Posts Tagged Milton Friedman

Milton Friedman’s Distortions, Part II

I have previously noted that Milton Friedman’s debating techniques and attitude towards facts were, erm, slippery to say the least. However, I focused primarily on his public face, and it seemed he could merely have adopted a more accessible narrative to get his point across, losing some nuance along the way. It could be argued that most are guilty of this, and it didn’t reflect Friedman’s stature as an academic.

Sadly, this is probably not the case. Commenter Jan quotes Edward S. Herman on Friedman’s academic record, giving us reason to believe that Friedman’s approach extended through to his academic work. It appears the man was prepared to conjure ‘facts’ from nowhere, massage data and simply lie to support his theories. With thanks to Jan, I’ll channel some of what Herman says, using it to discuss Friedman’s major academic contributions in general, and how his record seems to be rife with him torturing the facts to fit his theories.

The Permanent Income Hypothesis

The Permanent Income Hypothesis (PIH) states that a consumer’s consumption is not only a function of their current income, but of their lifetime income. Since people tend to earn more as they get older, this means that younger generations will tend to borrow and older generations will tend to save. The PIH has been a key tenet of economic theory since its inception, and Friedman won the Nobel Memorial Prize for it in 1976.

When discussing Friedman’s in-depth empirical treatment of the PIH, Paul Diesing (as quoted by Herman) found it wanting. He listed six ways Friedman manipulated the data:

1. If raw or adjusted data are consistent with PI, he reports them as confirmation of PI
2. If the fit with expectations is moderate, he exaggerates the fit.
3. If particular data points or groups differ from the predicted regression, he invents ad hoc explanations for the divergence.
4. If a whole set of data disagree with predictions, adjust them until they do agree.
5. If no plausible adjustment suggests itself, reject the data as unreliable.
6. If data adjustment or rejection are not feasible, express puzzlement. ‘I have not been able to construct any plausible explanation for the discrepancy’…

It does not surprise me that Friedman had to treat the data this way to get the results he wanted. For the interesting thing about the PIH is that it displaced a model that was far more plausible and empirically relevant: the Relative Income Hypothesis (RIH). The RIH argues that individual consumption patterns are in large part determined by the consumption patterns of those around them, so people consume to “keep up with the Joneses“. It was developed by James Duesenberry in his 1949 book Income, Saving and the Theory of Consumer Behaviour.

In his discussion of this apparent scientific regression, Robert Frank lists 3 major ‘stylised facts’ any theory of consumption must be consistent with:

  • The rich save at higher rates than the poor;
  • National savings rates remain roughly constant as income grows;
  • National consumption is more stable than national income over short periods.

The PIH can easily explain the last two phenomena, as it posits that saving (and therefore consumption) is unrelated to current income. However, this same proposition required Friedman to dismiss the first phenomenon outright. He therefore suggested that the high savings rates of the rich resulted from windfall gains rather than income. A neat hypothesis, but unsubstantiated by the evidence: savings rates also rise with increases in lifetime income.

Conversely, Duesenberry’s theory is well equipped to explain all three of the listed phenomena. The RIH implies that poor consume a higher percentage of their income to keep up with the consumption of the rich. As society as a whole becomes richer, this phenomenon will not disappear, as the poor will still be relatively poor. Thus, the apparently contradictory first two points in Frank’s list are reconciled. It is also worth noting that the third point, that consumption is less volatile than income over short periods, can be explained by the RIH because people are used to their current standard of living, so they will sustain it even through hard economic times.

So why, despite fitting the facts without manipulating them, did the RIH fall out of favour? Presumably, it made economists (particularly those of Friedman’s ilk) uncomfortable because of its implications that much consumption was unnecessary and wasteful, that redistributing income might spur consumption and therefore growth, and because it did not rest on innate individual preferences but on the behavior of society as a whole. The idea of a consumer rationally making inter-temporal consumption decisions in a vacuum was just, well, it was real economics. The result is that Friedman’s poorly supported hypothesis shot to fame, while Duesenberry’s well supported hypothesis was forgotten.

The NAIRU

NAIRU stands for ‘Non-Accelerating Inflation Rate of Unemployment’, and it implies that past a certain level of unemployment, workers will be able to demand wages so high that they will create a wage-price spiral. Hence, policy should aim for a ‘natural’ rate of unemployment, decided empirically by economists, in order to prevent the possibility of 1970s-style stagflation.

