The Age of Milton Friedman

Home , Andrei Shleifer, William Easterly

Journal of Economic Literature 2009, 47:1, 123–135 http:www.aeaweb.org/articles.php?doi=10.1257/jel.47.1.123

Andrei Shleifer*

Between 1980 and 2005, as the world embraced free market policies, living standards rose sharply, while life expectancy, educational attainment, and democracy improved and absolute poverty declined. Is this a coincidence? A collection of essays edited by Balcerowicz and Fischer argues that indeed reliance on free market forces is key to economic growth. A book by Stiglitz and others disagrees. I review and com- pare the two arguments.

1. Introduction also embraced free market policies. All three of these leaders professed inspiration from he last quarter century has witnessed the work of Milton Friedman. It is natural, Tremarkable progress of mankind. The then, to refer to the last quarter century as world’s per capita inflation-adjusted income the Age of Milton Friedman. rose from $5,400 in 1980 to $8,500 in 2005. The association between free mar- Schooling and life expectancy grew rapidly, ket policies and social progress notwith- while infant mortality and poverty fell just standing, economists remain divided in as fast. Compared to 1980, many more coun- their assessments of this Age. Two recent tries in the world are democratic today. books illustrate the divisions. A collection The last quarter century also saw wide of papers edited by Leszek Balcerowicz acceptance of free market policies in both and Stanley Fischer—Living Standards rich and poor countries: from private own- and the Wealth of Nations: Successes and ership, to free trade, to responsible budgets, Failures in Real Convergence (MIT Press, to lower taxes. Three important events mark 2006)—endorses free market policies. A the beginning of this period. In 1979, Deng volume by Joseph E. Stiglitz, José Antonio Xiao Ping started market reforms in China, Ocampo, Shari Spiegel, Richardo Ffrench- which over the quarter century lifted hun- Davis, and Deepak Nayyar—Stability with dreds of millions of people out of poverty. Growth: Macroeconomics, Liberalization, In the same year, Margaret Thatcher was and Development (Oxford University Press, elected Prime Minister in Britain, and initi- 2006)—rejects them. A joint review of these ated her radical reforms and a long period two books allows for a brief look at both the of growth. A year later, Ronald Reagan was facts and the disagreements. elected President of the United States and I begin this review by quickly summariz- ing the salient facts about the world economy and society over the last quarter century. I * Shleifer: Harvard University. then consider the two books in turn. 123

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9,000

8,000

7,000 World GDP per capita PPP 6,000

5,000

1980 1985 1990 1995 2000 2005 Year

Figure 1. World GDP Per Capita PPP (Constant 2000 International Dollar)

Source: World Bank 2006b.

2. Basic Facts the former Soviet Union and Eastern Europe grew slowly during the 1980s, declined Some of the central facts of economic and sharply after the beginning of economic social development during 1980–2005 can reforms, but then expanded rapidly over the be easily summarized in pictures. Figure 1 last decade. shows the evolution of world per capita GDP Figure 3 shows a remarkable decline in at purchasing power parity between 1980 infant mortality in all regions, with the world- and 2005. During this period, world per cap- wide population-weighted average dropping ita income grew at about 2 percent per year. from 64.5 to 37.5 per thousand births. The rest of the figures are organized by Figure 4 presents data on life expectancy, region. Figure 2 presents the growth of per revealing strong increases in all regions but capita income for the main developing regions transition economies and Africa. of the world. Figure 2 shows rapid growth in Figure 5 shows the gains in education East and South Asia (the economic history of around the world. Worldwide population- the last twenty-five years is indeed the story weighted years of schooling grew from 4.4 in of Asia), slow growth in Latin America, and 1980 to almost 6 in 1999. stagnation in Africa. Figure 2 also suggests Figure 6 presents the now-familiar picture that the so-called transition economies of of growth in democracy. With the conspicuous

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8,000

6,000

4,000

2,000

GDP per capita PPP (Const. 2000 INTL) 1980 1985 1990 1995 2000 2005

Year

East Asia Paci c Eastern Europe and Central Asia Latin America and Caribbean Middle East and North Africa South Asia Sub-Saharan Africa

