• • • • Sample • • • •

www.harriman-house.com/miltonfriedman

• • • • Sample • • • •

* $ 3 4 + 2 % %

9 % $ = £ * £ 1 * € + %+ + % = $ * 3 =3 £ *= £ 4 £ % ££* € + % 4 + + 1 5 % 7 8 £ £ = % * 2 $ 1 % = $ 5 * $ 5 % £ ii MILTON FRIEDMAN

A concise guide to the ideas and influence of the free-market economist

EAMONN BUTLER

* $ 3 4 + 2 % % Hh

9 % $ = £ * £ 1 * € + %+ + % = $ * 3 =3 £ *= £ 4 £ % ££* € + % 4 + + 1 5 % 7 8 £ £ = % * 2 $ 1 % = $ 5 * $ 5 % £ HARRIMAN HOUSE LTD 3A Penns Road Petersfield Hampshire GU32 2EW GREAT BRITAIN

Tel: +44 (0)1730 233870 Fax: +44 (0)1730 233880 Email: [email protected] Website: www.harriman-house.com

First published in Great Britain in 2011

Copyright © Harriman House Ltd

The right of Eamonn Butler to be identified as the Author has been asserted in accordance with the Copyright, Design and Patents Act 1988.

ISBN: 978-0857-1-90369

British Library Cataloguing in Publication Data A CIP catalogue record for this book can be obtained from the British Library.

All rights reserved; no part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise without the prior written permission of the Publisher. This book may not be lent, resold, hired out or otherwise disposed of by way of trade in any form of binding or cover other than that in which it is published, without the prior written consent of the Publisher.

No responsibility for loss occasioned to any person or corporate body acting or refraining to act as a result of reading material in this book can be accepted by the Publisher, by the Author, or by the employer(s) of the Author.

Published in association with the Institute of Economic Affairs. The mission of the Institute of Economic Affairs is to improve understanding of the fundamental institutions of a free society by analysing and expounding the role of markets in solving economic and social problems.

Set in Minion, Gotham Narrow and Frutiger.

Printed and bound in the UK by CPI Antony Rowe.

Hh Harriman House cONTENTs

About the author vii

Introduction 1 A timeline of Milton Friedman's life and work 7

1. The economist who changed everything 11 Worldwide influence 13 The making of an economist 17 The public intellectual 25

2. How to end financial crises 33 The false trust in governments 34 A better explanation 41 Lessons for today 47

3. Curing inflation and unemployment 49 The disease of inflation 51 Other explanations of inflation 58 Inflation versus unemployment? 59 How to control inflation 61 How not to control inflation 65

4. A bonfire of controls 69 Free people and free trade 71 Setting currencies free 77 The poverty of regulation 82

5. The failure of government 89 The role of government 91 Why governments fail 94 The fraud of government 98 A different approach 105

v MILTON FRIEDMAN | EAMONN BUTLER $

6. The merits of markets 109 Friedman on markets 111 Diversity, not discrimination 118 Markets help ordinary people 122

7. Freedom and equality 127 The quest for equality 130 Why freedom works 134 The importance of personal freedom 137 Friedman's view of humankind 139

Further reading 143

Index 147

vi $ £ $ % € ABOUT ThE AUThOR =

Eamonn Butler is director of the , rated one of the world’s leading policy think tanks. He has degrees in economics, philosophy and psychology, gaining a PhD from the in 1978. During the 1970s he worked on pensions and welfare issues for the US House of Representatives, and taught philosophy in Hillsdale College, Michigan, before returning to the UK to help found the Adam Smith Institute. Eamonn is author of books on the pioneering economists F. A. Hayek, and Adam Smith. He is also co-author of Forty Centuries of Wage and Price Controls , and of a series of books on intelligence testing. Eamonn contributes to the leading UK print and broadcast media on current issues, and his recent popular books The Best Book on the Market , The Rotten State of Britain and The Alternative Manifesto have attracted considerable attention.

vii 1 $ + 1 $ 5 $ $ % £ 4 INTRODUcTION 9 $

“Milton Friedman was a very great man indeed – a man of intellectual courage who was one of the most important economic thinkers of all time, and possibly the most brilliant communicator of economic ideas to the general public that ever lived.” – Nobel economist Paul Krugman, New York Review of Books

What this book is about his book guides the reader through the startlingly original ideas of Milton Friedman (1912–2006) – a Nobel laureate Tin economics, but best known to many for his TV series and book Free to Choose (1980), a searing critique of big government and robust defence of individual freedom. Friedman’s thinking had a powerful influence on world leaders such as Margaret Thatcher in Britain and Ronald Reagan in America. In the 1970s, it underpinned the replacement of fixed exchange rates by open currency markets and free trade. In the 1980s, it contributed to the demise of Soviet communism in the East and to privatisation in the West. In the 1990s, it provided the blueprint for reform as countries in Eastern Europe and Latin

1 MILTON FRIEDMAN | EAMONN BUTLER

America emerged from years of totalitarianism. By the 2000s, it had helped cut world inflation to a tenth of what it had been a decade before. Friedman was the best-known economist of his generation. He undid the grip that Keynesianism – based on the thinking of John Maynard Keynes, with its faith in large-scale government spending and intervention – held over postwar politicians and economists. The radical alternative he created – Monetarism – called instead for sound money, balanced budgets and deregulation. And he showed how the Great Depression of the 1930s was caused, not by some failure of capitalism, but by a profound failure of government – drawing lessons that are just as relevant to how we should handle financial crises today. But Friedman was much more than an economist. At a time when the world was bitterly divided between capitalism and communism, he threw himself into every major debate on how society should be organised. He became the world’s leading advocate of personal and economic freedom; and his arguments helped change the politics of a generation.

