Philip Pilkington: Let’s start with the obvious question that the book raises. Namely, why studies on inequality have, until this point, been so poor. You point out in the book that the studies that have been done have been competently researched but that they simply don’t have access to the correct types of data etc. Could you talk a little about this (without getting too technical, of course) and maybe speculate a little about why this important issue has been sidetracked by the economic profession?

Jamie Galbraith: I have great respect for the many researchers around the world who have conducted income surveys over many decades, and also for those at the World Bank and elsewhere who have tried to assemble this work into useful data sets. But there are two major problems. The first is that surveys are relatively scarce, especially in poorer countries; in many countries they are available only for a few widely-scattered years. The second is that the concept – what is being measured – can vary widely from place to place and from time to time. For instance, some surveys measure the inequality of incomes; others the inequality of spending. In some cases the measures are for households; in others they are for individuals. And so forth.

The result is that when these very disparate measures are brought together, the data are sparse and very noisy, it is very hard to find clear patterns, and in quite a few cases apparent comparisons between countries just don’t make sense. This prompted us to look for other types of economic information that could be used to fill in gaps and improve the quality of the measures.

What we found, is that there is quite a lot of raw information that can be useful for this purpose, so we set about collecting it and making calculations. Our approach has its own limitations – which I’m careful to describe. But it does fill in many gaps and it does reveal clear patterns, both through time and across countries. So it permits us to use our inequality measures as a new source of insight into how the world economy is bound together, especially by the far-reaching forces of global finance.

PP: You mention that surveys are scarce. From the book I get the impression that this is bit of a dark corner in the economics profession. Why do you think this is the case?

JG: Two reasons primarily. One is that surveys are expensive. The other is that for many years there wasn’t that much interest in economic inequality among economists; growth, development, trade and finance were all more fashionable fields. More recently there has been an explosion of interest in inequality — but it’s too late to go back and take surveys for past years, let alone past decades.So the challenge for us was to find other types of data, which could fill in some of the missing information.

PP: As pretty much everyone knows by now, inequality has been rising in most advanced countries in the past few decades. One of the interesting points you make in the book is that you don’t believe rising inequality in many advanced countries could have been turned to electoral advantage. Could you please explain how you came to this conclusion?

JG: Inequality rose almost everywhere – both in the advanced countries and in the rest of the world – very sharply from 1980 to 2000. After that, the global picture becomes less clear, since lower interest rates, rising commodity prices and political change improved the picture in many places, including especially Latin America. We have strong evidence of declining inequality in parts of Latin America after 2001.

The book includes a chapter on the relationship between inequality and electoral outcomes in the United States. The US is interesting because what is relevant for presidential electoral outcomes – thanks to the Electoral College – is inequality within states. Getting good measures of inequality within states was a very interesting challenge, all by itself.

What we found is that when you look at inequality in that way, you find that higher inequality is associated with lower voter turnout. But it’s also true that states with more inequality of a very particular type, namely states that tend to have a lot of geographical stratification between the rich and the poor, tend toward the Democratic Party. And states for which this is less true tend Republican. There is very striking evidence for the 2000 election: you can practically predict which way a state went in that election by the measure we developed, right down to the tie vote in Florida.

We conclude two things: first that higher inequality inside a state is associated with policies that discourage voting by the relatively poor, and second that when the rich and poor tend to live in separate local political jurisdictions (which is more common in big states like California and New York) the rich don’t interfere with the poor as much as they do when both are voting in the same places.

Anyone who lives (as I do) in the American South will, I think, not find this surprising. It’s very much consistent with, for instance, the history of the Voting Rights Act.

PP: And how then did you conclude that the left could not have turned the rising inequality into electoral victory over the past few decades?

JG: That’s a question with an ironic answer, at least for the US. A rise in inequality – while it lasts – can and often does appear to be a moment of prosperity. We saw our largest rise in income inequality under a Democratic President, Bill Clinton. Why? Because he presided over a stock market and information-technology boom. And of course the beginnings of that boom helped win him re-election in 1996. So you might say that rising inequality did help produce electoral victory for ‘the left’ – or what passes for ‘left’ in this country, at least on that occasion. But not in the way most people imagine. The problem is that expansions of this type cannot and do not last.

PP: If I understand correctly you also found that nations have very little control over their own levels of inequality. How did you come to this conclusion?

