious about the claim that the United States is a uniquely unequal society, even now. First, as Joe Stiglitz also notes, inequality is much higher out in the wide world than we realize because we consider “developing countries” as separate from our own. I take the view that economics is economics, that the world economy is in many ways a single unit, and that the distinction between “advanced” and “developing” economies is a throwback — and perhaps also a way for economists to duck the hard work of incorporating the wide world into their analyses. I think we can learn a lot by studying all the countries together — including the common movement of inequality in the global economy taken as a whole — and that it's useful to compare inequality in the US with inequality in China or Brazil.

Still, the main comparisons are with other rich countries. By my measures, while inequality in the US is fairly high compared to other wealthy countries, it's not out of line with some of them: Italy, for instance, or Spain. There is the further point that many of the low-inequality countries to which the US is frequently compared — for example, Finland or Denmark — are very small and homogeneous. It is much easier to achieve low inequality across 5.5 million people (the population of Denmark) than across a country with some 311 million.

Here's another complication. In the past, comparisons of inequality between the US and Europe have always been made between a measure for the US and a measure for some individual country in Europe — France, or Germany, or Sweden. However, Europe today isn't a loose collection of separated countries. It's a single unified continent, with a (troubled) common currency, many common regulations, and no internal barriers to trade or capital movement. The relevant concept of inequality is not that within any particular country, but that for Europe taken as a whole. This must include inequality measured within countries, as well as the differences between the average level of income or pay in the different countries of Europe. These differences — say between Germany and Poland, or Sweden and Portugal — can be very large. Unfortunately, no such measure has existed.

A nice feature of the techniques used in Inequality and Instability is that they permit us to add together inequality within and between countries. When we do that, we find that inequalities of pay within Europe, taken as a whole — at least for manufacturing, a critical sector for trade and technology — are larger than they are in the United States. Inequalities of income, overall, probably remain larger in the United States, mainly because the US has so much taxable private capital income, concentrated in so few hands; but even here one can't be sure. Part of the difference may lie in different standards about what is required to be reported, and in different degrees of tax compliance. Of course, tax avoidance and evasion are big problems on both continents; but because the US has a single unified tax law, it may do a better job of measuring top-level incomes than the European countries do.

That said, the finding that manufacturing pay inequalities are actually larger in Europe strongly supports Joe Stiglitz's point that equality and efficiency are complements, not substitutes. Before the crisis, it used to be said that Europe's chronic high unemployment was due to too much equality, the fault of strong unions and big welfare states. In that telling, the US enjoyed near-full employment because it paid low wages and had “flexibility.” However, the story had many problems, among them the inconvenient fact that countries with the most compressed wages and the strongest unions and welfare systems (in Northern Europe) usually had less unemployment than their more unequal counterparts in the South. Some economists would gloss over this by referring to the “Scandinavian model” as something special and unexplained, a very ad hoc evasion. There was also the problem that before the 1970s, several highly egalitarian countries — such as postwar Germany and Britain — had hardly any unemployment at all.

Our findings work to resolve these puzzles. They show that greater equality is systematically associated with more jobs and less unemployment. Europe's problem before the crisis was not too much equality. It was, rather, that capital and (to a lesser degree) labor markets had become integrated, and as they did, the amount of inequality that was relevant went up — along with European joblessness. Europe's problem was that it had not experienced the measures of continental integration and development that the United States initiated under the New Deal and Great Society, which (notwithstanding the modern, free-market world-view) have continued to shape and unify the American economy ever since.

It is true that income inequality in the US has risen sharply. In my data it rises to a peak in 2000, with a saw-tooth pattern after that. While economists have advanced many explanations for rising inequality in America and around the world, including technology, trade and changing institutions, Joe Stiglitz and I converge in assigning an important role to the financial sector. We think that the banks did it, first and foremost.

Specifically, we pinpoint our growing dependence, after the mid-1970s, on economic growth generated by unsustainable credit booms. My data show the force of the information-technology boom in the late 1990s ending with the NASDAQ crash. More recent numbers show a similar effect of the mortgage-fueled real estate boom and debacle in the mid-2000s. Looking at a map of the contributions to income inequality by county in the United States in 2007 (see below), it is easy to pick out the housing hot-spots of Southern California and Florida, and a few others — as well as the financial epicenter in New York, New York.

map



This leads to a metaphor that isn't in my book, but only because I didn't think of it in time. Income inequality in an economy seems to be a measure with a number of useful parallels to blood pressure in human beings. To begin with, there is a normal range. Within that range, lower readings are better, the sign of a healthier, more resilient organism. Certainly, it is possible for the readings to be too low, as they were in the communist states, and the result is sluggish performance. Zero inequality, like zero blood pressure, is achieved only in the morgue. However, when inequality rises sharply, past the upper bound of a normal and healthy range, then like rising blood pressure that's a sign of a coming crisis. That is how inequality and instability are linked.

Of course we had the crisis — a massive economic heart attack — in late 2008. We are still coping with the aftermath, but that's not surprising either. After such an event, core institutions are deeply damaged, and cannot be expected to recover quickly. Stimulus is not going to be sufficient when a heart transplant — make that a bank transplant — is required. Inequality may even be down a bit compared to the peak; but in these conditions, that isn’t necessarily a good sign.

James K. Galbraith holds degrees from Harvard (BA magna cum laude, 1974) and Yale (PhD in economics, 1981). He teaches economics and a variety of other subjects at the LBJ School at the University of Texas at Austin, where he directed the School's PhD Program in Public Policy from 1995 to 1997. He directs the University of Texas Inequality Project, and serves as Chair of the Board of Economists for Peace and Security.