How Capitalism Endogenously Creates Rising Income Inequality and Economic Crisis: The Macro Political Economy Model of Early Industrial Relations

Date01 January 2018
Published date01 January 2018
DOIhttp://doi.org/10.1111/irel.12201
AuthorBruce E. Kaufman
How Capitalism Endogenously Creates Rising
Income Inequality and Economic Crisis: The
Macro Political Economy Model of Early
Industrial Relations*
BRUCE E. KAUFMAN
A major economic issue today is the causes and consequences of wage stagnation
and rising income inequality. This paper uncovers, describes, and formalizes the
macro political economy model developed by preNew Deal institutional/indus-
trial relations economists to explain these issues. The model is formalized in a
three-part diagram and used to explain the role of inequality and wage stagnation
in causing the Great Depression and World Financial Crisis and the appropriate
policy responses.
The forces of equilibrium are real, but they are only half the story.
There are also forces making for breakdown. And intellectual interest
in or emotional enthusiasm for the smooth-running features of compet-
itive capitalism should not blind us to the other side of the story.
Paul Douglas (1935a: 85).
Given a political system that is so sensitive to moneyed interests,
growing economic inequality leads to a growing imbalance of political
power, a vicious nexus between politics and economics.Joseph Sti-
glitz (2012: xx).
Introduction
The two epigraphs come from books separated by nearly 80 years, Control-
ling Depressions by Paul Douglas (1935) and The Price of Inequality by
Joseph Stiglitz (2012). Although one author is a labor economist and professor
of industrial relations (his position title at Chicago) who writes about the Great
*The authorsafliation is Georgia State University, Atlanta, Georgia and Grifth University, Brisbane,
Australia Email: bkaufman@gsu.edu.
INDUSTRIAL RELATIONS, Vol. 57, No. 1 (January 2018). ©2017 Regents of the University of California
Published by Wiley Periodicals, Inc., 350 Main Street, Malden, MA 02148, USA, and 9600 Garsington
Road, Oxford, OX4 2DQ, UK.
131
Depression of the 1930s, and the other is a Nobel laureate economic theorist
who writes about the World Economic Crisis of 20072008, their respective
messages are connected parts of an institutionalist theory of endogenous
income inequality and macroeconomic crisis.
Both men argue that a free-market economy, through a nexus of interacting
economic and political forces, internally generates rising income and wealth
inequality, aggregate demand/supply imbalance, and risk of economic and nan-
cial collapse. Stiglitz (2012) cites, for example, adverse dynamicsand vicious
circles(p. 82) and says, unbalanced politics driven by extremes of inequality
leads to instability(p. 89). Similarly, Douglas (1935a) says, There are present
in our economic system latent tendencies which may, and more or less periodi-
cally do, result in a cumulative disequilibrium(p. 85). To combat this destabi-
lizing dynamic, both economists advocate an agenda of institutional and policy
reforms that redistribute economic and political power to labor and the lower-
middle classes, including initiatives that strengthen labor laws, collective bar-
gaining, social safety net programs, education and training opportunities, and
full-employment scal/monetary policies. Douglas and Stiglitz are both aware
their diagnoses and solutions are likely to get a failing grade when viewed
through the lens of orthodox theory but to them the theory is a romantic day-
dream(Douglas 1935a: 249) and pleasant fantasy(Stiglitz 2012: 116).
Papers with an explicit macroeconomics focus are unusual in an industrial
relations (IR) journal (and vice versa). However, few labor-related topics today
gure as prominently in academic research and political/policy debates as the
causes of macro-level wage stagnation, rising income inequality, and anemic
employment and gross domestic product (GDP) growth (Freeman 2007; Palley
2012; Piketty 2014; Wisman 2013). These trends, for example, were at center
stage in the U.S. 2016 presidential election, particularly as the political parties
responded to growing middle-class anger and frustration at the disappearance
of rising living standards and secure well-paying jobs, and brought out a
stream of conicting diagnoses and solutions from right- and left-oriented
think tanks (e.g., Sherk 2013; Bivens and Mishel 2015). These trends have
also been identied as causal factors in the labor-market collapse of the Great
Depression of the 1930s and near-collapse in the World Financial Crisis of
20072008 and subsequent slow recovery (Treeck 2014; Stockhammer 2015).
Also germane for an IR audience is the little-known fact that the macroeco-
nomic connection between wages, inequality, and economic cycles and crises
was the leading research topic in the early American IR eld from its founding
in 19181920 through the rst phase of the New Deal in the mid-1930s. In
this area the three most important American contributors were institutional
labor economists John Commons, Paul Douglas, and Sumner Slichter, while in
Britain the major contributors were Sidney and Beatrice Webb, John Hobson,
132 / BRUCE E. KAUFMAN
G.D.H. Cole, and William Beveridge. Although some second-order differences
separate their respective models and policy recommendations (the British were
more left-radical than the Americans; see Wright 1979: ch. 8), as a group these
IR pioneers carved out a distinctive theoretical and policy program broadly in
the middle between the neoclassical free-market and laissez-faire right and
Marxian socialist and central planning left.
Given the current-day importance of the income inequality topic, and
plethora of competing and sometimes incommensurate explanations, this paper
makes a contribution by going back to the institutional economics/industrial
relations (IEIR) literature of the 1920s1930s, with primary focus on the
American team of Commons, Douglas, and Slichter (CDS), and analytically
represents their theory of endogenous wage stagnation, rising income inequal-
ity, and macroeconomic crisis. Their theory is distinctive because it was the
rst alternative to Marxist versions, complemented and incorporated business
cycle ideas from other early institutionalists like Veblen and Mitchell (Davan-
zati and Pacella 2014; Sherman 2001), and has signicant points of overlap
but also key differences with modern Post-Keynesian and Marxist theories
(Goda 2013; Hein 2017).
Three research questions are the center of analysis: (1) does a neoliberal,
free-market economy have a built-in propensity to generate a secular increase
in income inequality and, if so, how and why?; (2) if it does, can an economy
maintain long-run macroeconomic demand/supply (DS) balance and full-
employment GDP growth as real wages stagnate and labors income share
declines?; and (3) similarly, what role do IR institutions and policies play in
the inequality-crisis scenario and, in particular, how can they reduce or prevent
the trend toward inequality and stagnation/crisis? The answers to these ques-
tions, which boil down to Yes, No, and Share Productivity Gains with Labor,
are worked out by formalizing into diagrams the key ideas of this early IEIR
literature.
The only analytical requirement for readers is familiarity with aggregate
demand/aggregate supply (AD/AS) analysis from basic economics (e.g., Krug-
man and Wells 2015) and patience to work through two diagrams with numer-
ous letters and arrows. The paper develops the theory ideas from early IR
largely in the historical context of the 1920s1930s but at the end applies the
insights and policy recommendations to todays economy. Although the analy-
sis is largely developed with reference to the American situation, in which the
economy is more free-market/neoliberal and inequality trends are likewise
most pronounced, a number of other countries have rising income inequality
for which these ideas also have application (Berlingieri, Blanchenay, and Cris-
cuolo 2017).
Wage Stagnation, Inequality, and Crisis / 133

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