Monetarism was a powerful force in economic debate for about three decades after Friedman first propounded the doctrine in his 1959 book A Program for Monetary Stability. Today, however, it is a shadow of its former self, for two main reasons.
First, when the United States and the United Kingdom tried to put monetarism into practice at the end of the 1970s, both experienced dismal results: in each country steady growth in the money supply failed to prevent severe recessions. The Federal Reserve officially adopted Friedman-type monetary targets in 1979, but effectively abandoned them in 1982 when the unemployment rate went into double digits. This abandonment was made official in 1984, and ever since then the Fed has engaged in precisely the sort of discretionary fine-tuning that Friedman decried. For example, the Fed responded to the 2001 recession by slashing interest rates and allowing the money supply to grow at rates that sometimes exceeded 10 percent per year. Once the Fed was satisfied that the recovery was solid, it reversed course, raising interest rates and allowing growth in the money supply to drop to zero.
Second, since the early 1980s the Federal Reserve and its counterparts in other countries have done a reasonably good job, undermining Friedman’s portrayal of central bankers as irredeemable bunglers. Inflation has stayed low, recessions—except in Japan, of which more in a second—have been relatively brief and shallow. And all this happened in spite of fluctuations in the money supply that horrified monetarists, and led them—Friedman included—to predict disasters that failed to materialize. As David Warsh of The Boston Globe pointed out in 1992, “Friedman blunted his lance forecasting inflation in the 1980s, when he was deeply, frequently wrong.”
By 2004, the Economic Report of the President, written by the very conservative economists of the Bush administration, could nonetheless make the highly anti-monetarist declaration that “aggressive monetary policy”—not stable, steady-as-you-go, but aggressive—“can reduce the depth of a recession.”
Now, a word about Japan. During the 1990s Japan experienced a sort of minor-key reprise of the Great Depression. The unemployment rate never reached Depression levels, thanks to massive public works spending that had Japan, with less than half America’s population, pouring more concrete each year than the United States. But the very low interest rate conditions of the Great Depression reemerged in full. By 1998 the call money rate, the rate on overnight loans between banks, was literally zero.
And under those conditions, monetary policy proved just as ineffective as Keynes had said it was in the 1930s. The Bank of Japan, Japan’s equivalent of the Fed, could and did increase the monetary base. But the extra yen were hoarded, not spent. The only consumer durable goods selling well, some Japanese economists told me at the time, were safes. In fact, the Bank of Japan found itself unable even to increase the money supply as much as it wanted. It pushed vast quantities of cash into circulation, but broader measures of the money supply grew very little. An economic recovery finally began a couple of years ago, driven by a revival of business investment to take advantage of new technological opportunities. But monetary policy never was able to get any traction.
In effect, Japan in the Nineties offered a fresh opportunity to test the views of Friedman and Keynes regarding the effectiveness of monetary policy in depression conditions. And the results clearly supported Keynes’s pessimism rather than Friedman’s optimism.
In 1946 Milton Friedman made his debut as a popularizer of free-market economics with a pamphlet titled “Roofs or Ceilings: The Current Housing Problem” coauthored with George J. Stigler, who would later join him at the University of Chicago. The pamphlet, an attack on the rent controls that were still universal just after World War II, was released under rather odd circumstances: it was a publication of the Foundation for Economic Education, an organization which, as Rick Perlstein writes in Before the Storm (2001), his book about the origins of the modern conservative movement, “spread a libertarian gospel so uncompromising it bordered on anarchism.” Robert Welch, the founder of the John Birch Society, sat on the FEE’s board. This first venture in free-market popularization prefigured in two ways the course of Friedman’s career as a public intellectual over the next six decades.
First, the pamphlet demonstrated Friedman’s special willingness to take free-market ideas to their logical limits. Neither the idea that markets are efficient ways to allocate scarce goods nor the proposition that price controls create shortages and inefficiency was new. But many economists, fearing the backlash against a sudden rise in rents (which Friedman and Stigler predicted would be about 30 percent for the nation as a whole), might have proposed some kind of gradual transition to decontrol. Friedman and Stigler dismissed all such concerns.
In the decades ahead, this single-mindedness would become Friedman’s trademark. Again and again, he called for market solutions to problems—education, health care, the illegal drug trade—that almost everyone else thought required extensive government intervention. Some of his ideas have received widespread acceptance, like replacing rigid rules on pollution with a system of pollution permits that companies are free to buy and sell. Some, like school vouchers, are broadly supported by the conservative movement but haven’t gotten far politically. And some of his proposals, like eliminating licensing procedures for doctors and abolishing the Food and Drug Administration, are considered outlandish even by most conservatives.
