"As a result of the patterns of global interaction and globalization, there is a systematic increase in inequality, even controlling for income, over this 20 year period from 1980 to 2000", according to American economist James K. Galbraith, who for 15 years has been directing research on inequality across the globe, at the Lyndon B. Johnson School of Public Affairs of the University of Texas at Austin. In an interview with ALAI, he clarified the scope and conclusions of this project, as well as commenting on the character of the present world economic crisis and its implications for Latin America.

JKG:- The focus of the research effort has been to improve the measurement of inequality in the world economy at the international comparative level and also in particular national cases at the level of regional and industrial data sets. The unifying theme in the project is that it is possible to greatly deepen and broaden one's knowledge of what has happened in the world economy by taking advantage of information measures that are fairly readily available but which have not previously been used for this purpose.

A central conclusion at the level of the world economy has been that when you bring together enough data to be able to see the movement through time across many countries of inequality you find a very straightforward pattern, and that pattern is very closely related to the governing structures of the world financial economy. In very simple terms, if one goes back to the Bretton Woods period up to 1971, it is broadly speaking a period of stable distributions, there's a brief period when distributions became somewhat more equal, through the 1970s, in the period of the commodities boom and the global expansion of credit. That came to an abrupt end in 1980. From 1980 to 2000 there's a massive upward movement of inequality that goes around the world; the first major area to be affected is Latin America, then one has central Europe and the former Soviet Union, ultimately in Asia, and then a peak occurs around 2000 so that there's some tendency of this process to stabilize and even to improve a little bit for the data we have into the 2000's, primarily as a function of the fact that interest rates fell practically to zero and commodity prices began to improve.

So the story of inequality in the world economy first of all does show that there are very strong common patterns in the world economy and secondly that it is very closely related to macroeconomic phenomena; it’s very strongly influenced by the structures of policy that are set in places like Washington, New York and London.

ALAI:- You're talking here about equality within countries mainly or also between countries?

- The two phenomena are very closely related, but the measurements that I have are of inequality within countries and then taking the common movement of inequality within countries, and looking at that across countries.

- Have you looked into the social and political impacts of inequality?

- We've done a fair number of studies of the relationship between inequality and political systems; not so much on the relationship between inequality and social phenomena, because that is an area of interest of a great many other researchers, and it seemed to us that the focus of our effort should be on supplying a comprehensive and consistent and high quality information set that those people who are working on those questions can incorporate into their work, so as to improve in general terms the reliability of information about this issue.

- Have you looked at the relationship between inequality and violence? Latin American is known both as the most violent continent and the one with the greatest inequality, and there's often a relationship made there…

- Well, our information does not have Latin America as a uniquely high inequality continent; some countries in Latin America such as Brazil and Peru in particular show up very high on our measures, but then so do countries in Central and Sub-Saharan Africa, and so do certain countries in Asia. We show India to be a much higher inequality country than other methods of measuring have shown. We have done some work on inequality and certain types of violence, particularly civil war and war, and the effect of conflict on inequality, and there's certainly a relationship there, that you can see particularly in the detailed information. If you look at what happens in countries as violence escalates to this level of national conflict, you can certainly find very definite effects on the movement of inequality.

- What about the relationship between inequality and development of the economy itself, beyond the fact that it obviously means some groups become wealthier and others become poorer?

- Our basic conclusion is that broadly speaking there is a systematic relationship between inequality and the processes of economic development and levels of income. Our findings are broadly consistent with what Simon Kuznets argued more than a half century ago, that is that in the early stages of industrialization, inequality tends to increase because of the differential between the city and the countryside; over a broad phase of industrialization that most countries are in, inequality tends to decline, with increasing wealth, because of understood processes of consolidation. For the richest countries inequality has risen sharply with increasing income – that's true of the US, and of the UK- but we also find that, as a result of the patterns of global interaction and globalization, there is a systematic increase in inequality, even controlling for income, over this particular 20 year period from 1980 to 2000. And so we put that down to the influence of transnational forces. So you have to take into account both the way in which a national economy is developing structurally and the influences on that economy that are international forces.

- And have you formulated policy recommendations with relation to that?

- I think there are clear-cut policy implications, and that they have to do with the processes of control, particularly of the financial sector. When you look at this from the standpoint of the data sets available within individual countries, one of the things you find very consistently is that rising inequality is associated with a larger increase in the income share of the financial sector, and this is a kind of predatory process that's associated with both high interest rates and with the use of the credit mechanism as the primary instrument for generating economic growth, something which is intrinsically unstable. It's clear that in a post crisis period –for example since 2002 in Argentina, to take an example of a country for which we have very good data that’s right up to date- inequality actually declines, and that decline is associated with the shrinking of the financial sector relative to the rest of the economy. The same is true in Brazil where one observes that the financial sector has been brought back into something more approximating a reasonable share of total activity; then the public sector has been able to expand and the public sector of course serves very different functions from the financial sector, so you have not only a broader base of people who are receiving those incomes but also services that are being provided that were not being provided in the earlier period.

