Capitalism & Freedom (Milton Friedman)

Milton Friedman’s Capitalism and Freedom, published in 1962, is the definitive summary of the philosophy of the arguably the most influential economist of the last 50 years. Written at a time between the post-war construction of the welfare state, and the emergence of Reagan and Thatcherite administrations, Friedman, along with F.A.Hayek were the instrumental intellectual influences of what was to become Neoliberalism. Friedman applies his pro-free market ideology to micro and macroeconomics, as well as various aspects of public policy, providing a coherent picture of his ideal of a modern democratic state. 

Many of his prescriptions at the time seemed outlandish (some still do), whilst many have been adopted as norms throughout the world. The caricature of a set of policies designed to benefit the rich at the expense of the poor is a false one, for Friedman is against cronyism in all its forms. He advocates the abolition of inheritance tax, but also a negative income tax; he is against public housing but favours instead simply giving cash to those unable to afford housing, he is against trade tariffs, and argues against army conscription. 

The central argument around which Friedman’s programme revolves, is the idea that economic freedom is a prerequisite for political freedom. Accepting this to be true, his prescription is to minimise government involvement in economic matters (and therefore government power), and to disperse this power by the principle of subsidiarity - decisions made at the most local level that is practicable. This way he argues, if the local council abuses its power, one has the option to move a few miles to the next town, and similar at regional or state level. Changing countries is far more difficult, he argues, and so national power must be limited to matters that are necessarily national (for example, defence). 

Economic freedom is desirable for two reasons, argues Friedman. Firstly, economic freedom itself is underrated, and not to be relegated beneath general freedoms. If a nation's laws prohibit foreign travel due to currency controls, this is no less a prohibition on one’s freedom than a travel ban for overt political reasons. Of course, this argument depends entirely on its specificity. We all suffer from a restriction on our freedom to not pay taxes, just as we are not free to commit murder; when restrictions reach a point where we are no longer free to change vocation, restrictions on economic freedom are surely of paramount import. Where we draw the line is entirely subjective - some strongly object to restrictions on passing on hard-earned wealth to family members, whilst others see inheritance tax as being antithetical to a meritocratic society. Writing at the height of the Cold War (and before the failure of the Soviet system was apparent), Friedman’s book appears to take aim at the definition of ‘Socialism’ in which all economic activity is centrally planned, but absent the totalitarianism of the USSR. By this definition, economic freedom is clearly very limited. 

Secondly, Friedman argues that by separating economic and political power, the former acts as a counterbalance to the latter. This is a compelling argument. The evolution from monarchy into democracy in Britain in the 18th and 19th centuries occurred as a result of pressure to change by the newly emergent industrial classes. The exchange of goods and services between millions of autonomous individuals is either achieved through coercion by a central body (backed up by force), or on a voluntary basis - as in capitalism. The ability to ‘go elsewhere’ if a transaction is not beneficial to either party is, says Friedman, the key to its ability to protect from the tyranny of dictators or a temporary majority. We can all vote on what colour tie we prefer, and rather than going with the majority vote, capitalism allows us to simply go with our own choices - what Friedman calls ‘unanimity without conformity’. Of course some decisions must be made centrally and uniformly, but Friedman’s point is that those decisions can and should be severely limited. 

How can the market protect political freedoms? For one, the more competition, the more anonymity a market provides, and thus freedom from individual persecution. One has no idea about the skin colour or sexual orientation of the worker who made the grain that went into the bread purchased at the market. Friedman shows that the Hollywood Blacklist failed entirely, since studios wanted their services. “When Robert Rich won the Oscar for writing The Brave One, he never stepped forward. Robert Rich was a pseudonym, masking one of about 150 writers...blacklisted by the industry since 1947 as suspected Communists”. Thereby the power of government is limited as long as economic freedom exists. In a less trivial example, commerce has historically been the refuge of Jewish communities excluded from public service and other occupations in many societies.

