Book Review of Capitalism and Freedom by Milton Friedman

This Book Review of Capitalism and Freedom by Milton Friedman is brought to you from Michael Mulcahy from the Titans of Investing.

Genre: Economics
Author: Milton Friedman
Title: Capitalism and Freedom (Buy the Book)

Summary

A leading thinker of capitalism in American history, Milton Friedman combines a series of lectures he gave at Wabash College in 1956. Friedman discusses the definition of capitalism by describing the actions and economic plans of a capitalist. He walks through a variety of government actions ranging from social benefits to licensure, and he details and justifies the capitalist’s response.

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Friedman’s lessons on capitalism came at a unique time in American history. America was still benefiting from the expanding production and spending from World War II, and the American welfare state was just beginning to form. Friedman, as all capitalists, valued man’s freedom to choose and man’s freedom to fail.

He saw the formation of Old Age Survivor’s Insurance and development of urban housings, and Friedman began to educate on the distinctions between economic policies by coercion and economic policies by freedom.

Capitalism and Freedom is a book addressed to a college educated audience. Friedman attempts to answer the question “What is capitalism” by walking through a series of examples and defenses of the application of capitalism in American society.

While Friedman offers pragmatic steps to promote political freedom through economic freedom, his chief focus is illustrating how capitalism responds to various problems in a society.

It is important to understand while there are capitalist actions, capitalism is a thought framework. Friedman sums up capitalism as regarding the freedom of man as paramount and possessing the humility to allow man to fail.

Because every action the government embarks upon is either promoting economic freedom or coercive, it is vital that the individual understands the significance of man’s freedom and the dangers of a coercive government.

Introduction

“The great achievement of capitalism has not been the accumulation of property, it has been the opportunities it has offered to men and women to extend and develop and improve their capacities.”

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Capitalism and Freedom, published in 1962, contains a compilation of lectures given by Milton Friedman at a conference in 1956. Capitalism and Freedom addresses an increasingly pervasive debate between capitalism and socialism.

Friedman was one of the leading American, capitalist economists for half a century.

His book explains and articulates Friedman’s justification, defense, and promotion of a competitive and capitalist market. Friedman discusses the necessity of economic freedom as a foundation of political freedom.

Capitalism and Freedom is a series of twelve lectures bridging a variety of subjects regarding free markets and government involvement. Friedman begins his series of lectures addressing macroeconomic and monetary policy, and ends with discussions on the “liberal” (who pursues personal freedom) and the “egalitarian” (who pursues equality in outcome).

It is important to note that Friedman refers to himself as a “liberal” using the original sense of the word – an individual who takes the freedom of the individual as his ultimate goal. In this brief, I will summarize the book and Friedman’s lessons.

Economic Freedom and Political Freedom

Friedman discusses the relationship between economic freedom and political freedom. It was widely believed that economic freedom and political freedom were unrelated; however, Friedman establishes the importance of economic freedom in the process of ensuring political freedom.

Economic systems are important as they control the distribution of wealth and power.

History speaks of the necessity of economic freedom for political freedom, but it is not a sufficient condition. Modern political freedom came shortly after the development of free markets in the eighteenth and nineteenth centuries.

Friedman establishes his book’s hero and villain in his first lecture. There can only be two methods of coordinating economic activity within a country, and these two methods are the voluntary cooperation of individuals and coercion.

Friedman favors voluntary cooperation. Cooperation is voluntary if the parties are private and if the parties are free to enter, or not to enter, the exchange of goods or services. Coercion is the fundamental threat to freedom whether in the hands of a dictator or a majority.

Friedman uses the latter half of his first lecture defining the beliefs of a liberal. In a society of freedom, the liberal does not concern himself with what an individual does, but rather values his ability to do with his property whatever he chooses, as long as it does not infringe upon the freedom of others. The liberal views men as imperfect beings, yet he must tolerate men making mistakes independently.

The Role of Government in a Free Society

The goal of the liberal is to promote and ensure economic and political freedom. He achieves this by engaging free discussion and voluntary cooperation. There is no room for coercion in this process. Ensuring an environment of free discussion and voluntary cooperation allows “unanimity without conformity.”

However, there still exist values with which agreements cannot be resolved. Friedman asserts the only way to decide on these differences is through conflict. He believes the government’s role is to minimize these differences; it can accomplish that by utilizing the free market, where little agreement is necessary.

In areas where the market is insufficient, the government must act as a rule-maker and umpire.

The government exists to provide a way to create and modify market rules, mediate differences, and ensure compliance with the created market rules, all the while minimizing coercion and ensuring a voluntary, competitive market.

Another area where the government must act is in the definition of property rights. It must define what an individual is allowed to do with their property and what they may not. Finally, the government exists to establish and maintain a monetary system.

