INSTABILITY AND FINANCE
By Paula Green
Global Finance sat down with noted author and international economist James K. Galbraith to hear his views on political instability, its relation to income inequality, and what the implications are for the European crisis.
Photo Credit: Luca Ventura
Decades of experience as an economist acquainted with the workings of governments inside and outside the Washington Beltway stand behind Galbraith, who now holds the Lloyd M Bentson Jr chair in government and business relations at the Lyndon B Johnson School of Public Affairs, University of Texas in Austin. He holds degrees from Harvard and Yale universities and studied economics as a Marshall Scholar at Kings College in Cambridge.
Galbraith had his first bird's-eye view of financial chaos as a 23-year-old staffer with a US Congressional Banking Committee handling the New York City financial crisis of 1975. Since then, he has advised global policymakers on many of the major events that shaped the past three decades.
Galbraith's latest book, Inequality and Instability, builds on his breadth of work advising governments wrestling with economic and financial turmoil. Galbraith posits—and backs up with research from a vast cross-section of economic, financial, geopolitical and demographic data—that income inequality does not hinge on the popular explanations of supply and demand or rising unemployment and falling wages. Rather, there is a correlation between the so-called "financialization" of a country's economy—the growth of industries such as finance, technology and real estate—and rising income inequality. While not necessarily negative for lower-income workers during times of economic prosperity, this "inancialization process is unsustainable and ultimately creates instability.
Global Finance: What are the implications of your work?
James K. Galbraith: There has been a view of late that labor market flexibility, including wage cuts, is the cure for economic instability. This is simply not true. There is evidence that extreme egalitarian policies promote stability—for example in the Nordic countries. Conversely, income inequality, which comes with rising financialization, appears to be an indicator of instability. If we look at the deepening crisis in Europe, for example, there is no evidence that any amount of austerity will bring needed investment to Greece.
GF: What is the key difference between the US and Europe in terms of income distribution, and how does this relate to the current crisis in Europe?
Galbraith: There's an enormous surplus in Germany. But there is no mechanism for resource transfer from richer countries in Europe to its poorer countries. There are no adequate fiscal mechanisms in Europe.
In the United States, there has been wealth redistribution, across all regions, since the 1930s with [then-president Franklin Roosevelt's] New Deal. And major social reforms in the 1960s, with [then-president Lyndon Johnson's] Great Society, and the civil rights and antiwar movements, all contributed to a more egalitarian country.
As a result, today, you can have a Massachusetts professor go to Texas and command the same salary he did back East. That wouldn't have happened in the 1930s. And it wouldn't happen today in Europe. You could not get a professor from Germany to take up a position at a Greek university—paid only a fraction of the income they would command at home. And this is why we are now seeing a diaspora from the periphery countries.
GF: Are the reforms in Europe enough to end the crisis? What is the solution?
Galbraith: It is dangerous to prescribe a solution. The last thing you want to do is turn this over to the academics, who think they have it all figured out before anything happens.
The technical solution is a Europe-wide bank regulator. But what is really needed is the political will to resolve the crisis. There needs to be a change in mentality at the highest level of European leadership.
GF: What impact will the May election of France's first Socialist president in nearly two decades have on the financial crisis in Europe?
Galbraith: It may raise a reality check. There has been a fantasy in Europe that if a country complies with all its obligations, then investors will return and the economy will stabilize. Look at Portugal—it did all the right things and complied with its obligations. Then a bad thing happened in Greece and investors fled Portugal. No single country has the capacity to turn itself around in today's economic environment.
GF: What is the role of regulators in all this?
Galbraith: The recent global financial crisis was a consequence of the lack of regulation. You can't take away the moderators. You need a regulator for any type of machine.
There needs to be a demonstrated presence of regulations and regulators and the prosecution of offenders to restore trust in our institutions. There were 1,000 insiders prosecuted during the savings and loan industry crisis. [Nearly 750 of about 3,235 savings and loan associations in the US failed during the S&L crisis of the 1980s.] That helped restore trust in the many savings and loan institutions that were not part of the crisis. This has not happened with the recent global financial crisis.
"The last thing you want to do is turn this over to the academics, who think they have it all figured out before anything happens"
– James K. Galbraith
GF: Why has the attitude on Capitol Hill—in Washington— changed to become much more anti-Fed and anti-regulation?
Galbraith: In the 1990s there was a significant gold lobby that played a part in the anti-regulatory stance. I see little movement toward more regulation.
Today you have 70 members sitting on the House Banking Committee [US House Committee on Financial Services]. In the 1970s you had 40 members. You can't get anything done today unless it helps the finance industry [since most of the members now have some tie to financial services].
GF: How important is the "Occupy" movement?
Galbraith: It carried a symbolic statement that was very important. It was not a counter-culture movement as emerged during the 1960s. But for a time it conveyed a simple, abstract message: That this small self-governing unit carried the same values and interests as the middle class of the United States.