milton friedman - harriman house about the author vii introduction 1 a timeline of milton...

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MILTONFRIEDMAN

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MILTONFRIEDMAN

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

EAMONN BUTLER

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HARRIMAN HOUSE LTD

3A Penns RoadPetersfieldHampshireGU32 2EWGREAT BRITAIN

Tel: +44 (0)1730 233870Fax: +44 (0)1730 233880Email: [email protected]: 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 inaccordance with the Copyright, Design and Patents Act 1988.

ISBN: 978-0857-1-90369

British Library Cataloguing in Publication DataA 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 aretrieval system, or transmitted in any form or by any means, electronic,mechanical, photocopying, recording, or otherwise without the prior writtenpermission of the Publisher. This book may not be lent, resold, hired out orotherwise disposed of by way of trade in any form of binding or cover other thanthat 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 orrefraining to act as a result of reading material in this book can be accepted by thePublisher, by the Author, or by the employer(s) of the Author.

Published in association with the Institute of Economic Affairs. The mission of theInstitute of Economic Affairs is to improve understanding of the fundamentalinstitutions of a free society by analysing and expounding the role of markets insolving 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 1A timeline of Milton Friedman's life and work 7

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

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

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

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

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

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

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

Further reading 143

Index 147

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MILTON FRIEDMAN | EAMONN BUTLER $

ABOUT ThE AUThOR

Eamonn Butler is director of the Adam Smith Institute, rated oneof the world’s leading policy think tanks. He has degrees ineconomics, philosophy and psychology, gaining a PhD from theUniversity of St Andrews in 1978. During the 1970s he worked onpensions and welfare issues for the US House of Representatives,and taught philosophy in Hillsdale College, Michigan, beforereturning to the UK to help found the Adam Smith Institute. Eamonn is author of books on the pioneering economists F. A.

Hayek, Ludwig von Mises and Adam Smith. He is also co-authorof Forty Centuries of Wage and Price Controls, and of a series ofbooks on intelligence testing. Eamonn contributes to the leading UK print and broadcast

media on current issues, and his recent popular books The BestBook on the Market, The Rotten State of Britain and The AlternativeManifesto have attracted considerable attention.

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INTRODUcTION

“Milton Friedman was a very great man indeed – a manof intellectual courage who was one of the mostimportant economic thinkers of all time, and possiblythe most brilliant communicator of economic ideas tothe general public that ever lived.”

– Nobel economist Paul Krugman, New York Reviewof Books

What this book is about

This book guides the reader through the startlingly originalideas of Milton Friedman (1912–2006) – a Nobel laureatein economics, but best known to many for his TV series

and book Free to Choose (1980), a searing critique of biggovernment 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 inAmerica. In the 1970s, it underpinned the replacement of fixedexchange rates by open currency markets and free trade. In the1980s, it contributed to the demise of Soviet communism in theEast and to privatisation in the West. In the 1990s, it provided theblueprint for reform as countries in Eastern Europe and Latin

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America emerged from years of totalitarianism. By the 2000s, ithad helped cut world inflation to a tenth of what it had been adecade before.Friedman was the best-known economist of his generation. He

undid the grip that Keynesianism – based on the thinking of JohnMaynard Keynes, with its faith in large-scale government spendingand intervention – held over postwar politicians and economists.The radical alternative he created – Monetarism – called insteadfor sound money, balanced budgets and deregulation. And heshowed how the Great Depression of the 1930s was caused, not bysome failure of capitalism, but by a profound failure of government– drawing lessons that are just as relevant to how we should handlefinancial crises today.But Friedman was much more than an economist. At a time

when the world was bitterly divided between capitalism andcommunism, he threw himself into every major debate on howsociety should be organised. He became the world’s leadingadvocate of personal and economic freedom; and his argumentshelped change the politics of a generation.

What this book coversThis book does not go into the academic detail of Friedman’s

economic ideas – though it does explain many of them in astraightforward and accessible way. It focuses more on hisinnovative public policy thinking – and how his prescriptions ledto 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, maildelivery, defence and other public services; how governmentscreate 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 governmentgrows, and why so much that it does is counterproductive; why

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MILTON FRIEDMAN | EAMONN BUTLER

drugs policy has failed, and what we should do instead; whyfreedom cannot be traded for equality; the rights of minorities; andindeed 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 ofthe time, showing just how revolutionary they appeared to hiscolleagues and contemporaries. And it places them in the contextof the policy debate today, showing how many of them, onceshocking, have become commonplace parts of our lives.