My first problem with the NAIRU is the way it is commonly seen as ‘overthrowing’ the naive post-war Keynesians who insisted on a simplistic trade off between inflation and unemployment. As I have previously noted, the originator of the curve, William Phillips, did not believe this; nor did Keynes; nor were the post-war Keynesians unaware of the possibility of a wage-price spiral. Furthermore, the NAIRU idea was really just a formalisation of a long standing conservative notion that we should keep some percentage of people unemployed for some reason. In this sense, the launch of the NAIRU was more a counter revolution of old ideas than a novel approach.

However, the real issue is whether the NAIRU is empirically relevant, and it seems it is not. First, as Jamie Galbraith has detailed, there is little evidence that unemployment has an accelerating effect on inflation at any level. Furthermore, empirical estimates of the NAIRU seem to move around so much, depending on the current rate of unemployment, that the idea has little in the way of predictive implications. The data simply do not generate a picture consistent with a clear value of unemployment at which inflation starts to accelerate;: we are far better off pursuing full employment while keeping numerous inflation-controlling mechanisms in place.

“OK” you say. “Perhaps the NAIRU does not exist. But what about this was disingenuous on Friedman’s part?” Well, the notion that the interplay between workers and employers is a key determinant of the rate of inflation flat out contradicts Friedman’s oft-repeated exclamation that “inflation is always and everywhere a monetary phenomenon”. If inflation is purely monetary, then the level of unemployment should not affect it at all! However, for whatever reason, Friedman was prepared to endorse both the NAIRU and his position on inflation simultaneously.

The Great Depression

Friedman’s Great Depression narrative was probably his biggest attempt to rehabilitate capitalism in a period where unregulated markets had fallen out of favour. He blamed the crash on the Federal Reserve for contracting the money supply in the face of a failing economy. This always struck me as strange – he was, in effect, arguing that the Great Depression was the fault of ‘the government’ because they failed to intervene sufficiently. This implies that the real source of the Great Depression came from somewhere other than the Federal Reserve, and therefore its sin was more one of omission than commission. Even if we accept the idea that the Great Depression was worsened by the action (or inaction) of central banks, Friedman is being disingenuous when he says that the Great Depression was “produced” by the government.

However, even Friedman’s own figures fail to support his hypothesis: according to Nicholas Kaldor, the figures show that the stock of high powered (base) money increased by 10% between 1929 and 1931. Peter Temin came to a similar conclusion: using the same time period as Kaldor, real money balances increased by 1-18% depending on which metric you use, and the overall money supply increased by 5%. Though base money contracted by about 2% at the onset of the crash, a contraction this small is a relatively common occurrence and not generally associated with depressions.

There is then the issue of causality. In many ways Friedman assumed what he wanted to prove: that the money supply is controlled by the central bank. Yet there are good reasons to doubt this, and believe that movements in income instead create a decrease in the money supply, which would absolve the central bank of responsibility. When economists such as Nicholas Kaldor pointed out this possibility, Friedman reached a new level of disingenuous (the first paragraph is Friedman’s comment; Kaldor responds in the second):

The reader can judge the weight of the casual empirical evidence for Britain since the second world war that Professor Kaldor offers in rebuttal by asking himself how Professor Kaldor would explain the existence of essentially the same relation between money and income for the U.K. after the second world war as before the first world war, for the U.K. as for the U.S., Yugoslavia, Greece, Israel, India, Japan, Korea, Chile and Brazil?

The simple answer to this is that Friedman’s assertions lack any factual foundation whatsoever. They have no basis in fact, and he seems to me to have invented them on the spur of the moment. I had the relevant figures extracted from the IMF statistics for 1958 and for each of the years 1968 to 1979, for every country mentioned by Friedman and a few others besides… Though there are some countries (among which the US is conspicuous) where in terms of the M3 the ratio has been fairly stable over the period of observation, this was not true of the majority of others.

Bottom line? Friedman had to assume his conclusion – that the money supply was in control of the Federal Reserve – in order to reach it. Yet, based on his own numbers, his conclusion was still false, as the money supply increased over the ‘crash’ period from 1929-1931. When Friedman was pushed on these matters, he simply made things up. However, lying hasn’t helped him escape the fact that his theory of the Great Depression is false.

