Milton Friedman--Posner's Comment

I knew Milton Friedman, but not well; and I am not competent to express an informed opinion on his major academic work, which was in macroeconomics. The economists of his generation with whom I principally associated were George Stigler, Ronald Coase, and Aaron Director (Friedman's brother-in-law)--microeconomists who had a major impact on the law and economics movement. I did, however, read a few of Friedman's essays. Two in particular struck me around the time I came to Chicago. One was his essay on the methodology of positive economics, in which he argued that the way to test a theory was not by assessing the realism of its assumptions, but by assessing the accuracy of its predictions. Economics makes heavy use of unrealistic assumptions, primarily concerning rationality, and yet the predictions generated by models based on those assumptions are often accurate. Where they are inaccurate, this is a spur to reexamining the assumptions and perhaps modifying them, as is occurring in such fields as finance, where assuming a more complex human psychology than finance theorists traditionally assumed has helped to explain anomalies (from a rational-choice perspective) in the behavior of financial markets. The emphasis on predictions connects Friedman's essay to Karl Popper's philosophy of science, in which the scientific method is viewed as a matter of making bold hypotheses, confronting them with data, and ascribing tentative (always tentative) validity to the hypotheses that survive the confrontation. Popper's methodology of fallibilism has strong affinities with Friedman's methodology. Both are strongly empiricist. Stigler in conversation merged these two closely related approaches, and I was very struck by the melded approach. The other essay of Friedman's that struck me was an essay on taxation in which he argued, contrary to the conventional view at the time (though I gather the argument was not original with him), that there was no theoretical reason for supposing income taxes superior in point of efficient resource allocation to excise taxes. An excise tax--say, a 10 percent tax on yachts--drives a wedge between cost and price and so deflects buyers to substitutes that may cost more to produce but look cheaper because they are not taxed at so high a rate. (The effect is the same as monopoly pricing.) But Friedman argued that income taxes have the same effect, by driving a wedge between the cost of work and the wage (price) received by the worker, thus deflecting him to untaxed substitutes, such as leisure, or to jobs that generate untaxed benefits, including leisure in the case of teaching (for example), but also prestige, amenities, tax-favored fringe benefits, and job security. This idea of the parity of excise and income taxes has wide-ranging implications for public policy, since the tendency (still) is to neglect the misallocative effects of income taxation--a neglect of which I think even Friedman was sometimes guilty, as I am about to argue. Perhaps his most important general contribution to economic policy was the simple, but when he first propounded it largely ignored or rejected, point that people have a better sense of their interests than third parties, including government officials, do. Friedman argued this point with reference to a host of issues, including the choice between a volunteer and a conscript army. With conscription, government officials determine the most productive use of an individual: should he be a soldier, or a worker in an essential industry, or a student, and if a soldier should he be an infantryman, a medic, etc.? In a volunteer army, in contrast, the determination is made by the individual--he chooses whether to be a soldier or not, and (within limits) if he decides to be a soldier what branch, specialty, etc., to work in. A volunteer army should provide a better matching of person to job than conscription, and in addition should create a more efficient balance between labor and capital inputs into military activity by pricing labor at its civilian opportunity costs. But this is in general rather than in every case. The smaller the armed forces and the less risk of death or serious injury in military service, the more efficient a volunteer army is relative to a conscript one. These conditions are not satisfied in a general war in which a significant fraction of the young adult population is needed for the proper conduct of the war and the risk of death or serious injury is substantial--the situation in World War II. For then the government's heavy demand for military labor, coupled with the high cost of military service to soldiers at significant risk, would drive the market wage rate for such service through the roof. Very heavy taxes would be required to defray the expense of a volunteer army in these circumstances and those taxes would have misallocative effects that might well exceed the misallocative effects of conscription. I mention this example because I find slightly off-putting what I sensed to be a dogmatic streak in Milton Friedman. I think his belief in the superior efficiency of free markets to government as a means of resource allocation, though fruitful and largely correct, was embraced by him as an article of faith and not merely as a hypothesis. I think he considered it almost a personal affront that the Scandinavian nations, particularly Sweden, could achieve and maintain very high levels of economic output despite very high rates of taxation, an enormous public sector, and extensive wealth redistribution resulting in much greater economic equality than in the United States. I don't think his analytic apparatus could explain such an anomaly. I also think that Friedman, again more as a matter of faith than of science, exaggerated the correlation between economic and political freedom. A country can be highly productive though it has an authoritarian political system, as in China, or democratic and impoverished, as was true for the first half century or so of India's democracy and remains true to a considerable extent, since India remains extremely poor though it has a large and thriving middle class--an expanding island in the sea of misery. What is true is that commercial values are in tension with aristocratic and militaristic values that support authoritarian government, and also that as people become economically independent they are less subservient, and so less willing to submit to control by politicians; and also that they become more concerned with the protection of property rights, which authoritarian government threatens. But Friedman seemed to share Friedrich Hayek's extreme and inaccurate view that socialism of the sort that Britain embraced under the old Labour Party was incompatible with democracy, and I don't think that there is a good theoretical or empirical basis for that view. The Road to Serfdom flunks the test of accuracy of prediction! I imagine that without the element of faith that I have been stressing, Friedman might have lacked the moral courage to propound his libertarian views in the chilly intellectual and political climate in which he first advanced them. So it should probably be reckoned on balance a good thing, though not to my personal taste. His advocacy of school vouchers, the volunteer army (in the era in which he advocated it--which we are still in), and the negative income tax demonstrates the fruitfulness of his master micreconomic insight that, in general, people know better than government how to manage their lives. But perhaps not always.