What this book covers This book does not go into the academic detail of Friedman’s economic ideas – though it does explain many of them in a straightforward and accessible way. It focuses more on his innovative public policy thinking – and how his prescriptions led to real and powerful policy changes that still determine, in part, how millions of people across the world live and work today. Accordingly, the book covers Friedman’s thinking on such varied subjects as how best to organise education, healthcare, mail delivery, defence and other public services; how governments create monopolies, and how to end them; radical tax simplification; how free markets coordinate the work of people across the world; why we should deregulate commerce and trade; why government grows, and why so much that it does is counterproductive; why

2 INTRODUCTION drugs policy has failed, and what we should do instead; why freedom cannot be traded for equality; the rights of minorities; and indeed the whole relationship between government and the citizen. The book seeks to outline and explain Friedman’s thoughts and prescriptions on all these subjects. It puts them in the context of the time, showing just how revolutionary they appeared to his colleagues and contemporaries. And it places them in the context of the policy debate today, showing how many of them, once shocking, have become commonplace parts of our lives.

Who this book is for This book is consciously written for the intelligent layperson who is interested in the debate on how our social and economic lives should be organised. It is perfect for anyone who wants to understand, or learn more about, the free-market, liberal (in the European, not the American, sense) side of the argument. After all, Milton Friedman, the book’s subject, himself laid out most of that case at one point or another in his various books and articles. This book organises all that material into a short, structured guide. The book aims to explain Friedman’s ideas straightforwardly, without distortion and in plain language. Hence there are no academic-style footnotes or bibliography – just an essential reading list of Friedman’s most significant books and articles. It should also interest school and university students of economics, politics and social philosophy, giving them a concise insight into a set of radical ideas and opinions that are frequently dismissed or ignored in orthodox economics and social science teaching. There is plenty in here to challenge those teachers! There is also a political interest to the book, in that Friedman was one of the greatest intellectual inspirations behind the rise of the New Right in the 1980s and 1990s. His ideas had huge influence on policy makers such as Reagan, Thatcher, the US Federal Reserve Chairman Alan Greenspan, the Estonian Prime Minister Mart

3 MILTON FRIEDMAN | EAMONN BUTLER

Laar, the Czech Prime Minister and President Václav Klaus, and many others. This book explains how Friedman’s ideas came to shape the views of such leaders all round the world, from America to China.

Friedman and the author… I knew Milton Friedman. As a student I found his Capitalism and Freedom (1962) breathtaking in its originality – an exhilarating libertarian alternative to the prevailing mood. So I was thrilled to meet him at the 1974 conference of the – the international association of free-market, liberal thinkers which he co-founded – and again a year later at the next conference in my own university of St Andrews, and at many other events over the next 30 years. In 1978 Friedman spoke at one of the first meetings of the Adam Smith Institute, the free-market think-tank of which I am director. And in 1985 I wrote a book outlining his economic theories in simple language – a book about which he was very kind, and characteristically encouraging.

…and this book People who met Friedman found him impossible to dislike. He was indeed a brilliant, and highly personable, communicator, always smiling, particularly when enjoying a good argument – which was most of the time, since his novel and challenging ideas were so frequently in the minority. But it is not my purpose here to take Friedman’s side of those arguments against his many critics, or elaborate his case. I wrote this book on the eve of his centenary year, a good moment to take stock of his life’s work and lasting influence. Friedman’s written work amounted to scores of books, both technical and non- technical, and hundreds of articles, not to mention his TV series and countless media appearances and interviews. My ambition is

4 INTRODUCTION only to distil from all this the essence of Friedman’s ideas and present them systematically and simply. In doing so, it is natural that I should give slightly greater space to those ideas that seem most relevant for the issues we face today – Friedman’s views on the origins of boom-bust cycles, for example, and how to prevent them. Yet I have also indicated where time has tested his ideas – as in the practical difficulties that the financial authorities found when they did try to control money and inflation as Friedman prescribed. As for his libertarian social policies – decriminalising drugs, ending the state licensing of doctors and lawyers, getting the government out of hospitals, schools and universities – Friedman remains, as he once put it, “so happily blessed with critics” that I see no point in adding myself to them here. how this book is structured The book is not a chronological history of Friedman’s life and work. Rather, it is structured round the key themes of his contributions to economics and politics. After a short account of Friedman’s upbringing – he was the child of poor Hungarian Jewish immigrants to the US – and of his subsequent, glittering career and continuing influence today, the book moves first to outline his contribution in economics. In particular it sets out his dispute with Keynes over the causes of financial crises such as the Great Depression, his view that ‘stimulus’ packages actually make things worse – an argument that is still very relevant today – and his groundbreaking insights into the causes and cures of inflation and unemployment. The book goes on to explain Friedman’s criticism of government regulations and controls over commerce, trade and international markets; it then outlines his explanation of why he thought most government programmes are either a failure or a fraud, and recounts his recommendations for rolling back the state.

5 MILTON FRIEDMAN | EAMONN BUTLER

The book then lays out Friedman’s ideas as the leading advocate of free and largely unregulated markets, and his explanation of why he thought free markets allocated resources so much more efficiently – and fairly – than governments. This leads on to Friedman’s libertarian views on freedom, equality, the limited but important role of government, and his robust but humane faith in the “genius” of free individuals in a free society.