Conclusion

Milton Friedman’s academic contributions do not stand up to scrutiny. Friedman seemed to be prepared to conjure up neat, ad hoc explanations for certain phenomena, simply asserting facts and leaving it for others to see if they were true or not, which they usually weren’t. He selectively interpreted his own data, exaggerating or plain misrepresenting it in order to make his point. Furthermore, his methods should be unsurprising given his incoherent methodology, which allowed him to dodge empirical evidence on the grounds of an ill-defined ‘predictive success’, something which sadly never materialised. In almost any other discipline, Friedman’s attempts at ‘science’ would have been laughed out of the room. Serious economists should distance themselves from both him and his contributions.

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The Myth of Neutral Money

Conventional economic theory purports that money is neutral: that is, changes in the money supply do not affect the ‘real’ economy (patterns of trade, production and consumption). Instead, the only interaction between the monetary and the real economy is thought to be through the determination of nominal quantities such as prices, wages, exchange rates and so forth. Though a change in the quantity of money may create short term disruptions, the economy eventually will settle at the same long term equilibrium as before.

An extreme interpretation of the neutrality of money would lead to absurd conclusions, such as the idea that the ‘real’ economy would operate the same whether it had a gold standard or hyperinflation. I’d therefore interpret the ‘neutral money’ view as the claim that, at ‘normal’ levels of money, a change in the money supply will not alter the long term economic equilibrium. This viewpoint was described well by Milton Friedman in his famous ‘helicopter drop’ story, which I will use as the basis for my critique.

Friedman began his story by imagining a community in economic equilibrium:

Let us suppose, then, that one day a helicopter flies over our hypothetical long-stationary community and drops additional money from the sky equal to the amount already in circulation-say, $2,000 per representative individual who earns $20,000 a year in income. The money will, of course, be hastily collected by members of the community. Let us suppose further that everyone is convinced this event is unique and will never be repeated….

…People’s attempts to spend more than they receive will be frustrated, but in the process these attempts will bid up the nominal value of goods and services. The additional pieces of paper do not alter the basic conditions of the community. They make no additional productive capacity available. They alter no tastes….the final equilibrium will be a nominal income of $40,000 per representative individual instead of $20,000, with precisely the same flow of real goods and services as before.

It is first worth noting that the ‘real’ benchmark for Friedman’s equilibrium is somewhat hard to define – after all, the real economy is an artificial construct with no real world counterpart. Economic agents must necessarily negotiate with and act on the nominal: as John Maynard Keynes pointed out, workers do not have control over the general price level, and hence can only impact their nominal wages. Clearly, nobody has control over the ‘general price level’ (itself surely a problematic concept), so Keynes’ argument also applies to prices, exchange rates and other variables (sorry, economists, no ‘as if‘ arguments allowed). Nominal variables are actually observable, while proponents of money neutrality have no moneyless baseline by which they can judge real activity, despite repeatedly appealing to the idea.

More generally, I find the idea expressed by Friedman – that the economy will tend toward a stable, long term equilibrium, perhaps oscillating in the short term – is often used by economists, but is rarely fully justified. It is merely assumed that the economy will behave this way, and any erratic behaviour – such as money illusion, and sticky wages/prices – can be dismissed as short term ‘noise’. However, seems to me that such an idea can only be sustained by sweeping potential problems under the rug. Indeed, this supposed ‘noise’ (a) could be more relevant to understanding the system than the equilibrium and (b) could have a permanent impact on the economy and therefore equilibrium itself.

It is entirely possible – common, even – for a system’s behaviour to differ markedly from its equilibrium value(s). This is true even if the system has some tendency toward the equilibrium**. In examples such as Friedman’s, a monetary disturbance will surely alter people’s perceptions (something Friedman acknowledges), and they will engage in economic activity based on these altered perceptions, continually adjusting as they overshoot or undershoot their plans. Hence, a monetary shock could push the economy out of equilibrium and into a long term trajectory that has little relation to its initial position. Furthermore, if there are constant changes in the money supply, any tendency toward equilibrium will be continually thwarted. As Irving Fisher put it, “equilibrium is seldom reached and never long maintained”.

In fact, monetary disruptions can have even more fundamental effects than this. Due to path dependence, a monetary disturbance could change not only the immediate behaviour of the system but also the long term equilibrium itself. If money is invested based on people’s altered perceptions, long term capital goods can be created that otherwise would not have been. This phenomenon is all the more pronounced if new money is not evenly distributed but injected at specific points, something known as Cantillion effects. Friedman considers this possibility, but dismisses it without must justification (“during the transition some people will consume more, others less. But the ultimate position will be the same”. Erm, why?). The fact is that a company, individual or government who finds themselves with a relatively higher income due to a monetary injection could make important investments, altering long term patterns of production and consumption.