Figure 2. GDP Per Capita PPP (Const. 2000 INTL) (Population Weighted Means by Continent)

Source: World Bank 2006b.

exceptions of China and the Middle East, growth; Sub-Saharan Africa, with little or no the world has made significant strides in economic growth, is where the really poor democratization. Latin America and Eastern are concentrated. Europe are the shining examples. What about economic policies? Figure 7 The World Bank presents figures on pov- shows that the world median (taken over coun- erty based on Yuri Dikhanov (2005). Between tries) inflation rate in 1980 was 14.3 percent; 1980 and 2000, the share of the world’s pop- by 2005 that median declined to 4.1 percent. ulation living on less than $1 a day fell from Figure 8 shows top marginal income tax 34.8 percent to 19 percent. The World Bank rates, which fell around the world from the forecasts that the number of people living on population-weighted average of 65 percent less than $1 a day will continue to fall sharply in 1980 all the way down to 36.7 percent in despite population growth, and account for 2005. 10 percent of the world’s population by 2015. Figure 9 presents official versus black Ironically, the Millennium foreign aid proj- market exchange rates, a common measure ect argues that massive increases in foreign of financial liberalization. In the 1980s, most aid are needed to reach this goal—the World governments restricted foreign exchange Bank forecast suggests that such increases transactions; by 2005 “black market” are unnecessary to reach the 10 percent exchange rates have nearly vanished. goal. Billions of people in Asia have been Figure 10 shows tariff rates, which fell from lifted out of poverty thanks to economic the population-weighted world average of 43

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150

100

1980 1985 1990 1995 2000 2005 Mortality rate of infants (per 1,000 births) Year

East Asia Paci c Eastern Europe and Central Asia Industrialized Latin America and Caribbean Middle East and North Africa South Asia Sub-Saharan Africa

Figure 3. Mortality Rate of Infants (per 1,000 births) (Population Weighted Means by Continents)

Source: World Bank 2006b.

percent in 1980 to 13 percent in 2004, in par- 3. Balcerowicz–Fischer allel with vast expansion in world trade. Finally, figure 11 presents much more Balcerowicz and Fischer edited a recent data on trends in regulation, using the collection of articles presented at a con- number of procedures an entrepreneur must ference in Poland devoted to convergence follow before he can legally start a business among economies. Most of the contributions (Simeon Djankov et al. 2002). These data are country studies of economic reforms are only available since 1999. Over the last and their consequences. In addition to theo- six years, these data show downward trends, retical and historical papers, these include although East Asia and Latin America remain studies of China, Chile, Spain, Portugal, heavily overregulated. Greece, Ireland, as well as the Former The message of these figures is simple. Soviet Union. The conclusion of the book is In the Age of Milton Friedman, the world summarized by the editors more than once: economy expanded greatly, the quality of life “reliance on market forces within an open improved sharply for billions of people, and economy in a stable macroeconomic envi- dire poverty was substantially scaled back. ronment, with assured property rights, are All this while the world embraced free mar- the keys to rapid economic growth.” Milton ket reforms. Is this a coincidence? Two recent Friedman would have put it better, but with books disagree on the answer. the same idea.

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40 Life expectancy at birth (total years) (total birth at expectancy Life 1980 1985 1990 1995 2000 2005

Year

East Asia Paci c Eastern Europe and Central Asia Industrialized Latin America and Caribbean Middle East and North Africa South Asia Sub-Saharan Africa

Figure 4. Life Expectancy at Birth (Total Years) (Population Weighted Means by Continents)

Source: World Bank 2006b.

