Wednesday, May 12, 2010


Does homo economicus exist? The notion that market actors are the dominant players who drive and shape society towards efficiency and stability - and should be left alone to pursue their ends for doing so - has it's roots in the 18th century, and persists to this day. In my view, whether you believe in homo economicus isn't as important as whether you can explain WHY you believe it.

All to often people believe something simply because: (1) it's convenient, (2) it's what they were told growing up, or (3) they don't know any better. This is one of the reasons why I wrote The Myth of the Free Market: The Role of the State in a Capitalist Economy. I wanted to help shed light on the misguided belief that market players should be deferred to because they're virtuous in a market setting.

To help my students prepare for exams in my International Commerce class I address the issue of what Milton Friedman got wrong, and cover several concepts they need to be familiar with for their exams. Below are some of the issues I've covered (I've listed page numbers where the topic can be found in my book throughout the text below).


To understand how Nobel Laureate Milton Friedman got it wrong I start by looking at what Adam Smith, the patron saint of modern capitalism, said about markets and trade in 1776. Adam Smith made it clear that a level playing field - or what he called the "laws of justice" - should not be undermined. Custom, tradition, privilege, market conspiracies, favorable legislation, and affronts to human dignity all work to undermine the market's playing field by shifting resources to those that don't necessarily work for their reward (15-17, 26).

The interesting thing is that Adam Smith wasn't the only one who saw how the laws of justice could could be violated in 1776. James Madison and the Founding Fathers spoke about the need to reign in merchants and other factions because the "most common and durable source of factions has been the various and unequal distribution of property" (17-19).

These considerations, according to the Founding Fathers, inflamed "passions" in post-revolutionary America and threatened to tear apart the new union. Worse, according to Madison, is how "the latent causes of factions are thus sown in the nature of man." Simply put, we're not necessarily good people, especially in a trading environment. Madison wrote: "If men were angels, no government would be necessary." Guess what? We're not angels. And unicorns don't exist either.

We can't trust one another, even in a market setting. This is why we have a Constitution (see especially Art. I, Section 8). This is why we create laws and regulations.

All of this is something Milton Friedman passed over, or got wrong, when he discussed the power of "the market" to transform the passions of merchants. More specifically, Friedman placed so much faith in people doing the right thing in a market setting that he virtually ignored what the Founding Fathers, and Adam Smith, said about the human condition. The Founding Fathers, in particular, had seen in real time what a weak central government would produce, and did not want to re-visit the Articles of Confederation.

Like it or not, they all believed merchants can't always be trusted in a market setting. Indeed, Adam Smith believed that merchants, left to their own devices, would work against the interests of the consumer, and would use the state to secure their positions if necessary. If  Adam Smith, James Madison, and the Founding Fathers understood this, why not Friedman?

I think I know why ...

Making Milton Friedman's position on freedom even more bizarre is how he assumes liberty is like air, it's just there for everyone. This is why he suggests an "umpire model" for society. Let the state call balls and strikes in markets, and that's it.

However, Friedman ignored how umpires can be changed (to market friendly umpires). He ignored how strike zones can be changed (deregulation & favorable legislation). He ignored how, for a long time, some people never got to the plate (women and people of color). Finally, he ignored how umpires can get dirt thrown in their faces (yes, market players can and will collude with government regulators and members of Congress ... as Wall Street in 2008, and what's happening in the Gulf of Mexico now, illustrate).

All of this can undermine our level playing field and, worse, can destroy the moral justification of capitalism. We need to remember that the moral justification of capitalism, which is the cornerstone of our market economy, rests on one simple principle: If you work hard you will get ahead.

Personal responsibility and a strong set of moral obligation has grown out of this simple principle.

Once you undermine the conditions that make the moral justification of capitalism work we're all in trouble. Personal debt levels, record bankruptcies, and homeowners walking away from their mortgages, among others, are not good signs today.

Still, today market players continue to invoke what Adam Smith referred to as our system of "natural liberty" to pursue their own selfish ends. Ironically, while they channel the spirit of Adam Smith to justify their efforts in the market, their activities in the modern era both undermine the laws of justice (i.e. our level playing field which helps determine how reward and resources are distributed) and violate what Adam Smith called "the order of nature and reason" (which leads to market imbalances and societal disconnect; 37-45).

Because his belief that market players will do the right thing in a market setting was so strong Milton Friedman irresponsibly grafted his biases on to his policy analysis, and his policy prescriptions. This is where he got it wrong. Men aren't angels. Men pursuing profits and wealth can become even worse.

To believe otherwise is to embrace the unicorn.

Milton Friedman didn't simply get the human condition wrong. He doubled down on the Unicorn.

Specifically, he went beyond promoting his umpire model of markets (we can all be trusted in a market setting while we're pursuing profits) to deliberately distorting the debate, and the facts. While there are many things that Milton Friedman missed when it came to understanding human nature, below is a partial list of what Milton Friedman got wrong, ignored, or misrepresented in his work(s) (which I discuss in chapter 2 of my book).