Who this book is forThis book is consciously written for the intelligent layperson who

is interested in the debate on how our social and economic livesshould 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’ssubject, himself laid out most of that case at one point or anotherin his various books and articles. This book organises all thatmaterial into a short, structured guide.The book aims to explain Friedman’s ideas straightforwardly,

without distortion and in plain language. Hence there are noacademic-style footnotes or bibliography – just an essential readinglist 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 conciseinsight into a set of radical ideas and opinions that are frequentlydismissed or ignored in orthodox economics and social scienceteaching. 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 ofthe New Right in the 1980s and 1990s. His ideas had huge influenceon policy makers such as Reagan, Thatcher, the US Federal ReserveChairman Alan Greenspan, the Estonian Prime Minister Mart

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INTRODUCTION

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

Friedman and the author…I knew Milton Friedman. As a student I found his Capitalism and

Freedom (1962) breathtaking in its originality – an exhilaratinglibertarian alternative to the prevailing mood. So I was thrilled tomeet him at the 1974 conference of the Mont Pelerin Society – theinternational association of free-market, liberal thinkers which heco-founded – and again a year later at the next conference in myown university of St Andrews, and at many other events over thenext 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 insimple language – a book about which he was very kind, andcharacteristically encouraging.

…and this bookPeople 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 ideaswere 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 wrotethis book on the eve of his centenary year, a good moment to takestock of his life’s work and lasting influence. Friedman’s writtenwork amounted to scores of books, both technical and non-technical, and hundreds of articles, not to mention his TV seriesand countless media appearances and interviews. My ambition is

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only to distil from all this the essence of Friedman’s ideas andpresent 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 hastested his ideas – as in the practical difficulties that the financialauthorities found when they did try to control money and inflationas Friedman prescribed. As for his libertarian social policies – decriminalising drugs,

ending the state licensing of doctors and lawyers, getting thegovernment out of hospitals, schools and universities – Friedmanremains, as he once put it, “so happily blessed with critics” that Isee no point in adding myself to them here.

how this book is structuredThe book is not a chronological history of Friedman’s life and

work. Rather, it is structured round the key themes of hiscontributions 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 hissubsequent, glittering career and continuing influence today, thebook moves first to outline his contribution in economics. Inparticular it sets out his dispute with Keynes over the causes offinancial crises such as the Great Depression, his view that‘stimulus’ packages actually make things worse – an argument thatis still very relevant today – and his groundbreaking insights intothe 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 internationalmarkets; it then outlines his explanation of why he thought mostgovernment programmes are either a failure or a fraud, andrecounts his recommendations for rolling back the state.

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INTRODUCTION

The book then lays out Friedman’s ideas as the leading advocateof free and largely unregulated markets, and his explanation of whyhe thought free markets allocated resources so much moreefficiently – and fairly – than governments. This leads on to Friedman’s libertarian views on freedom,

equality, the limited but important role of government, and hisrobust but humane faith in the “genius” of free individuals in a freesociety.

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A TIMELINE OF MILTONFRIEDMAN’s LIFE AND WORk

1912 Milton Friedman born in Brooklyn, New York, to JewishHungarian immigrant parents; his father trades goods while hismother sews garments in a New York sweatshop.

1928–32 Reads mathematics at Rutgers University; meets economistsArthur Burns and Homer Jones.

1932–33 At the University of Chicago as a graduate student; influenced byeconomists Jacob Viner, Frank Knight and Henry Simons; meetshis future wife Rose Director; graduates with a master’s degree ineconomics.

1929 The Wall Street crash heralds a decade of economic turmoil, theGreat 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; meetsGeorge Stigler, who would become a lifelong friend and fellowNobel economist.

1935 Begins work on consumer spending at the National ResourcesCommittee in Washington; this work informs his subsequent bookThe Theory of the Consumption Function.

1936 Keynes’s General Theory of Employment, Interest and Money ispublished, introducing concepts such as the multiplier andpromoting activist economic management.

1937 Assists Simon Kuznets’ work on professional incomes at theNational Bureau of Economic Research; this work informs theirbook Income from Independent Professional Practice (see 1945).

1938 Marries Rose Director.

1940 Teaches economics at the University of Wisconsin–Madison asassistant 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 PreventInflation; testifies on taxation and inflation in Congress – withoutmentioning money.

1943 Wartime work as a statistician at the Division of War Research atColumbia University, where he and colleagues at the Statistical

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INTRODUCTION

Research Group developed the technique of sequential analysis,still used today.

