On Milton Friedman's Ideas--BECKER

Milton Friedman died this past week. He was the most influential economist of the 20th century when one combines his contributions to both economic science and to public policy. I knew him for many decades starting first when I was a graduate student at Chicago, and then as a colleague, mentor, and very close friend. I will not dwell here on what a remarkable colleague he was. However, I do want to describe my first exposure to him as a teacher since he enormously changed my approach to economics, and to life itself. After my first class with him a half-century ago, I recognized that I was fortunate to have an extraordinary economist as a teacher. During that class he asked a question, and I shot up my hand and was called on to provide an answer. I still remember what he said, "That is no answer, for you are only restating the question in other words." I sat down humiliated, but I knew he was right. I decided on my way home after a very stimulating class that despite all the economics I had studied at Princeton, and the two economics articles I was in the process of publishing, I had to relearn economics from the ground up. I sat at Friedman's feet for the next six years-- three as an Assistant Professor at Chicago-- learning economics from a fresh perspective. It was the most exciting intellectual period of my life. Further reflections on Friedman as a teacher can be found in my essay on him in the collection edited by Edward Shils, Remembering the University of Chicago: Teachers, Scientists, and Scholars, 1991, University of Chicago Press. In considering his many contributions to economics I will pass over his major innovations in scientific economics. These include his emphasis on permanent income in explaining aggregate consumption and savings, his study of the monetary history of the United States, his explanation of the stagflation of the 1970's, his analysis of the value of a stable and predictable monetary framework to help stabilize the economy, his early contributions to the theory and measurement of human capital, his discussion of choice under uncertainty, and his famous essay on methodology in economics. I will discuss instead several ideas in his remarkable book, Capitalism and Freedom, published in 1962, that contains almost all his well-known proposals on how to improve public policy in different fields. These proposals on based on just two fundamental principles. The first is that in the vast majority of situations, individuals know their own interests and what is good for them much better than government officials and intellectuals do. The second is that competition among providers of goods and services, including among producers of ideas and seekers of political office, is the most effective way to serve the interests of individuals and families, especially of the poorer members of society. The famous education voucher system found in this book, and based on an article published in the 1950's, embodies both principles: that parents generally know the interests of their children better than teachers unions and school boards do, and that competition among schools is the best way to serve the educational interests of children. He added the further insight that one can and should separate government financing of education from government running of schools. The voucher system retains government financing, but forces public schools to compete for funds against private for-profit and non-profit schools. The voucher proposal has I believe won the intellectual battle over the value of competition among schools at the k-12 school level as well as at the college level, but so far vouchers have won only limited political victories in terms of actual implementation. This is mainly due to the dedicated opposition of public school teachers unions who fear competition from private schools. Both individual choice and competition are the foundation of Friedman's 1962 radical proposal to privatize the social security system. He argued, correctly in my judgment, that the vast majority of families could be trusted to provide for their retirement if given appropriate incentives, and that they should be allowed to invest in retirement funds provided by competitive investment companies. The government-run social security systems then in effect in the United States and all other countries with retirement systems taxed earnings in ways that discouraged effort and encouraged underground activities. These tax receipts were then paid out to retirees according to politically determined criteria. Chile started the first private system of personal accounts modeled along the lines laid out in Capitalism and Freedom, and Chile has since been followed to some degree by many other countries, such as Mexico, Singapore, and Great Britain. The United States has its tax-free IRA's and Sep savings accounts, but this country has not yet implemented privatization of its basic social security system, even though an enormous financial deficit on this system will occur in about 15 years unless the system is significantly reformed. Friedman also proposed a flat income tax rate in Capitalism and Freedom, and showed that a rate of about 20% in the United States could raise the same revenue and in a much simpler and far less costly way than the quite progressive income tax system in effect in the early 1960's. Further theoretical analysis of what is called optimal tax rates has generally concluded that a rather flat tax would be best at combining efficiency with redistribution of income to poorer families. The appeal to Friedman of the flat tax was based again on his confidence that individuals react to incentives, and that they take steps to further their interests. In this case, he argued that highly progressive taxes induce taxpayers to find and exploit tax loopholes, so that legally, and at times illegally, taxpayers cut their tax payments by