Thursday, September 23, 2010

James K. Galbraith on Income Inequality

In his book, The Predator State, James K. Galbraith addresses—and often destroys—a number of conservative economic assumptions. One of his more interesting and provocative discussions is on the issue of income inequality.

Discussions of income inequality will generally produce references to the response of the “labor market.” Explanations generally focus on blaming either a “skill gap” or a “trade effect” to explain the increasing separation between the top and bottom rungs of the economic ladder. Either we do not have the right skill mix for the jobs being produced, or low-wage competition from overseas is eliminating jobs and driving wages down. In each case, the conclusion is that any attempt to directly counter these effects would create inefficiencies in the economy and be counterproductive.

Galbraith believes the issue is more complicated. While each of the above concerns is part of the problem, both together are insufficient to explain what has been observed over the past few decades. He points out that inequality is a social choice that a country makes, and the country may be guided by a false premise.
“Does the supposed trade-off between efficiency and equality really exist? Is there really a price, in terms of efficiency, output, and growth to be paid for creating a society where work is more equally paid? Is the moral argument therefore the only tenable and correct objection to high pay inequality? Or is it perhaps instead the case that more equal societies are more efficient?....Indeed we may have the makings of an entirely different story in which stable distributions, held in place by institutional, social, and political norms, come to drive the evolution of technology and the patterns of trade.”
The author’s fondness for Scandinavian methods leads him to propose Denmark as an example of the point he is trying to make.
“Denmark also lacks major industry, and….it is not a major technological power…And yet Denmark today is the third wealthiest country of Europe, evidence of strong, consistent, stable economic growth over the decades. It is roughly the most equal country in Europe and perhaps in the world. And it enjoys roughly the lowest unemployment rate in Europe, alongside one of the highest ratios of employment to active population. If Denmark’s celebrated egalitarianism has forced it to sacrifice prosperity, the evidence for this is quite hard to find.”
Galbraith reports that Denmark is not a unique case—it is merely the standard setter.
“The strong welfare states of North Europe have higher employment rates and lower unemployment rates than the relatively unequal countries of the South. These rules apply across all of Europe.”
Galbraith then goes on to suggest that this is not a fluke or a cultural phenomenon, but rather an economic law.
“In the United States, unemployment and pay inequality rise and fall together, month by month and year by year.”
He provides as evidence to support this “law” the fact that raising the minimum wage has tended to lower unemployment rates rather than raise them.

In order to understand why this “law” is valid he provides this explanation.
“When a society is very unequal, there are, necessarily, just a few “good” jobs and many “poor” ones. That is what being highly unequal means. And when this situation holds, it is normal for large numbers of people to go hunting for the few available good jobs. Long queues are the inevitable result. That is unemployment. Thus, other things equal, inequality produces unemployment, and unemployment produces waste: people who are not working do not contribute to the production from which ultimately everyone consumes.”

“But in a fairly equal society, those relatively low-skill, low-productivity workers are already being paid pretty well. They are within economic shouting range of their more productive compatriots. They therefore have much less incentive to leave their job, even to migrate, and join the search for a better one. Furthermore, highly equal societies subsidize many of the amenities of life, from education to health care to housing: they indulge in the efficient provision of public goods. That being so, who cares to leave?”
And finally he concludes:
“The resulting society may lack excitement. Pushed too far it can completely lack dynamism….But if the right balance is struck, it is capable of producing high levels of output and economic well-being simply because the full use of human resources is efficient. This is the Scandinavian principle, and it is not an accident that Denmark is both egalitarian and rich.”
Galbraith’s explanation for why inequality and unemployment move together seems reasonable, but still arguable. So why don’t we start arguing about it? This country needs a revolution. If Galbraith is correct, then perhaps we have our call to arms.

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