The Friedmans’ daughter, Janet, is born; their son, David, is borntwo years later.

1945–6 Teaches at the University of Minnesota, alongside George Stigler;they collaborate on a pamphlet opposing rent controls, Roofs orCeilings?

1945 Refines and publishes Income from Independent ProfessionalPractice with Simon Kuznets. This work further convincesFriedman of how government regulation can be counterproductiveand harmful to the public.

1946 Awarded PhD from Columbia.

Begins a 30-year teaching position in the economics departmentat the University of Chicago, where he is further influenced by thefree-market ideas of Frank Knight and his colleagues; begins hiscollaboration with economic historian Anna Schwartz; works onthe role of money in business cycles at the National Bureau ofEconomic Research, now headed by Arthur Burns.

1947 At the invitation of F. A. Hayek, Friedman attends the inauguralmeeting of the Mont Pelerin Society, with his friend George Stiglerand many of the world’s leading liberal scholars.

1948 Friedman’s article ‘A Monetary and Fiscal Framework’ suggeststhat free-market capitalism is more efficient than socialistalternatives.

1951 Gary Becker, who would subsequently win the Nobel Prize inEconomic Science, enters Chicago to study economics – the firstof five Nobel laureates who were taught by Friedman.

1951 The American Economic Association awards Friedman the JohnBates Clark Medal, the profession’s most prestigious prize.

1953 Essays in Positive Economics argues that the goal of economics isprediction, 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’, inStudies in the Quantity Theory of Money, edited by Friedman.

1962 Friedman publishes the bestselling Capitalism and Freedom, whichargues for libertarian economic and social policies.

1962–3 Milton and Rose visit 22 countries to study different monetary andpolitical systems.

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1963 Publishes A Monetary History of the United States with AnnaSchwartz.

1964 Economic advisor to the unsuccessful presidential candidate BarryGoldwater.

1965 Friedman publishes The Optimum Quantity of Money: And OtherEssays, outlining his monetarist ideas.

The Friedmans build a hilltop home in Vermont, where they spendevery summer and autumn.

1966–84 Writes a regular column for Newsweekmagazine.

1967 Friedman becomes president of the American EconomicAssociation, using his presidential address to introduce the ideaof a ‘natural rate of unemployment’.

1968 Publishes Dollars and Deficits, on inflation, monetary policy andbalance of payments problems.

Recommends flexible exchange rates to US president-elect RichardNixon; other advice follows, but Friedman splits with Nixon overthe wage and price control policy of 1971.

1970 Friedman’s Wincott Memorial Lecture The Counter-Revolution inMonetary Theory brings his ideas to the UK.

1971 Nixon allows the US dollar to float against gold and othercountries, 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 themilitary dictator, Augusto Pinochet, of the need for economicliberalisation. 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 hiswork on consumer behaviour, monetary history and economicstabilisation policy. Published as Inflation and Unemployment, hisacceptance speech rejects the idea of a trade-off between inflationand unemployment.

1977 Retires from Chicago and becomes a fellow of the HooverInstitution 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 oneconomic policy.

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INTRODUCTION

Free to Choose, a book and TV series, brings Friedman’s ideas tomillions of people around the world.

Friedman invited to Peking to advise China on the adoption ofmarket-economic reforms.

1984 Publishes Tyranny of the Status Quo, noting the “iron triangle” ofpoliticians, officials and beneficiaries that fuels the growth ofgovernment.

1988 Friedman is awarded the US Presidential Medal of Freedom.

1989 Collapse of the Berlin Wall and decline of Soviet occupation inEastern Europe.

1992 Mart Laar becomes prime minister of Estonia and takes hiseconomic 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 MiltonFriedman Prize for Advancing Liberty.

2006 Friedman dies on November 16 in San Francisco, aged 93. RoseFriedman dies three years later.

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“There are very few people over the generations whohave ideas that are sufficiently original to materiallyalter the direction of civilization. Milton is one of thosevery few people.”

