This 1980 book by Milton and Rose Friedman (subtitle: “A personal statement”) is well-known for its role in promoting free markets and deregulation. It sold millions of copies and motivated not one, but two television series devoted to its contents. The book now often serves as a totem for those who rant against “big government,” often (in the case of Fox news et al.) without the covers being opened. (I got my unread copy from my dad, who supports lots of these “causes.”)
I wanted to read the book to learn how the Friedmans analyzed policies and suggested reforms for the general public. I also wanted to know how many of their ideas stand up to scrutiny from someone (me) who appreciates markets but has some reservations related to the ways that markets interfere with the commons (via, e.g., negative externalities) as well as the importance of non-market public and common-pooled goods.
It turns out that most of the book is excellent, except where the Friedmans (Rose was perhaps a perfect example of the “woman behind the man” in the way she contributed to work that often bore his name) brushed over collective goods, in what looks to be a spectacular example of over-confident misunderstanding.
In this review, I will follow their ten chapter titles:
In Chapter 1 (The Power of the Market), the Friedmans discuss how prices signal information, provide incentives, and distribute wealth and income. They acknowledge the role of government in distribution and regulation of bads (negative externalities) but caution against trusting governments to choose on behalf of the majority when politicians might choose for themselves. They quote Adam Smith on the role(s) of government:
First, the duty of protecting the society from violence and invasion of other independent societies; secondly, the duty of protecting, as far as possible, every member of the society from the injustice or oppression of every other member of it, or the duty of establishing an exact administration of justice; and, thirdly, the duty of erecting and maintaining certain public works and certain public institutions which it can never be for the interest of any individual, or small number of individuals, to erect and maintain; because the profit could never repay the expense to any individual or small number of individuals, though it may frequently do much more than repay it to a great society. [OMG. I tried to get a page reference for this actual quotation. but it seems like there are no searchable editions of Smith on the internet (econlib is dysfunctional). What an ironic failure in the provision of public goods!]
It is in this third role — the provision of public goods — that the government’s place is essential — and contested, by liberals in the American (don’t trust markets) and European (do trust markets) traditions. Sadly, the Friedmans dismiss this role via a sophistic slight-of hand that still surprises me. Here is their text (pp 30-32) with [my comments in brackets]:
Adam Smith’s third duty raises the most troublesome issues. He himself regarded it as having a narrow application. It has since been used to justify an extremely wide range of government activities. In our view it describes a valid duty of a government directed to preserving and strengthening a free society; but it can also be interpreted to justify unlimited extensions of government power.
The valid element arises because of the cost of producing some goods or services through strictly voluntary exchanges. To take one simple example suggested directly by Smith’s description of the third duty: city streets and general-access highways could be provided by private voluntary exchange, the costs being paid for by charging tolls. But the costs of collecting the tolls would often be very large compared to the cost of building and maintaining the streets or highways. This is a “public work” that it might not “be for the interest of any individual to erect and maintain though it” might be worthwhile for “a great society.” [This example describes a collective action problem in providing a public good that government “solves” via collecting taxes to pay for the roads. The Friedmans do not address the problem of congestion that plagues such collective goods but not toll roads that use prices to limit demand.]
A more subtle example involves effects on “third parties,” people who are not parties to the particular exchange — the classic “smoke nuisance” case. Your furnace pours forth sooty smoke that dirties a third party’s shirt collar. You have unintentionally imposed costs on a third party. He would be willing to let you dirty his collar for a price — but it is simply not feasible for you to identify all of the people whom you affect or for them to discover who has dirtied their collars and to require you to indemnify them individually or reach individual agreements with them.
To lapse into technical jargon, there is a “market failure” because of “external” or “neighborhood” effects for which it is not feasible (i.e., would cost too much) to compensate or charge the people affected; third parties have had involuntary exchanges imposed on them.
Almost everything we do has some third-party effects, however small and however remote. In consequence, Adam Smith’s third duty may at first blush appear to justify almost any proposed government measure. But there is a fallacy. Government measures also have third-party effects. “Government failure” no less than “market failure” arises from “external” or “neighborhood” effects. [Here the Friedmans seem to imply that market failures will automatically lead to government failure] And if such effects are important for a market transaction, they are likely also to be important for government measures intended to correct the “market failure.” The primary source of significant third-party effects of private actions is the difficulty of identifying the external costs or benefits. When it is easy to identify who is hurt or who is benefited, and by how much, it is fairly straight-forward to replace involuntary by voluntary exchange, or at least to require individual compensation. If your car hits someone else’s because of your negligence, you can be made to pay him for damages even though the exchange was involuntary. If it were easy to know whose collars were going to be dirtied, it would be possible for you to compensate the people affected, or alternatively, for them to pay you to pour out less smoke. [This is a clear application of the “Coase Theorem” that was proposed in 1960; it depends on “low transaction costs” in measuring harm and finding those harmed.]
