Montreal, April 23, 2006 No 176

 

CAPITALISM & COMMERCE

 

Dr. Edward W. Younkins is a Professor of Accountancy and Business Administration at Wheeling Jesuit University in West Virginia.

 
 

MILTON FRIEDMAN'S PRAGMATIC
AND INCREMENTAL LIBERTARIANISM

 

by Edward W. Younkins

 

          Milton Friedman (1912 - ) is a consequentialist libertarian and one of the most influential economists of the 20th century. He has been able to create both academic and popular support for the idea of increasing individual freedom and reducing government controls. Friedman fervently believes in the power of a sort of secular religion of progress to move the world forward. His enthusiasm for the positive consequences for the world resulting from economic progress has been contagious.

 

          Friedman achieved his influence as an economist and as a political commentator by first gaining impeccable credentials in technical economics. Once this highly respected student of the money supply had a firm standing in the academic world, he was thus free to look outward to the world of policy. He has had the courage and force of free will to take controversial positions in the face of widespread professional and public hostility. This leader of the Chicago School of monetary economics gained additional influence through his books and articles, op-ed pieces, lectures, Newsweek columns, testimony before Congress and his ten-part TV series, Free to Choose. As a result of his zeal, many of Friedman's economic ideas and public policy proposals have made the transition to conventional wisdom in a short amount of time.

          Preferring not to be a theoretical system-builder, Friedman engages in rigorous, historical, empirical, quantitative and equilibrating analysis and research to support his ideas and to empirically test his own ideas and those of the Keynesian model. He believes that positive economics can be value-free, scientific, and objective, and can provide a system of generalizations that can be employed to make correct predictions about the outcomes of changes in conditions. Holding that accurate predictions can be made from simplified assumptions, Friedman builds models involving uncomplicated suppositions to attain what he believes to be sound, powerful, predictable and pragmatic conclusions. He maintains that, because the goals of value-free science are exclusively predictions, a theory that enables individuals to make reliable predictions is a good theory. Rejecting the idea held by Austrian economists that the natural and social sciences are separate realms requiring different methods of investigation, Friedman argues that an economic model should be judged only by its predictive power.

          Friedman's highest ethical principle is the absence of coercion among individuals. He therefore advances a moral vision of a society where people are free to choose for themselves. Such a society requires individuals to be free to use their own resources in their own way. Friedman says that the essence of human freedom is the ability of people to make their own decisions as long as they do not prevent others from making their own decisions. He explains that economic freedom is a necessary, but not a sufficient, condition for political freedom. Recently, in addition to economic freedom and political freedom, Friedman has added the notion of social (or civil) freedom the freedom to speak, to assemble, etc. He observes that human freedom is the only mechanism that allows a complex society to be organized from the bottom up. Because people generally know better than anyone else what they should do, they should be permitted to pursue their own interests. Friedman views social groups as contracts into which people have entered in order to further their purposes. The moral values of voluntary exchange and voluntary association provide the least coercive apparatus to organize social life. He says that the major aim of liberalism is to leave the ethical problem for the individual to wrestle with. The really important ethical problems concern what an individual should do with his freedom. Politics only provides the context for the exercise of this freedom.

          According to Friedman, the goal of social policy is to permit as many individuals as possible to pursue their own interests as fully as possible. He says that he wants the smallest, least intrusive government compatible with the optimal freedom for each person to pursue his own projects and follow his own values as long as he does not interfere with any other person's like freedoms. Friedman explains that there is no basis upon which any one of us can judge the preferences of any other. It follows that the government should not attempt to substitute its own judgment for the judgment of free persons. He says that not only do such regulatory and welfare state attempts and measures unduly restrict freedom, they usually fail to accomplish what they were intended to do with disastrous results. Problems are either produced or aggravated by well-intentioned government efforts. Friedman also contends that there is no meaningful content to frequently espoused "ideas" of common good, public interest, or social justice.

          Friedman states that the basic essential functions of government are to: (1) to defend the nation from coercion from the outside and to defend individuals from coercion by others within the country; (2) to enable the free market by establishing rules for exchange and by providing the medium of exchange; and (3) to respond to neighborhood effects. He says that the government should do only what markets cannot do and should enforce the "rules of the game." Specifically, the government should maintain law, order, and policy to prevent coercion; preserve the peace and provide for national defense; adjudicate disputes and enforce contracts voluntarily entered into; define the meaning of property rights and provide the means for modifying them and the other "rules of the game"; provide a monetary framework; foster competitive markets and overcome technical monopolies; and address neighborhood effects which are actions affecting others (e. g., pollution) where it is not feasible to charge or reward them. Friedman explains that where the actions of one person affect another, and where the range and value of the effects can be controlled and determined, those involved should pay the price or receive the benefits or compensation for the actions.

