The Legacy of Milton Friedman
Last month I attended a conference on Milton Friedman, in Austin, Texas. The final session discussed his legacy, and I thought I’d share a few of my remarks.
I argued that Friedman and Schwartz’s Monetary History of the United States was Friedman’s most influential contribution. Recall that the Great Depression had convinced most intellectuals that laissez-faire capitalism had two major drawbacks:
1. It was unfair (something they believed even before the Depression.)
2. Capitalism didn’t even work very well; it was inefficient.
This change in the zeitgeist during the 1930s had caused governments all over the world to become far more statist. Note that there wasn’t anything particularly “left wing” about this policy shift, right wing governments also became far more statist.
Friedman and Schwartz’s book began to change this perception. But not right away. The world wasn’t quite ready for their message in 1963, when the price of gold was still pegged at $35 an ounce. After the dollar was floated in April 1968, inflation and NGDP growth soared. And the rate at which inflation soared seemed to depend on how fast various countries printed money. Those that printed money at a faster pace than the US (such as Italy and Britain) had higher inflation than the US. Those that printed money at a slower rate (such as Germany and Switzerland) had lower inflation that the US. It looked like you could choose any long run inflation rate you wished, merely by adjusting the rate of money growth.
The 1970s saw a gradual acceptance of the view that money growth determines inflation and NGDP growth. And that meant that the Great Depression could have been prevented if the US had printed money at a faster rate. There was a minor dispute about how much could have been done under a gold standard, but that debate had no relevance for the fiat money world of the 1970s. The younger economists coming along at that time would have laughed at anyone suggesting that a fiat money central bank would not be able to create inflation.
Once this was accepted, the Great Depression went from being viewed as a failure of capitalism, to what it actually was, a failure of demand management, i.e. bad monetary policy.
That meant capitalism wasn’t a dysfunctional system after all, just an unfair one.
At this point the left decided the best solution was free markets plus social insurance. By the late 1970s even Ted Kennedy was calling for deregulation, and for tax reforms that cut top income tax rates and simplified the tax code. By the 1980s left wing governments all over the world began deregulating and privatizing. Growth did not speed up in absolute terms (the golden age of growth ended in 1973, for unrelated reasons) but at least those who liberalized rapidly did better than those who moved slowly.
So the Monetary History helped usher in neoliberalism, which was a synthesis of classical liberalism and socialist 1930s liberalism—free markets plus social insurance.
The book also ushered in New Keynesianism. No longer was fiscal policy viewed as the appropriate stabilization tool. Later work by Friedman convinced economists that low rates didn’t mean easy money (until they forget in 2008.) He convinced them that there is only a temporary trade-off between inflation and unemployment. New Keynesianism might just as well be called new monetarism. Brad DeLong did an excellent article on this.
New Keynesianism was a synthesis of the classical quantity theory of money and old Keynesianism. Thus the Monetary History contributed to two major sea changes in economics; neoliberalism and new Keynesianism.
Some argue that Friedman’s free market ideas were utopian, out of touch with political reality. But you can never tell which policies that are viewed as crazy today, will still be viewed that way in the future. Who would have expected gay marriage and legalized pot in a number of states, even 30 years ago?
At the end of Capitalism and Freedom (1962) Friedman lists 14 government policies he didn’t like. I was struck by the fact that substantial progress has been made in many of these policies:
1. AFAIK, the Texas Oil Commission no longer controls oil production.
2. Price controls are not very widespread, and Massachusetts voted to abolish all rent controls a few years back.
3. Legal restrictions on bank interest rates (loans and deposits) have mostly been removed.
4. The Interstate Commerce Commission has been abolished.
5. The FCC still regulates TV and radio, but entry is now far easier (perhaps technology gets credit here.)
6. The sort of public housing projects built in the early 1960s are no longer being built, and the voucher approach has gained ground. Of course things are still far from perfect with housing policy.
7. The military draft has been abolished.
8. Some toll roads have been privatized.
9. Tariffs are not gone, but are much lower than in 1951.
Of course there are lots of other free market policy reforms that are not called for on his 1962 list. Pot smoking wasn’t a big issue in 1962, but when it became one he advocated legalization, which is now well underway. I’d guess he favored legalized gambling, another area where great progress has been made. He later advocated school vouchers, and there has been some progress on that front (much more in countries such as Sweden.)
His record is not perfect, I think he underestimated how much moral hazard was created by FDIC, and hence the risks of banking “deregulation.” I use the scare quotes as banks were not deregulated, rather they were regulated in a way that encouraged more subprime loans, but banks did become freer to engage in risky loans to developers, and that’s caused a lot of bank failures.
Friedman was my favorite economist, and the one who had the greatest impact on my beliefs. He left the University of Chicago just a few months before I arrived. 🙁