- So how would you relate all of this to the present financial crisis, also obviously related to the excessive growth of the financial sector?

- I think that there is a clear relationship between inequality and financial instability. (I have a book which Oxford will publish in a few months called “Inequality and Instability”, which conveys that theme). What happened in the detail of the financial crisis in the US was an effort to maintain the impression of prosperity that had been achieved in the 1990s, after the collapse of the information technology bubble, and that effort was carried out through massive expansion of lending against houses as collateral, a lending process which had none of the potential for technological transformation or improvement of living standards that the earlier phase did, and was deeply corrupted, essentially by loans that the originators knew would not be repaid. So it was precisely the reliance on the de-supervised financial sector as the engine of economic growth of the 2000s, which brought us to the collapse of 2008.

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- How would you characterize the present crisis in the US and Europe and its impact on the rest of the world?

- They're very closely related but I think there's just one crisis and it's a crisis of the global banking sector. The crisis in Europe gets underway in late 2008 and early 2009, and why is that? Why do all the weaker European sovereigns get affected at the same time, even though their actual individual situations –Greece, Spain, Portugal, Ireland -- are very different and the answer to that is that these are countries whose bonds were held by a single relatively unified global investment and financial community, and when that community realized the extent of the losses that it was going to incur on toxic assets that had been created in the US and then sold to them by American banks, they naturally did what any investor would do, they looked to see how to protect themselves from further losses, and that meant selling the weak sovereigns and buying the strong ones. So the prices of Greek bonds went down and the prices of French or German or US or UK bonds went up. And yields on the big countries went down and yields on the small countries went up, in a massive movement towards an unsustainable situation and instability. It wasn't that people suddenly discovered that Greece is a country with a deficit problem and a weak tax system and a big public service. It wasn't that people suddenly discovered that Ireland had had an unsustainable construction boom. This was not news, it was known. Anybody who went to Dublin knew that. You didn't even have to go to Dublin to know that or to Athens to know what the situation in Greece was. But it's characteristic of financial crises that in the boom period, loans are made to weak credits and to unstable entities and in the slump those loans are withdrawn and everybody suddenly discovers all these risks that were there all along. What's important here is what triggered the movement from the boom phase to the contraction, and that was the realization that the US banks had perpetrated the world's largest financial fraud, over the course of the better part of a decade before the collapse came in 2008.

- Do you think the policies that have been adopted by the EU or by the US government and Federal Reserve are adequate to deal with the situation?

- They're self-evidently not adequate. The US Federal Reserve has had a policy essentially of unlimited lending, which can be credited with forestalling institutional collapse up to this point. It's obvious that the powerful authorities in Europe, the Germans in particular, are unwilling to follow the same path, and there has been massive tension in the European Union, first over the "blood price" of austerity in Greece and other countries. The point of imposing austerity on Greece is not –as is commonly said- to make the credit markets open up again, I think everybody understands that is not going to happen and there's nothing the Greeks can do that will make it happen; the point is to satisfy the German financial constituencies and the electorate -- Angela Merkel's constituencies -- that a sufficiently high price has been extracted for a bailout or a rollover of the Greek debts. There’s obviously now a growing sentiment, possibly a decisive sentiment in Germany that no price is high enough and that it’s time to cut the cord and force matters to a conclusion and that could very well be where we are right now. So then the question becomes: what happens next? and it’s a very interesting question and to what degree, if there’s a default, does that imply a break-up of the Euro zone and an exit of the defaulting countries from the Euro zone? Is there a cascade of defaults if Greece defaults because of the pressures of the banks and other countries, including potentially on Italy? and if Italy then potentially Belgium and France? And at that point the question is, what do individual countries or groups of countries do to try to adjust to this situation? Do they try to divide the Euro zone in an orderly way, or do they go back to national currencies and pass through a period of major disorder and potentially an adjustment to a much lower level of output as you move back toward the environment of the pre-euro period?

- Do you think that for a country like Greece withdrawing from the euro would be the best solution at this point, something similar to Argentina in 2000?