To convey the flavor of the book, I briefly market policies, and in particular of export- focus on a few studies I liked the most. Wing led growth. He presents a great deal of evi- Thye Woo asks whether the extraordinary dence, and his story is compelling. China, like success of China is due to its embrace of free much of the rest of Asia, succeeded because market policies, or the deviations from those. it embraced capitalism—including a largely Since the beginning of China’s reforms, China open economy, financial stability, and reason- specialists have argued that China succeeded ably secure property rights for entrepreneurs, in its transition because of its deviations from despite, not because of, the “Chinese charac- free market policies. First, there was the idea teristics” of its program. that China’s township village enterprises, with Anders Åslund draws attention to the their uncertain ownership structures, were extraordinary acceleration of growth in the responsible for its success. Others claimed former Soviet Union at the beginning of that China’s dual pricing system—in contrast the twenty-first century. The growth has to market pricing—avoided the bankruptcy of been pervasive, in both resource-rich and state enterprises, and thus helped economic resource-poor countries, and has accelerated growth. Still later, we heard that China’s delay just as Eastern Europe began to slow down. of privatization and retention of a large state Åslund was among the first to point out the sector explains its success. Woo debunks the explosion of growth in the region and to argue argument that the key to China’s success that market reforms have worked. Åslund’s is anything other than its adoption of free explanation of the acceleration of growth in

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6 Education 4

1980 1985 1990 1995 2000

Year

East Asia Paci c Eastern Europe and Central Asia Industrialized Latin America and Caribbean Middle East and North Africa South Asia Sub-Saharan Africa

Figure 5. Education (Years of Schooling) (Population Weighted Means by Continent)

Source: Barro and Lee 2000.

the former Soviet Union, and deceleration in there are certain key prerequisites neces- Eastern Europe, is smaller government bud- sary to sustain high growth—namely, sound gets and lower taxes in the former. There is macroeconomic policies, a strong commit- much to be said for the huge success of low tax ment to free trade, a lightly regulated com- policies in many countries in the region during petitive microeconomic environment, and this period. But an important part of explain- a well-educated and flexible labor force” (p. ing the evidence is also the longer recession 285). Starting as one of Western Europe’s in the former Soviet Union: the fruits of free laggards, Ireland became the richest country market reforms ripened in the late 1990s, five of the region in the span of one generation. years after they did in Eastern Europe. Nearly all the essays in the volume note The collection also includes a pair of essays roles of fiscal restraint and low inflation in —one by Thomas O’Connell and Diarmaid encouraging economic growth. This is true Smyth and one by John Bradley—on about essays on wealthy economies joining Ireland, the miracle of Western Europe. the European Union, such as Spain, and As much as any other country in the world, those on developing countries, such as Chile. Ireland embraced the prescriptions of Milton The Chile essay, by Vittorio Corbo L. and Friedman: trade openness, low taxes, low Leonardo Hernández T., includes a convinc- regulations, and balanced budgets. “The ing discussion of the role of responsible fiscal main lesson from the Irish experience is that policy and financial regulation in allowing the

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4 Democracy 2

1980 1985 1990 1995 2000 2005

Year

East Asia Paci c Eastern Europe and Central Asia Industrialized Latin America and Caribbean Middle East and North Africa South Asia Sub-Saharan Africa

Figure 6. Democracy (Population Weighted Means by Continent. 0=low 10=high) Source: Jaggers and Marshall 2000.

country to sail smoothly through the Asian Australia and New Zealand. Such talk might financial crisis. Corbo and Hernández briefly be ambitious, but it shows where free market mention capital controls in Chile (a subject I policies got the Chileans. later return to), but do not give them much credit for Chile’s stability, and approvingly 4. Stiglitz et al. report their abolition in 2001. Interestingly, the Balcerowicz–Fischer The world is a much gloomier place in the book is framed in terms of not just growth, volume Stability with Growth by Stiglitz, but convergence. There is no talk of per- Ocampo, Spiegel, Ffrench-Davis, and Nayyar manent backwardness, or of fundamental (hereafter Stiglitz et al.). The book is an irreversible differences between, say, transi- extended critique of free-market policies and tion economies and the rich West European their advocates, and a proposal for alterna- countries. Rather, the question is what poli- tive policies. This volume does not deal with cies will accelerate convergence. Nor is this all the policies Stiglitz has embraced, such thinking confined to transition economies. as state ownership and extensive regulation. When I visited Chile a decade ago, its It merely emphasizes the virtues of inflation ambition was to overtake Argentina. When and capital controls. I visited in 2007, the question on the minds Central to the organization of the book, of many policymakers was convergence to Stiglitz et al. classify economists concerned

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In ation in consumer prices (Annual %) 1980 1985 1990 1995 2000 2005

Year

East Asia Pacic Eastern Europe and Central Asia Latin America and Caribbean Middle East and North Africa South Asia Sub-Saharan Africa

