THE ECONOMIC THEORIES OF MILTON FRIEDMAN

The Economic Theories of Milton Friedman

Milton Friedman was one of the top and most influential economists whose conservative economic theories became influential during the last part of the twentieth century. This paper will explore his economic theories and how his policies were embraced by some conservative politicians but are not as widely adopted today. Milton Friedman would famously say “there is no such thing as a free lunch” (Moore 2012). What he meant was that everything comes with an opportunity cost. If the government spends money then that money must come from the private economy. He was an advocate of capitalism and his views helped revive modern capitalism in the latter part of the twentieth century. He was a proponent of the free market economic system and was opposed to government interference in the economy. Many of his theories have become accepted and lauded by modern day conservative politicians. Milton Friedman was born in Brooklyn, NY in 1912 to immigrant parents. He was awarded a scholarship to Rutgers University where he majored in mathematics. While at Rutgers he became interested in economics due to the poor state of the economy during the Great Depression. After graduating from Rutgers University he went on to receive his master’s degree from the University of Chicago and then on to Columbia University for his doctoral work (Academy of Achievement, 2010). During the early years of his career, Friedman went to work for the Treasury Department. While there he helped implement the income withholding tax as a way to help finance World War II. At the time, taxes were paid in a lump sum one time per year. He later came to regret helping implement the withholding tax. Friedman remarked that: we concentrated single-mindedly on promoting the war effort. We gave next to no consideration to any longer-run consequences. It never occurred to me at the time that I was helping to develop machinery that would make possible a government that I would come to criticize severely as too large, too intrusive, too destructive of freedom. Yet, that was precisely what I was doing. (North, 2012) Although he made no apologies for helping implement the withholding tax during war time, he later regretted that it became a permanent tax on citizens and wished it would be abolished. He later became in favor of and proposed a flat rate tax with no exemptions, deductions or loopholes. With the flax tax rate, there would be less government interference and it would be a more equitable type of tax system. Even though he did not believe in exemptions, he believed in an exception for the poor. He proposed a negative income tax to replace welfare. Those eligible would receive payments depending on how far below the threshold their incomes fell The flat rate proposal was never realized but Friedman’s proposal of a negative income tax has its form today in the Earned Income Tax Credit (Thorndike, 2006). After his work with the Treasury Department, Friedman accepted a position at the University of Chicago to teach economic theory. He became head of what was known as the Chicago School of Economics. This school of thought advocated free market capitalism. Keynesian economics was widely accepted at the time. As the leader of this school of thought he challenged many of the Keynesian views. Friedman challenged the Keynesian model of consumption function with his book “A Theory of the Consumption Function”. Keynesian’s supported short term solutions such as tax breaks to stimulate consumer spending and the economy. They believed that tax breaks would stimulate spending without giving up revenue by making tax cuts. Friedman used empirical evidence to refute the Keynesian theory. Friedman’s Permanent Income Hypothesis determined that people will base their consumption according to their normal incomes. Tax breaks and short term windfalls do not have much effect on consumer spending whereas a change in permanent income could have large effects on consumer spending (Daniels). Milton Friedman was also known as being a monetarist. Monetarists believe “the best thing for the economy is to keep an eye on the money supply and let the market take care of itself: in the end, markets are more efficient at dealing with inflation and unemployment” (Radcliffe, 2009). Friedman believed that increasing the money supply would only be a temporary lift to economic growth and that in the long run it would create inflation and higher unemployment. To control inflation, the money supply would need to be controlled. Friedman recommended that central banks and the Federal Reserve control the money supply to keep the inflation rate down. By keeping the inflation rate down, the price of goods would be kept down as well (Academy of Achievement, 2010). His views on the money supply were not well received at the time he introduced them. The 1970’s was considered a period of stagflation with high inflation rates and unemployment. To get inflation under control, the Federal Reserve Chairman Paul Volcker put the monetarist theories into practice by controlling the money supply. This brought interest rates down and reduced inflation but put the economy into a recession. Ben Bernake would later say that the recession was caused by the Fed waiting too long to put Friedman’s monetary policies into place (Nielsen, 2000). Milton Friedman’s theories about limited government involvement were laid out in his book “Capitalism and Freedom”. Friedman associated economic freedom to political freedom. He believed that without economic freedom, political freedom would be impossible (Bumpus, 2010). He also believed that government should play a limited role in the economy. The government should only be involved by protecting the rights of those involved through either fines, regulation or other means. Other theories that Friedman discussed in his book included the control of money into the economy. He proposed that the Federal Reserve only increase the money supply by 3 – 5 % every year. In addition, he proposed a floating exchange rate system. He also advocated for the end to trade barriers and currency controls. Friedman also was an advocate of education vouchers to allow families choose where to send their children to school. He believed this would allow low-income families to receive a better education by being able to choose their school rather than being forced to attend the worst public schools. He believed in privatization of the educational system. Friedman believed that: “we will only see improvements in education by privatizing a major segment of the educational system – by enabling a private, for-profit industry to develop that will provide a wide variety of learning opportunities and offer effective competition to public schools”. (Burke, 2012)
Friedman was showing his free market colors here as well. Although not completely what Friedman had in mind regarding school choice for everyone, choices for schooling have improved with options such as charter schools, tax credits and vouchers. Friedman became an economic advisor for President Ronald Reagan and was influential in advancing his anti-inflation, tax cutting and anti-government policies during that administration. In addition President Bush said of Friedman, “His work demonstrated that free markets are the great engines of economic development (IP & Whitehouse, 2006). Friedman would not be a fan of the current administration’s policies. He would have disagreed with the bank bailout bill of 2008. He would have been against this bailout because he wouldn’t support any establishment that couldn’t compete in the free market. He would definitely be against the stimulus package of the Obama administration. He would have preferred to cut government spending and reduce taxes. Since he was a proponent of the flat tax rate he would have recommended tax cuts to both the personal income tax and the Social Security and Medicare taxes. He probably would have supported expansion of the Earned Income Tax Credit since it was a form of his negative income tax. He would be an ardent critic of ObamaCare since he believed that government intervention is always unfavorable. The one area that he would have been satisfied with is the education voucher program although he would probably feel that more could be done. There are still many conservative politicians who are in favor of many of Friedman’s theories. Mitt Romney said of Friedman during his presidency campaign, “Milton Friedman understood what, frankly, our president, President Obama, I don’t think has learned even after three years and hundreds of billions of dollars in federal spending, and that is: Government does not create prosperity. Free markets and free people create prosperity.” (Wapshott, 2012)
Had Romney been elected he would have attempted to move toward a more free market by cutting government spending. Milton Friedman was one of the most influential economists in the latter part of the twentieth century. Some of his policies such as the income tax withholding are still part of economic policy. Many still view his free market, limited government involvement in the economy as the correct economic policy for our country. Milton Friedman’s economic theories can be summed up in this humorous quote, “If you put the federal government in charge of the Sahara desert, in five years there’d be a shortage of sand” (Hawkins, 2011).

