The Truth about Milton Friedman

[Bono]

www.cato-at-liberty.org/2008/04/21/the-truth-about-milton-friedman/

The Truth about Milton Friedman

Peter Goodman writes in the New York Times that we live in a laissez-faire world created by Milton Friedman and that that wild, unfettered market has led to our current economic problems.  David Henderson, the first editor of Cato Policy Report, begs to differ. David R. Henderson is a research fellow with the Hoover Institution, an economics professor in the Graduate School of Business and Public Policy at the Naval Postgraduate School, and the editor of The Concise Encyclopedia of Economics (Liberty Fund, 2008). Here’s his critique of the Times article:

In the April 13 New York Times, economics reporter Peter S. Goodman takes “A Fresh Look at the Apostle of Free Markets,” the late Milton Friedman.  Goodman’s goal seems to be to persuade the reader that we’re emerging from an era of laissez-faire that Ronald Reagan and Milton Friedman implemented together, that laissez-faire didn’t work, and that now we need to reregulate.  No, really.  I’m not kidding.  That seems to be what he’s saying.

Now, Peter is a nice guy.  He’s interviewed me a few times and we had a nice hour-long talk at the Hoover Institution earlier this year.  But his article is full of confusions and misstatements and is crying out for an answer.  Here’s mine.  The quotes from Peter’s article are indented and my answers follow.

    Joblessness is growing. Millions of homes are sliding into foreclosure. The financial system continues to choke on the toxic leftovers of the mortgage crisis. The downward spiral of the economy is challenging a notion that has underpinned American economic policy for a quarter-century — the idea that prosperity springs from markets left free of government interference.

The first two sentences are probably correct.  The third might be correct.  The fourth, the most important in the paragraph, is badly wrong.  Markets haven’t been seriously free of regulation since before the Great Depression.  There were some major deregulatory victories—in airlines, railroads, and trucking—but interestingly, these victories preceded the last quarter century—they happened in the late 1970s and 1980, under President Jimmy Carter.  And they led to good results—cheaper air travel and shipping and more accountability for truckers and railroads, to name two.  It’s true that people give lip service to economic freedom.  But the current president nationalized prescription drugs for the elderly, nationalized airport security except in five cities, and dramatically expanded federal intervention in education.  The previous Congress banned Internet gambling and the current Congress has banned certain kinds of light bulbs.  The government is now pushing people into more-expensive sources of energy.  State and local governments have passed laws that prevent owners of bars and restaurants from allowing smoking.  Congress in the 1990s started to dictate that insurance policies cover certain medical procedures. And notably, federal regulations from mortgage subsidies to the Community Reinvestment Act encouraged ill-advised investments. Those are some of the increases in government regulation.  There have been few decreases.

    The modern-day godfather of that credo was Milton Friedman, who attributed the worst economic unraveling in American history to regulators, declaring in a 1976 essay that “the Great Depression was produced by government mismanagement.”

True.  And, by the way, Friedman got this one right as even that superregulator, Ben Bernanke admitted.  At Friedman’s 90th birthday party, Bernanke said, “I would like to say to Milton and Anna [Schwartz]: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

    Five years later, Ronald Reagan entered the White House, elevating Mr. Friedman’s laissez-faire ideals into a veritable set of commandments.

Oh, really?  Within a few months, Reagan had persuaded the Japanese government to forcibly limit the number of cars the Japanese auto companies could sell to the United States. And Reagan left almost all federal regulations in place.

    Taxes were cut, regulations slashed and public industries sold into private hands, all in the name of clearing government from the path to riches.

Reagan did cut taxes in 1981–and then raised them in 1982, 1983, 1984, 1985, 1986, and 1987.

    As the economy expanded and inflation abated, Mr. Friedman played the role of chief evangelist in the mission to let loose the animal instincts of the market.

This certainly is a “fresh” look at Milton Friedman.  It’s also wrong.  I don’t think Friedman ever thought that in advocating that humans be freer, he was advocating letting loose “animal instincts.”  Animals act far more like governments—that is, they use force against their competitors—than like peaceful market participants.

    But with market forces now seemingly gone feral, disenchantment with regulation has given way to demands for fresh oversight, placing Mr. Friedman’s intellectual legacy under fresh scrutiny.

Unfortunately, Goodman doesn’t say how market forces have gone feral.  Government remains feral and government seems poised to use more force against more victims, but how markets do that is beyond me.  As for Friedman’s intellectual legacy, or anyone else’s, fresh scrutiny is always good.  You won’t find any of it in Goodman’s article, though.

