Is the rising economic inequality an existential threat to capitalism?

Arguably one of the biggest threats to the stability of world economies is the undeniable rise in economic inequality over the past decades. With few exceptions, economic inequality has been on the rise in advanced and developing countries alike, posing a major hurdle to economic prosperity and growth for most.

In a recent webinar by the John D. Gerhart Center, Jr. Chair in Government/Business Relations at The LBJ School of Public Affairs, James K. Galbraith, brings the topic of global inequality to the forefront.

“As far as we have it now, most of the world is exhibiting patterns of economic inequality, similar to those that existed in the developing world 50 years ago,” said Galbraith.

“That’s not to say that countries have become as regressed or become as poor as they were before. They’re certainly much wealthier than they were before, but the pattern of inequality is essentially similar to what it was 50 years ago.”

Further elaborating, Galbraith equated the threat of inequality with existential economic crises the world has endured before. “Capitalism got out of control in the 1920s and collapsed, and the pattern of inequality that we’re seeing now is not that dissimilar from what we saw back then.”

Changing how economists see inequality

The topic of inequality has long intrigued economists and researchers across the world. There needs to be, however, a different way to look at and study the issue, according to Galbraith.

“There is a common global macroeconomic pattern to rising inequality, which I suggest has very important implications for the way we think about this problem in economics,” he explains.

Furthermore, national policies designed to combat inequality could be rendered ineffective due to failure to factor in how the world financial system is run.

“Economic inequality has been largely treated as an [issue pertaining to] micro labor market, problem skills, trade, education, technology, and something which is specific to particular countries, but that’s not what we’re finding. What we find is that there is a common pattern and that the timing of it [rising inequality] strongly suggests the relationship to the way the world is governed and the financial and the global financial order that prevails in any given time.”

Factors affecting inequality

Many factors come at play when inequality is to be understood in the right context. One major factor, explains Galbraith, has to do with what he calls ‘industrial inequality’ and its relationship with informality.

“In most countries, inequalities tend to come from within the structure of industrial pay [as in how much workers in that sector are paid], and/or will reflect on that structure or between the industrial sector and every other sector,” elaborates Galbraith.
“That is captured by the share of manufacturing employment in the in the population. And these two variables tend to give us some purchase on what the effect of increasing informality will be on inequality across the whole society.

That is, looking at informality rates alone isn’t a good prediction of inequality, but rather measuring the share of employment in the manufacturing sector against informality is what gives us a clearer picture on the state of inequality in a certain economy.
“The informal sector reflects people who are in distress, who have low income, but it’s not terribly unequal because many people in the informal sector are actually rich,” he clarifies.

Having strong industrial sectors that export valuable products is essential to a country’s economic development, but can also lead to income inequality in case of a currency crisis or devaluation – similar to what Egypt experienced in late 2016.
“Goods that countries export tend to be their highest value added goods, meaning that those [industrial] sectors are best paid. When a country experiences a devaluation, particularly when it experiences a currency crisis, then inequality goes up in that immediately because the exporters have more local currency [due to exporting in US dollars ] and those who don’t export are being paid what they were being paid the previous day.”

In fact, Galbraith found that any country that goes through devaluation of local currency immediately experiences higher inequality.
“For rich countries and poor countries, big countries and small countries, you find the relationship [between higher US exchange rate and higher inequality] remarkably consistent; a positive relationship as currencies lose value relative to the dollar.”

Regulatory framework is key

When it comes to one crucial factor without which no economy can function properly and hence becomes more ineffective and inadvertently experiences rising inequality, Galbraith points to one main component.

“You really can’t have an effective social policy unless one brings the financial sector under a regulatory framework that works,” asserts Galbraith

“You have to regulate; regulation is a fundamental aspect of economic development. The big distinction between effectively developed and less developed country is the quality of the regulatory system.”

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