The role of finance

All of these effects would be important even in Friedman’s imaginary world. But it only becomes clear quite how important they are when we consider the nature of the modern banking system is particularly important, something entirely absent from Friedman’s example. This is because in neoclassical theory, banks are generally assumed to be ‘intermediaries’ who take money from Peter and loan it to Paul. The result is that banks only really ‘smooth things out’ by matching borrowers and lenders, and hence can be assumed away, perhaps save for one or two ‘frictions’ (transaction costs, interest rate mark ups). Effectively, we model the economy as if Peter is loaning directly to Paul, and from there we suppose that the nominal amount of money lent & borrowed is arbitrary, having no impact on Paul’s ‘real’ activity.

However, as has been comprehensively discussed in the blogosphere, this is not how banks work in the real world. Rather than taking money from Peter and loaning it to Paul, banks simply create a loan for Paul out of nothing. The ‘other side’ of the loan is not Peter’s deposit; it is a deposit that belongs to Paul, created at the same time as his loan, at an amount equal to the loan itself. At the moment the loan is issued, the money supply expands, and when the loan is repaid, the money supply will contract. Hence, the real economic activity Paul engages in is inextricably intertwined with the change in the money supply. The goods and services Paul buys, or the business he starts, or the assets whose price he bids up are a direct consequence of the same decision that expands the money supply. We cannot say that only prices will be affected, as the loan has a clear impact on production and consumption patterns in the real economy.

Furthermore, the constant extending and repaying of credit means the money supply is always expanding and contracting, with no discernible regularity. This is in stark contrast to the idea that the quantity of money simply moves from one long-term quantity to another, or increases at a constant rate. The idea of an underlying ‘real’ equilibrium simply becomes irrelevant when the nominal economy is constantly shifting like this, as irrelevant as discussing a surf board on calm waters if we want to understand its motion when it’s riding a wave.

Lastly, I previously noted that nominal variables are the variables which are actually observed and used in the real world, and nowhere is this more important than in the financial sector*. It is clear that by doubling the quantity of money in circulation, the relative value debts and assets would halve, which would have a big impact on the economy – imagine waking up to find your savings and mortgage were now worth half as much! Plans would be thwarted; firms, households and the government would find themselves in dramatically different financial situations: better or worse depending on whether they were a debtor or creditor. Bankruptcies and spending sprees would surely ensue. Likely, it would be a highly chaotic situation.

The constant interaction between the real and nominal – whether due to people’s perceptions, the financial sector, Cantillion effects, or what have you – means that they are impossible to separate. This leads me to question how useful the idea of real variables is, and whether theories should use nominal variables instead. This is especially important when trying to understand the role of assets and the financial sector – in fact, economist’s ‘real’ benchmark, and their adherence to the neutrality of money, which allowed them to gloss over the role of money and finance, surely helped blind them to the financial crisis. Perhaps further acknowledging the importance of money and the nominal could be a positive step forward for economic theory.

*I have seen people suggest that such variables should be made real to ‘correct’ the problem. Well, this was tried in Iceland, and it didn’t work. You simply cannot force the world to behave like theories; you have to do things the other way round.

**This is easy to show using difference or differential equations. Try, for example, plugging values into y(t+1) = y(t)*(1 – a*(y(t) – y’), where 0 < y < 1, a is some constant, and y’ is the equilibrium value of y. There is a negative feedback loop, yet depending on the value of a, and the initial values, the average can be far from y’ for long periods of time.

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Against Friedman: Why Assumptions Matter

I have previously discussed Milton Friedman’s infamous 1953 essay, ‘The Methodology of Positive Economics.’ The basic argument of Friedman’s essay is the unrealism of a theory’s assumptions should not matter; what matters are the predictions made by the theory. A truly realistic economic theory would have to incorporate so many aspects of humanity that it would be impractical or computationally impossible to do so. Hence, we must make simplifications, and cross check the models against the evidence to see if we are close enough to the truth. The internal details of the models, as long as they are consistent, are of little importance.

The essay, or some variant of it, is a fallback for economists when questioned about the assumptions of their models. Even though most economists would not endorse a strong interpretation of Friedman’s essay, I often come across the defence ‘it’s just an abstraction, all models are wrong’ if I question, say, perfect competition, utility, or equilibrium. I summarise the arguments against Friedman’s position below.

