Milton Friedman died last week. His was a remarkable story. Born in Brooklyn, of Hungarian immigrant parents, he earned a scholarship to Rutgers and a doctorate in economics from Columbia. Like his chief academic rival, John Kenneth Galbraith, he worked for the Roosevelt administration, helping draft and implement many of its New Deal policies. Both men became public intellectuals, with Galbraith taking up long term residence at Harvard, while Friedman found a home at the University of Chicago.
In later years, unlike Galbraith, Friedman rejected the theories of John Maynard Keynes, and found salvation in the theories of the founding father of the dismal science, Adam Smith. He moved from Liberalism to Libertarianism, convinced that the lot of man would be greatly improved if government kept its meddling fingers out of the lives of all folk, particularly the common folk.
His chief claim to fame was that he correctly predicted the period of stagflation of the early 1970's; and for his work he was -- deservedly -- awarded the Nobel Prize. His policies were, in large measure, adopted first by Margaret Thatcher in Britain and then by Ronald Reagan in the United States. And they worked. By following Friedman's dictum that the only economic lever a government should possess is control of the money supply, both leaders started long periods of economic growth; and they wrung -- after much pain -- inflation out of their economies.
In the process, Keynesianism -- and its chief proponent in North America, Galbraith -- were relegated to the Museum of Irrelevant Luminaries. Galbraith saw economics at the centre of history, power and human nature. And, when it came to human nature, he tended to agree with Mark Twain that "the closer you get to the human race the more you find layers and layers of nonsense." This nonsense he labeled "the conventional wisdom." Never far from his boyhood on a southwestern Ontario farm, he referred to classical economics as "trickle down," where the economy's principal assets were introduced at the front end of the cow and what remained for the common man was what came out the back end.
Galbraith believed that the function of government was to establish "counterveiling forces," so that what came out at the back end was at least of more value and more quantity than the classical economic model allowed. Government could mitigate the traditional boom and bust of economic cycles and thereby create some equity between citizens -- so that the cow's digestive system produced more value for the common man -- and put an end to "private wealth and public squalor."
These views were heretical in the 1920's; but the Great Depression forced western democaries to give heresy a try; and for forty years the prescription worked. But in the 1970's, in reaction to Israel's victory in the 1967 War in the Middle East, Arab oil producing states formed OPEC and established a monopoly on oil prices, which increased from a dollar and a half a barrel to thirty-four dollars a barrel. The result, in the West, was that ecomomic activity ground to a halt. Interest rates soared to a high of eighteen percent in 1980. Unemployment also hit new highs. Keynes policies no longer seemed to work.
Up until the oil shock of the 70's, Friedman was what Keynes had been a generation before -- a pariah. But, just as extreme conditions in the '30's forced a re -examination of the conventional wisdom, Friedman's prescriptions became the order of the day and -- like Keynes theories a generation before -- dogma. Essentially, the Friedman dogma held that, if an economy was to work well, Galbraith's counterveiling forces had to be dismantled in the name of freedom. If Galbraith viewed human nature skeptically, Friedman viewed the nature of that human institution -- government -- skeptically. His has been the prevailing economic paradigm for the last thirty years.
The problem in this new century is, however, that -- once again -- the policy is not working. Just as Keynes had never factored in a global oil cartel, Friedman's thought did not make room for globalization. In the Friedman paradigm, individual central banks exercise control over separate national economies. But now those central banks are, to some degree, hostages to international economic forces. They certainly are hard pressed to deal with a world where capital crosses international borders at the spead of light and the economic shifts which the flow of captial cause can be just as swift and brutal. Workers can lose their jobs as quickly as capital moves. Finding new and similarly remunerative employment takes a long time -- if such employment can be found at all. One simple lever is not enough to deal with a globalized economy. Once again, the cow is eating well; but not much of either quantity or quality is coming out the back end. Or as Jane Yellen, the president and chief executive of the Reserve Bank of San Francisco put it in a recent speech," much of the gain for macroeconomic performance has gone to just a small segment of the population -- those already in the upper part of the distribution."
In other words, while Friedman's policies encouraged economic growth and low inflation, they also encouraged tremendous economic inequality. According to Executive Paywatch, an AFL-CIO website, the pay differential between executives and their employees went from 80 to 1 in 1980 to 411 to 1 in 2005. And during this time, Yellan says, not only were many low wage jobs eliminated by technology, but "wages in the middle not only rose far more slowly than those at the top, they also rose more slowly than those at the bottom of the distribution." The folks who have felt the inequality most are the folks in the middle.
That record needs to be set alongside the thirty years from the beginning of World War II until the Great Downturn of the 1970's. According to Richard Parker, the author of a recent biography on Galbraith, from 1940 until 1970 median household income (adjusted for inflation) doubled, while from 1970 until 2000 the growth in the economy "made for a radical income and wealth distribution, as the fortunes of the rich increased, the poor stagnated, and the middle class suffered through the longest drought of real income gains since the Great Depression."
What all of this suggests is that it is dangerous to turn economists into high priests who speak eternal truths. Both Friedman and Galbraith are dead now. But, considering their humble origins, this development is more than a little ironic. Both men had far reaching influence in their time -- although Friedman's libertarianism returned us to a more brutal universe. However that may be, the point is that times change and dogma doesn't. Dogma is an appropriate subject for theology. But it has no place in economic theory. Once economics becomes theology, we are all in trouble. To find solutions for our times, we would be wise to begin looking to today's economic heretics.