There are two cases where voluntary exchange is not possible: in a monopoly and in neighborhood effects. When a monopoly exists, there are three options: a private monopoly, a public monopoly, or public regulation.

Friedman argues in favor of a private monopoly citing it as the least of the evils.

Friedman claims the other two options are less responsive in a dynamic economy as newer parties will emerge if they are able to succeed in competition. In a neighborhood effect, the actions of one party’s transactions have an effect on other individuals in which it is impossible to compensate them.

Friedman cites pollution as an obvious example. Individuals can do little to avoid the exchange, but as a collective whole, it becomes feasible. Friedman acknowledges the necessity of government action in this circumstance, but urges caution and careful evaluation of the pros and cons of utilizing government action.

Friedman ends this lecture arguing against action through government on paternalistic grounds. There is a clear distinguishment between responsible adults and individuals incapable of caring for themselves. Friedman concludes with a list of 14 major activities that he views as unjustifiable. Among them are tariffs, minimum wage, present social security programs, and military conscription.

The Control of Money

Friedman claims the Great Depression and other periods of severe unemployment resulted from government mismanagement rather than instability of the private sector. There are two major views regarding monetary policy.

The Scylla is the belief that a gold standard would solve all the problems of economic instability, as well as being more feasible. The Charybdis believes in wide discretionary powers for an independent central bank. In Friedman’s opinion, both are insufficient.

An automatic commodity standard is infeasible and impractical for today’s society due to the large costs associated with the procurement of that commodity, and the beliefs in the value of the commodity no longer exist in the required strength.

After the establishment of the Federal Reserve, measurements of stock of money, prices, and output were significantly more unstable than before. Friedman attributes a third of the price rise after World War I to the establishment of the Fed. He cites mismanagement and excusable human mistakes as key factors in the severity of the Great depression.

Inaction followed by overreaction led to liquidity crises as well as massive economic contractions. This leads Friedman to conclude, “Any system which gives so much power and so much discretion to a few men that mistakes – excusable or not- can have such far reaching effects is a bad system.”

Friedman ends his discussion on the control of money with what he considers the optimal government action.

He suggests utilizing a government law rather than a body of men to control monetary policy; this prevents policy from being subject to political authority and man’s reactions. The liberal’s choice of action would be legislating a law instructing the monetary authority to control and target a specified rate in the M1 money supply (ideally between 3-5%).

International Financial and Trade Arrangements

One of the largest dangers to economic freedom in American society is the balance of payments. An increasingly uncontrolled loss on the income account could lead to a widespread devaluing of the U.S. dollar causing severe banking instability. There are only four ways that a country can adjust its income account.

  1. The United States foreign currencies reserve can be lowered and raised, adjusting for the exchange rates.
  2. Domestic prices can be pushed down relative to foreign prices.
  3. The exchange rate can be determined by domestic and foreign prices; this is a floating interest rate.
  4. The government could implement tariffs or quotas to reduce expenditures and expand receipts.

These are the only four options available to a government, and one must always be used. Friedman considers tariffs and quotas as the worst method to employ, as it is most destructive because it limits decisions for a free society.

There is no political interest in devaluing the United States dollar so this leaves the United States with two options: a worldwide gold standard or a floating exchange rate. As mentioned, the gold standard is no longer desirable or economically feasible. Thus, a free-floating exchange rate becomes the preferable option.

Friedman recommends America adopt a free-floating exchange rate unilaterally.

In his view, no amount of exchange rate manipulation can hide economic problems and instability within a nation. Floating exchange rates are not the cause of hyperinflation, but rather exhibit economic instability. A floating exchange rate ensures the balance of payments finally ensuring dollars received always matches dollar outflow.

Fiscal Policy

Friedman addresses discretionary spending and goes on to attack the belief that government expenditures can mitigate recessions and bolster expansions. Friedman’s intellectual opposition claims the government should act as an economic balance wheel. Unfortunately, that balance wheel is unbalanced.

The government usually does not enact spending programs until after a recession has passed.

This leads to the government exasperating the expansion instead. This has caused not only an inflationary bias, but also prevented reductions of tax burdens. Because government expenditures are such a large portion of our economy, changes in government spending have significant impacts.

In Friedman’s analysis, he found no evidence supporting the claim that an increase in government spending is expansionary. In fact, he found that an increase of government spending may increase money income, but all of it is absorbed by the expenditures, resulting in unaffected private expenditures. Couple this with rising prices and the private sector may even find their expenditures smaller in real terms.

The Role of Government in Education

There are two arguments in favor of government intervention in education. The first argument is neighborhood effects, and the second is based on paternalism. It is important to distinguish between two tiers of education: general education for citizenship and vocational education.

Friedman believes a stable democratic society is impossible without a minimum degree of literacy and competence. The most obvious thing, therefore, is to provide a general education to fill those needs. Friedman believes a government voucher for education should be provided, allowing education at the school of the individual’s choice.