Now consider the reverse. In a society where all jobs were government jobs, the ability to campaign and lobby for radical change is severely limited. The Suffragette movement in Britain took almost a century to achieve its central aim of female suffrage, despite demonstrations, publications, rallies, and an irrefutable central argument. If all media, printing presses, and employment opportunities were government controlled, the advancement of ideas that appeared at first to be heretical would be considerably more difficult. Finally, curtailment of economic freedom is a practical bridge to political persecution. A state with oppressive tendencies is far more difficult to escape if (as was the case in Germany in the 1930s), wealth of certain groups is appropriated by the state. 

The obvious objection to this argument is that economic power has the ability both to concentrate and obtain political power. Such concentration is perpetuated by education and inheritance (U.S. Ivy League Colleges typically contain more students from the top 1% of earners than the bottom 60%). Friedman’s suggestion that all parents be given vouchers towards education (which would be privatised), to be ‘topped up’ at parent’s discretion, would exacerbate this concentration of wealth, as would the abolition of inheritance tax. 

In his pursuit of free markets, Friedman is predictably anti-monopoly. In instances of natural monopoly, such a railroad, governments typically operate such industries themselves. Friedman argues that this is more often than not a case of static thinking in a dynamic world. In the case of railways, the monopoly is broken by alternative transport such as trucking, and (as was the case in the U.S.), the rail authority becomes protectionist, stifling competition. This is relevant to today’s debate on tech giants such as Google, who's supposed monopoly will undoubtedly go the way of the telephone in time. Equally, if a monopoly is truly ‘natural’ argues Friedman, it need not be protected by legislation. In the case of the post office, outlawing alternatives merely reduces choice and increases costs to consumers - indeed, FedEx circumvented the protection afforded to the Post Office through a legal loophole, exposing the fallacy of natural monopoly for what it was. 

Where a monopoly does exist in modern economies, is in the creation of money. Here the Federal Reserve has the sole right to mint new currency, leading to concentration of power amongst unelected technocrats. Friedman is perhaps best known for his advocacy of Monetarism, that is, the idea that the quantity of money in an economy is a major determinant of output and inflation. In his A Monetary History Of The United States (co-authored with Anna Schwartz), he asserts that the contraction of the money supply was the cause of the depth and severity of The Great Depression. Famously, Ben Bernanke as Fed chair (prior to the 2008 financial crisis) said “I would like to say to Milton and Anna: Regarding the Great Depression, you're right. We did it. We're very sorry. But thanks to you, we won't do it again”.

Those arguments are presented in shorter form in Capitalism and Democracy. When a person deposits a dollar in their bank, 80-85 cents goes back into the economy in the form of loans or overdrafts. In the case that a substantial amount of people withdraw their funds from a bank, that bank must immediately sell assets and call in loans in order to meet the cash demands of its panicked customers. This alone would reduce the quantity of money in circulation. More seriously, if a bank should go bankrupt, it creates a run of self-perpetuating bank runs, each one reducing the quantity of money in an economy. In addition, raising interest rates reduces the money supply, as (as with any commodity), an increase in price reduces the demand for loans. Friedman demonstrates how, from 1928, the Federal Reserve raised interest rates, and allowed thousands of banks to go bankrupt, failing to recapitalise banks or address the shrinking money supply. The reason that this is relevant to the general argument, is that the conventional wisdom at the time was that capitalism naturally tends to boom and bust, and that output must be managed by a central authority, using fiscal policy. The ideas of Keynes had won out in the 50s and 60s, largely due to the experience of The Great Depression.