– Alan Greenspan, former chairman of the USFederal Reserve

WORLDWIDE INFLUENcE

Alan Greenspan was right: the change in direction that hasresulted from Milton Friedman’s powerfully original workis indeed remarkable. For most of Friedman’s career as a

professional economist, from the 1930s to the 1980s, the world wasdominated by the ideas of government planning, management andcontrol. But at last a new set of ideas started to spread – MiltonFriedman’s ideas of free markets, open trade, freedom andcapitalism. Though these ideas remain controversial to many, theyhave become part of the everyday life of billions of the world’scitizens.On the fall of the Berlin Wall and the ending of Soviet occupation

in Eastern Europe, the small republic of Estonia embarked on acomprehensive reform programme that lifted the prosperity of its

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citizens to previously undreamed-of levels. Within a decade it hadbecome the most internet-wired country in the world; stateindustries were privatised, business taxes were abolished, personaltaxes were slashed, controls were swept away. Estonia became theBaltic 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 receivedthe 2006 Milton Friedman Prize for Advancing Liberty. In theSoviet era, Western economics books were unobtainable. The onlyone he could get hold of was Milton Friedman’s Free to Choose(1980). And luckily, he joked, he had none of the West’smainstream economists around to assure him that these ideascould not possibly work. Facing 1,000% inflation, a 30% drop inthe economy and 35% unemployment, he simply adoptedFriedman’s ideas. They worked far better than anyone expected.

“Only a crisis – actual or perceived – produces real change. Whenthat crisis occurs, the actions that are taken depend on the ideasthat are lying around. That, I believe, is our basic function: todevelop alternatives to existing policies, to keep them alive andavailable until the politically impossible becomes the politicallyinevitable.”

– Milton Friedman, Capitalism and Freedom, Preface to 1982edition

The passing of the revolutionary communist Mao Zedong sawChina 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 theuse of market mechanisms within a planned economy. Today,China’s adoption of market mechanisms has seen it storming upthe league table of world economies, and has improved the lives ofhundreds of millions of its citizens.Meanwhile, a billion people in India are enjoying another huge

economic boost, following the country’s economic liberalisationof 1991, which ended price controls, cut taxes, abolished public

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monopolies and scrapped regulations. India’s free-market reformsmade it one of the fastest-growing economies in the world, andbrought its people rising literacy and life expectancy. The peopleof India and China may not realise it, commented Nobel economistGary Becker, but “the person they are most indebted to for theimprovement 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 socialistgovernment of Salvador Allende, Friedman accepted an invitationto lecture there on the merits of economic freedom; and he wroteto the military dictator, Augusto Pinochet, outlining a programmeto end the country’s hyperinflation and establish a marketeconomy. Pinochet promoted a number of young Chileaneconomists – dubbed the Chicago Boys – who had studied at theUniversity of Chicago, where Friedman was a professor. They cutimport tariffs, replaced the failing state pension system with onebased on personal savings and accounts, privatised farms,stabilised the currency and liberalised the financial sector. Theirreforms turned Chile’s economic crisis around, making it one ofLatin America’s most thriving economies.

Ongoing impactToday, in countries as diverse as Estonia, China, India and Chile,

we can see the benefits of the economic prosperity and personalfreedom that have followed the adoption of Friedman’s ideas. AlanGreenspan summed up Friedman’s legacy, saying that: “His impactis not only on the 20th century but on the 21st, and I suspectongoing.” Friedman was engaged in all the late 20th century’s most bitter

but pivotal intellectual conflicts over the role of government ineconomic and social affairs. For most of that time, his views werevery much in the minority. From the upheavals of the 1930s,through the New Deal, to the economic ‘fine-tuning’ and planningof the postwar years, a belief deepened that government activismin the economy was both essential and inevitable – a belief given

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THE ECONOMIST WHO CHANGED EVERYTHING | CHAPTER 1

credence by the writings of the time’s most prominent economist,John Maynard Keynes. Further afield, the Soviet Union wasdominating Eastern Europe and exporting international socialismto Asia, Africa and Latin America, in an onslaught that seemedunstoppable.Though it often seemed hopeless to resist these sweeping

movements, Friedman joined the intellectual battle withenthusiasm. He relished a good argument, and took on even hissternest opponents in a characteristically cheerful manner – hiscommon-sense, optimistic style winning him many supporters. Anaturally brilliant teacher and communicator, he spoke to the widerpublic in popular books, magazine articles and interviews, andthrough a widely influential worldwide television series, Free toChoose. He was the world’s leading exponent of personal andeconomic freedom.