Figure 7. Inflation in Consumer Prices (Annual %) (Median by Region. Excluding Eastern Europe and Central Asia)

Source: World Bank 2006b.

with policy into three types. The first is “stan- World Bank, and the United States Treasury. dard Keynesian” economists, who adopt the As a consequence, the world came close to an 1960s Keynesian model and focus on coun- economic cataclysm. tercyclical fiscal policy. Since most of these Finally, there are the “heterodox” econo- economists are long retired or dead by now, mists, like Stiglitz et al. “The heterodox they receive little attention. approach attempts to bridge the gap by The second type is “conservative” or “neo- building a coherent model of the economy, classical” economists (this is an upgrade based on realistic micro-foundations, which from being called “market fundamental- recognize that information and markets are ists” in earlier Stiglitz books). Conservative imperfect” (p. 39). In this approach, neoclas- economists, according to Stiglitz et al., rely sical factors play a bigger role than they do in on a neoclassical model that assumes com- Keynesian models, yet market imperfections petitive markets, rational consumers, and are also appreciated. In other words, hetero- profit-maximizing firms. They do not believe dox economists are reasonable middle-road- in market failure and therefore in government ers squeezed between the two extremes of intervention. They seek to achieve zero infla- standard Keynesians and conservatives. Note tion and balanced budgets. Unfortunately the crucial rhetorical structure of the classi- for the world, in the 1990s these economists fication: just as consumers faced with the took over policy making at the IMF, the choice of three toasters—an expensive one,

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100

Top marginal income tax rate 20

1980 1985 1990 1995 2000 2005

Year

East Asia Paci c Eastern Europe and Central Asia Industrialized Latin America and Caribbean Middle East and North Africa South Asia Sub-Saharan Africa

Figure 8. Top Marginal Income Tax Rate (Population Weighted Means by Continents. Scale 0 to 100%)

Source: Gwartney, Lawson, and Easterly 2006.

a cheap one, and a mid-price one—tend to of economic policy making—abroad as well pick the one in the middle, so a reasonable as in Washington, D.C. The book becomes reader should avoid the extremes and opt for a lopsided dialogue between the real (and the “heterodox” position on economic policy. heterodox) Socrates, and the fictitious (and The image of Stiglitz as the man in the mid- conservative) Eutyphro. dle might surprise those who see him as the Setting aside the rhetorical methods, con- academic spokesman of the antiglobalizers, sider the two substantive issues that Stiglitz but here it is. et al. address. The first is inflation. Stiglitz The deeper problem with the classifica- et al. argue repeatedly that conservative tion is that there are not many conserva- economists believe in balanced budgets tives, as defined by Stiglitz et al., involved in and zero inflation, but that in reality there economic policy making. Economists who is not much evidence that moderate infla- have held high positions at the World Bank, tion is detrimental to economic growth. To the IMF, and the U.S. Treasury during the bolster this claim, Stiglitz et al. present one period in question can scarcely be described of the few tables in the book, aptly entitled as Walrasian purists, let alone as conserva- “Countries where inflation has not impeded tives. As Stiglitz et al. classify their targets, growth.” The data for that table draw on a the traditional Keynesians are dead, and the 1998 paper by Michael Bruno and William conservatives are absent from the centers Easterly—Bruno presumably being one of

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Of cial vs. black maket exchange rate 1980 1985 1990 1995 2000 2005

Year

East Asia Paci c Eastern Europe and Central Asia Industrialized Latin America and Caribbean Middle East and North Africa South Asia Sub-Saharan Africa

Figure 9. Official vs. Black Market Exchange Rate (Population Weighted Means by Continents. Scale 0=worst to 10=best)

Source: Gwartney, Lawson, and Easterly 2006.