The first problem with Friedman’s stance is that it requires a rigorous, empirically driven methodology that is willing to abandon theories as soon as they are shown to be inaccurate enough. Is this really possible in economics? I recall that, during an engineering class, my lecturer introduced us to the ‘perfect gas.’ He said it was unrealistic  but showed us that it gave results accurate to 3 or 4 decimal places. Is anyone aware of econometrics papers which offer this degree of certainty and accuracy? In my opinion, the fundamental lack of accuracy inherent in social science shows that economists should be more concerned about what is actually going on inside their theories, since they are less liable to spot mistakes through pure prediction. Even if we are willing to tolerate a higher margin of error in economics, results are always contested and you can find papers claiming each issue either way.

The second problem with a ‘pure prediction’ approach to modelling is that, at any time, different theories or systems might exhibit the same behaviour, despite different underlying mechanics. That is: two different models might make the same predictions, and Friedman’s methodology has no way of dealing with this.

There are two obvious examples of this in economics. The first is the DSGE models used by central banks and economists during the ‘Great Moderation,’ which predicted the stable behaviour exhibited by the economy. However, Steve Keen’s Minsky Model also exhibits relative stability for a period, before being followed by a crash. Before the crash took place, there would have been no way of knowing which model was correct, except by looking at internal mechanics.

Another example is the Efficient Market Hypothesis. This predicts that it is hard to ‘beat the market’ – a prediction that, due to its obvious truth, partially explains the theory’s staying power. However, other theories also predict that the market will be hard to beat, either for different reasons or a combination of reasons, including some similar to those in the EMH. Again, we must do something that is anathema to Friedman: look at what is going on under the bonnet to understand which theory is correct.

The third problem is the one I initially honed in on: the vagueness of Friedman’s definition of ‘assumptions,’ and how this compares to those used in science. This found its best elucidation with the philosopher Alan Musgrave. Musgrave argued that assumptions have clear-if unspoken-definitions within science. There are negligibility assumptions, which eliminate a known variable(s) (a closed economy is a good example, because it eliminates imports/exports and capital flows). There are domain assumptions, for which the theory is only true as long as the assumption holds (oligopoly theory is only true for oligopolies).

There are then heuristic assumptions, which can be something of a ‘fudge;’ a counterfactual model of the system (firms equating MC to MR is a good example of this). However, these are often used for pedagogical purposes and dropped before too long. Insofar as they remain, they require rigorous empirical testing, which I have not seen for the MC=MR explanation of firms. Furthermore, heuristic assumptions are only used if internal mechanics cannot be identified or modeled. In the case of firms, we do know how most firms price, and it is easy to model.

The fourth problem is related to above: Friedman is misunderstanding the purpose of science. The task of science is not merely to create a ‘black box’ that gives rise to a set of predictions, but to explain phenomena: how they arise; what role each component of a system fills; how these components interact with each other. The system is always under ongoing investigation, because we always want to know what is going on under the bonnet. Whatever the efficacy of their predictions, theories are only as good as their assumptions, and relaxing an assumption is always a positive step.

Hence, the ‘it still behaves as if it matches our theories’ mentality of economists can easily be shown to be quite absurd, for example:

Consider the following theory’s superb record for prediction about when water will freeze or boil. The theory postulates that water behaves as if there were a water devil who gets angry at 32 degrees and 212 degrees Fahrenheit and alters the chemical state accordingly to ice or to steam. In a superficial sense, the water-devil theory is successful for the immediate problem at hand. But the molecular insight that water is comprised of two molecules of hydrogen and one molecule of oxygen not only led to predictive success, but also led to “better problems” (i.e., the growth of modern chemistry).

If economists want to offer lucid explanations of the economy, they are heading down the wrong path (in fact this is something employers have complained about with economics graduates: lost in theory, little to no practical knowledge).

The fifth problem is one that is specific to social sciences, one that I touched on recently: different institutional contexts can mean economies behave differently. Without an understanding of this context, and whether it matches up with the mechanics of our models, we cannot know if the model applies or not. Just because a model has proven useful in one situation or location, it doesn’t guarantee that it will useful elsewhere, as institutional differences might render it obsolete.