Friedman’s economic impactFriedman won important battles in economic science, too. He is

best known for his part in the fight against inflation, where hisideas were hugely successful. Through following the high-spendingpolicies of Keynes and his followers, postwar governments hadquickly found their finances getting out of control, their currencieslosing their value and prices escalating. By the time the Berlin Wallfell in 1989, world inflation was a staggering 19% and rising. Atthat 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 asociety.” It could not be endured or safely traded off against othereconomic objectives like employment, as mainstream economistsbelieved. He argued that there was a “natural rate” ofunemployment, which reflected the realities of the labour market.When governments adopt high-spending policies to expandemployment beyond this level, they succeed only in making thingsworse. Their policies raise inflation, which undermines the delicate

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workings of the market economy, and so causes moreunemployment.Friedman was blunt: the source of this disease could be explained

in a single sentence – “Inflation is always and everywhere amonetary phenomenon.” To cure inflation, governments must takemore care with money. It was a simple message from a brilliantcommunicator that eventually the world came to understand. Asmore and more governments adopted Friedman’s advice, worldinflation plummeted, from a peak of nearly 29% in 1994 to justover 3% a decade later. With that came a significant rise in peaceand prosperity. And most of the credit belongs to Milton Friedman.

ThE MAkINg OF AN EcONOMIsTThough a staunch defender of free-market capitalism, Friedmancame from a poor background. He was born in Brooklyn, NewYork, in 1912, to Hungarian Jewish immigrant parents. His fathertraded goods and took work as he could get it, while his mothersewed garments in a New York sweatshop. Some 68 years later,Friedman would take his Free to Choose television audience toexactly the same sort of workshop – this time in Hong Kong – tomake the point that, while the pay and conditions might be poor,such places gave unskilled and often unloved immigrants their firststep onto the ladder of self-improvement.

“My mother came to this country when she was 14 years old. Sheworked in a sweatshop as a seamstress, and it was only becausethere was such a sweatshop in which she could get a job that shewas able to come to the US. But she didn’t stay in the sweatshopand 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 oldcountry. And she never thought it was anything else. I must saythat I find it slightly revolting that people sneer at a system that’smade it possible for them to sneer at it.”

– Milton Friedman, Playboy interview (1973)

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From this foothold, the Friedmans were eventually able to moveto a new home, 20 miles from New York, where they lived over thedry-goods store that his mother now ran while his father workedin New York. In Friedman’s early years, the family never earnedenough to be above what today would be considered the povertyline; 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 avoracious reader. At 16, he won a scholarship to study mathematicsat Rutgers University. And in addition to what he learnt in class,Rutgers also taught him something about the market. Freshmen atRutgers were expected to wear green neckties: Friedman and afriend made some money by buying up a stock of these ties andselling them door to door. The next year they did a deal withBarnes & Noble to buy their classmates’ used textbooks and supplynew ones. But the big intellectual issue of the time was the stock market

crash of 1929 and the Depression that followed it. Two ofFriedman’s professors, Arthur Burns and Homer Jones, passed onto him their enthusiasm for how economics might explain theseevents and prevent them happening again. So Friedman turned tothe study of economics. He entered graduate classes at the University of Chicago, under

the tutelage of the economists Jacob Viner, Frank Knight andHenry Simons – founders of what subsequently became known asthe Chicago School of Economics, which was critical of theprevailing faith in government economic management. It was atChicago that Friedman met his future wife, Rose Director, withwhom he wrote a number of radical books on public policy, andwho provided constructive criticism of nearly all of his professionaleconomics works. Friedman graduated in 1933, at the dawn of Roosevelt’s New

Deal, with its large-scale public works projects aimed at creatingnew jobs, and high import tariffs aimed at preserving existing ones.

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Roosevelt’s expanding government was sucking in talentedeconomists, and soon Friedman became one of them, joining theNational Resources Committee in Washington. His research thereon consumer behaviour gave him insights that would subsequentlyenable him to challenge Keynes himself.

The wartime keynesianYet at this time, Friedman was – like everyone – a Keynesian.

After a short teaching stint and a period at the National Bureau ofEconomic Research doing research with Simon Kuznets onprofessional incomes, Friedman returned to Washington in 1942to undertake wartime work on tax policy for the US Treasury. Heeven worked on Keynes’s idea of raising taxes to combat inflation,testified to Congress in support of it, and co-authored a 1943 paperon 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 affectinflation: only changes in the supply of money, he insisted, coulddo 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 forany 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 ColumbiaUniversity’s Statistical Research Group, where he and colleaguesdeveloped a statistical technique known as sequential analysis. Itstill remains one of the key tools in quality control experiments,such as the clinical trials of new pharmaceuticals. Only after thewar did he begin to strike out as a radical and controversialeconomic thinker.

