Economics, Political Philosophy

Milton Friedman’s Century

Today would have been the 100th birthday of Milton Friedman, the economist and author who helped inspire some of the most important economic policies of our time and helped millions of people escape poverty. Friedman doesn’t get much recognition outside of economic circles, but his achievements in that field were more than just writing a few textbooks. He helped change the face of the American economy for the better.


When Milton Friedman won the Nobel Prize for Economics in 1976, the world was enamored with the ideas of John Maynard Keynes, who taught that government spending would somehow produce a “mulitplier effect” that would lead to economic growth. The theory was that if the government were to spend $1 it would produce more than $1 in economic activity. In the 1960s, Friedman famously wrote that “we’re all Keynesians now”—a position later adopted by Richard Nixon in 1971.

In the 1950s through the 1970s, one could credibly think that the future lay not with free markets but with centrally-planned economies. Keynesianism was the dominant theory in economics and government policy. Governments across the globe were expanding the reach of central planning in a whole host of economic sectors. The ideas of the Austrian Economic School were dismissed as crackpot theories.

But then, the crash hit.

Friedman’s Revolution

In the 1970s, the world economy entered into a massive downslide. The Arab oil embargo pushed gas prices through the roof. But more critically, something happened that Keynesian theory said was impossible: stagflation – high inflation and economic recession. Conventional Keynesian theory taught that inflation and economic recession were opposites and could not happen at the same time. Yet in the 1970s, that is precisely what happened.

Across the globe, politicians tried the conventional Keynesian remedies. In the United States, Richard Nixon instituted wage and price controls to try to stop inflation, an effort that appeared to work at first until it led to massive shortages of goods. Governments tried to spend their way out of the recession, to little forward growth. The world economy was hanging by a thread, and the conventional economic theories were not helping the world pull out of its economic recession.

But it was Milton Friedman that popularized the way out of the mess. Friedman had already chipped away at the intellectual foundations of Keynesianism. He observed that Keynesian spending and the Keynesian multiplier did not work in practice—once the spigots were turned off, a fiscal hangover resulted. Because there was no new production happening to support all the extra spending, the result of Keynesian stimulus was inflation and recession. Governments wanted to try to inflate their way out of the borrowing costs of all the extra spending, which only made things worse. Further, government “investment” was taking place at the expense of private investment that would produce long-term growth.

Friedman’s theories were right, and his work led him to receive the Nobel Prize in 1976. It was not until the end of the 1970s into the early 1980s that leaders such as Ronald Reagan and Margaret Thatcher embraced his ideas that the world economy truly began to recover.

Free To Choose

But Friedman was more than just a theoretical economist. He was a gifted philosopher and writer as well, and his work on why free markets are so important to a free society is some of his most important work. His first major popular work, Capitalism and Freedom went into the details of why the economic theory of capitalism was so deeply entwined with having a free society. When it was first published, Capitalism and Freedom was a revolutionary work: Friedman advocated such bizarre notions as a “negative income tax,” an all-volunteer military, and school vouchers.

Friedman continued to popularize his pro-free market ideas in the press, writing columns for Newsweek and other publications. But it was in 1980 when Friedman published one of his most accessible works, Free to Choose, that Friedman’s ideas started truly influencing the popular conversation.

Friedman dedicated himself to pursuing advocacy for free markets and limited government, and he did it with a sense of clarity and purpose. He was able to explain why even the most well-intentioned government programs are thwarted by the complexity of a modern economy. The following clip from the Donohue show in the 1980s shows Friedman at his best:

Friedman, of course, had the better argument, and was able to not only write about economics, but to get millions of people to look at economics in a new way. Instead of viewing economics as the “dismal science,” concerned with the shuffling of abstract value, Friedman popularly imbued economics with a moral aspect. Economics was about maximizing the freedom of the individual rather than the collective or the State. It was about ensuring that individuals were best able to pursue their own ends, provide for their own families, grow their own businesses, and prosper. This shift seems common-sense to us now, and that is due in large part to the influence of Milton Friedman.