The final problem, less general but important, is that certain assumptions can preclude the study of certain areas. If I suggested a model of planetary collision that had one planet, you would rightly reject the model outright. Similarly, in a world with perfect information, the function of many services that rely on knowledge-data entry, lawyers and financial advisors, for example-is nullified. There is actually good reason to believe a frictionless world such as the one at the core of neoclassicism leaves the role of many firms and entrepreneurs obsolete. Hence, we must be careful about the possibility of certain assumptions invalidating the area we are studying.

In my opinion, Friedman’s essay is incoherent even on its own terms. He does not define the word ‘assumption,’ and nor does he define the word ‘prediction.’ The incoherence of the essay can be seen in Friedman’s own examples of marginalist theories of the firm. Friedman uses his new found, supposedly evidence-driven methodology as grounds for rejecting early evidence against these theories. He is able to do this because he has not defined ‘prediction,’ and so can use it in whatever way suits his preordained conclusions. But Friedman does not even offer any testable predictions for marginalist theories of the firm. In fact, he doesn’t offer any testable predictions at all.

Friedman’s essay has economists occupying a strange methodological purgatory, where they seem unreceptive to both internal critiques of their theories, and their testable predictions. This follows directly from Friedman’s ambiguous position. My position, on the other hand, is that the use and abuse of assumptions is always something of a judgment call. Part of learning how to develop, inform and reject theories is having an eye for when your model, or another’s, has done the scientific equivalent of jumping the shark. Obviously, I believe this is the case with large areas of economics, but discussing that is beyond the scope of this post. Ultimately, economists have to change their stance on assumptions if heterodox schools have any chance of persuading them.

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Milton Friedman’s Distortions

Milton Friedman is quite a revered figure – among economists, conservatives, libertarians and some leftists – partly, of course, because he was a prolific economist, but also in large part due to his debating skills. He is generally perceived as able to shut down arguments from the left with simple, easy to understand, often amusing one liners. However, I have always found him unconvincing, and here I hope to show why.

There will be, of course, numerous conceptual disagreements which I will try not to discuss in this post: the phony market-government dichotomy, where government is some exogenous entity; the general idea that self interest will lead to the best of all outcomes; the invocation of the mythical ‘free market.’ Nor is the purpose of this post to draw attention Friedman’s major intellectual arguments themselves – though I have already done that with his stance on assumptions, corporate social responsibility, and I suppose by proxy I have commented on his interpretation of the Great Depression.

Instead what I want to do here is show Friedman’s general debating techniques are highly questionable. Many of his arguments rest on an abuse of the reductio ad absurdum. Sometimes Friedman was either ignorant about the evidence or just plain dishonest. Many of the ‘facts’ he cites don’t stand up to even a brief fact check. Here are some examples:

Here, Friedman references the late 19th century land deals as ‘minor.’ One billion acres of land is not minor. Much of this land was taken from citizens directly in the interests of privately owned corporations, and/or involved widespread fraud and corruption. The sheer volume of land seized suggests the deals played a massive part in establishing the railway lines, along with many other industries across the U.S. Would these engines of growth have been built if not for the coercive grabbing of masses of land?

The fact is that even cursory glance at social mobility in the United States puts lie to Friedman’s claims about it being high. Similar results hold for most developed countries, generally only changing as they become more Social Democratic.

In general I’ve noticed Friedman makes repeated vague references to ‘all of history,’* for which he never provides specifics, and which are actually completely at odds with the evidence. I can only conclude that what he says is based not on history but on armchair analysis of what must have happened, based on his own logic. But there is strong reason to doubt this logic – as I have discussed in my previous posts A Brief Anti-Economist History and How Natural is Capitalism, Exactly?, Western Capitalism did not just spring out of nowhere due to the magic of the market.

For example, was Friedman aware of hunting restrictions such as the Black Acts, which brutally enforced limits on peasant activity and so contributed to the initial rise in the industrial workforce? The rise in enclosure acts, which did something similar? Is he aware of the large amount of U.S. tariffs during the country’s rise to prominence, and similar trends in other Western countries, as well as more recently developed countries in Asia? Such historical debates are lost in a sea of sweeping assertions about the efficacy of the apparently omnipresent ‘free enterprise system,’ with narratives that would have Friedman fail a first year history essay.

To be sure, as with all historical analysis, there is always room for discussion, but Friedman’s arguments rest upon one interpretation of ‘facts’ that are usually incomplete or a blatant misrepresentation of what actually happened.