    Just as the Depression remade government’s role in economic life, bringing jobs programs and an expanded welfare system, the current downturn has altered the balance.

But wait a minute.  The Depression did alter the balance, increasing government power at the expense of people’s freedom dramatically.  Very few Depression-era programs were ended.  We’re still stuck with the SEC, agricultural subsidies, welfare, and Social Security.  Moreover, every president after Franklin Roosevelt increased government power, often, as with LBJ (Great Society), Nixon (price controls, OSHA, and EPA), and Bush Jr. (No Child Left Behind, nationalization of two industries), substantially.  So how can the current downturn alter the balance?  We’ve been moving away from economic freedom for 80 years.  (Herbert Hoover began what really should be called a mini-New Deal.)  How can more government programs alter the balance?

    As Wall Street, Main Street and Pennsylvania Avenue seethe with recriminations, a bipartisan chorus has decided that unfettered markets are in need of fettering. Bailouts, stimulus spending and regulations dominate the conversation.

It would be more accurate to say, “a bipartisan chorus has decided that fettered markets need to be fettered more.”  But that doesn’t have the same ring, does it?

    In short, the nation steeped in the thinking of a man who blamed government for the Depression now beseeches government to lift it to safety.

So if the nation is “steeped in the thinking of a man who blamed government for the Depression,” wouldn’t you expect most people to have, until recently, “blamed government for the Depression”?  Is that really what Goodman perceives?  It’s not what my students think when they start out in my class.  Nor is it what their parents think.  Where is Goodman getting his information?

    If Mr. Friedman, who died in 2006, were still among us, he would surely be unhappy with this turn.

Amen, brother.  Goodman finally got one right.

    “What Milton Friedman said was that government should not interfere,” said Allen Sinai, chief global economist for Decision Economics Inc., a consulting group. “It didn’t work. We now are looking at one of the greatest real estate busts of all time. The free market is not geared to take care of the casualties, because there’s no profit motive. There’s no market incentive to deal with the unemployed or those who have lost their homes.”

Where do I begin?  Sinai’s first statement is true.  But his second statement?  How could he say that not having government interfere didn’t work when through the whole era being discussed, government interfered?  Even if you were a dyed-in-the-wool advocate of government interference, you couldn’t make Sinai’s statement because throughout that era we had massive government interference.  And what are we to make of Sinai’s statement that the “free market is not geared to take care of casualties”?  Has he heard of insurance?  It’s a free-market way of taking care of casualties.  And there’s no profit motive?  Huh?  People don’t want to make profits?  And there certainly is a “market incentive to deal with the unemployed or those who have lost their homes.”  Employers deal with the unemployed through markets all the time—by hiring them.  And people who have lost their homes still want a place to live and so property owners want to deal with them by renting to them.

    To Mr. Friedman, such sentiments, when turned into policy, deprived the economy of the vibrancy of market forces.

Somewhat true, but overstated.  One of Milton’s favorite lines was one from Adam Smith: “There is much ruin in a nation.”  He once explained to me that that meant that a whole lot of things can go wrong, and government can mess things up in many ways, but the desire to better ourselves can still make markets work.

    Born in Brooklyn in 1912 to immigrant parents who worked briefly in sweatshops, Mr. Friedman retained a sense that America was a land of opportunity with ample rewards for the hard-working.

True. 

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    His intellectual bent was forged as a graduate student at the University of Chicago, a base for those who saw themselves as guardians of classical economics in a world then under the spell of woolly-headed revisionists.

Not exactly.  The marginal revolution of 1870 had upset the classical school.  The Chicago School economists of the 1930s believed in the marginal revolution.  And many of them advocated, at the same time, a great deal of government intervention.  Read Henry Simons’s work of that era and see if you would ever dream of calling him an advocate of laissez-faire.

    The chief object of their scorn was John Maynard Keynes, and his message that government had to juice the economy with spending during times of duress.

Not even close.  Milton Friedman was a Keynesian at least into his late thirties.  The shift in his thinking was gradual, so much so that he could never identify—we talked about this—when he became a non-Keynesian.   

    That notion dominated policy in the years after the Depression. Mr. Friedman would spend much of his career assailing it: He argued that government should simply manage the supply of money — to keep it growing with the economy — then step aside and let the market do its magic.