6 INTRODUCTION A TIMELINE OF MILTON FRIEDMAN’s LIFE AND WORk

1912 Milton Friedman born in Brooklyn, New York, to Jewish Hungarian immigrant parents; his father trades goods while his mother sews garments in a New York sweatshop. 1928–32 Reads mathematics at Rutgers University; meets economists Arthur Burns and Homer Jones. 1932–33 At the University of Chicago as a graduate student; influenced by economists Jacob Viner, Frank Knight and Henry Simons; meets his future wife Rose Director; graduates with a master’s degree in economics. 1929 The Wall Street crash heralds a decade of economic turmoil, the Great Depression. 1933–36 Roosevelt’s New Deal attempts to kick-start the US economy. 1933–34 Friedman studies statistics on a fellowship at Columbia University, under prominent economist and statistician Harold Hotelling. 1934–35 Works as research assistant to Henry Schulz at Chicago; meets George Stigler, who would become a lifelong friend and fellow Nobel economist. 1935 Begins work on consumer spending at the National Resources Committee in Washington; this work informs his subsequent book The Theory of the Consumption Function . 1936 Keynes’s General Theory of Employment, Interest and Money is published, introducing concepts such as the multiplier and promoting activist economic management. 1937 Assists Simon Kuznets’ work on professional incomes at the National Bureau of Economic Research; this work informs their book Income from Independent Professional Practice (see 1945). 1938 Marries Rose Director. 1940 Teaches economics at the University of Wisconsin–Madison as assistant professor. 1942–43 Wartime work on tax policy at the US Department of the Treasury; works on the withholding tax system; co-authors Taxing to Prevent Inflation ; testifies on taxation and inflation in Congress – without mentioning money. 1943 Wartime work as a statistician at the Division of War Research at Columbia University, where he and colleagues at the Statistical

7 MILTON FRIEDMAN | EAMONN BUTLER

Research Group developed the technique of sequential analysis, still used today. The Friedmans’ daughter, Janet, is born; their son, David, is born two years later. 1945–6 Teaches at the University of Minnesota, alongside George Stigler; they collaborate on a pamphlet opposing rent controls, Roofs or Ceilings? 1945 Refines and publishes Income from Independent Professional Practice with Simon Kuznets. This work further convinces Friedman of how government regulation can be counterproductive and harmful to the public. 1946 Awarded PhD from Columbia. Begins a 30-year teaching position in the economics department at the University of Chicago, where he is further influenced by the free-market ideas of Frank Knight and his colleagues; begins his collaboration with economic historian Anna Schwartz; works on the role of money in business cycles at the National Bureau of Economic Research, now headed by Arthur Burns. 1947 At the invitation of F. A. Hayek, Friedman attends the inaugural meeting of the Mont Pelerin Society, with his friend George Stigler and many of the world’s leading liberal scholars. 1948 Friedman’s article ‘A Monetary and Fiscal Framework’ suggests that free-market capitalism is more efficient than socialist alternatives. 1951 Gary Becker, who would subsequently win the Nobel Prize in Economic Science, enters Chicago to study economics – the first of five Nobel laureates who were taught by Friedman. 1951 The American Economic Association awards Friedman the John Bates Clark Medal, the profession’s most prestigious prize. 1953 Essays in Positive Economics argues that the goal of economics is prediction, not the refinement of mathematical models. 1954–55 Fulbright Visiting Fellow at Gonville and Caius College, Cambridge. 1956 Publishes ‘The Quantity Theory of Money: A Restatement’, in Studies in the Quantity Theory of Money , edited by Friedman. 1962 Friedman publishes the bestselling Capitalism and Freedom , which argues for libertarian economic and social policies. 1962–3 Milton and Rose visit 22 countries to study different monetary and political systems.

8 INTRODUCTION

1963 Publishes A Monetary History of the United States with Anna Schwartz. 1964 Economic advisor to the unsuccessful presidential candidate Barry Goldwater. 1965 Friedman publishes The Optimum Quantity of Money: And Other Essays , outlining his monetarist ideas. The Friedmans build a hilltop home in Vermont, where they spend every summer and autumn. 1966–84 Writes a regular column for Newsweek magazine. 1967 Friedman becomes president of the American Economic Association, using his presidential address to introduce the idea of a ‘natural rate of unemployment’. 1968 Publishes Dollars and Deficits , on inflation, monetary policy and balance of payments problems. Recommends flexible exchange rates to US president-elect Richard Nixon; other advice follows, but Friedman splits with Nixon over the wage and price control policy of 1971. 1970 Friedman’s Wincott Memorial Lecture The Counter-Revolution in Monetary Theory brings his ideas to the UK. 1971 Nixon allows the US dollar to float against gold and other countries, precipitating a worldwide move to free exchange rates. 1972 Publishes Price Theory , an important academic work. Friedman has open heart surgery at the Mayo Clinic. 1975 Visits Chile, refusing to speak on official platforms but telling the military dictator, Augusto Pinochet, of the need for economic liberalisation. Pinochet brings in Chicago-trained economists, including students of Friedman, to make the economic reforms. 1976 Receives the Nobel Memorial Prize in Economic Science for his work on consumer behaviour, monetary history and economic stabilisation policy. Published as Inflation and Unemployment , his acceptance speech rejects the idea of a trade-off between inflation and unemployment. 1977 Retires from Chicago and becomes a fellow of the Hoover Institution at Stanford University, California. 1979 Prime minister Margaret Thatcher starts implementing Friedman- style monetarist policies in the UK. 1980 Friedman begins advising US president Ronald Reagan on economic policy.