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The emerging radicalMilton Friedman was scarcely five feet tall. His friend George

Stigler was over a foot taller. They acquired ironic nicknames: MrMacro (Friedman, whose field was macroeconomics, the overallworkings of the economy) and Mr Micro (Stigler, who specialisedin microeconomics, the behaviour of individual consumers andhouseholds). In 1945, Stigler swung Friedman a job at theUniversity of Minnesota, where they collaborated on the pamphletRoofs or Ceilings?, a pungent repudiation of rent controls. Thiswartime measure, they argued, had perverse results. By keepingrents down, it made landlords less willing to rent out and maintaintheir property, reducing both the supply and the quality ofaccommodation.Economists and politicians considered the pamphlet an uncouth

assault on their ability to shape and regulate markets throughgovernment action. It was a rude insult to the mood of the times.But it marked the birth of Milton Friedman the free-marketeconomist; 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, outliningthe work they had done at the National Bureau of EconomicResearch. It is a dense statistical work of 600 pages, but it makes astrong public policy argument that Friedman the political radicalwould come back to again and again. It showed that the chiefbeneficiaries from occupational licensure – official regulation ofprofessions such as doctors, dentists, lawyers, accountants andengineers – are the professionals themselves, rather than the publicwhom this measure is supposed to protect. Because regulationrestricts competition, the public end up paying higher fees for apoorer service.

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The chicago economistFriedman’s career at Minnesota was cut short by the offer of a

teaching post at the University of Chicago – America’s leadingcentre for economics teaching and research. Although Friedman’searly teachers had mostly moved on, Chicago still retained arespect for markets that was deeply unfashionable elsewhere.Heavily influenced by Keynes, the overwhelming majority ofeconomists and political scientists advocated a mixed economywith a large degree of government ownership and control – or evena democratic socialism. It seemed unimaginable that the marketcould achieve better results than deliberate planning and carefulregulation. Keynes had demonstrated, to almost everyone’ssatisfaction, that the capitalist economy had run out of steam, andneeded government investment to kick-start job creation. Even atthe best of times, he thought, capitalism was inherently unstable –a point demonstrated by the 1929 crash and the turmoil thatfollowed. At Chicago, Friedman once again came under the influence of

iconoclastic economists, of whom Frank Kinght was probably themost persuasive. Knight understood, and was able to explain, howthe market system steered resources to where they were mosturgently needed, without the need for government direction,planning or controls. Indeed, one of Knight’s students from the1940s, James Buchanan – who would also receive the Nobel Prizefor economics – wrote that within six weeks of enrolling in Knight’sprice theory course, he had been converted from a rabid socialistto a zealous advocate of free markets. Another thing that Knight preached was that nothing should be

sacrosanct in academic argument and debate. Though theorthodoxy of the time might be to believe that capitalism had deepfailings and needed strong government intervention to correctthem, Knight urged his colleagues and students not to shy awayfrom 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.

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Its flaw, though, was that it was riddled with false assumptions andfactual mistakes. True to his nickname of Mr Macro, he analysedthe economy with the tools that Keynes had invented, using thesame sweeping concepts such as national income, governmentspending, and total unemployment, consumption and investment.Indeed, one of the things that made him so effective a critic ofKeynes’s followers was that he argued from within the sameframework that they accepted and understood. But he deliberatelyconfronted their prejudices with his 1948 article ‘A Monetary andFiscal Framework’, which impertinently suggested that unfetteredcapitalism, built on the foundation of private property, producedmuch greater economic efficiency – and a larger measure offreedom and democracy too – than the socialist or interventionistalternatives. And this was not a question of theory. It was a matterof 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 valuesand ethics. But economics must deal with facts, not values. Itssubject is whether or not a particular policy helps to achieve ourchosen goals. Economics is a science like any other: in science weformulate theories and make predictions about what an action willachieve, and then check the facts to see if we were right. Does theminimum wage, for example, reduce poverty (by giving workershigher wages) or increase it (by creating unemployment)? Theevidence provides an answer that people can agree on, regardlessof how high they rank poverty among our many social problems.