- I don’t think the situation is similar to Argentina in 2000 because, first of all Argentina was simply dropping its convertibility pledge, it was not changing its monetary unit, and also however integrated the global financial markets are, Argentina is a large self-contained country located in South America, and Greece is a very small country largely composed of islands, full of people with boats, that’s right in Europe. And of course the Greeks are accustomed to holding their wealth in euros, holding their assets in euros, so the return to a potentially very unstable national currency in a country with a very weak capacity to tax, could be much more traumatic even than it was in Argentina, and I think the Greek economists are well aware of this. Maybe they’re wrong. Maybe at the end of the day there’ll be a quick recognition that a new drachma is the only viable solution and that people would adjust to holding it; but I think most observers are betting against a benign or even orderly outcome if Greece does withdraw.

- What about the implications for Latin America? So far the region been relatively unscathed by the economic crisis -- some countries more than others --, but obviously a prolonged crisis is going to affect the Latin American economy. What would you recommend?

- I think that there are a number of different aspects of the potential effects of the crisis on Latin America. One has to do with the security of funds held in banks that are affected by the crisis; if there’s crisis of banking solvency the question of deposits has got to be on people’s minds. Second is a question of what happens to exports, and there the situation is a bit more favorable than it was 30 years ago because you have the stabilizing factor of the Chinese market, which has obviously been very substantial for the past decade. And a third area I would say is the structures of credit inside Latin America, because all of the mistakes and frauds that have characterized the banking system in North America and Europe could easily be reproduced by banks in Latin America. There’s nothing peculiarly Anglo Saxon about financial swindles.

So there is a real challenge of financial governance which is partly a question of capacity of bank supervision, of the public sector’s ability to operate as an autonomous and effective regulator of financial activity. And partly a much deeper challenge of how you deal with the world of highly fragmented, highly automated electronically-based contracts in the financial sector. How do countries in Latin America deal with the potential for manipulation of global commodity markets which affects the prices of their primary outputs? How do they deal with the ability of the marketing of credit default swaps and other derivative instruments to affect the prices of their bonds? These are all issues that go beyond the supervision of banking institutions to the relationship between countries and global financial markets, which you can’t escape simply by building a wall around any region. So I think that’s the third and especially profound challenge that faces any government that wants to chart a stabilizing course over the years ahead.

But Latin America does have some advantages. One of them is the fact that the terms of trade have been moving in favor of commodities, and so that has enabled growth over the last decade. Perhaps more fundamental is the fact that Latin America came to grips with the defects of neoliberal globalization at least a decade ago. And there’s much more diversity of thinking about this issue and there’s a stronger democratic consciousness of the issues that are raised here, than is true in either the US or Europe, where the sheer power of right-wing ideology is extraordinarily strong. I used to be an optimist about the US, on the theory that the fundamental institutions in the US were those created in the New Deal and the Great Society –social security, Medicare, Medicaid- and that the populations would defend those institutions. But when you see the power of what amounts to the assault by crackpot economics and right-wing financial power on these institutions, it’s truly impressive! And you have a capture of both political parties and a sense that things really will continue to get worse before they get better. And the same is true actually in Europe where if anything there is less flexibility of thought on these issues than in the US. And then they have magical austerity gremlins running policy in the United Kingdom and these hyper-orthodox sound money types with absolutely no internal dissent in Germany –or no internal dissent that actually matters in the political process—and you say, well, the great advantage that Latin America has is that people got over this and there’s a critical intellectual tradition which makes this in many ways the most interesting place to be in the world.

- Do you have any idea what political, social, economic or other forces will be needed to be able to put some kind of order in the global financial system?

- A conclusion I’m coming to is that the global financial system as we know it cannot be repaired. And coming to grips with that will mean empowering countervailing forces and rebuilding credit institutions on a very different basis. It’s not the first time this has been done. It happened in 1929-1930 and the world operated on a fundamentally more stable basis after the Second World War for 30 or 40 years. So it took a long time to return to a world in which public policy was dominated by bankers and investment bankers and so we have to come to grips with the fact that this is two tries in a century and two disasters and we ought to connect those two dots and come to some recognition about what this means.

In the US that’s going to require that one of the two parties take the risk of dissociating itself from the financial support of the financial sector, and it will be interesting to see which of the two parties chooses to do that. Interestingly enough, the best people in the Obama administration on this issue were holdovers from the Bush administration. It’s pure irony that the Obama administration is more the captive of the banks than the appointees of George W Bush. The best person in the Obama administration was Sheila Bair – the recently departed chair of the Federal Deposit Insurance Corporation (she was a congressional staffer initially, working for Bob Dole) a very sound, independent minded and determined individual, who unfortunately was not in charge of policy. The actual policy was being governed by Timothy Geithner of the Treasury Department. Probably the next best person is also a Bush holdover, the head of the Federal Housing Finance Agency, who just filed lawsuits worth 196 billion dollars against the major banks and the financial frauds. Again, these guys are not the hard-core Bush republicans, but they are nevertheless not people who were appointed first by this president.

(The interview took place in Quito, in September 2011).