9 £ +

MILTON FRIEDMAN | EAMONN BUTLER

Free to Choose , a book and TV series, brings Friedman’s ideas to millions of people around the world. Friedman invited to Peking to advise China on the adoption of £ market-economic reforms. 1984 Publishes Tyranny of the Status Quo , noting the “iron triangle” of politicians, officials and beneficiaries that fuels the growth of government. 1988 Friedman is awarded the US Presidential Medal of Freedom. 1989 Collapse of the Berlin Wall and decline of Soviet occupation in Eastern Europe. 1992 Mart Laar becomes prime minister of Estonia and takes his economic policy straight out of Free to Choose . 1998 The Friedmans’ autobiography, Two Lucky People , is published. 2002 The Cato Institute of Washington DC inaugurates the Milton Friedman Prize for Advancing Liberty. 2006 Friedman dies on November 16 in San Francisco, aged 93. Rose Friedman dies three years later.

+

10 £

2 % 1. ThE EcONOMIsT 8 1. WhO chANgED TheE veEcoRynTohmINisg t who changed

everything 8 =

£ * + 1 £ 3 = 4 % 1 8 7 = * + 1 £ € 3 + £ % * £ 5 = 1 % 9 = 6 + % + * % $ £ 5 = € 9 £ % £ $ 4 * 1 4 + 8 + £ $ = 4 £ 2 5 9 £ % + + % 2 5 $ % + % £

=

“There are very few people over the generations who have ideas that are sufficiently original to materially alter the direction of civilization. Milton is one of those very few people.” – Alan Greenspan, former chairman of the US Federal Reserve

WORLDWIDE INFLUENcE

lan Greenspan was right: the change in direction that has resulted from Milton Friedman’s powerfully original work Ais indeed remarkable. For most of Friedman’s career as a professional economist, from the 1930s to the 1980s, the world was dominated by the ideas of government planning, management and control. But at last a new set of ideas started to spread – Milton Friedman’s ideas of free markets, open trade, freedom and capitalism. Though these ideas remain controversial to many, they have become part of the everyday life of billions of the world’s citizens. On the fall of the Berlin Wall and the ending of Soviet occupation in Eastern Europe, the small republic of Estonia embarked on a comprehensive reform programme that lifted the prosperity of its

13 MILTON FRIEDMAN | EAMONN BUTLER citizens to previously undreamed-of levels. Within a decade it had become the most internet-wired country in the world; state industries were privatised, business taxes were abolished, personal taxes were slashed, controls were swept away. Estonia became the Baltic Tiger, a model to which other ex-Soviet countries aspired. Mart Laar, Estonia’s prime minister at the time (1992–94 and 1999–2002), explained the source of his radicalism as he received the 2006 Milton Friedman Prize for Advancing Liberty. In the Soviet era, Western economics books were unobtainable. The only one he could get hold of was Milton Friedman’s Free to Choose (1980). And luckily, he joked, he had none of the West’s mainstream economists around to assure him that these ideas could not possibly work. Facing 1,000% inflation, a 30% drop in the economy and 35% unemployment, he simply adopted Friedman’s ideas. They worked far better than anyone expected.

“Only a crisis – actual or perceived – produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around. That, I believe, is our basic function: to develop alternatives to existing policies, to keep them alive and available until the politically impossible becomes the politically inevitable.” – Milton Friedman, Capitalism and Freedom , Preface to 1982 edition

The passing of the revolutionary communist Mao Zedong saw China opening up to Friedman’s economic thinking too. In 1980, just over a year after the reformist Deng Xiaoping became China’s ‘paramount leader’, Friedman was invited there to lecture on the use of market mechanisms within a planned economy. Today, China’s adoption of market mechanisms has seen it storming up the league table of world economies, and has improved the lives of hundreds of millions of its citizens. Meanwhile, a billion people in India are enjoying another huge economic boost, following the country’s economic liberalisation of 1991, which ended price controls, cut taxes, abolished public

14 THE ECONOMIST WHO CHANGED EVERYTHING | CHAPTER 1 monopolies and scrapped regulations. India’s free-market reforms made it one of the fastest-growing economies in the world, and brought its people rising literacy and life expectancy. The people of India and China may not realise it, commented Nobel economist Gary Becker, but “the person they are most indebted to for the improvement of their situation is Milton Friedman.” On the other side of the world, Friedman’s influence can also be seen in Chile. After the military coup that ended the socialist government of Salvador Allende, Friedman accepted an invitation to lecture there on the merits of economic freedom; and he wrote to the military dictator, Augusto Pinochet, outlining a programme to end the country’s hyperinflation and establish a market economy. Pinochet promoted a number of young Chilean economists – dubbed the Chicago Boys – who had studied at the University of Chicago, where Friedman was a professor. They cut import tariffs, replaced the failing state pension system with one based on personal savings and accounts, privatised farms, stabilised the currency and liberalised the financial sector. Their reforms turned Chile’s economic crisis around, making it one of Latin America’s most thriving economies.