The monetary theoristTo Friedman, economics is about making accurate predictions,

not about refining elegant mathematical models. Economistsshould aim to understand the big economic issues of the day, testtheir theories against the facts, and so find solutions that improvepeople’s lives. It may have been this idea that drew him to the fightagainst inflation – a particularly big problem in the postwar years

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– and to the economic theory with which he is most stronglyassociated, the quantity theory of money. He saw the quantity ofmoney in circulation as a powerful predictor of future prices, andtherefore a powerful tool for combating inflation. Keynesians – that is, nearly all of Friedman’s professional

contemporaries before the 1980s – dismissed the quantity theoryas outdated and crude. At its crudest, it runs like this: governmentscontrol the amount of money in their country’s economy byprinting new banknotes and minting new coins. If they print ormint a lot more currency, then – like anything that suddenlybecomes more plentiful – its value falls. Producers then demandmore pounds or more dollars for their goods and services, becausethey now value those notes and coins less. In other words, pricesrise. We call this inflation, and its cause is a rise in the quantity ofmoney. Control the production of money, and you controlinflation.Friedman did not invent the quantity theory; it had been around

for centuries. But mainstream economists attributed price rises toother 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 walletsor bank accounts, where it had no effect on the economy or pricesat 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 ofMoney: A Restatement’, Friedman brilliantly revived it. Thetheory’s power to predict inflation hinged not on the supply ofmoney from governments, but on the demand for that money fromconsumers – the amount that people actually choose to keepreadily to hand. Friedman proved that this demand is surprisinglystable. If extra money is created, it does not languish unused inpeople’s wallets or bank accounts: consumers actually keep a prettyconstant amount of cash to hand. Any extra, they spend; and it isthis extra spending that bids up prices. The quantity theory reallydoes explain inflation.

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Friedman’s 1962 A Monetary History of the United States, co-authored with Anna Jacobson Schwartz, demonstrated the impactof money on inflation in enormous detail. It furnished a fineexample of the role of money in inflation: during the AmericanCivil War, the South suffered huge price rises – which endedabruptly after Northern troops captured the presses that printedthe South’s money. It also showed that the Great Depression, a timeof dramatic price falls, stemmed not from any inherent instabilityof capitalism, but from the US Federal Reserve’s inept constrictionof the supply of money.

“During the Civil War the North, late in the Civil War, overran theplace in the South where the printing presses were sitting up,where the pieces of paper were being turned out. Prior to thatpoint, the South had a very rapid inflation. If my memory servesme right, something like 4% a month. It took the Confederacysomething over two weeks to find a new place where they couldset up their printing presses and start them going again. Duringthat two-week period, inflation came to a halt. After the two-weekperiod, when the presses started running again, inflation startedup again. It’s that clear, that straightforward.”

– Milton Friedman, Free to Choose, Episode 9

Taking on keynesFriedman’s work on consumer behaviour at the National

Resources Committee 20 years earlier gave him more facts to backup his thinking. It also enabled him to demolish another key partof Keynes’s economic structure, one that had encouragedgovernments 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. Thatargued for high taxes to limit people’s incomes, and for highergovernment spending to fill the spending gap.

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But in The Theory of the Consumption Function, published in1957, Friedman showed that people who have different levels oflifetime income actually have remarkably consistent spending andsaving habits. Keynes was simply wrong about the facts of humanbehaviour, and consequently had greatly overstated the need forgovernment spending and taxation.

ThE PUBLIc INTELLEcTUAL

However, the postwar years were dominated by a general belief inthe necessity and effectiveness of government controls. Those who,like Friedman, valued individual freedom and supported free-market capitalism were a beleaguered minority. In 1947 theeconomist and political scientist Friedrich Hayek brought ahandful of them together in the Swiss resort of Mont Pelerin. Hehoped they could form an intellectual kernel to keep the values ofliberalism – in the classical, European sense – alive during whatseemed particularly dark times.Two of the participants at Hayek’s meeting were Milton

Friedman and his friend George Stigler. Though the ideas of theMont Pelerin Society, as it became known, remained in theintellectual wilderness for decades, it continued to grow, becominga leading focus for liberal ideas. It would produce many Nobeleconomists – including Friedman, Hayek and Stigler – andFriedman 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-knownprofessional economist (albeit one who focused on the big publicissues like inflation) into a famously controversial publicintellectual.His 1962 book Capitalism and Freedom, written with his wife

Rose, pulled no punches. It began with a thoroughgoingendorsement of the principles of personal liberty on which their

