Noah Smith on Milton Friedman
In commenting on Milton Friedman’s contributions to economics, it was once remarked that “attempting to portray the work of Milton Friedman . . . is like trying to catch the Niagara Falls in a pint pot.” In yesterday’s Bloomberg View, however, Noah Smith argues that it is time economists give up on Milton Friedman’s biggest idea – the Permanent Income Hypothesis (PIH).
It seems to me that Smith has chosen to take one of the many contributions of Milton Friedman – far from his biggest or most important idea, I would argue – and give some examples of why it may not hold in particular cases. Smith then uses this to suggest that Friedman’s contributions are passé and economists and the general public should not invest further in learning or caring about these insights.
If this were true, what would the public be missing? Here are just a few:
1. Friedman’s theory concerning the positive relationship between economic freedom and political freedom. Friedman long argued that political freedoms are inextricably related to economic freedom. In today’s political climate, I would argue the public discussion desperately requires a renewed understanding of this relationship and what it means for questions of immigration, civil liberty, healthcare, security, war on terror, etc. Political campaigns in the UK and the US capitalise on the ability to decouple questions of political freedoms from their related economic freedoms.
3. Friedman and Schwartz showed that the Federal Reserve’s monetary policies were largely to blame for the severity of the Great Depression. An important contribution with which even Ben Bernanke agrees. More generally, Friedman brought renewed understanding to the dangers of inflation and central banks as a source of macro -instability.
4. Friedman argued for ending the war on drugs. A policy long overdue.
5. Friedman argued for how markets work to weed out discrimination and provide opportunities for discriminated groups to overcome bias. These ideas are under-explored when it comes to understanding processes of social change. When minority groups face political discrimination, markets and civil society can provide in-routes to positive change. For an illustration, consider the case of the Green Book.
4. Occupational licencing – for contemporary relevance see the recent CEA report; the costs of government-supplied public schooling; negative-income tax (or its political manifestation, the Earned Income Tax Credit).
Finally, to go back to Noah Smith’s examples of how the PIH doesn’t hold, it is curious that each of his examples involves relatively small windfall gains, not investment decisions. Smith looks at evidence relating to things like a bonus at work, or a tax refund, or a government stimulus check. It seems to me that the PIH is a useful way to understand personal investments decisions over one’s lifetime. For example, why young people who expect (even if inaccurately in many cases) to have high earnings after college incur student loans instead of directly entering the workforce. Or why people take out 30 year mortgages to buy homes. It doesn’t seem surprising that in some instances people’s behavior does’t conform to the exact predictions of consumption smoothing at any given point in time (for possibly many reasons – individual time preference, cognitive biases, etc). But that also doesn’t mean it isn’t a useful way to understand a general life cycle pattern of lower consumption/higher borrowing when young ; high consumption/higher savings or debt repayment when older; and lower consumption/dis-savings during retirement.
You don’t have to believe that markets are always efficient to see that many people think Friedman’s arguments are worth taking seriously. Just look at his citations.