Ongoing impact Today, in countries as diverse as Estonia, China, India and Chile, we can see the benefits of the economic prosperity and personal freedom that have followed the adoption of Friedman’s ideas. Alan Greenspan summed up Friedman’s legacy, saying that: “His impact is not only on the 20th century but on the 21st, and I suspect ongoing.” Friedman was engaged in all the late 20th century’s most bitter but pivotal intellectual conflicts over the role of government in economic and social affairs. For most of that time, his views were very much in the minority. From the upheavals of the 1930s, through the New Deal, to the economic ‘fine-tuning’ and planning of the postwar years, a belief deepened that government activism in the economy was both essential and inevitable – a belief given

15 MILTON FRIEDMAN | EAMONN BUTLER credence by the writings of the time’s most prominent economist, John Maynard Keynes. Further afield, the Soviet Union was dominating Eastern Europe and exporting international socialism to Asia, Africa and Latin America, in an onslaught that seemed unstoppable. Though it often seemed hopeless to resist these sweeping movements, Friedman joined the intellectual battle with enthusiasm. He relished a good argument, and took on even his sternest opponents in a characteristically cheerful manner – his common-sense, optimistic style winning him many supporters. A naturally brilliant teacher and communicator, he spoke to the wider public in popular books, magazine articles and interviews, and through a widely influential worldwide television series, Free to Choose . He was the world’s leading exponent of personal and economic freedom.

Friedman’s economic impact Friedman won important battles in economic science, too. He is best known for his part in the fight against inflation, where his ideas were hugely successful. Through following the high-spending policies of Keynes and his followers, postwar governments had quickly found their finances getting out of control, their currencies losing their value and prices escalating. By the time the Berlin Wall fell in 1989, world inflation was a staggering 19% and rising. At that rate, prices double every five years. “Inflation is a disease”, wrote Friedman: “a dangerous and sometimes fatal disease that, if not checked in time, can destroy a society.” It could not be endured or safely traded off against other economic objectives like employment, as mainstream economists believed. He argued that there was a “natural rate” of unemployment, which reflected the realities of the labour market. When governments adopt high-spending policies to expand employment beyond this level, they succeed only in making things worse. Their policies raise inflation, which undermines the delicate

16 THE ECONOMIST WHO CHANGED EVERYTHING | CHAPTER 1 workings of the market economy, and so causes more unemployment. Friedman was blunt: the source of this disease could be explained in a single sentence – “Inflation is always and everywhere a monetary phenomenon.” To cure inflation, governments must take more care with money. It was a simple message from a brilliant communicator that eventually the world came to understand. As more and more governments adopted Friedman’s advice, world inflation plummeted, from a peak of nearly 29% in 1994 to just over 3% a decade later. With that came a significant rise in peace and prosperity. And most of the credit belongs to Milton Friedman.

ThE MAkINg OF AN EcONOMIsT

Though a staunch defender of free-market capitalism, Friedman came from a poor background. He was born in Brooklyn, New York, in 1912, to Hungarian Jewish immigrant parents. His father traded goods and took work as he could get it, while his mother sewed garments in a New York sweatshop. Some 68 years later, Friedman would take his Free to Choose television audience to exactly the same sort of workshop – this time in Hong Kong – to make the point that, while the pay and conditions might be poor, such places gave unskilled and often unloved immigrants their first step onto the ladder of self-improvement.

“My mother came to this country when she was 14 years old. She worked in a sweatshop as a seamstress, and it was only because there was such a sweatshop in which she could get a job that she was able to come to the US. But she didn’t stay in the sweatshop and neither did most of the others. It was a way station for them, and a far better one than anything available to them in the old country. And she never thought it was anything else. I must say that I find it slightly revolting that people sneer at a system that’s made it possible for them to sneer at it.” – Milton Friedman, Playboy interview (1973)

17 MILTON FRIEDMAN | EAMONN BUTLER

From this foothold, the Friedmans were eventually able to move to a new home, 20 miles from New York, where they lived over the dry-goods store that his mother now ran while his father worked in New York. In Friedman’s early years, the family never earned enough to be above what today would be considered the poverty line; but through hard work they improved their lives. Perhaps significantly for his subsequent career, Friedman’s parents spoke English, not their native Hungarian, in the home. Milton entered school earlier than most other children, and was a voracious reader. At 16, he won a scholarship to study mathematics at Rutgers University. And in addition to what he learnt in class, Rutgers also taught him something about the market. Freshmen at Rutgers were expected to wear green neckties: Friedman and a friend made some money by buying up a stock of these ties and selling them door to door. The next year they did a deal with Barnes & Noble to buy their classmates’ used textbooks and supply new ones. But the big intellectual issue of the time was the stock market crash of 1929 and the Depression that followed it. Two of Friedman’s professors, Arthur Burns and Homer Jones, passed on to him their enthusiasm for how economics might explain these events and prevent them happening again. So Friedman turned to the study of economics. He entered graduate classes at the University of Chicago, under the tutelage of the economists Jacob Viner, Frank Knight and Henry Simons – founders of what subsequently became known as the Chicago School of Economics, which was critical of the prevailing faith in government economic management. It was at Chicago that Friedman met his future wife, Rose Director, with whom he wrote a number of radical books on public policy, and who provided constructive criticism of nearly all of his professional economics works. Friedman graduated in 1933, at the dawn of Roosevelt’s New Deal, with its large-scale public works projects aimed at creating new jobs, and high import tariffs aimed at preserving existing ones.

18 THE ECONOMIST WHO CHANGED EVERYTHING | CHAPTER 1

Roosevelt’s expanding government was sucking in talented economists, and soon Friedman became one of them, joining the National Resources Committee in Washington. His research there on consumer behaviour gave him insights that would subsequently enable him to challenge Keynes himself.