hiding income or converting income into other forms. A flat income tax was early introduced by Hong Kong, and has in recent years been followed by many countries, including Russia and eight other Eastern European countries. The United States significantly flattened its income tax structure since the time Friedman wrote this book, especially as a result of the tax reform act of 1986. Unfortunately, a more progressive structure has crept back since that reform. The voluntary army was not discussed in Capitalism and Freedom, but Friedman did propose to replace the military draft in several articles published about the same time as the book was published. He argued that a voluntary army would attract at reasonable cost a dedicated military force of men and women who volunteered due to a combination of patriotism and economic opportunities. A voluntary system is especially effective in situations where full-scale mobilization of available manpower is not required. His advocacy of the voluntary army induced President Nixon to put Friedman on a committee to consider whether the United States should replace its military draft by a fully voluntary armed force. Many persons on the committee initially opposed this idea, especially General William Westmoreland, head of military operations in Vietnam. Friedman's persuasiveness eventually won over the vast majority of the members to this position, and in 1973 the United States changed to a voluntary armed force. Seeing how well this system has operated, very few military leaders now want to return to a draft. Friedman proposed in Capitalism and Freedom, and earlier in an article in the 1950's, to abolish the Bretton Woods System of fixed exchange rates, and move to fully flexible exchange rates. Under a flexible exchange system, rates are determined by the competitive supply and demand for different currencies by individuals and businesses. The prevailing view had been that such a system of flexible exchange rates would be unstable, so he argued at length why flexible exchange rates would be not constant but stable--unstable rates implied, he argued, that speculators on the average would lose money, which he did not believe was likely. This view of the behavior of speculators was challenged, but I believe Friedman was basically right. In any case, the issue was decisively settled after Nixon took the United States off the gold standard in 1972, and replaced it with a system of flexible rates in 1973. The Chicago Mercantile Exchange led by Leo Melamed then saw the opportunity to set up futures markets in currencies, which it did with Friedman's help. These markets were enormously successful, and put to rest forever the belief that one could not have an effective system of flexible exchange rates. They provide an opportunity for businesses to hedge their currency risks by trading on currency futures. The first chapter of Capitalism and Freedom considers the link between economic and political freedom. He argues there that economic freedom promotes political freedom, and that political freedom is not likely to persist without economic freedom. "The kind of economic organization that provides economic freedom directly, namely, competitive capitalism, also promotes political freedom because it separates economic power from political power and in this way enables the one to offset the other." Findings since then suggest that while economic freedom can begin under totalitarian regimes, such as under General Pinochet in Chile and General Chiang Kai-Shek in Taiwan, economic freedom produces economic growth and other changes that usually eventually lead to much greater democracy, as in Taiwan, South Korea, and Chile. The important implication is that China would become more democratic if it continues on its path of greater economic freedom and greater growth. On whether one can have democracy without economic freedom, Friedman said, "I know of no example in time or place of a society that has been marked by a large measure of political freedom, and that has not also used something comparable to a free market to organize the bulk of economic activity." Sweden and other Scandinavian countries have been vibrant democracies, and yet governments in these countries tax away more than half the income. However, the majority of these taxes are transferred back to individuals in the form of retirement incomes, medical care, and in other ways. Although these countries mainly rely on private enterprise, not government enterprises, to organize their economies, is that "enough" freedom to qualify as economically free? That depends on the definition of economic freedom, yet I believe Friedman is right that thoroughgoing restrictions on economic freedom would turn out to be inconsistent with democracy. To conclude on a more personal level, I was most impressed by Milton Friedman's sterling character--he would never soften his views to curry favor--his perennial optimism, his loyalty to those he liked, his love of a good argument without any personal attacks on his opponents, and his courage in the face of prolonged and virulent attacks on him by others. I cannot count the number of times I participated with him in seminars, nor how many visits my wife and I shared with Milton and Rose, his wife of almost 70 years. Rose, a fine economist, would not hesitate to differ with her husband when she believed his arguments were wrong or too loose. When I spoke on the phone with him last Monday, he sounded strong and a bit optimistic about his health, even though he had just returned from a one-week hospital stay with a severe illness, an illness that a few days later took his life. Although his ideas live on stronger than ever, it is hard to believe that he is not here. I can no longer seek his opinions on my papers, but I will continue to ask myself about any ideas I have: would my teacher and dear friend Milton Friedman believe they are any good?