If it is difficult for private parties to identify who imposes costs or benefits on whom, it is difficult for government to do so. As a result a government attempt to rectify the situation may very well end up making matters worse rather than better — imposing costs on innocent third parties or conferring benefits on lucky bystanders. To finance its activities it must collect taxes, which themselves affect what the taxpayers do — still another third-party effect. In addition, every accretion of government power for whatever purpose increases the danger that government, instead of serving the great majority of its citizens, will become a means whereby some of its citizens can take advantage of others. Every government measure bears, as it were, a smokestack on its back. [Here I think they lose the plot, by implying that the lack of a specific victim — of climate change, say — undermines government action that would also be unjustified due to its funding via distortionary taxes, which have nothing to do with the problems of externalities (the fallacy of an irrelevant appeal). Then they go on to make quite the leap…]
Voluntary arrangements can allow for third-party effects to a much greater extent than may at first appear. To take a trivial example, tipping at restaurants is a social custom that leads you to assure better service for people you may not know or ever meet and, in return, be assured better service by the actions of still another group of anonymous third parties. [Are they implying that pollution problems can be resolved via a system of tipping? This trivialization signifies a failure of comprehension to me, as environmental damages — and government actions to reduce them — were well known in the 1970s.] Nonetheless, third-party effects of private actions do occur that are sufficiently important to justify government action. The lesson to be drawn from the misuse of Smith’s third duty is not that government intervention is never justified, but rather that the burden of proof should be on its proponents. We should develop the practice of examining both the benefits and the costs of proposed government interventions and require a very clear balance of benefits over costs before adopting them. This course of action is recommended not only by the difficulty of assessing the hidden costs of government intervention but also by another consideration. Experience shows that once government undertakes an activity, it is seldom terminated. The activity may not live up to expectation but that is more likely to lead to its expansion, to its being granted a larger budget, than to its curtailment or abolition.
So I agree that benefits must exceed costs, but the Friedmans appear to take this exposition as the end of the conversation, i.e., that governments should not, by default, be trusted to regulate negative externalities because such regulations create burdens on the market and require the services of bureaucrats who are paid via taxes. This discussion is oversimplified to the point of uselessness. Only someone as stupid as Donald Trump would read this and conclude that all regulations should be ditched, because it’s too hard to identify winners and losers, and that taxes are theft, but it’s exactly because of idiots like Trump that the Friedmans’ conclusion that regulations are unjustified unless they pass a strict benefits/costs test gets boiled down to “regulations are bad.” That’s a real missed opportunity.
That said, I must note that the discourse around non-excludable (public and common-pooled goods) was underdeveloped in the 1970s, so perhaps the Friedmans were working with the tools of the times. OTOH, they could have thought a little more about what even Adam Smith noticed in the 18th century. (The index has nothing on commons, public goods or collective action — perhaps because it has too many entries on “communism”? 😉 )
In Chapter 2 (The Tyranny of Controls), the Friedmans make a good case for freedom in trade and choice of occupation. They would have dismissed Trump as a short-sighted mercantilist whose policies would harm the country as a whole as they aided the special interests who got his attention. I agree with all this, with the only caveat that I would regulate industries (oil, finance, medicine) that create negative externalities (pollution; financial crises) and/or possess market power (asymmetric information) over consumers.
In Chapter 3 (The Anatomy of a Crisis), they go over the role of government in worsening the Great Depression, mostly by messing up the money supply (the topic that won Friedman his Nobel Prize) and interfering with trade. All I can say about this chapter is that its lessons were not heeded in the late 80s, as a too-big-to-fail financial system attracted government bailouts, and thus even larger risk-taking by those who would privatize profits and socialize losses. (The Friedmans were not fans of business per se.)
In Chapter 4 (Cradle to Grave), the Friendmans argue against social security (setting the foundation for “privatize social security”) as a bureaucratic, unsustainable gift to the rich. They suggest a “negative income tax” (i.e., wage subsidy) as a better way to help poor people. This proposal has been adopted in the U.S., although its recipients are vilified by the Right (and thus attacked by IRS agents asking for masses of paperwork), and the system is also far too bureaucratic in comparison to a universal basic income — an idea that I support and the Friedmans would not due to its potential to tax the productive to reward the lazy. The rest of the chapter complains that government transfer programs are wasteful (due to paperwork and bureaucratic salaries), which may be true to some degree for some programs (regulations written by industry to mess up health care, to give one example) but not for all programs (the IRS and Social Security Administration have tiny budgets relative to the funds they handle). In the end, I think that the Friedmans would regret the extent to which their ideas have been used as dogma by Republicans who cut taxes for the rich while leaving the poor to “bootstrap themselves off the floor, climbing via crumbs scattered by 1 percenters.”