Second, the pamphlet showed just how good Friedman was as a popularizer. It’s beautifully and cunningly written. There is no jargon; the points are made with cleverly chosen real-world examples, ranging from San Francisco’s rapid recovery from the 1906 earthquake to the plight of a 1946 veteran, newly discharged from the army, searching in vain for a decent place to live. The same style, enhanced by video, would mark Friedman’s celebrated 1980 TV series Free to Choose.
The odds are that the great swing back toward laissez-faire policies that took place around the world beginning in the 1970s would have happened even if there had been no Milton Friedman. But his tireless and brilliantly effective campaign on behalf of free markets surely helped accelerate the process, both in the United States and around the world. By any measure—protectionism versus free trade; regulation versus deregulation; wages set by collective bargaining and government minimum wages versus wages set by the market—the world has moved a long way in Friedman’s direction. And even more striking than his achievement in terms of actual policy changes has been the transformation of the conventional wisdom: most influential people have been so converted to the Friedman way of thinking that it is simply taken as a given that the change in economic policies he promoted has been a force for good. But has it?
Consider first the macroeconomic performance of the US economy. We have data on the real income—that is, income adjusted for inflation—of American families from 1947 to 2005. During the first half of that fifty-eight-year stretch, from 1947 to 1976, Milton Friedman was a voice crying in the wilderness, his ideas ignored by policymakers. But the economy, for all the inefficiencies he decried, delivered dramatic improvements in the standard of living of most Americans: median real income more than doubled. By contrast, the period since 1976 has been one of increasing acceptance of Friedman’s ideas; although there remained plenty of government intervention for him to complain about, there was no question that free-market policies became much more widespread. Yet gains in living standards have been far less robust than they were during the previous period: median real income was only about 23 percent higher in 2005 than in 1976.
Part of the reason the second postwar generation didn’t do as well as the first was a slower overall rate of economic growth—a fact that may come as a surprise to those who assume that the trend toward free markets has yielded big economic dividends. But another important reason for the lag in most families’ living standards was a spectacular increase in economic inequality: during the first postwar generation income growth was broadly spread across the population, but since the late 1970s median income, the income of the typical family, has risen only about a third as fast as average income, which includes the soaring incomes of a small minority at the top.
This raises an interesting point. Milton Friedman often assured audiences that no special institutions, like minimum wages and unions, were needed to ensure that workers would share in the benefits of economic growth. In 1976 he told Newsweek readers that tales of the evil done by the robber barons were pure myth:
There is probably no other period in history, in this or any other country, in which the ordinary man had as large an increase in his standard of living as in the period between the Civil War and the First World War, when unrestrained individualism was most rugged.
(What about the remarkable thirty-year stretch after World War II, which encompassed much of Friedman’s own career?) Yet in the decades that followed that pronouncement, as the minimum wage was allowed to fall behind inflation and unions largely disappeared as an important factor in the private sector, working Americans saw their fortunes lag behind growth in the economy as a whole. Was Friedman too sanguine about the generosity of the invisible hand?
To be fair, there are many factors affecting both economic growth and the distribution of income, so we can’t blame Friedmanite policies for all disappointments. Still, given the common assumption that the turn toward free-market policies did great things for the US economy and the living standards of ordinary Americans, it’s striking how little support one can find for that proposition in the data.
Similar questions about the lack of clear evidence that Friedman’s ideas actually work in practice can be raised, with even more force, for Latin America. A decade ago it was common to cite the success of the Chilean economy, where Augusto Pinochet’s Chicago-educated advisers turned to free-market policies after Pinochet seized power in 1973, as proof that Friedman-inspired policies showed the path to successful economic development. But although other Latin nations, from Mexico to Argentina, have followed Chile’s lead in freeing up trade, privatizing industries, and deregulating, Chile’s success story has not been replicated.
On the contrary, the perception of most Latin Americans is that “neoliberal” policies have been a failure: the promised takeoff in economic growth never arrived, while income inequality has worsened. I don’t mean to blame everything that has gone wrong in Latin America on the Chicago School, or to idealize what went before; but there is a striking contrast between the perception that Friedman was vindicated and the actual results in economies that turned from the interventionist policies of the early postwar decades to laissez-faire.
