THE UNDERRATED POWER OF ECONOMISTS

Milton Friedman was the most prominent fighter for the free market. Who succeeds him?

By Uwe Jean Heuser

[This article published in: DIE ZEIT 48/2006 is translated from the German on the World Wide Web,  http://images.zeit.de/text/2006/48/Nachruf-Friedman.]


Economists have incredible influence, John Meynard Keynes said. “Their ideas, whether right or wrong, are more powerful than usually assumed.” The thinkers write down something in some back rooms. Later they fixed these ideas in the heads of practitioners and moved the world.

This is a great insight and yet is only a half-truth. The economists who first moved the thinking of their guild and then the world were not grey theoreticians. They had a concrete view of the world and could think politically. They sought to simplify their ideas and formulate them for everybody in a catchy way. They were charismatic and humorous. If one of their theses proved untenable, they didn’t insist on it – unlike many of their followers who after decades would not move an iota from their faith system. Keynes was such an economist like Milton Friedman, his influential opponent in the 20th century. Friedman died last week at the age of 94.

The economic debate functions like a pendulum in the big questions – the role of the state, the attitude to the market and the importance of the freedom of the individual. For years, this debate moved in one direction while other economists set different ideas in the world that led later to a counter-movement. During the Great Depression between the two world wars, the Brit John Meynard Keynes came to an insight that was implemented in the 1960s. The state must guide the economy by its spending to prevent the danger of standstill and depression. “We are all Keynesians,” US president Richard Nixon said in 1971. From then on, Keynesianism went downhill.

Milton Friedman had the alternative ready. His ideas also needed several decades and a global oil crisis before they shifted the pendulum with rage in the other direction. Up to today, Friedman’s work has been important on two planes, in economic research and in the public debate around worldviews.

No one including his many adversaries denies that the child of immigrants from Brooklyn, New York was a highly gifted economist. He quickly advanced to the core of important debates and sought to give them a new direction with clear simple arguments. Keynes was a great economist, Friedman said, but the Brit erred in the conviction that the state could guide the economy through the volume of its expenditures. Public spending would push back and not stimulate private investments, Friedman claimed. If necessary, the economy could be stimulated with low interest rates. However that was only a short-term remedy Thus the central banks and the state should not get involved in the economy but merely ensure that the money supply constantly grows.

CITIZENS CANNOT BE OUTWITTED

Friedman’s two-part argument strikes the core of Keynesianism. The first part said: Forget the instrument of higher state spending; state spending fizzles out. . In reality, only monetary policy counted. In a mammoth work on the monetary history of the US, he and his colleague presented evidence for this thesis and laid the foundation for a monetarism that starting from Chicago conquered the world for a time.

The second part said: Even active monetary policy leads to ruin after a while. The subject becomes taboo! In an important address, Friedman emphasized the so-called Philips curve that describes how unemployment falls when inflation rises. Remember, the master from Chicago cried to the assembled colleagues, the citizens aren’t idiots. Fiscal leaders could surprise them with higher inflation and seduce them to offer their labor too cheaply. However in 2005, citizens understood the trick with higher inflation. To realize a surprise effect, the fiscal leaders must let inflation rise again – until it is so high the economy collapses.

In the 1950s, Friedman attacked the prevailing assumptions about the conduct of consumers. People were in no way only focused on how much income they could expect next year. Their life income was the theme… If the economy was stimulated in the short-term, the consumers would not react. Accordingly Keynes’ thesis of the threatened consumer strike that counteracts inflation was wrong. For his early works, Friedman received the Nobel Prize in 1976.

Friedman the economist prevailed although monetarism in its pure form broke down. With time, he recognized the central banks could hardly determine or control the money supply. They may not ignore the real economy – and do not do this today. Consciousness of the dangers of inflation has grown in the European Union and globally.

Friedman’s students failed in building a theory around the rational person who foresees inflation and constantly has in mind his life income. Still that did not reduce the effect of the man from Chicago. He always knew theories are not permanent wise sayings but arguments in the great debates that are constantly improved and sometimes refuted. Young economists bridge over many differences between Keynesians and monetarists and adopt important insights from both.