 Friedman is saying that The Great Depression was the result of the incompetence of the central authorities, not an inherent flaw in capitalism. His prescription is that, rather than trust the judgement of technocrats, we ought to fix a rule for them to adhere to - he suggests a growth in the money supply on a monthly basis (obviously though, this still requires significant good judgement). Of course, from the 1990s to present day, most central banks are tasked with using monetary policy to hit an inflation target. If one reads Nigel Lawson’s autobiography (Chancellor of the Exchequer under Thatcher), he was constantly attempting to regulate the money supply, but the various measures of money proved difficult to measure. So whilst Friedman was wrong about the specifics, a rule-based monetary policy has since become the norm. That being said, his motivation for the policy was ultimately to reduce government interference in economic policy, which stemmed primarily from large fiscal spending justified along Keynesian lines. To this end he doubts the Keynesian assertion that deficit spending has a multiplier effect, that aggregate demand is boosted by ‘workfare’ type public projects. There is an inherent contradiction here, one that Modern Monetary Theory (MMT) highlights. Capitalism does tend towards boom and bust, and the mismanagement in the 1930s Friedman describes was a passive one in nature. Banks were allowed to fail, not sabotaged. What was required to end the depression was management of the money supply. In 2008, the Fed behaved exactly as Friedman would have wanted, recapitalising banks and purchasing bonds by Quantitative Easing (QE), thus increasing the money supply. This worked, avoiding depression. If money is being created out of thin air by the central bank, it will increase the money supply whether it is spent in ‘fiscal’ terms i.e. building a dam, or by buying bonds from financial institutions (although his point about the speed at which it can be spent by governments is valid). This is before even getting into the more contentious MMT argument that deficit spending with bonds issued in a country’s own currency are not ‘assets and liabilities’ but exclusively the creation of assets. So on monetary policy, we can say that Friedman’s policy subscription was the correct one, albeit justified for reasons more to do with his opposition to government interference than with true flaws in Keynesian responses to economic downturns.

Capitalism and Freedom was not reviewed in any major newspapers upon release, but went on to sell over 600,000 copies. Perhaps more surprising though, was that it was reviewed in several serious academic journals, despite the political and polemical nature of the writing. This is no doubt partly due to Friedman’s worldwide reputation as a economist, but also as a result of the sections of the book dealing with macroeconomic policy. Central to this was Friedman’s advocacy of free floating exchange rates between countries. The Austrian School of Economics, led by the likes of Von Mises and Hayek were always advocates of the gold standard, whilst Keynes himself was instrumental in designing the post-war Bretton-Woods system; entirely free floating currency was at the time a radical proposal. 

Closely connected to the above-discussed control of the supply of money, the international monetary arrangement is one of being able to conduct trade internationally on a stable and fair footing. Because the various methods of influencing these exchanges have such an impact on the domestic economy, this is a vital issue in the political-economic sphere. For example, if Britain were to wish to keep parity between the Pound Sterling and the U.S.Dollar, but the dollar was increasing in relative value, the Bank Of England may increase interest rates to increase the attractiveness of the pound. This of course would increase mortgage payments for all homeowners. Politicians have historically tried to avoid the reality of the relationship between prices, interest rates and exchange rates, by imposing various import tariffs and currency controls, much to the chagrin of free market advocates like Friedman. Adam Tooze’s The Wages Of Destruction outlines the complexity and cost involved in such action as occurred under Nazi rule. 

At the time Capitalism and Democracy was written, the U.S. dollar was pegged to gold, at a price of $35 an ounce. All other members of the Bretton Woods system effectively pegged themselves to the dollar. U.S. citizens were prohibited from owning or buying gold, and the price, being below market standard, was essentially being supported worldwide by the U.S. treasury. The rationale for this system (and the previous gold standard) was that by having a stable commodity to peg all currencies to, international prices would remain relatively stable between trading nations. 

When U.S. citizens and companies wish to buy British goods, they purchase pounds using dollars in order to do so. The reverse is true when British citizens wish to buy U.S. goods or services. The quantity of dollars spent for foreign currency will be exactly the same as the quantity of dollars purchased with foreign currency “just as the number pairs of shoes sold is precisely equal to the number of pairs of shoes bought”. However, there is nothing to say that at a fixed price, the number of dollars demanded is the same as the number of dollars people wish to spend. Just as at a fixed shoe price, the number of shoes people want to sell will equal the number of shoes people want to buy. Therefore, if the government is fixing the exchange rate, it is fixing the price of dollars in foreign currencies. 