So it’s quite easy to find instances of Friedman presenting questionable evidence to support his arguments. But what about his famous purely logical put downs? Do they stand up to scrutiny? Here is quite a widely watched YouTube clip (always worth noting that the young man is not actually Michael Moore):

The issue raised is whether Ford acted immorally by failing to install some safeguarding blocks in their infamous Pinto cars, which resulted in a large amount of deaths. Friedman suggests the problem is amoral, and simply a matter of price: nobody can place an infinite value on a human life, so whether the car should have been released rests on a monetary trade off. Friedman suggests the young man who posed the question is not interested in principle, only price. In fact this is not true; Friedman simply asserts it and builds his argument from there.

A moment’s thought will suggest that the important principle is not price, as Friedman suggested, but human life, as the young man seemed to think. Consider: if the automobile will kill 10,000 people a year unless the defect is fixed, does it really matter how much it will cost to fix the problem? Surely, if fixing the defect in the automobile is affordable, then the defect should be fixed. On the other hand, if fixing the defect in the automobile is not affordable, then defective car should not be released. However, a profit driven firm necessarily insists that lowering costs by not fixing the defect outweighs saving a certain number of lives each year. Friedman abuses the reductio ad absurdum by taking the issue – where it was clear Ford simply should have installed the boxes – out of context, and focusing on price as the important variable.

Here is another example where Friedman abuses the reductio ad absurdum:

What the man posing the question to Friedman is actually alluding to – in a roundabout sort of way – is a simple concept called the ‘income effect:’ reducing somebody’s income via taxation may well increase the amount they work (and empirical studies suggest it does), hence increasing overall production. Of course, if you increase it to 98% you will impoverish people and destroy the economy, but nobody actually suggested that.

Perhaps some might interpret this as cherry picking. So, finally, here is a full interview with Milton Friedman. I will discuss Friedman’s remarks throughout the interview:

(1) At 2:06, the presenter asks if a place such as Central Park would exist in a ‘pure market’ situation. Friedman fails to answer the question directly, but during his response he blames Central Park’s problems during the 1980s on public management. But Central Park is in fact a public private partnership, where the private firm employs 4 out of 5 of people maintaining the park. Again, Friedman either has no idea what he is talking about or is lying.

(2) At 4:10, the presenter brings up Thalidomide. Friedman’s response contains two problems. First, when he says that the FDA stalls potentially beneficial drugs from being used, he fails to distinguish between a Type 1 error – falsely rejecting, say, a perfectly safe drug – and a Type 2 error – failing to reject an unsafe one. Type 1 is generally considered worse on the logic of ‘convicting an innocent person.’

Second, Friedman suggests that the company responsible for Thalidomide did not make a profit, therefore the market would ‘signal’ for it to go bankrupt. I am not sure whether they made a profit in that particular instance. What I am sure of, however, is that the company is still around today. Again, Friedman references facts that are questionable on even a cursory inspection.

Lastly, when Friedman suggests that the airlines will make sure all of its planes are safe, he neglects the ‘weighing up logic’ we saw in the Ford Pinto video. (I am playing Devil’s Advocate, as I don’t think any sane person would defend current U.S. airport security.)

(3) From the beginning the interviewer asks Friedman about the government setting information requirements on packaging. I don’t really understand how Friedman can make the ‘if it mattered a profit seeking firm would take advantage of it’ argument when the interviewer has explicitly stated that the government had to start to enforce information requirements because private firms were not doing it.

Note also that he doesn’t actually engage with the civil rights act question explicitly.

(4) During the final video the interviewer takes Friedman through every government program and Friedman advocates abolishing the majority of them. What confuses me about this part is that Friedman advocated some of these programs elsewhere – for example in his books. In Capitalism and Freedom, he advocated building infrastructure, a negative income tax, school vouchers, praised antitrust laws and more. This highlights Friedman’s dual roles as a propagandist and serious thinker, as a man who was willing to make sensationalist claims and advocate radical policies just to get attention, even if he didn’t truly believe in them. (Some may suggest Friedman was older and had matured here, but there are examples of him criticising these things he advocated elsewhere when he was younger, too. I also see no justification anywhere, ever, for his surreal last minute ‘abolish the federal reserve‘ position).

I don’t mean to suggest what I have to say is the final word; I merely hope to point out that Friedman was somewhat disingenuous and often used logical sleights of hand to get his point across. His interviewers and opponents rarely seemed to press him on it, and to be honest I never saw him go up against anyone particularly formidable. Furthermore, Friedman’s case highlights how little weight should be placed on verbal debates: one liners that seem persuasive at first can evaporate under close scrutiny; facts can be presented with few checks and balances; questions can be dodged and twisted. Friedman was prepared to argue the more ‘free market’ position merely for the sake of it, and was undoubtedly skilled at this role. But once you unpick some of the arguments and cross-check the evidence, his world view leaves a lot to be desired.