Throughout his writings Friedman consistently warns about the collectivist tendencies he saw in western democracies. Seeing socialist ghosts in every corner, Friedman constantly warned about creeping socialism, and how market capitalism (at least his Unicorn vision of markets) was being threatened. What Friedman ignored is that markets aren't an either/or proposition. This is a false dichotomy (10). Saying you either do it my way or we're going down a socialist rat hole does not represent what happens in the real world, and is not sound analysis (especially for jump starting a debate).

For all of Milton Friedman's dire warnings about America - and the west - going to hell in a hand basket because of the creeping socialism he saw threatening our world, Friedman missed one important fact: Post-war America and the west experienced the greatest, and widest, degree of economic growth and prosperity in human history (5-13). We avoided the threat of major market collapse, or economic depression too.

Warning about the dire effects of an evolving "collectivist" regime when growth and stability are high and widespread is simple fear-mongering. Global confidence in the sturdiness of the world's financial center, New York, evolved for one simple reason: Transparency was tethered to sensible regulations (something to think about today).

Milton Friedman understood he could ride on the back of the field of economics, which maintains in an elevated - but undeserved - position in the political world, and in the social sciences of academia. This position was a powerful tool politically. Milton Friedman understood this and deliberately sought to discredit his opponent's arguments by:

(1) Conflating government regulations and the push for civil liberty protections with socialism and collectivism (his influence is so great that Tea Baggers today still don't know the difference between the categories).
(2) Marginalizing the efforts and duties of government as wasteful, when we all know that state functions are distinct from those of the market.
(3) Dismissing other, competing, disciplines as "speculative philosophical discourse" that are less rigorous than economics (which studies homo economicus).
(4) Denigrating his opponents arguments by making references to the "bubbly emotionalism" of their position(s).

To be sure, all intellectual battles require that you distort, marginalize, dismiss, and deride the efforts of your opponents if you can't defeat them on the merits (I know, I know ... the Unicorns). But think about it. How many professional economists saw the market collapse coming in 2008? (I'll link a short list here later.) How many understand it's roots today? (And, no, it's not Fannie Mae's fault, or the fault of all those people who took out loans they couldn't afford, or the fault of government spending alone ...) Milton Friedman understood the political climate of the day, and took advantage of it to irresponsibly push his world view (see esp. the intro to Ch. 4).

If you create an automobile we now know that we need the DMV, the CHP, the DOT, and ... the list goes on. Do you really trust Wall Street to do the right thing now that the crisis has passed (for now)? Do you trust British Petroleum will make things whole in the Gulf of Mexico? Do you care if your medical doctor is certified? Complex industrial societies require rules and regulations. Commerce over long distances requires it. Milton Friedman seemed to believe that creating a complex and interdependent society across a continent is it's own achievement. It's not. You might want the government off of your back, but I can assure that you want him on your neighbor's.

Whether it's Manifest Destiny, land grant colleges, our Indian land policy (someone had to kick them off for you to invest in it), land acquisition policies (war/purchase), market subsidies, mass market purchases (starting with the Civil War), infrastructures (Erie Canal, RR, etc.), the creation of America's middle-class (yeoman farmer, blue collar workforce, and the social wage earner), education policies, tariff policies, civil rights, etc. it's clear that the state has had the dominant role in creating the conditions for wealth creation in America (30-35, plus Ch. 6). There are no invisible hands here.

Work hard and get ahead? Not if you were a woman, black, or even white male without land (initially). The state has worked hard to open and guarantee opportunities for those who were once relegated to second class status in America. Access wasn't provided by enlightened market players. There was too much money to be made keeping the field tilted in their favor.

Later, when child labor laws, family wage laws, and Jim Crow/Civil Rights laws were required, the state once again stepped in. Industry, for the most part, fought the state every step of the way. The market didn't open opportunities magically. It was democracy in action. It was people making demands on the state, and then having the state act. This is politics, which means the state. The state made the moral justification of capitalism work in America, not market players.

There's more, but this is more than enough (for now). Next exam post: From War & Mercantilism to Classical Liberalism.

- Mark


Unknowable said...

"Conflating government regulations and the push for civil liberty protections with socialism and collectivism (his influence is so great that Tea Baggers today still don't kow the difference between the categories),"

"Tea Baggers"? Really? I notice that term used a lot as ad hominem attack by those who have no other recourse. And duly noted that you provide no proof of your baseless assertion...

I was reading your article on Friedman with the hope of adding to my understanding of economics.

But your snide, preening attitude more than outweighs any true insights you might have to share.

Someone presenting cogent arguments and valid positions doesn't need name calling and snide remarks to make their points...

Max said...

The title of this post led me to believe that there would be Milton Friedman quotes. There were no Milton Friedman quotes. That was disappointing.

Quoteschart said...

Personally I like Milton Friedman.