A Legacy of Freedom

Today, some of the revolutionary ideas in Capitalism and Freedom are a common part of our day-to-day lives. Milton Friedman pushed for an all-volunteer military prior to the Vietnam War, and today the military is and will remain an all-volunteer force. Friedman’s idea of a “negative income tax” blossomed into the Earned Income Tax Credit, a system where people in poverty who choose to work are rewarded for their efforts with a payment from the government. Instead of welfare, which subsidizes poverty, the EITC encourages work and employment. In 2010 alone, the EITC was responsible for lifting an estimated 5.4 million Americans out of poverty. Friedman’s ideas have lifted 200 million people from poverty into prosperity, an achievement that will stand the test of time.

Now, more than ever, we need leaders who will carry Friedman’s mantle of freedom. Keynesianism, discredited in the 1970s and later by the Japanese “lost decade” in the 1990s is making a resurgence. It isn’t that Keynesian theories suddenly work better than they did in the past, it is that governments are using Keynesianism as a rationale for consolidating political power and justifying more and more control over the world economy. Friedman would have seen right through these efforts.

Just as it was in the 1970s, what the world needs now is not more central State planning, but more economic freedom. The solution to our economic problems is to unleash the creative energies of our people and to get government out of the way of economic growth. Friedman understood this from both a philosophical and a practical viewpoint. Friedman was right back then, and he is right today. And if we listed to his wise counsel again, our economy can come roaring back once again. Milton Friedman’s legacy of freedom can bring millions more from poverty to prosperity again if we are only willing to listen.


The Myth Of The Laissez-Faire Meltdown

In The Spectator, Fraser Nelson has a searching piece on the myth that laissez-faire conservatives led to the current economic troubles:

So while it’s a statement of the obvious, the obvious can’t be stated enough at a time when we’re fighting (or should be) for the future of capitalism and the open society. The last ten years were not laissez-faire, as even Gordon Brown suggests. The crash was the result of bad regulation, not insufficient regulation. Brown told the Guardian last month that “laissez-faire had its day” and it did – in the 1880s. The problem this time was a blind, almost fundamentalist, faith in rules-based economics – the idea that, if inflation was low, everything else would be fine. And this stems from a blind faith in the power of governments.

He’s right. The crash was caused not be “Wild West capitalism” or anything similar. It was caused by a regulatory climate that encouraged systemic risk. The mortgage meltdown was not the product of evil capitalists meeting in smoky rooms to screw over everyone, it was the product of government meddling in the economy.

Our system of financial regulations has been based on a rules-based approach. Far from being unregulated, the financial markets are covered by a number of regulatory agencies—the Securities and Exchange Commission regulated the trade of stocks and other securities, along with FINRA (formerly the NASD) acting as a quasi-private regulatory body. Banks were governed by a massive amount of regulations by bodies like the Federal Deposit Insurance Company (FDIC) and the U.S. Treasury. Corporate books were governed by the Sarbanes-Oxley bill that was passed in the wake of the Enron and Worldcom scandals. The housing markets were heavily regulated by the Housing and Urban Development department, the Community Reinvestment Act, and the presence of Fannie Mae and Freddie Mac (who everyone know were “too big to fail” and would be bailed out by the government if things got too bad).

With all that going on, the argument that somehow the financial markets were totally unregulated is hardly justified by the facts. Quite the opposite, the government was doing plenty to tilt the market for various social policy reasons. Since President Carter signed the Community Reinvestment Act in 1977, it’s been government policy to expand home ownership to minorities and low-income people. President Bush’s “ownership society” was hardly a new direction from government policy, but rather a continuation of what came before.

Tilting the Playing Field: Why the Rules-Based Approach Failed

There are two rather huge problem with the rule-based approach: first, it gives incentives for industry to try to tilt the rules to their benefit, and secondly such an approach can’t work fast enough to effectively regulate a modern economy.