          Friedman is a scholar who was familiar with the Keynesian system and its policy implications and who used Keynes' own language and devices to prove him wrong. Friedman worked within the Keynesian system and used his statistical talents to examine the truthfulness of Keynesianism. He dismantled Keynesianism when he demonstrated that the Keynesian consumption function did not fit the historical data. Friedman's goal was to overthrow Keynesianism and replace it with his monetarist model.
 

Monetary Theory

          Friedman used empirical evidence to attack the consumption functions, the spending multiplier, the importance of monetary policy, the Phillips curve, and more. He demonstrated that the Keynesian idea of household behavior was mistaken and that any advantage attained by government expenditures via the multiplier process was much smaller than had been claimed. Friedman's insight, the permanent income hypothesis, stated that households adjust their expenditures only to recognized changes in their long-term expectations with respect to their permanent income. In other words, he showed that transitory or temporary changes in income have little effect on consumption spending. Friedman also supplied evidence that what happens to the quantity of money is far more important than fiscal policy and that the Phillips Curve hypothesis was wrong in suggesting that there was a stable and enduring functional and inverse relationship between the rate of price inflation and the level of unemployment. He explained that, in the long run, unemployment returns to its normal rate regardless of the rate of inflation. In the short run, there is an inverse relationship between inflation and unemployment but in the long run the relationship disappears. Let's now consider the specifics of Friedman's positions.

          In A Monetary History of the U.S. 1867-1960, co-written by Anna J. Schwartz, Friedman attacked Keynesian monetary theory and validated an updated version of the classical quantity theory of money. He demonstrated that monetary policy could be effective during both expansions and contractions. Friedman deepened people's understanding of the crucial role of money in determining the course of events and provided compelling evidence that federal government deficits do not have a stimulative effect. He recommended eliminating or playing down the role of fiscal policy and did not promote budget deficits to stimulate economic growth. On the other hand, he illustrated how changes in the money supply can cause ripple effects throughout the economy. Friedman's monetarism held that money supply and interest rates can do much more than fiscal policy to control business cycles. He also showed that, if misused, monetary policy could be devastating in its effects.

          According to Friedman, the stock market collapse of 1929 was not the fault of the Federal Reserve but that subsequent mistakes by the government caused the resulting depression to worsen into the Great Depression. He maintained that what converted it into a major depression was bad monetary policy. In the late 1920s, there existed a bubble with respect to levels of stock market prices that were not justified by the real earnings of the companies whose stocks were being valued. In 1929, the bubble burst and equity markets in the United States fell eighty per cent over the next three years.

          Friedman explains that by early 1930 the market had nearly recovered from its collapse the previous October, and that, if the Federal Reserve had followed a correct easy money policy, the bottom of the market would have taken place in 1930 or in 1931 rather than in 1933. He is convinced that the Great Depression resulted from deflation a too-sharp reduction of money in circulation. In addition to blaming the Fed for permitting the Great Contraction of the money supply, he was also critical of it for raising interest rates in 1931 and for failing to bail out commercial banks and letting them fail.

          In fact, it was in 1928 that the Fed began tightening monetary policy to curb speculation because of its concern with the stock market boom. This helped to lead to an economic slowdown and prompted people to realize that the economy was approaching a slump. However, at the time of the market crash in October, 1929 there was no bank panic and the ratio of bank deposits to currency in circulation remained relatively high for months thereafter. Unfortunately, the Federal Reserve proceeded to follow mistaken policies which led to a decline in the quantity of money by 1/3 between 1929 and 1933 resulting in the collapse of the banking system and the destruction of people's savings. Between 1929 and 1933 about 10,000 banks failed contributing to the huge drop in money supply and to widespread bankruptcies. Exploding unemployment, falling prices, and negative economic growth, therefore, characterized those years.

          Friedman explained that the Fed converted an economic contraction into the Great Depression by letting the money supply decline and by failing to provide banks with liquidity during banking crises. If the Fed had done its job the result would have been a normal business slump. The money supply had declined sharply at a time when the Federal Reserve should have been pumping additional funds into the system to bring a stop to the deflation and to save the banks. Prosperity would have returned if the money supply had been expanded during the early 1930s.

          In mid-December 1930, the Bank of the U.S. in New York failed resulting in a run on banks. In anticipation of panic withdrawals of deposits, banks reduced their lending yet further contracting the money supply. In addition, falling agricultural prices and farm bankruptcies helped to lead to bank failures. As a result, people stampeded out of bank deposits and into cash holdings. Government mismanagement had turned a recession into the worst depression of the century. The Federal Reserve could have prevented the decline of the stock of money during and the depression and could have produced a necessary increase in the money supply.