Comments

[Josh]

Prof. Becker:

What was Prof. Friedman's response to the Sweden counter-example cited by Judge Posner (democracy lashed to a command economy) and to the Singapore counter-example (authoritarian rule lashed to a free economy)?

Would you please expand on your own view of how Sweden and Singapore fit into theories about the link between personal and political liberty? Is it simply the case that both countries are lucky enough to be too wealthy for latent tensions to arise? Or is there an unfashionable cultural explanation?

Judge Posner accuses Prof. Friedman of dogmatism. Is the response that Prof. Friedman's policy prescriptions were informed both by economics and a passionate belief in personal freedom. Couldn't Judge Posner sometimes be accused of dogmatic pragmatism?

Best regards,

Josh

[Greg Ransom]

When and how did Milton Friedman come to be a (classical) liberal? Was the big influence Frank Knight or was perhaps it Rose herself?

And Friedman's views seemed to change in the wake of his exposure to the ideas of Friedrich Hayek (which Friedman taught in his graduate seminars and which play a central role in the first chapter of _Free to Choose_.)

[ben]

Thanks for this post, I very much enjoyed your tribute.

[Robert A. Book]

Prof. Becker,

I hope you consider it a compliment that sitting in your class and attempting to answer your questions had the same effect on me -- in terms of convincing me I had to (re)learn economics from the ground up -- that sitting in Prof. Friedman's class had on you. I suppose it didn't hurt that at times in class I would imagine that a few years (decades) before, you'd been in the same room taking the same class from him.

Now, I am teaching economics to senior military officers, diplomats, and others at the Industrial College of the Armed Forces. They all favor the all-volunteer military, and to a great extent they understand the benefits of free markets. All we have to do is explain the virtues of free trade. And they know the contributions of you and Milton Friedman and Friedrich Hayek.

Thanks for everything,

Robert Book
Industrial College of the Armed Forces
National Defense University

[Larry Horse]

Professor Becker,

A very thorough tribute. However, I am also very interested in learning about Milton Friedman's contributions to scientific economics. Is there a book or article that I should read in order to get this information (short of a jstor search on his articles)? Thank you.

[softair]

Mr.friedman is great, who has changed and will still change the world even after him.

[Drieu]

Pr. Becker,

I wouldn't say that General Pinochet and General Chiang Kai-Shek's regime were "totalitarian"; the URSS or Hitler's Germany were totalitarian, Pinochet's Chile and Chiang Kai-Shek's were authoritarian. There can be no "economic freedom" in a totalitarian regime, by definition.

Thank you for this great tribute to the great Milton Friedman.

Drieu Godefridi

[Katherine]

Thank you for this tribute to Milton Friedman; his ideas had a strong influence on my decision to major in economics and mathematics. I am sad that I will never have the opportunity to meet this great man, so I shall have to content myself with continued study of his brilliant contributions to economic thought.

[Larry]

Professor Becker,

Friedman came to oppose Chilean-style forced saving. In a New York Times op-ed ("Social Security Chimeras", 11 January 1999), he wrote, in response to Martin Feldstein's argument that contributions must be mandatory, "the fraction of a person's income that it is reasonable for him or her to set aside for retirement depends on that person's circumstances and values. It makes no more sense to specify a minimum fraction for all people than to mandate a minimum fraction of income that must be spent on housing or transportation. Our general presumption is that individuals can best judge for themselves how to use their resources. Mr. Feldstein simply asserts that in this particular case the Government knows better."