(In the US, “1 percenters” make more than $420k per year. Worldwide, 1 percenters make more than $32k and/or has a net worth of more than $770k. Scope matters. These figures are also dramatically larger than they were in the 1970s, when the rich paid more tax.)
Chapter 5 (Created Equal) argues for equality of opportunity rather than outcome. In the process, it rails against wealth and income taxes as unfair and harmful to voluntary efforts of the rich to help the poor. Although this perspective is (again) attractive in a world of rights, obligation and community, it’s a recipe for disaster in the present world of “I’ve got mine, fuck you.” It’s for this reason that I favor wealth (property) taxes devoted to funding goods available to all citizens, i.e., education, healthcare and/or basic income. It’s only when you have the basic opportunity to get an education or be healthy that you can thrive.
In Chapter 6 (What’s Wrong with Our Schools?), the Friedmans document the shift from choices among private providers to monopolization of “free” education by the State, which not only pursues its own goals (e.g., obedient citizens) but also spends far more on administrators than on students. They suggest giving educational vouchers to parents who can choose where to send their children (I recently learned this system is used successfully in the Netherlands and Chile; it’s also used, not without controversy, in the US). When it comes to higher education, the Friedmans are against subsidies, since most of the gains go to middle and upper-class students. They suggest that poorer students can afford school by “selling equity” in their future rather than taking (if they can get them) unaffordable loans. This podcast reviews a recent implementation of this system. As someone in “education,” I agree with their critiques and their solutions. I also agree that systems of “grading teachers” are probably worse than systems of parental choice.
In Chapter 7 (Who Protects the Consumer?) the Friedmans complain that government regulations result in lower economic growth and excess spending on bureaucracies that serve themselves or special interests. They then make the error of assuming that governments that make shoddy products (“private goods”) will also make shoddy regulations (“public goods”), which betrays an (intentional?) misunderstanding of the different natures of those goods. Later in the chapter, they are more open to “regulation via prices” (i.e., polluters pay carbon or effluent taxes) but still betray a bias or myopia (Page 215: “One source of atmospheric pollution is the carbon dioxide we all exhale. We could stop that very simply. But the cost would clearly exceed the gain.”) that supports my worry that they have missed an important element of “freedom to choose,” i.e., the freedom from polluted air, water or land that endanger our health or lifestyle. Whereas I agree 100 percent with many of their concerns on government overreach, I think their dismissal of regulations has given too much ammunition to ideologues (Trump, Julian Simon, Walter Block et al.) who think markets can supply public goods or protect common-pooled goods. They cannot.
In Chapter 8 (Who Protects the Worker?), the Friedmans argue against minimum wages, unions, etc., calling instead for more competition between employers. These positions made sense (they came at the end of what is now seen as the high-point in worker wages), but not in a world where industry concentration (thus market power to push down wages) are high and the 1 percenters suck money out of everyone’s pocket via corrupt legislation. I’m sure that the Friedmans would oppose this situation, but they seem to overlook its potential.
In Chapter 9 (The Cure for Inflation), the Friedmans revisit the topics of Chapter 3 and make the observation that governments cause inflation by creating too much money to spend and then benefit when the spending reduces the (book) value of the resulting debts. I wholeheartedly agree, which is one reason why I think that Bitcoin (for all its “interesting” market dynamics) has made the case for an asset with a known, steady and slow issue of new supply. A swap of central banks for “automatic money printing” algorithms might leave fewer tools for “managing” the economy, but fewer tools means that the consequences of their use will be easier to observe and thus their use more careful.
The book ends with Chapter 10 (The Tide is Turning), which accurately reflects the momentum of the late 1970s, when the book was written. In this chapter, they collect thoughts on government over-reach and capture by special interests, highlight attempts to bring more innovation and competition to markets affecting our lives, and even provide pro-forma constitutional amendments on free trade, sound money, and so on. The chapter is inspiring, and definitely had an impact on policy debates in the US and other countries.
Sadly, the Friendmans, in their opposition to government incompetence, gave too many reasons to oppose government per se. Although I hate the expression “smart government,” I do think there’s a need for the right kind of government and governance at the appropriate level. If I was writing a epilogue for this book (hopefully shorter than this review!), I’d mention that government programs should focus on protecting the collective goods we share and providing the public goods that benefit all of us. My metric would thus focus on subsidies that go to everyone (e.g., children, the sick and the old) rather than special interests (farmers, bankers, the 1 percent) that suck the wealth of the majority. Besides that, I agree on their emphasis on markets, competition and choice over regulation and bureaucracy, but I’d be more cautious about throwing out the baby with the bathwater. (Listen to this recent VOX podcast for a discussion on balancing the roles of the State and Market in making a just but productive society.)
Overall, I recommend this book, one-handedly, to anyone who wants to think about the role of government, the rights and responsibilities of the individual, and how ideology can open our eyes — and sometimes blind us.