References

Moore, S. (2012, Aug 1). The man who saved capitalism. The wall street journal, Retrieved from http://online.wsj.com/article/SB10000872396390444226904577558882802335216.html

Academy of Achievement. (2010, July 12). Champion of economic freedom. Retrieved from http://www.achievement.org/autodoc/page/fri0bio-1

North, G. (2012, Aug 01). [Web log message]. Retrieved from http://lewrockwell.com/north/north1178.html

Thorndike, J. (2006, November 16). Milton friedman dead at 94. Retrieved from http://www.taxhistory.org/thp/readings.nsf/ArtWeb/629A48DB6BB63EDD8525730800064E63?OpenDocument

Daniels , C. (n.d.). Milton friedman's permanent income hypothesis. Retrieved from http://www.achievement.org/autodoc/page/fri0bio-1

Radcliffe, B. (2009, February 26). Monetarism: Increasing money . Retrieved from http://www.investopedia.com/articles/economics/08/monetarism.asp

Nielsen, B. (2009, May 31). Stagflation, 1970's style. Retrieved from http://www.investopedia.com/articles/economics/08/1970-stagflation.asp

Bumpus, K. (2010, January 12). Capitalism and freedom by milton friedman review . Retrieved from http://amateurassetallocator.com/2010/01/12/capitalism-and-freedom-by-milton-friedman-review/

References

Burke, L. (2012, July 20). [Web log message]. Retrieved from http://blog.heritage.org/2012/07/30/remembering-milton-friedmans-school-choice-legacy/

IP, G. & Whitehouse, M. (2006, November 17). How milton friedman changed economics, policy and markets. The Wall Street Journal , Retrieved from http://www.columbia.edu/~esp2/WSJ Whitehouse Article.pdf

Wapshott, N. (2012, July 27). How conservatives misread and misuse milton friedman. The washington post, Retrieved from http://articles.washingtonpost.com/2012-07-27/opinions/35489157_1_interest-rates-cheap-money-economic-growth

Hawkins, J. (2011, November 29). [Web log message]. Retrieved from http://townhall.com/columnists/johnhawkins/2011/11/29/10_of_the_best_economics_quotes_from_milton_friedman/page/full/