Comments

[Bill Dougan]

Judge Posner's analysis of the economics of the volunteer army is an incomplete application of a general principle of public finance, namely that the full cost of government expenditures includes both the opportunity cost of the resources used and the excess burden of the taxes necessary to fund the purchase of those resources. This principle is as applicable to the salaries of federal judges as it is to the wages of soldiers. Thus, if in wartime the overall level of government spending would be so high as to warrant the forced servitude of soldiers it would also warrant the same policy toward all other public employees be they letter carriers, bureaucrats, or judges.

[David Wright]

Captain Video: You are right that Friedman at one time advocated a fixed-rate-of-growth rule for the money supply. At other times he advocated more complex rules, commodity links, and inflation targeting. The fed has never adopted any of these specific policy suggestions.

What you are missing is the context of the debate. Friedman was arguing with people (including economists and fed policy-makers) who didn't understand the seperate roles of monetary and fiscal policy. Some thought that government deficits or union wage demands might cause inflation, and that monetary policy could be used to reduce unemployment. With people like that in charge of the fed, you'd prefer a non-discretionary policy, too!

Thanks to Friedman, central bankers (from Volker on) know what to do to control inflation, and know not to try to use their lever for other purposes. That is a tremendous step, and afterwar making it, it's relatively unimportant which secific protocol central bankers use to apply that knowledge.

[David Welker]

Posner is right about Friedman. He was a bit religious in his views on the free market. But as Posner notes, maybe it was necessary for him to be like this given his time.

Pragmatism, of course, is superior to any sort of blind faith in markets. The exceptions to the rule matter a lot.

[yifan]

Posner says that Friedman's view that the government is nearly always inferior to market is more akin to faith than hypothesis.

This "faith" is only secondary and is the logical conclusion of several other primary assumptions made about the performance of government relative to market. For example, its own incentives, the lack of resource/information etc.

Therefore I think a believer in market believes that the market is superior to government when those general assumptions about government and market hold true.

There is no denial that market failures exist & compensations can be made. But it does not help to make general statement that market works better or worse than government.

[Aaron Krowne]

The Scandinavian countries cited above never
exceed in size that of many large American cities. Perhaps this has something to do with their relatively happy outcome. The UK is significantly larger, and socialism didn't work too well there. The US is even larger, and it is quite clear the economic and social situation is deteriorating in concert with the expansion of government here.

China is perhaps a bad counter-example as well. Despite the fact that government manipulation of exchange rates has goosed development and the GDP in that country, there were some 50,000 "mass unrest" events record last year.

I think Friedman and Hayek are sufficiently vindicated. The scale and extent of government matters. Freedom matters, and any attempt by government to force-feed economic success will be self-defeating.

[Tino Sanandaji]

”Sweden, could achieve and maintain very high levels of economic output despite very high rates of taxation, an enormous public sector, and extensive wealth redistribution resulting in much greater economic equality than in the United States.”

I respect professor Posner but in this he is compleatly uninformed.

1. Between 1870 and roughly 1970 Sweden had the highest GDP growth rate of any country on all, tied with Japan. In the late 1960s taxes as a share of GDP were slightly LOWER than the US.

Since than Sweden has had slower growth than most other industrialized countries, including the US. Per capita GDP is 30% higher in the US than Sweden, and 62% higher with the best comparison, if comparing Sweden with Americans of Swedish decent (US census).

http://oberon.sourceoecd.org.proxy.uchicago.edu/vl=7052475/cl=19/nw=1/rpsv/fact2006/data/02-01-02-t01.xls

In 1970 the US had a per capita national income that was 10.6% higher than Sweden, compared to 30% higher today. So Sweden did NOT manage to “maintain” it’s high (comparative) level of economic output.