          Friedman explains that business cycles are government-induced and that monetary stability is a prerequisite for economic soundness. He demonstrated that there has been a systematic pattern of the effects of monetary policy on economic activity in the U.S. Monetary policy influences economic activity far more than does fiscal policy. In fact, his work casts strong doubts regarding the effectiveness of fiscal policy in combating recessions or inflation. He observes that the Fed places too much power in the hands of too few people. Friedman warns that an activist monetary policy is a source of instability. He therefore recommends that the monetary framework should operate under the rule of law rather than through the discretionary authority of government administrators. Friedman has said that he would like to abolish the Fed, but has also written on how the Fed should operate, if it exists.

          Friedman proclaims that inflation is always and everywhere a monetary phenomenon and explains that stability in the growth of the money supply is critical for controlling inflation and recessions. The quantity of money is controlled by monetary policy. He therefore wants to sharply curtail the power of the Fed to create or to destroy money. The Fed should devote its attention solely to keeping a relatively stable price level of goods and services. Friedman desires a relatively automatic monetary system that will produce slow and steady monetary growth, bring inflation under control, and lead to sustainable economic growth. The government should be restricted to ensuring a constant rate of monetary growth. Friedman says that the Federal Reserve can be replaced by a computer that would implement his Monetarist Rule which automatically increases the money supply at a steady rate equal to the long-term average annual growth rate the nation most likely between 3-5 per cent per year. The money supply could go up regularly, day by day, week by week, month by month. Friedman desires to curb inflation through carefully calibrated increases in the money supply at a fixed annual rate.

          Friedman points out that the business of the Federal Reserve System is to keep general prices stable. It is not the Fed's business to attempt to control stock market prices. The Fed has never had control of the stock market but it has some control over the economy as a whole through the monetary growth within the economy. According to Friedman, the Fed should not let its monetary policy be determined by the stock market. He adds that central banks do not need to be worried about interest rates. In addition, he supports a 100 percent reserve rule with respect to demand deposits. Finally, he prefers a well-administered fiat money system over a commodity standard like gold which he says is uncertain and costly. He says that gold rushes may occur and that it would be a waste of resources to store gold in vaults and to watch over it. Of course, he did praise the classic international gold standard which was in effect during the early 1900s and said that the Great Depression could have been avoided if the classic gold standard had been in place at that time.
 

Economic Policy

          Friedman has made two especially important and basic contributions to economic policy debates. They are his work on the Quantity Theory of Money and on the Phillips curve. His relentless empiricism in these areas has been of enormous strategic importance in policy arguments with interventionists and collectivists.

          The classical Quantity Theory of Money was based upon Irving Fisher's Equation of Exchange which stated that:
 

MV = PT

where:

M is the amount of money in circulation
V is the velocity of circulation of that money
P is the average price level and
T is the number of transactions taking place

          Classical economists argued that the income velocity of the circulation of money (V) was a constant, that real income was unaffected by changes in the quantity of money (M), and that, therefore, changes in the supply of money (M) would directly affect the price level (P). These classical theorists suggested that V would be relatively stable and that T would always tend toward full employment.

          Keynesians believed and argued that V was not a constant, but instead was highly variable and acted to suppress any change in the money supply from having an impact on either real output or the price level. Friedman responded by further developing and rehabilitating the quantity theory, and found that V could no longer be assumed to be a constant, bur rather was a stable function of several variables. Friedman explained that V responds to monetary expansion in the short run by reinforcing, instead of cushioning, the impact of a monetary expansion on the right hand side of the equation. He concluded that V and T were both independently determined in the long run and that, therefore, a change in the money supply would lead to a change in the price level. If the money supply grew faster than the growth rate of output there would be inflation.

          The Phillips Curve is a graph portraying the relationship between the inflation rate on the vertical axis and the unemployment rate on the horizontal axis. A W.H. Phillips in 1958 had discovered that there was a consistent negative, or inverse, relationship between the rate of inflation and the rate of unemployment in the United Kingdom between 1861 and 1957. The implication is that there is a tradeoff between the inflation rate and the unemployment rate. However, a problem emerged with the Phillips Curve in the 1970s when unemployment and inflation were found to rise together (i.e., stagflation).

          Friedman had been arguing that inflation and unemployment tend in the same direction in the long run. In his view, government could not make a permanent trade-off between inflation rates and unemployment rates. This is because rational and well-informed workers and employers would pay attention only to real wages (i.e., the inflation-adjusted purchasing power of money wages). Friedman explains that only for a short time will people suffer from what economists call "money illusion" where people see that their nominal wages are rising but do not yet perceive that the general price level is rising throughout the economy. For a while, they are willing to supply more labor and the unemployment rate falls. Over time, they come to realize the truth and adjust their expectations and, as a result, real spending and labor supply return to their original levels, leaving only a higher inflation rate as the consequence. The real wage returns to its old level and the unemployment rate is restored to the natural rate. Unfortunately, inflation, brought on by the expansionary policies, will continue at new, higher rates. Friedman thus developed the idea of an "expectations-augmented" Phillips Curve that assumes that people suffer from no "money illusion" and will anticipate and expect higher prices and wages. He thus argued for a series of Phillips Curves one for each level of expected inflation.