The wartime keynesian Yet at this time, Friedman was – like everyone – a Keynesian. After a short teaching stint and a period at the National Bureau of Economic Research doing research with Simon Kuznets on professional incomes, Friedman returned to Washington in 1942 to undertake wartime work on tax policy for the US Treasury. He even worked on Keynes’s idea of raising taxes to combat inflation, testified to Congress in support of it, and co-authored a 1943 paper on the subject, Taxing to Prevent Inflation . Years later, Friedman would come to support almost any cut in taxes, famously rejecting the notion that tax rises could affect inflation: only changes in the supply of money, he insisted, could do that. But he had yet to develop these groundbreaking ideas: indeed, he never even mentioned money in his 1942 testimony.

“I am in favour of cutting taxes under any circumstances and for any excuse, for any reason, whenever it’s possible.” – Milton Friedman, interview with John Hawkins (2003)

Friedman spent the rest of the Second World War in Columbia University’s Statistical Research Group, where he and colleagues developed a statistical technique known as sequential analysis. It still remains one of the key tools in quality control experiments, such as the clinical trials of new pharmaceuticals. Only after the war did he begin to strike out as a radical and controversial economic thinker.

19 MILTON FRIEDMAN | EAMONN BUTLER

The emerging radical Milton Friedman was scarcely five feet tall. His friend George Stigler was over a foot taller. They acquired ironic nicknames: Mr Macro (Friedman, whose field was macroeconomics, the overall workings of the economy) and Mr Micro (Stigler, who specialised in microeconomics, the behaviour of individual consumers and households). In 1945, Stigler swung Friedman a job at the University of Minnesota, where they collaborated on the pamphlet Roofs or Ceilings? , a pungent repudiation of rent controls. This wartime measure, they argued, had perverse results. By keeping rents down, it made landlords less willing to rent out and maintain their property, reducing both the supply and the quality of accommodation. Economists and politicians considered the pamphlet an uncouth assault on their ability to shape and regulate markets through government action. It was a rude insult to the mood of the times. But it marked the birth of Milton Friedman the free-market economist; and it would be Friedman’s ideas that, albeit much later, would ultimately prevail. The same year, Friedman published Income from Independent Professional Practice , co-authored with Simon Kuznets, outlining the work they had done at the National Bureau of Economic Research. It is a dense statistical work of 600 pages, but it makes a strong public policy argument that Friedman the political radical would come back to again and again. It showed that the chief beneficiaries from occupational licensure – official regulation of professions such as doctors, dentists, lawyers, accountants and engineers – are the professionals themselves, rather than the public whom this measure is supposed to protect. Because regulation restricts competition, the public end up paying higher fees for a poorer service.

20 THE ECONOMIST WHO CHANGED EVERYTHING | CHAPTER 1

The chicago economist Friedman’s career at Minnesota was cut short by the offer of a teaching post at the University of Chicago – America’s leading centre for economics teaching and research. Although Friedman’s early teachers had mostly moved on, Chicago still retained a respect for markets that was deeply unfashionable elsewhere. Heavily influenced by Keynes, the overwhelming majority of economists and political scientists advocated a mixed economy with a large degree of government ownership and control – or even a democratic socialism. It seemed unimaginable that the market could achieve better results than deliberate planning and careful regulation. Keynes had demonstrated, to almost everyone’s satisfaction, that the capitalist economy had run out of steam, and needed government investment to kick-start job creation. Even at the best of times, he thought, capitalism was inherently unstable – a point demonstrated by the 1929 crash and the turmoil that followed. At Chicago, Friedman once again came under the influence of iconoclastic economists, of whom Frank Kinght was probably the most persuasive. Knight understood, and was able to explain, how the market system steered resources to where they were most urgently needed, without the need for government direction, planning or controls. Indeed, one of Knight’s students from the 1940s, James Buchanan – who would also receive the Nobel Prize for economics – wrote that within six weeks of enrolling in Knight’s price theory course, he had been converted from a rabid socialist to a zealous advocate of free markets. Another thing that Knight preached was that nothing should be sacrosanct in academic argument and debate. Though the orthodoxy of the time might be to believe that capitalism had deep failings and needed strong government intervention to correct them, Knight urged his colleagues and students not to shy away from questioning its assumptions, methods and conclusions. For his part, Friedman believed that Keynes’s macroeconomic analysis provided quite a useful way of understanding the economy.

21 MILTON FRIEDMAN | EAMONN BUTLER

Its flaw, though, was that it was riddled with false assumptions and factual mistakes. True to his nickname of Mr Macro, he analysed the economy with the tools that Keynes had invented, using the same sweeping concepts such as national income, government spending, and total unemployment, consumption and investment. Indeed, one of the things that made him so effective a critic of Keynes’s followers was that he argued from within the same framework that they accepted and understood. But he deliberately confronted their prejudices with his 1948 article ‘A Monetary and Fiscal Framework’, which impertinently suggested that unfettered capitalism, built on the foundation of private property, produced much greater economic efficiency – and a larger measure of freedom and democracy too – than the socialist or interventionist alternatives. And this was not a question of theory. It was a matter of evidence . Evidence was at the core of Friedman’s concept of economic science. As he explained in The Methodology of Positive Economics , the choice of what goals we should strive for is a question of values and ethics. But economics must deal with facts, not values. Its subject is whether or not a particular policy helps to achieve our chosen goals. Economics is a science like any other: in science we formulate theories and make predictions about what an action will achieve, and then check the facts to see if we were right. Does the minimum wage, for example, reduce poverty (by giving workers higher wages) or increase it (by creating unemployment)? The evidence provides an answer that people can agree on, regardless of how high they rank poverty among our many social problems.