the “conservatives” who served as the Chief to countries that lost control of their fiscal Economist of the World Bank in the 1990s. policy, including many Latin American and Bruno and Easterly find no evidence that transition economies. inflation rates below 40 percent have adverse The second policy that Stigltz et al. attack effects on growth. A more recent study is capital market liberalization. Instead, (Mohsin S. Khan and Abdelhak S. Senhadji they favor capital controls as a way to stem 2001) from the IMF presents evidence that the inflow and the outflow of speculative the thresholds beyond which inflation has finance. In this, Stiglitz et al. clearly do not adverse effects on growth are lower, at 11 to share the views of the authors of papers in 12 percent, not zero. Balcerowicz–Fischer, who generally see the The point is not that there are literally integration into world capital (and not just no advocates of zero inflation for develop- goods) markets as an essential part of their ing countries. I am sure there are some, nations’ growth strategies. although I did not find them, for example, Although the book presents little evi- in the Balcerowicz–Fischer volume. Rather, dence, it repeatedly mentions the exam- Stiglitz et al. claim for themselves the views ple of Malaysia as a country that imposed that seem rather conventional in the corridors capital controls during the Asian crisis and of power. And they express little concern for that has recovered splendidly as a conse- the huge costs that high inflation has brought quence. The question of whether capital

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100

40 Mean tariff rate 02

1980 1985 1990 1995 2000 2005

Year

East Asia Paci c Eastern Europe and Central Asia Industrialized Latin America and Caribbean Middle East and North Africa South Asia Sub-Saharan Africa

Figure 10. Mean Tariff Rate (Population Weighted Means by Continents. % Terms)

Source: Gwartney, Lawson, and Easterly 2006.

controls, which were imposed very late in One way to give the readers of this review an the crisis, have helped Malaysia, is actu- overall sense of this book is with an example. ally quite controversial, and many recent On p. 70, Stiglitz et al. chastise conservatives commentators fail to find evidence that for objecting to fiscal deficits by making “argu- they had macroeconomic benefits (see, e.g., ments based on the hard-to-verify notion of Simon Johnson et al. 2006; Eswar S. Prasad confidence.” “Despite how frequently con- and Raghuram G. Rajan 2008). Ironically, servatives invoke the confidence argument, Stiglitz et al.’s own data show South Korea there’s remarkably little empirical research recovering much faster than Malaysia (p. on the matter (including little research by the 183), a finding they do not mention. In IMF which seems to rely on the confidence contrast, it is uncontroversial that capi- argument heavily).” Then, on p. 148, Stiglitz tal controls in Malaysia have encouraged et al. attack George Bush’s budget deficits, misallocation of capital and corruption—a equally severely. “What will happen, not just key concern of the critics, which Stiglitz to the United States, but to the stability of the et al. briefly bring up and dismiss. Johnson global financial system if foreigners lose con- et al. (2006) present compelling evidence fidence (emphasis added) in the strength of that Malaysian capital controls encouraged the dollar, if they worry that it will depreci- corruption and benefited firms close to the ate in value in coming years?” A reader might Prime Minister. lose confidence in the rest of the book.

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Number of procedures 6

1999 2001 2003 2005

Year

East Asia Paci c Eastern Europe and Central Asia Industrialized Latin America and Caribbean Middle East and North Africa South Asia Sub-Saharan Africa

Figure 11. Number of Procedures to Start a Business (Population Weighted Means by Continents)

Source: World Bank 2006a.

5. Conclusion troubles along the way raised questions about appropriate tactics of policy reform. The last quarter century of world develop- Grappling with these questions improved ment has presented economists interested in our understanding of the workings of market economic policy with many complex chal- economies, and of interactions between the lenges. To name a few, economies moving state and the private sector. Transition has from socialism to capitalism and embracing taught us that economic and political disor- market policies at first collapsed, and began ganization, combined with obsolete human growing only after three to six years. The capital of both economic agents and politi- rapidly growing and heavily market oriented cians, can sharply slow down the economic Asian economies suffered major setbacks in turnaround. The Asian crisis has reinforced the late 1990s, with major recessions that the centrality of the financial system in the slowed them down for at least a couple of workings of a market economy, and exposed years. The economies of South America the vulnerability of that system to financial embraced budget discipline and privatiza- bubbles and generally imprudent financial tion in the 1980s and 1990s, yet showed truly arrangements. The Latin American expe- lackluster economic growth. Importantly, rience has laid bare the fact that private many of these regions ended the era in a ownership and fiscal prudence yield only spurt of rapid economic growth, but the limited benefits in a regime of overbearing