          When the government decides that it wants to lower the unemployment rate it will take steps to boost demand through its expansionary fiscal or monetary policies. The increase in demand for goods and services will disappear as people realize that there has not been a real increase in demand. Firms will lay people off and unemployment will move back to where it began. The next time the government attempts to stimulate the economy, people will anticipate the inflation. Friedman notes that the imagined trade-off between inflation and unemployment is a trap with joblessness declining only briefly before returning to the previous level.

          Increased inflation reduces unemployment, but only in the short run. Friedman explains that unemployment below the natural rate can be maintained only by increasing rates of inflation. In 1967 Friedman introduced the natural rate of unemployment concept. This natural rate of unemployment is not constant but changes according to an economy's structural parameters. It is the rate prevailing in a perfectly competitive labor market. It is the rate of unemployment in an economy in which economic agents have full information about pricing activity and could anticipate the rate of inflation. He says that only one level of unemployment, the natural rate, is consistent with stable inflation. Friedman demonstrated that the Phillips Curve was unstable unless the economy operated at the natural rate of unemployment. Given the customs, institutions, and civil laws of an economy, beyond a particular point any increase in the rate of unemployment will result in deflation and a recession will take place until wages fall to a level that will encourage businessmen to begin hiring. Also, any decrease in unemployment below a certain point will result in inflation and a recession that will continue until employment returns to its natural rate.
 

"Friedman knows what the libertarian ideal is but is willing to entertain less than ideal changes as long as they point in the right direction. He draws a distinction between his ultimate goals and interventionist reforms that he believes will get us on the right path."


          According to Friedman, any rate of unemployment below the natural rate leads to inflation. When workers expect high inflation, they will demand more generous wages. The real wage remains unchanged when any increase in anticipated inflation is matched by wage inflation. With the real wage rate unchanged, the unemployment rate will remain constant. Friedman thus concludes that it is only unanticipated inflation that can lead to temporary reductions in unemployment below the natural rate. It follows that, in the long run, inflation is totally anticipated and there is no trade-off between inflation and unemployment.

          The long-run Phillips Curve is a vertical line at the natural rate of unemployment. Once unemployment falls to its natural rate, expansionary policies will not take it any lower except for brief periods of time. If the government attempted to increase employment beyond that natural rate by injecting more money, the short-term trade-off between inflation and unemployment would be repeated at ever increasing levels of inflation and unemployment. In addition, the more quickly expectations of inflation adapt, the more quickly unemployment will return to the natural rate, and the less successful the government will be in reducing unemployment through its fiscal and monetary policies. Friedman determined that the impact of a fiscal deficit on nominal income is short-lived and that, after a lag, the increased rate of growth in the money supply has long-term effects on the rate of inflation. He demonstrated that, in the long run, additional monetary growth affects only the inflation rate and has essentially no effect on the level or rate of growth of real production.
 

Corporate Social Responsibility

          Milton Friedman wrote "The Social Responsibility of Business is to Increase Profits" in the September 13, 1970 issue of the New York Times Magazine. This seminal article, along with several more to follow, contained Friedman's thoughts regarding the nature of corporations and the responsibilities of the parties involved with them.

          Friedman explains that corporations do not exist in physical reality, that only people can have responsibilities, and that businesses have no responsibilities as such. He maintains that there is one and only one social responsibility of business to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game. To earn profit is the purpose of the corporation which should engage in open and free competition without deception or fraud. Friedman also contends that corporations do not and cannot have any objectionable degree of power except for that power that is received through government intervention. He says that there is a need to curb government power that contending interest groups attempt to use for their own advantages. He does not blame businessmen for going to Washington to attempt to get special privileges (within the rules of the game) but rather blames all of the citizens for adopting rules of the game that permit that to occur.

          He says that the corporate executive is an employee of the owner of a firm and that the relationship between shareholders and the manager is an employee-owner or principal-agent one. His direct responsibility to his employers is to conduct the business in accordance with their desires. By implicit legal contract, salaried executives of a corporation have a fiduciary responsibility to the shareholders of the firm who assign them the right and duty to use corporate resources to increase the wealth of those shareholders by pursuing profits. Under this contract, they do not have the right to act on their own preferences by making discretionary decisions to spend the firm's resources to attain social goals which cannot be demonstrated to be directly related to gaining profits and to their fiduciary responsibility. Managers should use available assets to make investments to maximize the shareholders' wealth. They have no right to dispose of the shareholders' profits in any manner that does not directly benefit the corporation. The critical question is whether or not some action or project is enough in the interest of the corporation to justify the expenditures.