The monetary theorist To Friedman, economics is about making accurate predictions, not about refining elegant mathematical models. Economists should aim to understand the big economic issues of the day, test their theories against the facts, and so find solutions that improve people’s lives. It may have been this idea that drew him to the fight against inflation – a particularly big problem in the postwar years

22 THE ECONOMIST WHO CHANGED EVERYTHING | CHAPTER 1

– and to the economic theory with which he is most strongly associated, the quantity theory of money. He saw the quantity of money in circulation as a powerful predictor of future prices, and therefore a powerful tool for combating inflation. Keynesians – that is, nearly all of Friedman’s professional contemporaries before the 1980s – dismissed the quantity theory as outdated and crude. At its crudest, it runs like this: governments control the amount of money in their country’s economy by printing new banknotes and minting new coins. If they print or mint a lot more currency, then – like anything that suddenly becomes more plentiful – its value falls. Producers then demand more pounds or more dollars for their goods and services, because they now value those notes and coins less. In other words, prices rise. We call this inflation, and its cause is a rise in the quantity of money. Control the production of money, and you control inflation. Friedman did not invent the quantity theory; it had been around for centuries. But mainstream economists attributed price rises to other causes – the rising cost of oil or food imports, for example. And even if the quantity of money did increase, they thought, people might not spend it; perhaps it would just sit in their wallets or bank accounts, where it had no effect on the economy or prices at all – Keynes’s famous ‘liquidity trap’. By the mid-20th century, the quantity theory seemed dead and buried; but it was not. In a 1956 article, ‘The Quantity Theory of Money: A Restatement’, Friedman brilliantly revived it. The theory’s power to predict inflation hinged not on the supply of money from governments, but on the demand for that money from consumers – the amount that people actually choose to keep readily to hand. Friedman proved that this demand is surprisingly stable. If extra money is created, it does not languish unused in people’s wallets or bank accounts: consumers actually keep a pretty constant amount of cash to hand. Any extra, they spend; and it is this extra spending that bids up prices. The quantity theory really does explain inflation.

23 MILTON FRIEDMAN | EAMONN BUTLER

Friedman’s 1962 A Monetary History of the United States , co- authored with Anna Jacobson Schwartz, demonstrated the impact of money on inflation in enormous detail. It furnished a fine example of the role of money in inflation: during the American Civil War, the South suffered huge price rises – which ended abruptly after Northern troops captured the presses that printed the South’s money. It also showed that the Great Depression, a time of dramatic price falls, stemmed not from any inherent instability of capitalism, but from the US Federal Reserve’s inept constriction of the supply of money.

“During the Civil War the North, late in the Civil War, overran the place in the South where the printing presses were sitting up, where the pieces of paper were being turned out. Prior to that point, the South had a very rapid inflation. If my memory serves me right, something like 4% a month. It took the Confederacy something over two weeks to find a new place where they could set up their printing presses and start them going again. During that two-week period, inflation came to a halt. After the two-week period, when the presses started running again, inflation started up again. It’s that clear, that straightforward.” – Milton Friedman, Free to Choose , Episode 9

Taking on keynes Friedman’s work on consumer behaviour at the National Resources Committee 20 years earlier gave him more facts to back up his thinking. It also enabled him to demolish another key part of Keynes’s economic structure, one that had encouraged governments to expand in size and to raise taxes. Keynes thought that as we grow wealthier, we tend to spend less and save more. With less being spent on goods and services, production would decline and unemployment would rise. That argued for high taxes to limit people’s incomes, and for higher government spending to fill the spending gap.

24 THE ECONOMIST WHO CHANGED EVERYTHING | CHAPTER 1

But in The Theory of the Consumption Function , published in 1957, Friedman showed that people who have different levels of lifetime income actually have remarkably consistent spending and saving habits. Keynes was simply wrong about the facts of human behaviour, and consequently had greatly overstated the need for government spending and taxation.

ThE PUBLIc INTELLEcTUAL

However, the postwar years were dominated by a general belief in the necessity and effectiveness of government controls. Those who, like Friedman, valued individual freedom and supported free- market capitalism were a beleaguered minority. In 1947 the economist and political scientist brought a handful of them together in the Swiss resort of Mont Pelerin. He hoped they could form an intellectual kernel to keep the values of liberalism – in the classical, European sense – alive during what seemed particularly dark times. Two of the participants at Hayek’s meeting were Milton Friedman and his friend George Stigler. Though the ideas of the Mont Pelerin Society, as it became known, remained in the intellectual wilderness for decades, it continued to grow, becoming a leading focus for liberal ideas. It would produce many Nobel economists – including Friedman, Hayek and Stigler – and Friedman would become one of its most distinguished presidents. Some 15 years after that first meeting in Mont Pelerin, Friedman produced a book that changed him from a little-known professional economist (albeit one who focused on the big public issues like inflation) into a famously controversial public intellectual. His 1962 book Capitalism and Freedom , written with his wife Rose, pulled no punches. It began with a thoroughgoing endorsement of the principles of personal liberty on which their

25 MILTON FRIEDMAN | EAMONN BUTLER country was founded. It went on to show how government intervention had eroded this liberty, leaving human society less free and the economy less efficient, capable and prosperous. It closely reflected the views of the 19th-century English philosopher John Stuart Mill: a belief in the dignity of the individual, a conviction that progress occurs only through the genius of individuals, and the conclusion that we must uphold the diversity and variety that allows individualism to flourish. It also drew from the arguments in Hayek’s seminal book The Road to Serfdom , that the greatest threat to freedom and progress is concentrated power. From this liberal foundation, Capitalism and Freedom went on to address the great public issues of the day – economic policy, trade, education, discrimination, monopoly and poverty. Its policy prescriptions seemed unachievably radical at the time; but 40 years on, almost all of them have begun to be implemented or trialled in some part of the world or another. It called for flat taxes, with everyone paying the same rate – a system pioneered by Estonia and now adopted by a score of other countries. It demanded that state- run Ponzi-scheme pension systems should be replaced by saving through personal accounts – a transformation made by Chile and a growing number of other nations. It recommended replacing the state mail service by competition, which is happening today across the European Union. It called for an end to military conscription, a bitter argument in the United States at the time, which Friedman eventually won. It recommended that drugs should be decriminalised – a policy that is now being tested in several places.