JG: A nation’s level of inequality has a lot to do with its underlying economic structure and level of development: agrarian, industrial, or high-technology. But we also found, in examining the movement of inequality in the world economy over 40 years, that there was a very strong common pattern. This suggests that *changes* in inequality have a common source. Looking at the major turning points, which were in 1971-3, 1981 and 2000, a leading candidate for that source emerges: the changes in the world financial system.

Until 1971, the world’s economies were largely stabilized under the Bretton Woods system. After 1973, there was a widespread commodities-and-debt boom that tended to reduce inequality in developing countries. After 1980, high interest rates and the debt crisis raised inequality almost everywhere. And finally in 2000 there was a peak; after that interest rates fell, commodity prices recovered, and inequalities around the world tended to ease.

In the face of these global pressures, it’s possible for some countries with very stable policies and strong institutions to resist for a time: for example Denmark does not show rising inequality in our data. Or a country may be insulated from global shocks, as China and India were from the debt crisis in the 1980s (but not in the 1990s). But these cases are very few. In most cases the global forces dominate the picture.

PP: Right, so finance tears away any protective veils the nation-state tries to use to maintain equality and stability. Are you then implying that finance, or at least finance when it grows to a certain level and gains a certain amount of power, becomes a redistributive mechanism?

JG: Of course.

PP: But finance is supposed to channel investment. What shift takes place that causes it to act in such a strange manner?

JG: I suppose that is what they say. In reality, whether banks distribute resources from lenders to borrowers or back from borrowers to lenders depends on the terms of the loan. In the high-interest-rate environment of the 1980s and 1990s, the redistribution vastly favoured the lenders, which is to say, the wealthy. This is not surprising. My father once coined a “Galbraith’s Law,” which held that, as a rule, “people with money to lend have more money than people who do not have money to lend.”

PP: Mainstream economics doesn’t deal much with income distribution, why do you think this is?

JG: For many years the study of income distribution held no interest for economists, in part because the distribution seemed to be stable or becoming more equal over time. That changed in the 1980s. And beginning in the early 1990s, the mainstream did get into the act, with many papers offering up the hypothesis that inequality was driven by technology and the demand for skill. This was called “skill-biased technological change” and it became the standard explanation for rising inequality in mainstream circles. I wrote one of the earliest critiques of this, in a book called “Created Unequal” that was published in 1998. Since then, numerous applied economists have also broken ranks on this interpretation, although some continue to promote it.

PP: What was your interpretation of this rise in inequality?

JG: As my title back in 1998 suggested, it was “created.” I did a lot of original data work, creating new time series measures, which enabled me to show exactly when pay inequality rose during this period. It was clear that what we measure as *pay* inequality was very closely related to unemployment and to involuntary part-time at the low end of the pay scale. That’s not the entire story but it’s the biggest piece of it.

Inequality of *incomes* in the US is different, because measured incomes (reported on tax forms) include money made from capital gains, stock options, and the payout from venture capital investments, all of which are highly concentrated in a relatively few places, companies and people. When you look at income inequality, it’s clear that the major driver is the movement of the stock market, especially the NASDAQ. But that’s capital-asset valuations; it’s not “demand for skill.” I’ve often said it’s actually redundant to measure income inequality in the US. You can watch it go by on cable TV, on the stock ticker.

PP: I’m pretty sure that mainstream macroeconomics doesn’t pay much attention to income distribution, but it seems probable that income distribution would have important macroeconomic effects. Do you think that income distribution has macroeconomic effects? If so, what do you think are the most important?

JG: The evidence is pretty clear that a very bad income distribution leads to economic instability; that is to panic, slump and collapse. The reason is that the bad distribution emerges from growth driven too much by private credit: from too much debt taken on by the middle and lower strata, ending in crisis. That is what we observed in the US stock market euphoria that peaked in 1929. That is what we observed in the housing finance disaster that peaked in 2007.

But one can also say that the reverse is true: the income distribution is driven by macroeconomic forces. The act of extending credit – a macroeconomic force – generates fees and capital gains and other incomes that accrue, largely, to the top strata. You can see this very plainly in US data, but also in most other countries we’ve looked at, from Brazil to China. In sectoral data, it shows up in the fact that rising inequality is closely associated with relative gains by the financial sector.