          According to Friedman, if a corporation makes a donation to charity, it is actually the managers who are making donations of assets that belong to the shareholders. They would be spending others' money unless those shareholders express their desire to make such a donation. He explains that managers should not substitute their judgment for the judgment of the shareholders. Friedman maintains that another reason against managers spending funds for social causes is that insofar as those actions increase consumer prices, he is effectively spending customers' money. Similarly, when such actions lower the wages of employees, he is disbursing their money.

          Corporate executives, when acting in their official capacity and not as private persons, are agents of the corporation's shareholders. Friedman explains that the corporate executive is also a person in his own right and as a private person may voluntarily assume responsibilities and spend his money, time, and energy on them. Many supposed corporate socially responsible actions are actually a disguised form of the managers' own self-interest where they donate corporate funds to their own favored schools, hospitals, community organizations, or cultural associations. Friedman maintains that by maximizing corporate profits, executives contribute much more to "social welfare" than they would by spending shareholders' money on what they as individuals view as meritorious projects. He also says that the tax laws should not permit corporate contributions to be deducted and should abolish the capital gains tax (or at the very least index the basis for capital gains).

          Friedman explains that it is better to return money to shareholders in the form of dividends (or as capital gains when they sell their stock) thus permitting them to decide which charities to support. He has argued for the abolition of all corporate taxes and for returning all corporate profits to the stockholders who can then decide as individuals how they will use their money. Individuals could be directly taxed on both their distributed and undistributed earnings and could then decide whether or not to reinvest their profits in that company depending upon their prospective returns from their alternative investment possibilities.

          According to Friedman, businessmen undermine the basis of a free society when they espouse corporate social responsibility. He explains that many executives embrace and advance their social goals in order to please individuals and groups who believe that corporations have social responsibilities and thus should set social goals. Friedman says that the only legitimate way of enlisting the help of business in solving social problems is to frame laws that enable businesses to profit by providing for social needs.

          Friedman's fundamentalist theory of social responsibility states that corporations have nothing more than obligations to make a profit within the framework of the legal system. He sees corporate social responsibility as a subversive doctrine and as a pernicious idea that shows a fundamental misconception of the character and nature of a free society and that undermines its foundations.

          Friedman's view on corporate social responsibility could certainly have been strengthened if he had a theory of individual rights. He could have said that the social responsibility of the corporation, through its directors, managers, and other employers is simply to respect the natural rights of individuals. Individuals in a corporation have the legally enforceable responsibility or duty to respect the moral agency, space, or autonomy of persons. This involves the basic principle of the noninitiation of physical force and includes: the obligation to honor a corporation's contracts with its managers, employees, customers, suppliers, and so on; duties not to engage in deception, fraud, force, threats, theft, or coercion against others; and the responsibility to honor representations made to the local community. Beyond the above, a corporation and its managers are not ethically required to be socially responsible. If managers, as agents of the stockholders, were to breach an agreement with the shareholders to maximize profits in order to give one or more groups more benefits than they freely agreed upon, they would be violating the rights so the owners. Managers should not divert corporate funds for other purposes. Of course, the idea that a corporation should respect rights leads to the same conclusions as Friedman reaches.
 

Public Policy

          For the most part, Friedman rejects programs based on paternalism because they force taxpayers to provide assistance and limit the freedom of the recipients of the aid to act as they choose. He speaks of distortions in the marketplace that accompany government programs and proclaims that the only case for government occurs when it is not feasible for market arrangements to make individuals pay. Friedman declares that the market should be the main instrument for organizing economic activity but also acknowledges that there are areas that cannot be handled through the market or that can be privately conducted, but at so great a cost, that political approaches may be preferable. He prefers to allow everyone the opportunity to use his own resources as effectively as he can to promote his own values as long as he does not interfere with anyone else. In addition, he naturally wants to leave problems of an ethical nature to the individual to deal with. Many of Friedman's policy prescriptions would reduce the centers of decision making by abolishing bureaucratic or political agencies.

          Friedman has offered an astounding range of public policy ideas across a number of areas, including but not limited to: social welfare programs; taxation (including the negative income tax); education; social security; the FDA; narcotics laws; trade restrictions; deregulation and privatization; discrimination; occupational and medical licensure; monopolies and antitrust; wage and price controls; fixed exchange rates; unions; labeling; environmental pollution; the all volunteer army; and the black market. We will now take a detailed look at his positions in several of these areas.