If there were a difference in price, the individual would pay for the preference. The idea is to promote diversity by allowing students to look among schools they may have previously been unable to enroll in due to zoning or the double tuition that comes with choosing parochial schools over public schools.

Friedman addresses the vocational education with a more radical idea.

He relates investments into human capital to machinery. When a firm makes a loan to an individual for a tangible asset, they hold a lien against that asset until the debt is repaid. This is impossible to do against an individual in the case of tuition loans.

However, Friedman proposes that contracts could be utilized to exchange a share of an individual’s earning capacity for a tuition loan. This method would fund itself and eliminate the need for subsidies. This aligns with Friedman’s liberal view as the individual bears the cost of the investment himself or herself.

Capitalism and Discrimination Evidence supports that in areas where there is the greatest economic freedom and competition there is the littlest discrimination against groups of particular colors or races. However, minority groups have frequently been the most vocal regarding alterations to the capitalist economy.

They attribute residual discrimination to the free market rather than recognizing that the free market helped advance society to its current state.

An individual who expresses a bias against a certain people group has inherently limited himself to fewer options, thus creating in himself an economic disadvantage. He who discriminates pays the price for doing so.

While Friedman believed strongly a man should not be judged by the color of his skin or the religion he possesses, he was also against employing coercive means to enforce his opinion on others.

Friedman argues that any minority that counts on the majority to defend its interests is shortsighted. He also argues against utilizing fair employment practices. Friedman illustrates how fair employment practices damage the business owner, and thus, the individuals utilizing that business.

In Friedman’s opinion, fair employment practices results in a less than ideal employee being higher or employees not preferred by society; both scenarios are damaging to the company and surrounding society.

Monopoly and the Social Responsibility of Business

Monopolies exist when an individual or company has sufficient control over a product or service and can significantly affect the price or quality of said service. To a liberal, there are two problems with a monopoly.

First, a monopoly places limits on an individual’s ability to make decisions, reducing freedom. Secondly, it raises the issue of being socially responsible.

Monopolies exist in three areas, each of which require separate evaluations. There can be monopolies in industry, labor, and government. Friedman does not believe monopolies in industry are significant enough to warrant actions.

He believes there is a tendency to overemphasize the significance of these monopolies. Friedman views labor monopolies as relatively insignificant as well. After extensive study, Friedman concluded labor monopolies have contributed to an income gap between the highest paid workers and the lower paid workers.

Finally, Friedman dislikes government-supported monopolies.

In his opinion, they simultaneously restrict freedom while wasting resources. Friedman believes that if a government-supported monopoly were truly the most efficient method for providing a service, then new companies would not enter the market given the opportunity.

However, Friedman emphasizes the importance of allowing the free market to decide whether private enterprises are more effective than government-supported monopolies.

Milton Friedman concludes with his recommendation regarding monopolies. He proposes abolishment of the corporate tax. In his plan, the investor would record undistributed earnings on his own tax return as well as the dividend. He believes this would eliminate many tax avoidance devices, which exist today.

Occupational Licensure

In his lecture on occupational licensure, Friedman states that liberal principals do not justify licensure even in medicine, and that the medicine practices, which exist today, are completely unacceptable. The pressure to implement licensure rarely comes from the individuals damaged by a certain occupation; instead, the pressure typically comes from those within the specific occupation itself.

Friedman believes this is because they are more aware of their ability to exploit the customer. A liberal views licensure as a severe infringement on the right of an individual to pursue activities of their own choice, and when pressured with continual desire for legislation, this problem only becomes worse.

There are three tiers of control utilized by the government: registration, certification, and licensure. Of these three, only registration is justifiable. Even then, registration may only be justifiable if used for protecting against fraud or for generating tax revenue.

Friedman ends his discussion on occupational licensure by looking at the American Medical Association.

The AMA is in the position where it can limit the number of people who can enter the medical field by influencing the amount of people accepted into medical school. The rationalization for this control is that such control raises the quality of the profession. Friedman disagrees.

Licensure does not have the good effects on quality advertised. First, whenever you establish a barrier for a field, you create an incentive to find ways around this barrier. This has given rise to chiropractic and spiritual medicines, both of which have underperformed traditional medical services.

Second, the quantity of medical professionals is significantly smaller than what would exist without licensing resulting in fewer medical person-hours worked. This alone reduces the overall quality of healthcare in the United States.

Friedman concludes with a defense of eliminating licensing.

He sees no relevance to healthcare quality in regards to a doctor’s ability to pass a test sometime in the past. He does not believe association to a society or one’s grades are even a major source of assurance for the customer.

Friedman ends with the proposition that the deciding factor of business in the medical field is reputation. The development of business of reputation would still exist given the elimination of licensure and would protect the individuals from fraud and incompetence.

