Milton Friedman

Milton Friedman, one of the greatest economists of the 20th century, died recently. He was a proponent of monetarist theory, which regards the money supply as the central controlling factor in economic development. He won the Nobel Prize in economics in 1976 for his theory. He also believed in laissez faire capitalism (as laissez faire as it can be) and small government. Many insisted he was a conservative but he insisted he was a liberal.

Friedman became best known to the general public in the 70's chiefly for his idea that governments should be kept small and that the free market, not government, makes people's lives better. He believed that the chief purpose of government is to create an hospitable environment in which individuals can pursuit their own self-interests.

In the 70's the American economy went through a period know as 'stagflation', a period of high inflation, very low growth and fairly high unemployment, culminating in a stagnant economy. Theoretically this combination of economic events was not supposed to occur simultaneously. Friedman blamed government policy and its economic meddling for this bizarre performance. He believed that if government 'got out of the way', loosened its grip on the economy and used a better monetary policy things would improve substantially. He urged governments around the world to privatize and deregulate so as to free things up and allow economies to reach their full potential. Two of his most devoted followers were Prime Minister Margaret Thatcher and President Ronald Reagan.

Friedman first came to prominence in the late 40's with his theory about what really caused the Great Depression of the 1930's and why it lasted so long. He believed it basically had to do with the monetary policy of the time. He believed that if in the late twenties the Hoover government had reined in the circulation of money the over speculation of the stock market would not have happened, causing its crash. Similarly, Friedman argued, an increase in the money supply after the crash, instead of cutting back on it, could have prevented the Depression. In other words, he believed that if the money supply had been handled more wisely the Depression may not have happened or have lasted as long as 12 years. His theory was radical but it put him in good standing.

With hindsight wisdom makes itself known. However, did the economists of the time possess the monetary wisdom Friedman suggested they might have, which could have averted the Depression. Maybe he didn’t believe that they possess such wisdom but he certainly talked as if they did. Nevertheless, in his analysis he projected his hindsight on that time, as if the knowledge of prudent monetary policy existed then. But that knowledge didn’t exist then.

Because of Friedman's death the issue of what really caused the Depression came up again. The argument: It wasn’t the stock market crash of October 1929 that caused the Depression but the bad monetary policy of the time that did. I find this kind of argument misleading because of what it implies. That argument puts what happened back then in the context of today and what we know today. It suggests that people knew enough in those days to stave of a Depression. However, people back then did not have the economic resources or wisdom they have today to avoid such economic disasters.

And that is the problem with some analyses of past events. People tend to put yesteryears in the context of the present, thinking that in the past people knew as much as they know today. Some people think that in the twenties and thirties people had as much knowledge about economic matters as we do today. They think that the world then was as fluent and sophisticated in economic matters as it is today. Nothing could be further from the truth. In the twenties and thirties the world was economically backward in comparison to today. The world had no comprehension of things like money supply and liquidity like it does today. The world has learned empirically from those days and from the economic mistakes of the past.

It is wrong to think the Depression could have been prevented by means we know today because back then those means were non-existent. The economic sophistication of today didn’t exist then to prevent the Depression. Such knowledge wasn’t even a twinkle in the eyes of economists. The means of preventing recessions today were learned from the mistakes made back then and even from the mistakes made just 20 years ago.

In those days the governments of the world did not work in tandem to prevent economic disasters as they do today. That necessary interaction took at least a world war and a few other incidents to discover. The world has had to learn from experience on how to handle its economics. The way I hear it from some, though, is that there is some kind of bible out there, which specifically outlines how to do the right thing economically. But there is no such bible. We have had to learn the ins and outs of economics empirically, through trial and error. And that bible of economic wisdom is still being written.

There is one thing Milton Friedman regretted, that he helped institute the payroll tax during WW2. It was designed to help pay for the war effort. After the war it was supposed to have been dismantled but it wasn't. He regretted it because this tax became a cash cow for the government, which became a direct source of funds for its expansion. For an economist who believed in small government this was unintended consequence. And as we know, the world is full of unintended consequences.