          Friedman is in favor of a flat-rate income tax perhaps above a certain exemption but with no additional exemptions, deductions, or loopholes. With such a system he believes that there would be less interference with private incentives and that such a system would be more efficient and more equitable. It is interesting to note that Friedman was an employee of the Treasury Department between 1941 and 1943 and was involved in the development of the withholding tax a government scheme that contributed to the growth of big government. Of course, he now says that he wishes there was some way to abolish it.

          According to Friedman, the tax code can be used to get people off conventional welfare in order to live on earned income while at the same time eliminating welfare bureaucracies. He was the first person to suggest that poverty could be abolished through a negative income tax involving the transfer of money directly to the poor by a much simpler formula and with fewer adverse effects on work incentives. Friedman sees the negative income tax as an expedient alternative to the present welfare system. His proposal would substitute a minimum income for the variety of welfare, disability, and unemployment programs that have multiplied each with its own inefficient and expensive administrative organization. There would be a floor below which no person's net income could fall a guaranteed income. This "public charity" would be granted on the basis of income, up to a predetermined maximum, would eliminate bureaucratic determination, could be withdrawn by majority vote, and would be in cash so that recipients could spend it as they choose. People who work would lose only a fraction of a grant dollar for every dollar they earn thus providing them with an incentive to work. Under the negative income tax, the poor would fill out income tax forms and if a family's income falls below some predetermined level, the U.S. Treasury would write a check to bring the income up to a minimum amount. A version of Friedman's idea came into law with the tax credit for low-income taxpayers in the Tax Reduction Act of 1975. His negative income tax is still embodied in today's earned-income tax credit.

          Friedman views public education at the elementary and secondary school levels as a large socialist enterprise that teaches socialist values. He wants to end compulsory education so that parents can decide if they want their children to attend school and when and where they should go to school. Friedman sees no valid reason for nationalized schools which limit parents' freedom to spend their own money on their own schooling choices. Public education is a monopoly insulated from the challenges of efficiency and excellence that stem from free competition. He states that competition would improve all schools and would provide variety and flexibility. He would like to see teachers' salaries to be able to respond to market forces. Friedman cautions businesses not to support government schools because businesses have been adversely affected by the low quality of the public school system. Instead, they should support private schools and the private school system.

          Friedman laments the fact that a parent who decides to send his child to a private school is required to pay twice once in the form of taxes and again in the form of tuition. He suggests providing parents with educational vouchers that they can spend at any school rather than solely through a monopolistic public school system. Friedman is a tireless advocate of free choice as a means of empowering parents and improving the performance of students and schools. A voucher system could be used to provide parents of school-age children with redeemable tuition certificates worth a certain number of dollars per child to spend on the schools of their choice as long as these meet certain educational standards. He is confident that parents would generally select a good education for their children. Friedman sees the voucher system as an incremental step in moving toward a private educational system. He maintains that vouchers are a good, partial, and attainable solution in moving away from a government system. Friedman would like to see the government entirely out of the education business but sees vouchers as a step in the right direction. Today's charter schools represent an adaptation of Friedman's voucher idea.

          Against mandatory participation in the Social Security program, Friedman calls for separation of retirement funding from the state and wants people to be able to buy their annuities from private concerns. He is concerned about the redistribution of money from the young to the old and that poor people pay a larger percentage of their income into the system than do the wealthy. He criticizes the pay-as-you-go Social Security system for restricting the ability of persons to decide how much and, and in what form, to save for retirement. Friedman explains that the fraction of an individual's income that it is appropriate for him to set aside for retirement depends upon that person's values and circumstances. Each person can best judge for himself how to use his resources.

          Friedman wants to abolish the Food and Drug Administration (FDA). He says that it is in the self-interest of pharmaceutical firms not to produce unsafe drugs and that tort law can handle any problems. Friedman points out that people never see the lives that are lost due to the slowness of the FDA in approving a drug that eventually turns out to be beneficial. He observes that the FDA has an interest in being late in approving drugs. If the FDA approves a drug that turns out to be bad, then it is in trouble. On the other hand, if it disapproves a drug that later turns out to be valuable, then it is only the drug companies that criticize the FDA. Friedman says that there is evidence that the FDA causes more deaths because of delayed approval than it has saved by early approval of drugs.

          Friedman wants to legalize drugs. He says that the fight against narcotics is an immoral war that has destroyed the lives of people at home and abroad. The prohibition of drugs destroys civil rights at home and has wrecked nations. Victims of the "war on drugs" include many minority members who have been jailed for low-level drug offenses. Friedman contends that the United States has become a police state that arrests around 1.5 million people annually who are suspected of drug offenses. He deplores the social tragedy that has resulted from the effort to keep people from ingesting an arbitrary list of substances depicted as "illegal drugs."