True.  But I don’t recall Friedman ever using the word “magic.”  The way markets work is a completely understandable result of private property and freedom.

    So firm was his regard for market forces, so deep his disdain for government, that Mr. Friedman once said: “If you put the federal government in charge of the Sahara Desert, in five years there would be a shortage of sand.”

I didn’t know that was his line, but it’s a good one.

    This antagonism toward bureaucracy seemed to spring from Mr. Friedman’s conception of his country as a bastion of rugged individualism. During an interview on PBS in 2000, he noted that Adam Smith, the father of classical economics, published his canonical work, “The Wealth of Nations,” in 1776, “the same year as the American Revolution.”

Basically correct.  But his antagonism toward bureaucracy also sprang from his empiricism.  He saw how badly bureaucracy worked and how well economic freedom works.

    He spoke in the interview of his concern at the end of World War II that socialism was gaining adherents because countries had been forced to organize collectively to produce armaments.

    “You came out of the war with the widespread belief that the war had demonstrated that central planning would work,” Mr. Friedman said. “The left, in particular, … interpreted Russia as a successful experiment in central planning.”

True.

    Mr. Friedman’s brand of libertarianism rested on the assumption that economic and political freedom were one and the same. It meshed with and fed the cold war thinking of his time, as the United States offered up capitalism as liberty itself in contrast to the authoritarian Soviet Union.

The first sentence is absolutely false.  Friedman argued, in one of the classic passages in Capitalism and Freedom, that a great deal of economic freedom is required if we are to have political freedom.  He always distinguished clearly between them.

    Among professional economists, Mr. Friedman’s analytical mastery was near-universally admired.

True.

    His first breakthrough came in the 1950s with his idea that people’s savings and spending were not a function of psychological factors, but based on rational estimations of wealth.

That’s actually a nice statement of Friedman’s “permanent income theory of the consumption function.”

    His greatest contribution came the following decade, when Mr. Friedman dismantled the consensus view that inflation was a tolerable byproduct of high employment. 

No.  Friedman’s biggest contribution was his book, co-authored with Anna Schwartz, A Monetary History of the United States, 1867-1960, their analytical contribution to, among other things, the view that Federal Reserve monetary policy was the major contributor to the Great Depression.  It was this work that led, four decades later, to Bernanke’s aforementioned apology.   

    He demonstrated that high inflation would eventually cost jobs, as businesses were discouraged to invest by the higher wages they had to pay.

Not even close.  Probably what Goodman is referring to is Friedman’s insight, in his 1967 Presidential address to the American Economics Association, that there is no long-run tradeoff between inflation and unemployment.  Friedman made an argument that Friedrich Hayek had made years earlier.  Friedman argued that an unanticipated spurt in inflation could reduce unemployment because unemployed workers would be “fooled” into accepting jobs at high nominal wages that were really low real wages.  Once workers figured this out, Friedman argued, unemployment would creep up to the “natural rate.”

    “This triumph, more than anything else, confirmed Milton Friedman’s status as a great economist’s economist, whatever one may think of his other roles,” Paul Krugman, an economist (and a New York Times columnist) wrote last year in The New York Review of Books.

Overstated.  Friedman made steady headway all through the 1960s.   

    Mr. Friedman captured the era with a new formulation known as monetarism: that the government should gradually and predictably inject cash into the financial system, and then let the market figure out where it should go.

That’s one of the worst statements of monetarism I’ve seen.  Monetarism is the theory that monetary policy matters more than fiscal policy in its ability to affect nominal GDP, and that changes in the velocity of money are slow and predictable.  Actually, for the best succinct statement of monetarism, see Ben McCallum’s article, “Monetarism,” in David R. Henderson, ed., The Concise Encyclopedia of Economics, Liberty Fund, 2008.

    “Any honest Democrat will admit that we are now all Friedmanites,” Lawrence H. Summers, the Harvard economist and former Clinton administration Treasury secretary, wrote in an appreciation published in this newspaper when Mr. Friedman died. “He has had more influence on economic policy as it is practiced around the world today than any other modern figure.”

Actually, I think Larry overstated the case.  I think you could be honest and not be a Friedmanite.

 

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  But the reviews for Mr. Friedman’s work grow mixed when the subject moves to his role as chief proselytizer in the drive to reduce the role of government in public life.

Too vague to evaluate.  Whose reviews?  He doesn’t say.  The reviews of Friedman’s work as proselytizer have always been mixed.