*This type of thinking is found throughout most of videos, including the ones already embedded. Specifically, though, see 3:10 here, 1:15 here, the general narrative here.

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Milton Friedman on Corporations

Milton Friedman famously argued that corporations have no social responsibility, only a responsibility towards their customers and shareholders to maximise profit. In fact, he even supported legislation to makes them to do this. Funny how legislation is OK when…no, forget it (again).

Friedman’s position is obviously an odd one. If corporations have no social responsibility, then presumably they are, in abstract, permitted to steal, defraud and coerce for their customers and shareholders? My guess is Friedman wouldn’t support this position. This leaves two possibilities:

(1) They shouldn’t do these things because they are constrained by the law. In other words: they should obey the law, just because it’s the law. I can’t imagine Friedman supporting a position like this, either.

(2) They shouldn’t do these things because they have a moral obligation apart from the law. In other words, they have some social responsibility.

Presuming Friedman doesn’t think corporations are allowed to coerce, defraud and steal, and presuming he doesn’t think laws should be obeyed simply because they are laws, the only conclusion can be that corporations have some moral and social obligations. The question then becomes where these lie.

As with much of libertarianism, on close inspection, the dichotomies become blurred, and the debate collapses back to where it’s always been.

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Milton Friedman’s Methodology: A Critique

Economics has come under a lot of criticism recently, and proponents sometimes try to defend themselves by pointing to Milton Friedman’s methodology of positive economics. In this essay, Friedman loses his mind argues that the assumptions of a theory do not matter as long as its predictions are correct. Of course, even if you accept this there are still plenty of criticisms of neoclassical economics – the theories internally contradict themselves, and it is also incredibly hard to verify empirical predictions in social science, making Friedman’s litmus test somewhat of a damp squib. However, let’s put these objections to one side.

In the essay, Friedman takes us on a typical Friedman logic train to his preordained conclusion and leaves you to puzzle over how you got there. He argues that to be completely realistic a theory would have include everyone on earth’s eye colour, qualifications, etc. But how do you test whether or not to include these things? You see whether evidence corroborates the theory without them! Fantastic – assumptions don’t matter.

In this case, Friedman’s sleight of hand lies in not properly defining the word ‘assumption’. This is, in fact, so significant that it means his paper is effectively advocating any methodology whatsoever (if I assume throwing darts at this board will give me the GDP figures for next year…). The crucial characteristic of assumptions in engineering or science is that they eliminate specific variables. A perfect gas is one where many of the smaller forces between molecules are ignored. Assuming a vacuum eliminates air resistance. This gives us an appropriate method, as ‘relaxing’ an assumption means adding in more variables, and this process can continue for as long as it is practically feasible.

However, many economic assumptions could not be argued to be eliminating a certain variable - assuming that people are rational self maximisers, or that firms calculate expenditure based on marginal costs and revenue, are actually hypotheses, not ‘assumptions’ in the scientific sense of the word. As such, the ‘assumptions’ themselves are empirically falsifiable and cannot be swept under the rug.

Furthermore, in science theories are only deemed as valid as their assumptions are realistic. A theory can always be improved by making the assumptions resemble reality more accurately. So even if we were to accept Friedman’s premise, we could still improve theories by abandoning rationality based on behavioural evidence, or abandoning marginal cost based on surveys*. Unsurprisingly, in the case of widely used economic models such as Arrow-Debreu, it is incredibly difficult to relax assumptions before the theory collapses – if this were true in physics, the model would be abandoned.

To be honest, it is a sad indictment of economics that an essay which contains the passage:

The articles on both sides of the controversy [regarding marginalist analysis]…concentrate on the largely irrelevant question of whether businessmen do or do not in fact reach their decisions by consulting schedules, or curves, or multivariable functions showing marginal cost and marginal revenue.

has to be critiqued formally. A theory’s assumptions are always relevant to its conclusions, and improving them will always yield more accurate results. That much is obvious to the man on the street, but clearly not to economists.

*Friedman argues surveys are as useless as asking octogenarians how they account for their long life. I can only interpret this as him saying businesses have no idea what they are doing, which sort of undercuts him intellectually elsewhere.

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