          According to Friedman, the real cost of the war on drugs is what is done to our civil rights, judicial system, and to other countries. He observes that we have destroyed Colombia because we cannot enforce our own laws prohibiting the consumption of certain substances. Friedman argues that under prohibition law enforcement can temporarily reduce the supply of drugs causing drug prices to rise. Higher prices, in turn, attract new sources of supply and newer drugs to the market resulting in a greater supply. The government then reacts with tougher law enforcement and legislation.

          He explains that individuals do not have great incentives to report drug crimes which tend to be victimless crimes much unlike assault, murder, and theft. When a willing buyer and seller transfer a drug, there is no real incentive to report what the government has declared to be a crime. Instead, evidence must be obtained through informants, searches, and seizures of property often without due process. Friedman contends that drug prohibition is unethical and that teenagers are primarily attracted to drugs because they are illegal. He says that the people who would benefit the most from legalization are addicts who would have an assurance of quality and who would not have to become "criminals" in order to support their habit. Friedman does not want people in prisons because of the mistaken attempt to control what people put into their bodies.

          According to Friedman, the government should step aside from its efforts in a number of unjustifiable areas. He says that tariffs and other trade restrictions hurt us and that the U.S. should move unilaterally to free trade even if trading partners do not. This would be easier with floating exchange rates because they are prompt, automatic, and effective and do not require government involvement. International government should cease attempting to maintain fixed exchange rates and instead allow the market to determine the price of foreign currency.

          In a private market, one person benefits only as long as the other person does also. On the other hand, in a government market a person can only satisfy his needs at the expense of someone else. It follows that Friedman is in favor of deregulation in areas such as airlines, trucking, railroads, utilities, interest rates, broker rates, the petroleum industry, and so on. He also wants to remove government support for the many medical, legal, and professional restrictions with respect to competition. According to Friedman, occupational and medical licensure and certification interfere with the rights of individuals to enter voluntarily into professions and to pursue activities of their own choosing. In the medical field, the restriction of new doctors forces people to pay more for less satisfactory medical services. Less expensive medical service would result if there were no monopoly. He says that, because only "first-rate" physicians are permitted, some people receive no medical care at all. Friedman adds that private markets, rather than the government, can take care of any needs for professional certifications. He is also in favor of private labeling because, if customers really want to know about a product's ingredients, it would be in the self-interest of the company producing it to list them on the package. He does not know why so-called "experts" in Washington know more about what customers want to be disclosed on packages. Although some reforms would be gradual and others immediate and radical, deregulation would result in enhanced and widespread competition and in reduced prices.

          Friedman observes that many public enterprises should be privatized. This involves the transfer, divestiture, or contracting out of assets or services from the tax-supported public sector to the competitive markets of the private sector. In many cases, market arrangements are far more effective than command and control arrangements. He says that private monopoly is generally superior to public monopoly or regulation. He opposes government ownership or regulation of industries except where monopolies or other imperfections exist which result in divergences between social and private costs. Of course, even in these cases, he contends that government intervention is seldom justified. If a private venture fails, it shuts down but if a government venture fails, it is expanded.

          Friedman explains that public-sector spending would be severely reduced because private enterprises would do much of what government currently does. He notes the problem of overcoming vested interests and thwarting rent-seeking with respect to changing the status quo regarding government policies and programs. Privatization can be undertaken all levels of the government. At the national level, there are Social Security, national parks, the air traffic control system, AMTRAK, surplus military bases, public hospitals, the U.S. Post Office, turnpikes, and so on. At the state level, prison management and utilities are good examples. There are also numerous candidates at the local level including garbage collection, waste treatment, street cleaning, fire and police protection, parking structures, jails, snow removal, etc. It is obvious that Friedman's ideas for privatization and other steps toward smaller government have had a great influence in the U.S. and around the world.

          Rather than direct regulation, Friedman has advocated graduated charges for pollution thus creating a market incentive to clean up the air and water. He has talked about selling the right to emit a certain amount of pollutants into the air thereby establishing a market in effluent rights.

          Friedman is opposed to wage and price controls, price supports for agriculture, rent controls, government control of output, legal minimum wages or maximum prices, control of radio and TV by the FCC, and laws that favor unions which hold wage rates up artificially. He says he is more cautious regarding antitrust enforcement because the actual extent of market competition is a subtle matter that requires the analysis of empirical evidence in the form of concentration ratios, market share analyses, consumer surplus analyses, and so on. Friedman views the black market as a positive way of getting around government controls thus enabling the free market to work via mutually beneficial exchanges. He also defends the market as a destroyer of discrimination. Finally, Friedman is also famous for being the intellectual godfather of our all-volunteer army.
 