Now lets say, from a position of being roughly in balance of payments, something changes to make manufacturing more competitive abroad, and imports are extremely cheap to U.S. consumers, who demand more Sterling in order to purchase these cheap goods. If the U.S. government is intent on maintaining the exchange rate, it can use its reserves to sell dollars for pounds and keep supply and demand in equilibrium - but it won’t be able to do this for long - it will run out of currency or gold. Secondly, it can impose a plethora of exchange and currency controls, damaging trade, impinging on freedom to go abroad, buy foreign goods etc - as in the Nazi example. These two are very much short term, limited solutions. 

The third solution is to lower prices in the U.S. so that competitiveness is restored. This solution is the classical economist’s one, and was economic orthodoxy for a century. In practice, it is a painful and incomplete process, in which wages (and other fixed contracts) refuse to go down unless untold pain is inflicted upon an economy, involving increased unemployment. Any reading of economic history of the interwar years shows that this is an absurd policy to pursue, destroying an economy in order to keep exchange rates ‘stable’. Yet in 1963, the above three policy solutions were all that were available. 

The fourth solution to the above rather realistic conundrum is simply to let the prices of currencies fluctuate. This has an identical outcome to real prices in an economy falling, without the pain. As U.S. citizens demand more Sterling, the price of pounds rise relative to dollars, and so the goods themselves rise in price. This is a free floating exchange rate, advocated by Friedman in 1963 to much derision, and now adopted by most developed economies in the world. 

As an aside, in discussing the merits of free floating exchange rates, Friedman extrapolates what happens in the event that Japan was able to produce and sell everything U.S. citizens wanted more cheaply than they could themselves, perhaps because wages in Japan were so low. What he asks, would a Japanese person do with all the paper dollars she received for her goods - assuming the exchange rate is 1000 Yen to the Dollar? Since they cannot buy from America goods cheaper than available in Japan, the dollars will be worth less to her, and she will trade them for less. All Japanese would do this, the dollar would fall in value, restoring real-world competitiveness. This example is interesting, given Friedman states “what can the Japanese exporters do with the dollars? They cannot eat them, wear them, or live in them. If they were to simply hold them, the printing industry...would be a magnificent industry.” Consider then, that China has been able to produce an inordinate quantity of goods cheaper than the U.S. in recent decades, but did not want the mechanism described above to come into play. As a consequence, China used it’s billions of U.S. dollars to buy and hold U.S. Treasuries, keeping the dollar strong and China competitive. This meant cheap credit for the U.S. as well as cheap goods, and an export boom for China. 

Capitalism and Freedom today can be read superficially as a right-wing tract with a mixture of obvious and radical ideas for political and economic policy. This book has far more depth than a right wing manifesto however, tackling the status quo wherever the author finds it. It is powerful then, both as a justification of capitalism on philosophical grounds, and a snapshot of radical thinking in the early 1960s before such thinking entered the mainstream. Friedman himself stated that in 1945 socialism was an idea of the intelligentsia in America, but that by 1980 people had experienced enough government intervention to be more open to its rejection. A common narrative by the 1990s was that the failure of communism and the success of free market ideology settled the debate. John Gray’s False Dawn reveals that Reagan and Thatcher’s government spending were both higher at the end of their reign than the beginning. Police and prison spending exploded as social cohesion was wrecked by the stripping away of any social safety net, and the withering of institutions including the family. Market fundamentalism is further undermined by the success of the nordic social democracies and Asian tiger economies. This is not to say that Friedman’s theories were a failure - undoubtedly he would argue that they have not been faithfully executed - particularly stripping away subsidies and implementing negative income tax were absent from those governments mentioned above. Friedman’s emphasis on individual freedom is laudable, and is only caricatured as a justification of selfishness. To finish with a quote, “The free man will ask neither what his country can do for him, nor what he can do for his country. He will ask rather “what can I and my compatriots do through government” to help us discharge our individual responsibilities, to achieve our several goals and purposes and above all, to protect our freedom?”