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MILTON FRIEDMAN (1912-2006), CAPITALISM AND FREEDOM (1962)

By Barry Stocker
October 22nd, 2009 at 12:29 pm | 14 Comments | Posted in Economics, US Politics

friedmanMilton Friedman was a Nobel Prize winning economist and economic historian, associated with the Department of Economics at the University of Chicago, and was most famous as a ‘Monetarist’.  That is someone who regards the control of the money supply at a very constant, and slow, rate of increase, as central to controlling inflation, and for establishing the best framework for economic growth. He put this in the context of limited government, which establishes a framework for the market, rather than intervening in the market.

He explained his political ideas and public policy suggestions in Capitalism and Freedom, a book advocating a liberalism based on markets, individualism and limited government.     Friedman was not just concerned with business interests, criticising businesses strongly for their activities in trying to rig markets and influence the political process.  As Friedman points out, income inequality is greatest in those countries where the state is most inclined toward economic privileges for powerful interests.    Even in better governed countries, many schemes to help the poorest, and redistribute income, are counter productive. High income tax rates on high earners blocks entry to higher income groups, because it reduces the incentives to  earn income at that level, so the effect is to keep the same people rich.

Similar effects have come from efforts to improve the conditions of the poorest through minimum wages.  These have the effect of improving the income of some low earners, but the overall effect is to keep lower earners out of work as it is less economically viable for employers to hire them.  Friedman warned of the tendencies to bad and counter-productive effects where interventionism goes beyond very modest goals, and very simple methods.  The basis for legitimate interventionism is explained with reference to ‘neighbourhood effects’, in a negative sense, as a label for the impact of individual actions on a locality (or any general group of individuals), where it is very difficult to work out how everyone affected could be individually compensated through the law courts.  There are ‘neighbourhood effects’ in a positive sense when public policy provides something which brings great benefits to most people, and where it would be difficult in practice to charge individuals.  Pollution is an obvious example for Friedman of negative ‘neighbourhood effects’, and city parks are an example of a positive ‘neighbourhood effect’ following from public policy.

Friedman thought that it was a legitimate state activity to alleviate poverty through funds collected by taxation, but that the these efforts should remain simple and direct rather than becoming an element in a variety of schemes, with more than one gaol.  An example of the latter approach is Social Security in the United States, which compels everyone to contribute to a state old age pension fund.  One defence of this program is that it ensures a minimum living standard for the poorest on retirement.  Friedman’s response was that alleviating the poverty of the poorest retired could be done without such a big bureaucratic scheme, which takes away individual responsibility and choice.  Social Security both forces individuals to contribute a certain amount to old age, and to contribute that money to a state fund only, when we should all be free to exercise individual choice on these matters.

Concerns with simplicity and limited gaols led Friedman to suggest a combined program of flat tax, and negative income tax, as a means of funding the state and alleviating poverty.  Flat tax means setting one rate of income tax only at a high threshold, and with very few tax deductions allowed.  He argues that this will raise as much money as a multi-rate tax system, if the flat rate is set at just above the minimum rate in the previous system and well above the income threshold in the previous system.  It will also reduce incentives to find ways to avoid taxation; and reduce the size, and expense, of government tax raising bureaucracies.  This can be combined with a ‘negative income tax’ in which the lowest earners, and those on no income, receive money from the state sufficient to guarantee a basic income. This is contrasted with rent controls and public housing as means of assisting the poorest.  Rent control reduces incentives to rent out homes, and build homes for rent.  It makes housing cheaper for some people, while reducing the amount and quality of housing, particularly for the poorest.  Public housing groups together the poorest, inevitably therefore grouping together that section of the poorest who are poor because of family and psychological problems, creating a concentration of dysfunctional people and a very negative environment, inadvertently creating a negative version of the ‘neighbourhood effect’.

The best way of improving the educational chances of the poorest is to give everyone vouchers for purchasing education, enabling everyone to have choice, and not just those rich enough to afford private education out of post-tax income.  In general, liberty and prosperity for everyone, including the poorest, increases in a society with clear property rights defined by the state; and which avoids measures of price or wage control, economic subsidies and tariffs, as these all harm overall economic efficiency, along with individual freedom.

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