In fact, eliminating licensure also promotes diversity in the market by setting up an environment where specialization becomes significant and which permits the customer to decide what will serve them best.

The Distribution of Income

In the center of the debate for equality, two definitions arise. One defines equality as equal treatment while the other defines equality as equal outcome. A large part of inequality is caused by endowment in human capacities and property.

Some argue personal endowments and inherited wealth are different. Friedman does not agree with this premise. The liberal believes a man is entitled to use whatever he has produced in whatever legal means he desires. This includes passing on his wealth to his heirs.

Friedman likens the inheritance situation to an anecdotal story.

If an individual is walking down the street and comes across a twenty dollar bill, is he compelled to divide that amongst his friends? Even more so, are his friends justified in banding together and demanding a share of that wealth? Friedman suspects most individuals would say no.

Among western countries, inequalities in income distribution are smaller in more capitalistic societies. In fact, the development of capitalism has been associated with the decrease of inequality. It is important to distinguish between two types of inequality: temporary, short-run differences and long-run differences in income status.

Non-capitalistic societies tend to have a greater inequality gap while looking at the long run. These non-capitalistic societies’ inequality gaps also tend to be more permanent than in capitalist societies.

Social Welfare Measures

Friedman addresses four social welfare actions currently utilized by the United States government: public housing, minimum wage requirements, farm price supports, and old age and survivor’s insurance or OASI. In addressing these four issues, Friedman proposes changes or entire eliminations of such programs.

Public housing is often justified on the grounds of neighborhood effects, or on the grounds of helping poor families.

The problem with the neighborhood effect argument is that it does not argue for public housing, but for higher taxes on low quality houses as the social costs associated with them are higher. Friedman also questions the argument that the basis is to help the poor, suggesting that cash grants are more effective at combating poverty than public housing.

Minimum wage laws have the exact opposite effects than intended by good-willed men who support it. Friedman’s studies concluded the only thing minimum wage laws have done is increase poverty. Those who are rendered unemployed because of the laws are the same ones who can least afford giving up the income they were receiving.

Friedman is also opposed to minimum wage laws believing those hurt by the laws are anonymous and their problems are not clearly connected to their cause. Those who would have joined an industry can no longer do so, and this cost cannot be measured.

Farm price supports are a good intentioned misallocation of cash.

Benefit distributions do not help farmer poverty as intended because benefits are gauged by farm size. The larger the farm, the larger the benefit received. Smaller and less wealthy farmers are the least benefited individuals from this policy.

The individual who needs to consume a large portion of his or her own product for survival receives substantially less than the individual who is able to market a large percentage. The effect of farm price supports has not been to increase farmer wealth, but to increase farm output.

Friedman sees no way to defend redistribution through social welfare.

There is no justification on taxing the young to subsidize the old regardless of their wealth. Friedman also sees no justification for redistribution based on age. Friedman recognizes the current system is not self-financing. Due to the rising quantity of people on OASI, the tax revenue will not be enough to cover accumulated obligations.

Friedman supports allowing the individuals to decide whether they want to invest for retirement. Compulsory annuities are not justifiable, as Friedman believes the individual has the right to engage in private, public, or no retirement savings.

The Alleviation of Poverty

Friedman begins his final lecture with the observation that there was an extraordinary proliferation of private charitable institutions during the height of the laissez-faire economy in the nineteenth century in the United States. He has also observed a decline of these institutions since the expansion of governmental welfare activities.

Friedman acknowledges alleviating poverty is a good and justifiable governmental action. However, the government must answer the questions “how much” and “how.” If the program is to eliminate poverty, the program should target poverty, not housing or farming subsidies, but poverty. Friedman also insists the program should not impede the market in any form.

Friedman believed in a flat rate tax on income above an exemption. Any individual whose income is below this exemption would receive the difference times a redistribution percentage.

Utilizing a flat tax on income would eliminate tax avoidance and eliminate the problems arising from nominal rates associated with these avoidances. This arrangement also works at eliminating poverty, providing what the poor need most: cash.

Finally, Friedman concludes that the heart of the liberal philosophy is the dignity of man. Each man has the equal right to freedom, but each man does differently with that right. He can promote equality and freedom through the capital market.

He does not perform any action based on the grounds of justice because this infringes on another’s freedom. There is an inherent humility in Friedman’s liberalism. Man is inherently flaw and must be allowed to make mistakes.

Conclusion

Milton Friedman’s Capitalism and Freedom provides a simplistic, yet effective answer to many of today’s popular questions regarding economic activity and the role of government. Friedman establishes the definition of the classical liberal, and he explains his views and thoughts regarding governmental programs and apparent economic problems.

In the end, Friedman likens himself to the egalitarian claiming both care for freedom and equality, but Friedman believes man should have the freedom to fail where the pure egalitarian does not. Most importantly, Friedman establishes why capitalism is a necessary device for economic and political freedom.

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