On the first point, it’s obvious to all that there was a cozy relationship between the regulators of the financial markets and those people they were supposed to be regulated. Take the example of Sen. Chris Dodd, who while having been supposed to be in charge of regulating the financial industry was getting sweetheart loan deals from Countrywide and raking in tons of cash from AIG. This is, sadly, not a case of one bad apple in a bunch—Rep. Barney Frank was one of the biggest impediments to reforming Fannie Mae and Freddie Mac and fixing the problems with the mortgage market.

This cozy relationship meant that efforts at substantive reform like the Federal Housing Enterprise Regulatory Reform Act of 2005 could never get off the ground. The regulators were in the pockets of the regulated agencies like Fannie Mae and Freddie Mac, and no way would they allow the world to inspect their books and see just how deeply in trouble they were.

Even if federal regulators were uniformly brilliant and far-sighted (and some of them are), they’re no more insulated from political pressure than the corrupt politicians. Regulatory capture remains a major and persistent problem. There is enormous political pressure, not only from the financial companies, but from special interest pressure groups like ACORN and the unions to push rules through that try to expand home ownership to those who would be enable to afford it. In the end, it wasn’t just about turning a profit, it was about “helping the poor” by lowering lending standards so that more people could buy homes they couldn’t otherwise afford.

A rules-based approach will always produce these results. Ban the giving of money and the transactions go under the table. There’s no way to prevent this kind of influence-peddling so long as there is influence to be peddled. As long as people like Barney Frank, Chris Dodd, and the rest of our corrupt legislative class can tilt the playing field, entities like AIG, Fannie Mae and Freddie Mac, and others will have every incentive to see that the rules get tilted in their favor. That is human nature, what James Madison called “faction” all the way back in Federalist #10 in 1787.

The other problem with a rules-based approach is that it’s slow. The process of passing a new federal regulatory rule takes at least a year on average. Yet the financial markets move much faster. New financial equations and methods like David X. Li’s Gaussian copula function (which Wiredcalls “the formula that killed Wall Street”) is something that is difficult for anyone, especially federal regulators to understand and predict. Trying to craft a rules-based approach to deal with a modern financial system in the Internet age is ultimately futile: by the time there’s been a rule that’s survived the rule-making process, the system has already changed.

It’s not possible to have a regulatory system that works fast enough to meet the demands of today’s economy. Even if it were, we don’t want to have a system that produces rules without time for interested parties to have some say. Even worse than our deliberative rule-making process is one that pushes through rules without considering the potential ramifications.

Preventing the Next Crisis: Make Regulations Simpler, Fairer, and Automatic

The rules-based approach is not going to work in the 21st Century, at least not in the form that we have it now. There’s too many opportunities for regulatory capture and the system cannot keep pace with the needs of a rapidly-evolving market. We need a better approach to the financial system.

That approach should come in the form of a smarter system of regulations. Gary Becker wisely suggests that regulations be automatic rather than subject to the discretion of regulators—such as capital requirements that keep financial institutions from getting “too big to fail”. This approach would reduce regulatory capture, but it may be difficult for regulators to set the right ratio of assets to capital. Still, it’s a step in the right direction.

In addition to that, what we need is a set of financial rules that are dramatically simpler. The more complexity there is in a rule-based system, the easier it is for companies to find loopholes. The large and sophisticated players can find their way around the rules, the smaller and less sophisticated players are easily caught up in a system they can scarcely understand. That tilts the playing field away from smaller competitors and towards the bigger ones. That is not a smart way to run any kind of economic system.

We need to clear away the layers of over-complicated, overlapping, and over-burdensome regulations and replace them with a comprehensive system based on simpler rules that anyone can follow. That will naturally be met with huge cries from both the government agencies and the companies that have captured them, but it’s a necessary step to fixing this mess.

We also have an urgent need to reduce moral hazard. Fannie Mae and Freddie Mac knew they could get away with anything because they were “too big to fail” and their close ties with government would mean they would be the recipients of a federal bailout. That means that they could take far more risks than was safe, and once they did it, others started to follow suit. In a functioning free market system, there has to be a system in which smart risks get rewarded and dumb risks get punished—otherwise everyone will start making dumb and risky moves.