    He laid out a blueprint in his 1962 book, “Capitalism and Freedom,” calling for the end of the military draft, the abolition of the licensing of doctors and the creation of “education vouchers” that parents could use to send children to private schools, injecting competition into public education.

True.

    Two years later, Mr. Friedman put those principles to work as an economic adviser to the presidential campaign of Senator Barry Goldwater, a Republican from Arizona. The campaign called for the abolition of government oversight of the energy, telephone and airline industries and the dismantling of the Social Security system and national parks.

That would have been nice, but I’m virtually positive that it’s untrue.  Goldwater said nothing about the energy, telephone, or airline industries: at least in all the books I’ve read about his campaign, I don’t recall a thing ever said about those issues.  He also did not call for dismantling national parks, whatever that means.  As for Social Security, Goldwater did say a few times that it should be voluntary but that thought did not rise to the level of campaign promise.   

    Mr. Goldwater took a drubbing at the hands of Lyndon Johnson. Mr. Friedman would remain in the policy wilderness until the rise of President Reagan. Then, his notions about rolling back government took on the force of dogma.

The first sentence is true.  The second is wildly inaccurate.  Friedman was active in the push to eliminate the draft, serving as a key member of the President’s Commission on the All-Volunteer Force in 1969, which agreed 14-0 with one abstention, to recommend ending the draft.  Call me crazy, but I think that removing the government’s gun from the heads of two million men every year is a little bit of an accomplishment.  Friedman was also active in various state tax limitation campaigns, which he always had more confidence in than any presidential candidate.  The statement about dogma is typically overdone; more’s the pity.

    This was so not only in the United States, but also throughout much of the world. As former Iron Curtain countries embraced free markets, they did so with Mr. Friedman’s books in hand. The International Monetary Fund and the World Bank leaned heavily on his ideas in prescribing policies for countries from Asia to Latin America.

The first sentence is correct.  The third is not.  They talked a good game but the IMF and World Bank still handed out taxpayers’ money to ruthless governments.   

    “Among the cognoscenti, he became the figure that represented the war against the overwhelming welfare state,” said Hernando de Soto, a prominent Peruvian economist. “The idea that people are responsible for progress far more than government. One should reserve most of the action for the private sector. From Brazil to Mexico, that idea is still in place.”

Even Mr. De Soto overstates.  That idea is in place in Mexico?  Where does it show up in Mexico’s policies?

    But Mr. De Soto faulted Mr. Friedman for failing to temper his admonitions with an understanding of poverty and income inequality.

    “The problem with Milton Friedman and his fellow libertarians is they never took into consideration the importance of class,” Mr. De Soto said. “They ignored the way elites were able to distort the policies they prescribed for their own benefit.”

Well, I guess De Soto said it, but that doesn’t represent Friedman’s views.  Friedman has always been outspoken about well-heeled businesses seeking tariffs, import quotas, and regulation of their competitors.  Maybe De Soto has as much of a tin ear as Peter Goodman.

    In much of Latin America, economic growth never reached the poor, laying ground for the socialist backlash now led by Venezuela’s president, Hugo Chávez.

True.  But this is hardly a comment on Friedman’s beliefs in markets. Venezuela has had a combination of socialism and fascism for decades.

    In the United States, the reconsideration of the Friedman doctrine came via the global financial crisis that has resulted from the collapse of American real estate. Many economists blame regulators for ignoring warning signs that banks and investors were growing reckless. One Friedman acolyte has taken the brunt of such criticisms — Alan Greenspan, the former chairman of the Federal Reserve.

If many economists blame regulators, couldn’t this reporter name three?  And what is their case?  And does he even consider the tremendous moral hazard that results precisely because of regulation via deposit insurance and implicit government guarantees?  Nope.

    But as America reaches for regulation to tame the markets, the keepers of the Friedman flame remain resolute that government is no solution.

True.  We do.

    “Friedman taught some fundamental long-run truths and he was adept and skilled and almost brilliant at getting them into the public domain,” said Allan H. Meltzer, an economist at Carnegie Mellon. “Now we’ve come into a crisis that has dampened enthusiasm for those policies, and we’re headed back into a period of more regulations that will do the same bad things as in the past.”

Almost?  Well, here my objection is to Allan Meltzer, not Goodman.  Everything else Meltzer said, though, is spot on.   

posted by  David Boaz on 04.21.08 @ 8:45 am

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Rothbard>Friedman