SOCIAL HOUSING? STATE PENSIONS? MINIMUM WAGE? EVERYTHING IS GIVEN UP!

Friedman the ideologist was more successful than Friedman the economist. “If the free market economy were not the most efficient system, I would still prefer it – on account of its values: freedom of choice, challenge and risk.” This was the creed of the market radical. Whether the state driver’s license, doctor’s license, drug prohibition or abortion prohibition – Friedman wanted them all abolished. He regarded the welfare state as a costly monster benefiting only bureaucrats, politicians and small interest groups. Social housing? Absurd. State pensions? Madness. Minimum wage? Don’t you dare! As a substitute for the welfare state regulating everything, Milton Friedman suggested a negative income tax giving a basic income to everybody. Many economists are still proponents of this idea because, according to the argument, the individual knows best what is good for him or her.

In brilliantly written best-sellers, Friedman set individual freedom on a huge pedestal. Many of his demands – unlike his scholarly works – were far from reality. But with his idea of a libertarian society, he set the direction in the US and Great Britain. Friedman prepared the way for Ronald Reagan in the White House and Margaret Thatcher in 10 Downing Street. He advised the democratically elected US president Reagan and also the Chilean dictator Augusto Pinochet whose government was a plaything for Friedman’s Chicago Boys.

In the middle of the 1980s, the world had turned in his direction. He was more popular than ever. Before his followers in a convention hotel in San Francisco, one could hear the short lively man with the tiger’s grin. First, he described his libertarian worldview and then flirted with a confession: “My son here is still young,” the 76-year old said, he wants a state share of zero. I am not so radical. Ten percent is a good round number.”

The share actually rose after the Second World War in the relatively liberal US from 20 to 40 percent and continues there. Still the state intervenes much less than in the past. Friedman prepared the way for what opponents describe as neoliberalism: faith in privatization and liberalization, in a free market and a boundless economy. Paul Samuelson, the founder of modern textbook economics, an old friend and often antagonist of Friedman, now praised the deceased with the following well-chosen words: “No one else had as much ideological influence on the economy in the 20th century: from faith in the benefactor state in the time of the Great Depression to enthusiasm and trust in the free market. We economists have lost one of the very greats.” Samuelson himself refused the ideologizing of his discipline where he could.

The Friedman of the last years was surprising in many regards. Unlike his wife and co-author Rose, he was against the Iraq war which he considered an aggression of the US against a foreign power. The growing inequality in the US and the impoverishment of the lower strata worried him. Sooner or later they will give new support to the friends of the welfare state. Poor schools were responsible, Friedman found. Early on he proposed giving families vouchers for private schools of their choice.

Like Keynes, Friedman understood the nature of the economic debate. If capitalism goes too far in one direction, the counter-movement will come even faster. “We are all neoliberals,” said George W. Bush who has lowered taxes for the rich. The neoliberals are now slowly losing their prominent position. The inequalities produced by the international competition are too great. The ambivalent results of privatization are too visible. In Great Britain, the state has grown again after the Thatcher era and gains new influence. In the US, the demands for social corrections are growing. The rhetoric has also changed in Germany where the dominant arguments are always rattled off very loudly while economic policy is rather hesitant.

The question about the next movement is raised. Its first signs are manifest. The state should demand more from individuals (Promote and Demand) and from institutions like schools (performance comparisons). The rich should also be moved to share. The state should not dance to the tune of whole industries like the energy economy. Individual countries and the world community should find means to protect the losers of globalization.

What persons will follow Keynes and Friedman, the great polarizers? They are not the leading globalization critics like Joseph Stiglitz and Jeffrey Sachs. Their part is too small. No great totality results from their past theoretical studies and their present commentaries.

The most influential economists of the past derived many insights from their view of the person. Today many researchers are revising this economic view of the person. Perhaps these are the first signs of revolution. Perhaps the movement does not have a single face this time. Still that is not probable. What is likely is that somewhere in a backroom a gifted charismatic will write down ideas which politicians and researchers will use – to change the world.