Finally, we have to recognize that more government is not the right solution. More bad regulations will only make the system worse. They will continue to create even more problem with regulatory capture and corruption, and it’s quite likely that they will have a host of negative side effects that won’t be foreseeable for quite some time. Too much bad regulation got us into this mess, and trusting the same government actors that created the mess in the first place to get us out is a fool’s errand.

This crisis was not the result of laissez-faire capitalism, it was the result of bad regulation and corrupt government. In order to repair the damage and move ahead we must stop the culture of bailouts and expanding the power of the corrupt technocrats and move to a system that is fairer, less needlessly complicated, and less prone to regulatory capture. That will not make people like Chris Dodd and Barney Frank happy, nor will it be very welcome within the industries that have grown accustomed to buying favor with the government. But for the future of the American economy, it is the right thing to do.

Economics, Obama Administration, Politics

The United Socialist States Of America

The United States of America is now a de facto socialist nation.

That may seem like hyperbole, but there’s more than enough evidence to suggest that it’s true. Look at the definition of socialism from that font of all knowledge: Wikipedia:

Socialism refers to a broad set of economic theories of social organization advocating public or state ownership and administration of the means of production and distribution of goods, and a society characterized by equality for all individuals, with a fair or egalitarian method of compensation.

Let’s assume that definition is roughly accurate. Does the U.S. fall under that definition?

Well, we now have a system in which the government has a controlling interest in several major sectors of the U.S. economy. Whether the banking system is officially nationalized or not is largely irrelevant—it has already been de facto nationalized. The U.S. government now has effective control over all of AIGs operations, right up to the the amount that it may pay its workers. At least for a huge swath of the financial sector, the government has effective control.

Now, President Obama has set his sights on the auto industry, essentially firing GM’s president. The fact that the President just ordered an official of a private company to step down should be deeply troubling to all. What if President Bush had demanded that the Democratic president of a major arms manufacturer resign? The left would have been in an uproar. Regardless of Wagoner’s competency, to have the President of the United States order a private company to fire an employee should not happen in our system. The government is now calling the shots at GM. This isn’t forced nationalization, but like AIG, GM and Chrysler are now de facto state-run enterprises.

The government now controls the means of production in two huge swaths of two major industries. Even if we have not arrived at full-scale socialism yet, we are at the very least perilously close.

Economist Arnold Kling calls the current state of affairs “Progressive Socialism“—although it is really another version of state socialism. Socialism doesn’t require the government to own all the means of production (as does Communism), but merely to have effective control over the economy. Right now, the Obama Administration is effectively in the driver’s seat of the U.S. economy. Looking at the markets, it’s quite clear that the aimless direction that Obama is taking us is destroying trillions of dollars of actual value.

The Fall of Capitalism, The End of Freedom

Why should we care? The reason why the advent of American state socialism is such a problem is because political freedom and economic freedom are really two sides to the the same coin. As Janet Daley notes in The Telegraph an attack on capitalism is ultimately an attack on human freedom itself:

When we make the case for capitalism, we are defending the political principle of freedom, not arguing for one kind of rigid economic organisation over another. The debate is being hopelessly muddied by those late converts to free enterprise – politicians like Mr Brown who believe that markets should only survive if they can be made to serve Left-wing purposes.

Capitalism is premised on individual agency. Socialism is premised on the power of the state. The second we give government—which has the legal ability to use force—all of our economic power, what do we really have left? In essence, socialism is really a more “enlightened” form of feudalism in which the serfs trade their freedom for the protection of the elites.

The United State should not fall into the trap of socialism. Socialism is not a workable economic model. The larger and more diverse the nation, the more quickly socialism fails. Industrious and homogenous Sweden can ride out the problems of strong government control longer than could the large and diverse United States. If we continue down this road, our economic collapse will only get worse.

The United States has become a de facto socialist state, and the crisis on Wall Street is a reaction to this untenable and unsustainable trend. If we want to preserve our quality of life, we cannot have our economy being run by the same Washington apparatchiks who have caused this crisis in the first place. Obama’s shift of the U.S. economy to a more centralized and socialized one will lead this country ever closer to disaster.