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country was founded. It went on to show how governmentintervention had eroded this liberty, leaving human society lessfree and the economy less efficient, capable and prosperous. Itclosely reflected the views of the 19th-century English philosopherJohn Stuart Mill: a belief in the dignity of the individual, aconviction that progress occurs only through the genius ofindividuals, and the conclusion that we must uphold the diversityand variety that allows individualism to flourish. It also drew fromthe arguments in Hayek’s seminal book The Road to Serfdom, thatthe 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 policyprescriptions seemed unachievably radical at the time; but 40 yearson, almost all of them have begun to be implemented or trialled insome part of the world or another. It called for flat taxes, witheveryone paying the same rate – a system pioneered by Estonia andnow adopted by a score of other countries. It demanded that state-run Ponzi-scheme pension systems should be replaced by savingthrough personal accounts – a transformation made by Chile anda growing number of other nations. It recommended replacing thestate mail service by competition, which is happening today acrossthe European Union. It called for an end to military conscription,a bitter argument in the United States at the time, which Friedmaneventually won. It recommended that drugs should bedecriminalised – a policy that is now being tested in several places.

“Every friend of freedom. . .must be as revolted as I am by theprospect of turning the United States into an armed camp, by thevision of jails filled with casual drug users and of an army ofenforcers empowered to invade the liberty of citizens on slightevidence.”

– Milton Friedman in The Wall Street Journal, 7 September1989

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The book was a huge success, selling hundreds of thousands ofcopies. Milton and Rose called their summer cottage in VermontCapitaf after it. And it confirmed Friedman’s status as a nationalcontroversialist. His quick wit, engaging personality and easy-to-grasp arguments made him a natural participant in any publicdebate – particularly when some lone voice against mainstreamthinking was needed. He wrote magazine articles, appeared onradio discussions, and was always happy to criticise the FederalReserve at Congressional hearings in Washington.

Political involvementFriedman’s quick mind and economic expertise also put him in

demand with politicians. In 1964 he became chief economicadvisor to the US presidential candidate Barry Goldwater – thoughhe did not share in any campaigning. Goldwater’s crushing defeatat the hands of his opponent Lyndon Johnson – who brandedGoldwater as a bellicose extremist – did nothing to makeFriedman’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) GeorgeSchultz ended 25 years of fixed exchange rates and floated the USdollar. But Friedman openly disagreed with Nixon’s introductionof wage and price controls, which he argued would have no impacton 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 quotehim, and accepted the folly of politicians trying to control markets.He consulted Friedman, who advised him to cut spending, taxesand regulation, and pay keen attention to the money supply.

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Widening influenceFriedman found a wider audience with the regular column he

wrote in the popular news magazine Newsweek between 1966 and1984. He produced around 300 of these articles, using them tochallenge the economic and political orthodoxy of the day. Heexplained why minimum wages would hurt young blacks ratherthan help them; how current policy would produce inflation andrecession at the same time (something that mainstream economiststhought impossible); how big business talked free markets butprospered on government favours; and many other issues. TheseNewsweek columns made Friedman one of America’s mostprominent – and most controversial – policy thinkers. Gradually,Friedman’s startlingly fresh views, and his clear and unfussyexplanations, brought an understanding of economics – and inparticular, of free-market economics – to a whole generation ofAmericans.

“There is a standard pattern. When anybody threatens an orthodoxposition, the first reaction is to ignore the interloper. The less saidabout him the better. But if he begins to win a hearing and getsannoying, the second reaction is to ridicule him, make fun of himas an extremist, a foolish fellow who has these silly ideas. After thatstage passes, the next, and the most important, stage is to put onhis clothes. You adopt for your own his views, and then attributeto him a caricature of those views saying, ‘He’s an extremist, oneof those fellows who says only money matters – everybody knowsthat sort. Of course money does matter, but. . .’ ”

– Milton Friedman, The Counter-Revolution in MonetaryTheory

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 toCalifornia, where he took up a fellowship with the HooverInstitution, a public policy research centre at Stanford University.Shortly afterwards, Robert Chitester, a public broadcaster from

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Pennsylvania, put to Friedman an audacious project: a multi-million-dollar documentary series in which he would present hisown 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 FarEast. The series, Free to Choose (1980), became an instant hit, andwas screened around the globe. The book of the same name stayedon the US best-seller lists for five weeks, selling over a millioncopies worldwide and earning Friedman more royalties than all ofhis 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 quantitytheory – would still be considered useful in years to come. “Thetrue test of any scholar’s work”, he told Chitester, “is not what hiscontemporaries say, but what happens to his work in the next 25or 50 years. And the thing that I will really be proud of is if someof the work I have done is still cited in the textbooks long after Iam gone.” No doubt it will be. But Friedman will be remembered even more

for taking on, almost alone, the overwhelming consensus of histimes and spreading the ideas and institutions of personal andeconomic freedom across the greater part of the globe.

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