J. Bradford DeLong: Re-Capturing the Friedmans

On my desk right now are reporter Timothy Noah’s new book The Great Divergence: America’s Growing Inequality Crisis and What We Can Do about It and Milton and Rose Director Friedman’s classic Free to Choose: A Personal Statement. Considering them together, my overwhelming thought is that the Friedmans would find their task of justifying and advocating small-government libertarianism much harder today than they did in 1979.

Back then, the Friedmans made three powerful factual claims about how the world works – claims that seemed true or maybe true or at least arguably true at the time, but that now seem to be pretty clearly false. Their case for small-government libertarianism rested largely on those claims, and has now largely crumbled, because the world, it turned out, disagreed with them about how it works.

The first claim was that macroeconomic distress is caused by the government, not by the unstable private market, or, rather, that the form of macroeconomic regulation required to produce economic stability is straightforward and easily achieved.

The Friedmans almost always made the claim in its first form: they said that the government had “caused” the Great Depression. But when you dug into their argument, it turned out that what they really meant was the second: whenever private-market instability threatened to cause a depression, the government could avert it or produce a rapid recovery simply by purchasing enough bonds for cash to flood the economy with liquidity.

In other words, the strategic government intervention needed to ensure macroeconomic stability was not only straightforward, but also minimal: the authorities need only manage a steady rate of money-supply growth. The aggressive and comprehensive intervention that Keynesians claimed was needed to manage aggregate demand, and that Minskyites claimed was needed to manage financial risk, was entirely unwarranted.

Real libertarians never bought the Friedmans’ claim that they were as advocating a free-market, “neutral” monetary regime: Ludwig von Mises famously called Milton Friedman and his monetarist followers a bunch of socialists. But, whatever its packaging, the belief that macroeconomic stability requires only minimal government intervention is simply wrong. In the United States, Federal Reserve Chairman Ben Bernanke has executed the Friedmanite playbook flawlessly in the current downturn, and it has not been enough to preserve or rapidly restore full employment.

The second claim was that externalities were relatively small, or at least that they were better dealt with via contract and tort law than through government regulation, because the disadvantages of government regulation outweighed the harm done by those externalities that the legal system could not properly address. Here, too, reality does not seem to have endorsed Free to Choose. In the US, this is most apparent in changing attitudes toward medical-malpractice lawsuits, with libertarians no longer viewing the court system as the preferred arena to deal with medical risk and error.

The third, and most important, claim is the subject of Noah’s The Great Divergence. In 1979, the Friedmans could confidently claim that, in the absence of government-mandated discrimination (for example, the South’s segregationist Jim Crow laws), the market economy would produce a sufficiently egalitarian distribution of income. After all, it had appeared to do so – at least for those who did not suffer from legal discrimination or its legacies – for the entire post-WWII era.

So the Friedmans argued that a minimal safety net for those whom bad luck or a lack of prudence had rendered destitute, and elimination of all legal barriers to equality of opportunity, would lead to the most equitable outcomes possible. Profit-seeking employers, using and promoting human talents, would bring us as close to a free society of associated producers as is attainable in this fallen sublunary sphere.

Here, too, the Friedmans’ hopes have been disappointed. The end of American preeminence in education, the collapse of private-sector unions, the emergence of a winner-take-all information-age economy, and the return of Gilded Age-style high finance have produced an extraordinarily unequal pre-tax distribution of income, which will burden the next generation and make a mockery of equality of opportunity.

It would have been nice if the political program laid out a generation ago in Free to Choose had lived up to the Friedmans’ billing. It would have been nice if a relatively equal and prosperous society with full employment and equal opportunity had followed from a government that stood back from the economy and provided nothing but a minimal safety net, courts, and a constantly growing money supply.

Alas, that did not happen. And it did not happen because the world described by the Friedmans is not the world in which we live.

J. Bradford DeLong is Professor of Economics at the University of California at Berkeley and a research associate at the National Bureau for Economic Research. He was Assistant US Treasury Secretary during the Clinton Administration, where he was heavily involved in budget and trade negotiations. His role in designing the bailout of Mexico during the 1994 peso crisis placed him at the forefront of Latin America’s transformation into a region of open economies, and cemented his stature as a leading voice in economic-policy debates.