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taxation and regulation. All these episodes hostile to business. Many countries desper- taught important lessons for the tactics of ately need improvements in their legal sys- economic policy making. tems, including bankruptcy systems, to secure Perhaps the crux of these lessons is to focus property rights. Indeed, many Sub-Saharan on the right problem. The two areas of the African countries are rethinking their devel- world facing most dramatic economic chal- opment strategies, after several state-centered lenges today are Africa and Latin America. false starts. It is far from a foregone conclu- When thinking about their growth perfor- sion that their governments will make good mance, surely the most obvious problem is choices. We have a long haul ahead of us. the lack of new businesses and investment, References particularly in the formal sector. It seems Balcerowicz, Leszek, and Stanley Fischer, eds. 2006. highly unlikely that the central challenges Living Standards and the Wealth of Nations: Suc- have to do with whether inflation should be cesses and Failures in Real Convergence. Cambridge above or below 10 percent (so long as public and London: MIT Press. Barro, Robert J., and Jong-Wha Lee. 2000. “Inter- deficits are under control), or whether there national Data on Educational Attainment Updates should be a 0 or 1 percent transaction tax and Implications.” National Bureau of Economic on capital flows (so long as capital markets Research Working Paper 7911. Bruno, Michael, and William Easterly. 1998. “Inflation are broadly open). It seems obvious that the Crises and Long-Run Growth.” Journal of Monetary central challenges have to do with the short- Economics, 41(1): 3–26. ages of human capital, and with predatory Dikhanov, Yuri. 2005. “Trends in Global Income Dis- tribution, 1970–2000, and Scenarios for 2015.” In regulatory and tax policies conducted by UNDP Human Development Report 2005. New African and Latin American states. Indeed, York: United Nations Development Programme. my feeling is that reducing the burdens of Djankov, Simeon, Rafael La Porta, Florencio Lopez- de-Silanes, and Andrei Shleifer. 2002. “The Regu- (particularly corporate) taxation and regula- lation of Entry.” Quarterly Journal of Economics, tion, and replacing extremely inefficient reg- 117(1): 1–37. ulations with more appropriate ones, are the Gwartney, James, Robert Lawson, with William East- erly. 2006. Economic Freedom of the World: 2006 central challenges facing many developing Annual Report. Vancouver: Fraser Institute. www. countries today. The World Bank has prop- freetheworld.com erly drawn attention to the necessary reforms Jaggers, Keith, and Monty G. Marshall. 2000. “Polity IV Project.” Center for International Development through its Doing Business report, and we and Conflict Management, University of Maryland. have seen significant steps toward progress, http://www.systemicpeace.org/polity/polity4.htm. especially among transition economies. Johnson, Simon, Todd Mitton, Kalpana Kochhar, and Natalia T. Tamirisa. 2006. “Malaysian Capital Con- But tactics is only part of a broader strat- trols: Macroeconomics and Institutions.” Interna- egy. On strategy, economics got the right tional Monetary Fund Working Paper 06/51. answer: free market policies, supported but Khan, Mohsin S., and Abdelhak S. Senhadji. 2001. “Threshold Effects in the Relationship between In- not encumbered by the government, deliver flation and Growth.” IMF Staff Papers, 48(1): 1–21. growth and prosperity. And while a lot has Prasad, Eswar S., and Raghuram G. Rajan. 2008. “A been accomplished in the last quarter century, Pragmatic Approach to Capital Account Liberal- ization.” Journal of Economic Perspectives, 22(3): a lot remains to be done. Most countries have 149–72. embraced responsible fiscal policies, but it is Stiglitz, Joseph E., Jose Antonio Ocampo, Shari Spie- far from clear that such policies can survive gel, Ricardo Ffrench-Davis, and Deepak Nayyar. 2006. Stability with Growth: Macroeconomics, the volatility in the world’s economy. World Liberalization, and Development. Oxford and New trade has a long way to go to become truly York: Oxford University Press. open. Many developing countries, especially in World Bank. 2006a. “Doing Business.” www.doing- business.org. South Asia, Latin America, and Sub-Saharan World Bank. 2006b. “World Development Indicators Africa, urgently need government much less Online.”

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