As any knowledgeable economist would tell you economic theory does not predict that growth stops if you have high taxes for a small open nation. Why? Because technology flows over borders. We should expect the long run growth in Sweden to be the same as the US, which changes in LEVEL (this is conditional convergence).

This is exactly what Friedman would predict, higher income for the US, that has lower taxes/government spending. Government spending is 36% of GDP in the US and 54% in Sweden, so we are talking about degree differences, which is why we should expect to see degree differences in output.

2. It is largely, but not completely, a myth to write that “redistribution resulting in much greater economic equality than the US”.

Already before the expansion of the welfare state Sweden had a much much more even distribution of income than other countries, due to it’s homogenous population. Posner is confusing correlation with causality.

Wealth inequality today is essentially what it was in 1950.

http://www.naringslivsforskning.se/BinaryLoader.aspx?OwnerID=5fec1677-0475-4586-8c5b-0931179a61db&OwnerType=2&ModuleID=a8429cd5-a9d9-4e2b-a1d8-4a7cf26cd7a3&PropertyCollectionName=Content&PropertyName=File1&ValueIndex=0

Maybe it would be higher now without the welfare state, but the underlying distribution has always been more equal than the US, not because of the system, but because of population history.

For example the 4-5 million or so Americans of Swedish decent have a poverty rate of 5.2%.

If anyone is “dogmatic” here it is professor Posner, which dogmatically believes and spreads the leftwing myth about Scandinavia as the socialist paradise.

Milton Friedman was not dogmatic, he was once again right.

[CaptainVideo]

"Thanks to Friedman, central bankers (from Volker on) know what to do to control inflation, and know not to try to use their lever for other purposes."

During times that the economy was significantly potential output Alan Greenspan had the good sense to use expansionary monetary policy to help bring the economy back to potential output.

Economic policy making calls for pragmatism, not adherence to dogma.

[CaptainVideo]

"You are right that Friedman at one time advocated a fixed-rate-of-growth rule for the money supply. At other times he advocated more complex rules, commodity links, and inflation targeting."

Friedman obviously developed his monetarist approach gradually, and before he had developed it did not support the constant money growth rule. But monetarism was a central part of his career and did hold to the position that velocity was stable enough so that a policy of a constant rate of money supply growth would stabilize the eoonomy. Not only prevent inflation, but most of the ups and downs of the business cycles. Late in his career, faced with the evidence of a very unstable velocity he obviously had the good sense to back off. His support for inflation targeting was the last nail in the coffin of orthodox monetarism.

[Peter Jesella]

What is the cost of recruiting? How does the recruiter (salesman) convince a individual that volunteering is a good choice for them, without a false illusion of the benefits and conditions?
How clearly are those that volunteer, understand the contract, obligations, they sign up for, and the rights of freedom they give up once they are sworn in? Many have learned that their four year obligation has small print obligations that could extend that to five years, or more.
How do I explain a third way? Such as voluntary service with a different form of current registration of males at 18 for the Selective Service system.
Based on House bill from 1979, more info at my website www.myspace.com/peterview.
This is the policy of universal registration (male and female) at 17, encouraging debate over the future of being a voting age citizen, and at 18 provide the feedback towards volunteering for active military, reserve duty, community service (Americorps, Peace Corps, Teacher Corps etc), non-profit service (with voucher), maybe later up to age 23?, no or HELL NO!
Today with the Internet technology this form of educational wake up call to the role of participatory citizenship could be the framework for a more enhanced form of participatory democracy. A sort of EBAY citizen contribution and commitment market.

One benfit could be a greater number of individuals that have achieved meaningful contributions, that move on to the private sector with this degree of knowledge and confidence. Got to go, feedback would be helpful. Peter Jesella

[Jay]

Re: Political Freedom and Economic Freedom

Deepak Lal: Indian travails
Deepak Lal / New Delhi November 21, 2006

....... , both countries face political problems, which could derail their ongoing economic miracles. For China, as discussed in my last column, the problem is ending China’s continuing financial repression, without loosening the Communist party’s political control of the economy. For India the political problem lies in finding new avenues for “rent-seeking” for the political classes without too much damage to the economy, as liberalisation has closed many old ones..........

http://www.business-standard.com/opinionanalysis/storypage.php?tab=r&autono=265396&subLeft=2&leftnm=4

[Michael Martin]

There is more to be learned about Judge Posner in reading this post than there is about Friedman or Hayek.