“Every friend of freedom. . .must be as revolted as I am by the prospect of turning the United States into an armed camp, by the vision of jails filled with casual drug users and of an army of enforcers empowered to invade the liberty of citizens on slight evidence.” – Milton Friedman in The Wall Street Journal , 7 September 1989

26 THE ECONOMIST WHO CHANGED EVERYTHING | CHAPTER 1

The book was a huge success, selling hundreds of thousands of copies. Milton and Rose called their summer cottage in Vermont Capitaf after it. And it confirmed Friedman’s status as a national controversialist. His quick wit, engaging personality and easy-to- grasp arguments made him a natural participant in any public debate – particularly when some lone voice against mainstream thinking was needed. He wrote magazine articles, appeared on radio discussions, and was always happy to criticise the Federal Reserve at Congressional hearings in Washington.

Political involvement Friedman’s quick mind and economic expertise also put him in demand with politicians. In 1964 he became chief economic advisor to the US presidential candidate Barry Goldwater – though he did not share in any campaigning. Goldwater’s crushing defeat at the hands of his opponent Lyndon Johnson – who branded Goldwater as a bellicose extremist – did nothing to make Friedman’s ideas any more popular. In the early 1970s, President Richard Nixon invited Friedman to be one of his economic advisors. Following Friedman’s guidance, Nixon’s budget director (and fellow Chicago economist) George Schultz ended 25 years of fixed exchange rates and floated the US dollar. But Friedman openly disagreed with Nixon’s introduction of wage and price controls, which he argued would have no impact on the inflation of the time and would only harm the US economy. Later, another President, Ronald Reagan, was much influenced by Friedman, had read his Capitalism and Freedom , would quote him, and accepted the folly of politicians trying to control markets. He consulted Friedman, who advised him to cut spending, taxes and regulation, and pay keen attention to the money supply.

27 MILTON FRIEDMAN | EAMONN BUTLER

Widening influence Friedman found a wider audience with the regular column he wrote in the popular news magazine Newsweek between 1966 and 1984. He produced around 300 of these articles, using them to challenge the economic and political orthodoxy of the day. He explained why minimum wages would hurt young blacks rather than help them; how current policy would produce inflation and recession at the same time (something that mainstream economists thought impossible); how big business talked free markets but prospered on government favours; and many other issues. These Newsweek columns made Friedman one of America’s most prominent – and most controversial – policy thinkers. Gradually, Friedman’s startlingly fresh views, and his clear and unfussy explanations, brought an understanding of economics – and in particular, of free-market economics – to a whole generation of Americans.

“There is a standard pattern. When anybody threatens an orthodox position, the first reaction is to ignore the interloper. The less said about him the better. But if he begins to win a hearing and gets annoying, the second reaction is to ridicule him, make fun of him as an extremist, a foolish fellow who has these silly ideas. After that stage passes, the next, and the most important, stage is to put on his clothes. You adopt for your own his views, and then attribute to him a caricature of those views saying, ‘He’s an extremist, one of those fellows who says only money matters – everybody knows that sort. Of course money does matter, but. . .’ ” – Milton Friedman, The Counter-Revolution in Monetary Theory

But it was in later life that Friedman would gain the widest – indeed, worldwide – exposure for his liberal, free-market ideas. Retiring from Chicago at 65 in 1977, he and Rose moved to California, where he took up a fellowship with the Hoover Institution, a public policy research centre at Stanford University. Shortly afterwards, Robert Chitester, a public broadcaster from

28 THE ECONOMIST WHO CHANGED EVERYTHING | CHAPTER 1

Pennsylvania, put to Friedman an audacious project: a multi- million-dollar documentary series in which he would present his own social, economic and political ideas. There was no script; in each half-hour segment, Friedman merely explained his ideas off the cuff in his usual fluent and candid way, against the backdrop of world locations from America to the Far East. The series, Free to Choose (1980), became an instant hit, and was screened around the globe. The book of the same name stayed on the US best-seller lists for five weeks, selling over a million copies worldwide and earning Friedman more royalties than all of his previous works combined. When asked how he would wish to be remembered, Friedman said he hoped that his professional insights – permanent income, the natural rate of unemployment, the restatement of the quantity theory – would still be considered useful in years to come. “The true test of any scholar’s work”, he told Chitester, “is not what his contemporaries say, but what happens to his work in the next 25 or 50 years. And the thing that I will really be proud of is if some of the work I have done is still cited in the textbooks long after I am gone.” No doubt it will be. But Friedman will be remembered even more for taking on, almost alone, the overwhelming consensus of his times and spreading the ideas and institutions of personal and economic freedom across the greater part of the globe.

29 Milton Friedman A concise guide to the ideas and influence of the free-market economist Eamonn Butler

£ £ +

Available direct from Harriman House and all good booksellers. To order a copy of the print or ebook edition go to:

www.harriman-house.com/miltonfriedman

Paperback: 9780857190369 eBook: 9780857191250