On a more narrowly focused topic, one of Friedman’s key targets was what he considered the uselessness and counterproductive nature of most government regulation. In an obituary for his one-time collaborator George Stigler, Friedman singled out for praise Stigler’s critique of electricity regulation, and his argument that regulators usually end up serving the interests of the regulated rather than those of the public. So how has deregulation worked out?
It started well, with the deregulation of trucking and airlines beginning in the late 1970s. In both cases deregulation, while it didn’t make everyone happy, led to increased competition, generally lower prices, and higher efficiency. Deregulation of natural gas was also a success.
But the next big wave of deregulation, in the electricity sector, was a different story. Just as Japan’s slump in the 1990s showed that Keynesian worries about the effectiveness of monetary policy were no myth, the California electricity crisis of 2000– 2001—in which power companies and energy traders created an artificial shortage to drive up prices—reminded us of the reality that lay behind tales of the robber barons and their depredations. While other states didn’t suffer as severely as California, across the nation electricity deregulation led to higher, not lower, prices, with huge windfall profits for power companies.
Those states that, for whatever reason, didn’t get on the deregulation bandwagon in the 1990s now consider themselves lucky. And the luckiest of all are those cities that somehow didn’t get the memo about the evils of government and the virtues of the private sector, and still have publicly owned power companies. All of this showed that the original rationale for electricity regulation—the observation that without regulation, power companies would have too much monopoly power—remains as valid as ever.
Should we conclude from this that deregulation is always a bad idea? No—it depends on the specifics. To conclude that deregulation is always and everywhere a bad idea would be to engage in the same kind of absolutist thinking that was, arguably, Milton Friedman’s greatest flaw.
In his 1965 review of Friedman and Schwartz’s Monetary History, the late Yale economist and Nobel laureate James Tobin gently chided the authors for going too far. “Consider the following three propositions,” he wrote. “Money does not matter. It does too matter. Money is all that matters. It is all too easy to slip from the second proposition to the third.” And he added that “in their zeal and exuberance” Friedman and his followers had too often done just that.
A similar sequence seems to have happened in Milton Friedman’s advocacy of laissez-faire. In the aftermath of the Great Depression, there were many people saying that markets can never work. Friedman had the intellectual courage to say that markets can too work, and his showman’s flair combined with his ability to marshal evidence made him the best spokesman for the virtues of free markets since Adam Smith. But he slipped all too easily into claiming both that markets always work and that only markets work. It’s extremely hard to find cases in which Friedman acknowledged the possibility that markets could go wrong, or that government intervention could serve a useful purpose.
Friedman’s laissez-faire absolutism contributed to an intellectual climate in which faith in markets and disdain for government often trumps the evidence. Developing countries rushed to open up their capital markets, despite warnings that this might expose them to financial crises; then, when the crises duly arrived, many observers blamed the countries’ governments, not the instability of international capital flows. Electricity deregulation proceeded despite clear warnings that monopoly power might be a problem; in fact, even as the California electricity crisis was happening, most commentators dismissed concerns about price-rigging as wild conspiracy theories. Conservatives continue to insist that the free market is the answer to the health care crisis, in the teeth of overwhelming evidence to the contrary.
What’s odd about Friedman’s absolutism on the virtues of markets and the vices of government is that in his work as an economist’s economist he was actually a model of restraint. As I pointed out earlier, he made great contributions to economic theory by emphasizing the role of individual rationality—but unlike some of his colleagues, he knew where to stop. Why didn’t he exhibit the same restraint in his role as a public intellectual?
The answer, I suspect, is that he got caught up in an essentially political role. Milton Friedman the great economist could and did acknowledge ambiguity. But Milton Friedman the great champion of free markets was expected to preach the true faith, not give voice to doubts. And he ended up playing the role his followers expected. As a result, over time the refreshing iconoclasm of his early career hardened into a rigid defense of what had become the new orthodoxy.
In the long run, great men are remembered for their strengths, not their weaknesses, and Milton Friedman was a very great man indeed—a man of intellectual courage who was one of the most important economic thinkers of all time, and possibly the most brilliant communicator of economic ideas to the general public that ever lived. But there’s a good case for arguing that Friedmanism, in the end, went too far, both as a doctrine and in its practical applications. When Friedman was beginning his career as a public intellectual, the times were ripe for a counterreformation against Keynesianism and all that went with it. But what the world needs now, I’d argue, is a counter-counterreformation.