[N.E.Hatfield]

IF anyone deserves a bust or plaque in the Economic Pantheon, it's probably Milton Friedman. Although, I never knew the man personally, I have a passing acquaitance with some of his ideas. Being somewhat trained in the "Classical" and "Neoclassical" school of economics, Friedman's monetarist views always forced a review and rethinking of some basic fundamental assumptions of classical economics which were necessary. Even though I still disagree on some of them. Perhaps his repositioning in later life was a respnse to get monetarists to rethink some of their basic assumptions as the Monetarist school became more doctrinaire. Anyway, the debate still rages on.

[Lisa]

Prof. Becker,

Thank you for your tribute.
Personally I'm interested in Friedman's proposal of the voucher system. Currently many cities in China are starting to adopt this idea from a new perspective, that is, to provide subsidy in terms of education. Yet they are probably not successful enough, since it's apparent that parents tend to use the money saved from the benefit of the voucher received for something else rather than further education of the kids. The case in China is different from Friedman's experiment in California though, for several questions. And we are doing research on that now, to check whether or not it's a helpful system for China. After all, I'd like to express my admiration for Friedman's original proposal and sorrow at this sad news.

[Larry]

In your conclusion you say it is hard to believe he is not here. You are mistaken about that, because he is here. His ideas will always be with us and with our descendants. They will only bury that small part of Milton Friedman which could ever die.

[jay]

Thank you Dr.Gary Becker
Really a great tribute and eulogy.

[Vijay]

He was my hero and I was heart-broken to learn of his death. Thankyou for the post on his contributions to economics

[B. Meighan]

I disagree that Friedman was the most influential economist
of the past century. J.M. Keynes rescued and saved capitalism and the state during the Great Depression and enabled the post-W.W II era to be one of the greatest perioda of economic growth among democracies.

[woodstock]

I greatly respected Friedman as not only an economist, but also a philosopher. He helped to keep the important philosophies of Peirce and Popper alive and well in the current intellectual debate...namely, the philosphies of empiricism and pragmatism.

Peirce in particular was probably the greatest American thinker of all time, but is largely unrecognized. I wouldn't be surprised if Friedman had read a few of his essays, because Friedman's quote about the importance of a theory's predictive value appears to be a direct rephrasing of some of Peirce's ideas.

If anybody is curious, check out http://woodstock.typepad.com

[G.V.Varma]

Dear Prof.Becker,
Your teacher Prof.Milton Friedman's areas were mainly macro and money.Then as a student what tempted you to migrate to micro?
G.V.Varma,Kerala State,India.

[Kenneth R. Gregg]

“Capitalism and Freedom” came out at a time when his voice was the prototypical cry in the wilderness. One could not find such advocates of freedom easily. It was like traveling from one state to another: This state had one, that one had none, another perhaps one.

He will always be remembered.

Just a thought.
Just Ken

[Scott Wood]

Much as I love Milton Friedman, surely Keynes, by providing intellectual cover for naked vote-buying, was by far the most "influential" economist of the 20th Century.

[ttt]

Many have raised the question of whether Friedman was the most influential economist of the twentieth century. Along those lines, I wonder if he might've been more influential if he'd not stuck to policy prescriptions developed ab initio.

One example is vouchers. One of the strongest arguments against vouchers has been that they starve the public schools system of funds, in particular by providing money to people who'd been sending children to private schools (i.e. those essentially contributing money to public schools and getting nothing back). The obvious answer, and one that Friedman resorted to in several other places in the book, would be to increase the amount of the vouchers to compensate (indeed above the level of the initial cost of public schooling, to cover overhead). Then, years down the road, when competition presumably has evened everything out, cut physical plant, etc., vouchers could eventually be reduced. But this requires increasing taxes, which is immediately a no-go politically.

Several places in the book, he ridiculed the idea of advocating an illogical policy in order to take advantage of its beneficial side effects in an area which is politically untouchable. But like it or not, that's sometimes how the political system works. In that way, perhaps it's easier for, say China, or an Eastern European country just emerging out of Communism, to try vouchers, than for the US.

[Anonymous]

a good teacher can always have important influence on his students.

[Anonymous]

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[Anonymous]

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[Anonymous]

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[Anonymous]

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