[Chairman Mao]

Judge P,

If the economy is booming and civilian wages are high, would an extensive, low-grade war such as the one we are in, necessarily provide the government with the quality of soldiers that it desires by way of a volunteer army?

[Haynes Goddard]

Prof. Becker:

As one whose education in economics was greatly influenced by his writings, in particlar his microtheory notes that many of us were assigned, I nonetheless always had the vague sense when hearing his facilely expressed points in discussion that he was at times making up facts to support his point. And indeed Pierre Rinfret, an advisor to the Nixon administration, has asserted exactly that, to the point of dragging along large tomes to meetings with Friedman to contradict his assertations.

What is your view on this? Did he love a good argument so much that he never wanted to lose, and do you know of any cases where he conceded an argument to his opponent?

Haynes Goddard

[Peter K - Segal School of Business]

This is a great excerpt from Becker:

"I mention this example because I find slightly off-putting what I sensed to be a dogmatic streak in Milton Friedman. I think his belief in the superior efficiency of free markets to government as a means of resource allocation, though fruitful and largely correct, was embraced by him as an article of faith and not merely as a hypothesis. I think he considered it almost a personal affront that the Scandinavian nations, particularly Sweden, could achieve and maintain very high levels of economic output despite very high rates of taxation, an enormous public sector, and extensive wealth redistribution resulting in much greater economic equality than in the United States. I don't think his analytic apparatus could explain such an anomaly."

Its great to see you raise this example. When reading through 'Capitalism and Freedom' I was appalled at the absurdity of his claim that economic freedom necessarily implies political freedom. Much of that book condenses to faith-based opinion, rather than empirically supported analysis with the requisite amount of theoretical counterweight. A million examples for example contradict the political and economic freedom link. Perhaps foremost among them - Pinochet's Chile (an authoritarian regime with enormous latitude for free-market policies). China, rightfully belongs in this camp as well.

Notably though, Becker raises the point that economic freedom creates an increasingly powerful middle class. This middle class might be self-concerned and happy in its own position (and thus unlikely to challenge the established government), but, along a free-trading supporting commercial class, it does tend to promote free trade. The culmination of these policies and power redistributions moderates the level of authoritarianism the central government - making for example, stalinist totalitarianism less conceivable (e.g. Kim Il Jong).

[Peter K - Segal School of Business]

Tino wrote the following:

"”Sweden, could achieve and maintain very high levels of economic output despite very high rates of taxation, an enormous public sector, and extensive wealth redistribution resulting in much greater economic equality than in the United States.”

I respect professor Posner but in this he is compleatly uninformed.

1. Between 1870 and roughly 1970 Sweden had the highest GDP growth rate of any country on all, tied with Japan. In the late 1960s taxes as a share of GDP were slightly LOWER than the US.

Since than Sweden has had slower growth than most other industrialized countries, including the US. Per capita GDP is 30% higher in the US than Sweden, and 62% higher with the best comparison, if comparing Sweden with Americans of Swedish decent (US census)."

Be careful about using GDP alone to compare the economic value produced of two nations, especially ones as economically disparate as the US and Sweden.

A recent Economist article waged into the age-old question of whether Americans, with their high number of hours worked relative to Europeans, shorter vacations, higher incidence of heart attack, etc, should think themselves economically superior to welfare states such Sweden. When factoring for the value of vacation time consumed, decreased personal cost of security and crime-fighting due to greater levels of social support systems, decreased policing and law enforcement costs due to the same reasons etc, etc, it found the two countries more or less on equal ground. Americans earn more money than Europeans and have higher GDP but they have much higher personal costs to enjoy valued goods (leisure time, a sense of social safety, e.g. by blockading themselves in expensive, secure neighborhoods, etc).

One can think of leisure time as 'goods' which have higher marginal value for Europeans than Americans. Hence, they collectively pay for and consume more of these types of goods. That Europeans are able to consume vastly more of these kinds of goods while enjoying very high standards of living must be factored into productivity/GDP analyses. In additional, I suggest total factor productivity measures as opposed to often-misleading measures such as GDP, or labour hours worked (e.g. productivity leads to greater wealth in nations which are more productive and is a good indice of relative national wealth).

European nations such as Sweden invest enormously in high-tech industries, contributing to a high productivity level despite lower levels of labour hours worked (e.g. they have more capital inputs per worker than perhaps American firms do).

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