One of things Inequality and Instability shows is that there is a common pattern in the movement of inequality around the world. A very clear pattern. It isn’t just an American phenomenon. That suggests that there must be a common global force behind it. And that would have to be a macroeconomic force, by definition.

I’m hoping to get this point across to economists, as well as to the wider public. It should have an effect on how they conduct research into inequality, dislodging them from their fixations on such matters as education and training and even immigration and trade. Such local and country-specific forces cannot be working in such a powerful common way, all across the globe, as we observe. Of course, the wider public is much more open to evidence and to common sense, than are my professional colleagues – for the most part.

PP: So, if we accept that most inequality is generated through the finance sector, how do solve this problem? From what you say it appears that the entire economy is structured around this inequality. It seems that in order for policymakers to attack this they would have to target multiple points of the architecture simultaneously. Where would you start?

JG: In Argentina and Brazil, as I show in the book, inequality started to decline almost immediately once the financiers were knocked off their thrones. In Brazil the share of income passing through the financial sector was extraordinarily large, but over the course of twelve years and three presidencies, it has gradually been reduced, making room for expanded public services, improved social conditions and reduced inequality.

In the United States, the government has the power to bring the financial sector under control. It should use that power. Our problem is that the financial sector controls those parts of the government that set policy for finance. The banks are leading funders for presidential campaigns. The leading personnel in the Treasury and other financial agencies come from the banks, and if they do a good job (from the banks’ point of view), they can be confident that a lucrative sinecure awaits them, back at the banks, later on. This provides a very strong disciplinary effect on their conduct in office.

So – where to start? I’d *start* by breaking that link between the banking sector and the public sector. One practical way would be to create a truly independent, effective and well-financed financial crimes enforcement unit, beyond the control of the political appointees at the Department of Justice, Treasury and the captive regulatory agencies. Also restore mark-to-market accounting and place the full control of audits and stress tests in hands that do not have an obvious conflict of interest viz. the results.

PP: People in the US – especially due to the Occupy movement – are becoming increasingly concerned about campaign financing by, among other groups, the banks. This seems to be the tie between the two sectors that ensures nothing gets done about Big Finance. I understand that you’ve spent some time around policy circles and the like. Maybe you could say something about this, the effect it has on regulation and policymaking and the potential to do something about it?

JG: I was on the staff of the House Banking Committee in the second half of the 1970s. At that time, the Committee hearing room in the Rayburn Building had just two rows of desks for members. Today there are four rows, and barely space for a table of witnesses, let alone anyone else. In other words, the size of the Committee has about doubled.

Why is this? Because the leadership in the House uses that committee as a fund-raising magnet, especially for Members who might be a little bit vulnerable. Once a Member has a spot on the banking committee, money problems go away. And one can hold practically any position on other issues that may be convenient — liberal, conservative, the banks don’t care. All you have to do is be friendly to bankers.

This is a formula for locking down the Congress. As I said, with the executive branch, it’s a bit different; while campaign financing is a significant question, so too is the actual staffing of the government, which is controlled by bankers; people come in from the banks and go back to the banks. It’s not a secret, for instance, that Robert Rubin’s protégés took a very large share of the top policy positions on economics and finance in the Obama administration — from Larry Summers on down. It’s not a secret that Peter Orszag, the first director of OMB under Obama, took a well-paid position at Citigroup on leaving the White House.

I have no simple formula for dealing with this, beyond what I keep repeating: 1) enforce the laws against financial fraud and 2) downsize the financial sector as a matter of public policy.

PP: You note that things have gotten better with regards inequality and instability in many parts of Latin America after their financial crises. Yet, such has not been the case in the US post-2008. Are you optimistic about the future?

JG: According to our most recent measures, using county-level data, income inequality in the US did fall after 2008 and then rose again – tracking the stock market as I found in the book. For lower-income workers, for older workers and for homeowners, the bottom fell out in the crisis and it has not been repaired.

The grip of see-no-evil economics has been broken in many parts of the world, and especially in South America. But in the US and in Europe, especially in Northern Europe and in the UK, it remains very strong. This means that our two continents have actually less open debate, and so fewer political options, than is now the case in many other places.

We have seen, though, that severe events do have a way of opening up peoples’ eyes and minds, and so there is always hope. I don’t rely on hope, though. My friend William K. Black, the criminologist, likes to quote William of Orange: it is not necessary to hope in order to persevere.