Methodology

          Friedman says that economists form and use theories to help anticipate and control future events and that a theory is useful if it can predict and control such events. He says that the primary objective of positive economics is the making of ever more accurate predictions. His methodological position is based on the philosophy of science known as instrumentalism. If a theory predicts accurately, then it is a good theory. Predictive power is thus the hallmark of a good theory. Friedman requires that theories be simple yet have the ability to predict future events. He says that accurate predictions can be made from simplified assumptions, that truly important and significant hypotheses will be found to have assumptions that are wildly inaccurate descriptive representations of reality, and that, in general, the more significant the theory, the more unrealistic the assumptions.

          Friedman says that predictions must be based on theories, in the sense of explanatory hypotheses, that must constantly be tested empirically. He focused on the problem of deciding whether or not a suggested hypotheses or theory should be tentatively accepted as part of a body of systematized economic knowledge. For Friedman, assumptions are useful as economical means of expressing and determining the status of the premises of a theory in order to provide an empirical basis for predictions. Assumptions specify the conditions under which the theory is expected to apply.

          Friedman endeavors to demonstrate that economics meets positivist standards. He maintains that there is no test of a theory in terms of whether or not its assumptions are realistic and explains that the falsity of assumptions is unimportant unless such falsity detracts from the theory's ability to predict the phenomenon in question. His thesis is that the truth of assumptions is irrelevant to the acceptance of a theory, provided that its predictions succeed. Friedman also points to cases where changing premises to make them more realistic has resulted in the reduced usefulness (i.e., ability to predict) of the theories.

          Relying on Popper's falsification criterion (and rejection of induction), Friedman maintains that confirming a proposition does not add to the probability that it is true. He says that we do not have an inductive logic and offers the alternative of accepting an hypothesis as a matter of methodological judgment as a positive statement to be tentatively accepted on the basis of empirical evidence. Friedman contends that we can never prove a theory the most we can do is fail to disprove it. The process is to promulgate new theories and test them to see if they do in fact predict. An empirical process is used to eliminate those theories that do not predict the future and those that predict less reliably than others.

          Friedman denounces the theorist whose goal is a set of assumptions that are more realistic. He rejects introspection and the realism or plausibility of assumptions of ways of assessing a theory. He asserts that assumptions for theorizing should be derived from observation rather than from introspection. Friedman explains that, with regard to introspection, realistic assumptions are needed to deduce acceptable economic theory, and that such assumptions cannot be made a priori in the absence of a true inductive process.

          According to Friedman, efforts to eliminate unrealism deteriorate into pure tautology which avoids dealing with reality and makes impossible the refutable hypothesis, the primary research instrument. He also warns that economic theorists who value the realism of assumptions have to in some way take each new event and assimilate it into the theory. The theory thus becomes a description of what has occurred rather than a theory with predictive power.

          It is interesting to note that in practice Friedman argues based on the realism or reasonableness of assumptions. He accumulates facts, forms and hypothesis to explain them, makes predictions, compares the predictions with facts, reviews his assumptions and hypothesis in response to the outcomes of his empirical testing, and continues in an iterative process. Although he says we do not need to test the truth of assumptions, he also acts to change an assumption that is false whenever he comes across a particular conclusion that is false.

          Whereas absurd premises can yield correct conclusions, there can be no confidence that they will do so. Confidence in economics is based on direct and causal confirmation of realistic assumptions. Friedman's espoused approach can lead economists to give advice based on ridiculous theoretical constructs. It follows that he should stress understanding, as well as prediction, as the test of scientific validity.

          Friedman's models are simplified representations of the entire economy and his economic concepts are aggregations and averages. His economic approach is to engage in a process of pattern prediction to see overall effects and order. We should not forget that these aggregates are the result of a multitude of individual human actions.
 

Conclusion

          Milton Friedman has made significant contributions in macroeconomics, methodology, economic history, and in a variety of public policy areas. No one has done more to dismantle Keynesian economics and the welfare state. Friedman did this by using Keynes' own language and apparatus to prove him wrong. The paradox is that this libertarian economist, who shares the scientific paradigm of neoclassical social engineers, tries to defend incrementally more libertarian policies that are sometimes in contradiction with the principle of freedom. He has been known to use his talents to help the state to do more efficiently tasks that it should not be undertaking.

          Friedman knows what the libertarian ideal is but is willing to entertain less than ideal changes as long as they point in the right direction. He draws a distinction between his ultimate goals and interventionist reforms that he believes will get us on the right path.

          He maintains on empirical evidence that only competitive markets can coordinate the diverse elements of a complex society. Friedman constructs his liberalism around empiricism in attempting to refute the claims of interventionists. Unfortunately, empirical testing can only demonstrate that interventionist policies have contingently failed. This means that the failure of particular interventionist measures does not necessarily preclude the demand for more and different interventionist measures. Friedman's positivism and pragmatism have led to a number of incremental successes in the battle for a free society but more philosophical and moral approaches are required to win the war.
 

 

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