The end of Friedmanomics?

Friedman's advisees

Zachary Carter, of Price of Peace fame (a good book that I recommend, btw), wrote an interesting piece on Milton Friedman's legacy, which I think is, as Hyman Minsky said of Joan Robinson's work, wrong in incisive ways. But even before we get to his main point, that the era of Friedmanomics is gone, it is worth thinking a bit about the way he approaches the history of ideas. This is clearly a moral tale for Carter, with good guys and bad guys. Gunfight at high noon. It is more about vision than analysis, in the terminology of Schumpeter.

He starts, like Nancy MacLean in her Democracy in Chains -- I discussed only tangentially

the issue here -- with Brown v. Board of Education, and Friedman's, rather than Buchanan's, insidious behavior favoring policies that allowed the persistence of segregation. He tells us that: "it is hard to believe Friedman was merely naïve and not breathtakingly cynical about these political judgments, particularly given the extreme rhetoric he used to attack anti-discrimination efforts." Yet, as he continues he seems to change his mind and argue that: "yet he appears to have genuinely believed what he said about markets eliminating racism." So it seems he was naïve after all, according to Carter.

Of course, to determine whether Friedman was cynical or naïve is a thankless task and somewhat besides the point. Friedman was analytically wrong. There is a reason Schumpeter's monumental book is A History of Economic Analysis, and not of economic ideology. And Carter argument is built on moral, ideological grounds. Friedman is the bad guy. He tells us that: "[t]he chief political disputes of the 1950s and 1960s, as today, really were about moral values, not technical predictions." Don't get me wrong, vision matters, and it's hard to disentangle from analysis, but it is clear that Friedman's views differed analytically from the ones discussed by the Keynesian disciples at Cambridge (less so in the case of some of the Neoclassical Synthesis Keynesians that came to accept Friedman's notion of a natural rate of unemployment by the late 1960s). But it is hard to say that Friedman was for segregation, when he explicitly says he was against, and Carter himself thinks that he might have been sincere about that. Other than finding archival material that shows that Friedman knew better we are left with conjecture and guess work.

The key analytical differences between Friedman and the more heterodox Keynesians I alluded above, were not so much in his classic book on monetary history with Anna Schwartz, cited by Carter, but in his AEA presidential address from 1968. The return of the natural rate was the foundation that allowed, once the political circumstances were ripe for the demise of the Golden Age, for the return of marginalist analysis. In a sense, the notion of a natural rate of unemployment went full circle and added to the Neoclassical Synthesis notion that Keynes was fundamentally about wage rigidities or other imperfections. Note that this happened after the capital debates, when the logical foundations of the neoclassical theory was in shambles. In favor of Friedman, I might add, he did write the analytical model down in the debate with his critics, in contrast with Hayek, that after abandoning economics in the 1940s dedicated himself to ideological discussions without any analysis. Vision without analysis as my good friend Fabio Freitas poignantly says.

Carter is on firmer ground when he argues that Friedman was not a classical liberal, and had little in common with Adam Smith, although Friedman himself might have thought so; understanding of history of ideas is sadly vey uncommon among economists. Carter tells us that: "Friedman preferred to be identified as either a 'neoliberal' or a 'classical liberal,' invoking the prestige of the great eighteenth- and nineteenth-century economists—while conveniently gliding past their often profound differences with his political project. (John Stuart Mill, for instance, identified as a 'socialist,' while Adam Smith supported a variety of incursions against laissez-faire in the name of the public interest)." The differences with Smith were not fundamentally political though, but analytical (Stuart Mill is a more complicated transition author). Markets did not produce efficient allocation of resources or full employment of labor for Smith, as in the Marshallian world of Friedman and the Chicago School.

At any rate, the notion that Friedmanomics (or Neoliberalism for that matter; on that here) is dead is at best an exaggeration. In part, the misdiagnosis results from Carter's view according to which: "Friedman’s major theoretical contribution to economics—the belief that prices rose or fell depending on the money supply— simply fell apart during the crash of 2008." That's definitely not the main lesson from Friedmanomics. The quantity theory was never particularly dominant. It was a return to the simple notions of marginalism, of the theory of value, that suggests that supply and demand produce optimal outcomes, that lead to full employment, and that can fix all sort of social maladies (including racism, as Carter notes correctly) that was central to Friedmanomics, and neoliberalism.

In other words, his main legacy was the idea that the market society is a panacea. That free markets are prerequisite for a democratic society (Hayek was more forceful in that argument, without even trying to provide the analytical foundations). Something used cynically to favor the interests of a narrow group by the politicians Friedman advised (the three on top, for example). And while it is true that the last financial crisis (the 2008 one) has led to a reassessment of the role of government, and more so with the pandemic, as I discussed here, the notion that Friedmanomics is gone is wishful thinking.

Even though the profession has abandoned Friedman's Marshallian version of marginalism, his notion that markets do produce optimal outcomes has received no serious challenge within academia, and, in policy circles, interventions follow a pragmatic notion that market imperfections are worse than government imperfections. But that could change rapidly, like Larry Summers support for expansionary fiscal policies. Friedmanomics will certainly make a come back.

Racism, the election and more

After writing on Venezuela last week, Trump suggested that the US might intervene there. And then the predictable happened, violence and death ensued... in the US. I don't have much to say about what happened in Charlottesville. It is worth noting that even though the city and the University of Virginia are relatively progressive places these days, they do have a long history that ties them to slavery and white supremacy (see this on NPR; h/t URPE blog).*

At any rate, it's not surprise that Trump didn't condemn his base (and yes the racist voted for him; but as I noticed before 1964 those votes went mostly to Democrats). He certainly is more explicit than previous Republicans going beyond racist dog whistle  politics. I would insist that racism is not the main reason why he won the election, and that a left wing populist right have won.

The topic is still relevant (even in the middle of the violence and crazy confrontation with North Korea; btw, this is a must read for those interested on the history of US-Korea relations), since the lessons of the defeat are important to preclude 8 years of this madness. So this piece in the NYTimes shows that Obama-Trump voters, meaning voted for Obama in 2012 and for Trump in 2016, are real.

As the authors says, echoing what I said here a while ago:

... the national vote doesn’t count, and Mrs. Clinton is not the president. She lost primarily because of the narrow but deep swing among white working-class voters who were overrepresented in decisive battleground states.

The interesting twist is that racism did play a role in the flip from Obama to Trump, at least more than I thought it did by looking at the Rust Belt alone. The piece says:

... racial resentment is the strongest predictor of the Obama-Trump vote in this survey data. White, working-class Obama voters with racially conservative views were very likely to flip to the Republicans.

Note that not all the 'rednecks' in the Rust Belt are racists though. There is an interesting piece on the redneck revolt here.

* It's also the home of the Virginia School, or the Public Choice School of Buchanan (briefly discussed here), that has been the subject of a new book that generated some controversy in economics circles. I'll have more to say about the book later, once I'm done reading it.

Big government, functional finance and debt sustainability

Teaching the fiscal policy classes of my intermediate macro course. One of the few things that is still not well understood and discussed in manuals is functional finance. Froyen's manual, which is otherwise an old textbook similar to Dornbusch and Fischer or Gordon or any 1970s manual (meaning with short run ISLM and Phillips curve first, and then growth), includes in the policy discussion Partisan Theory and Public Choice, but not Functional Finance or any heterodox approach.

Partisan Theory, developed by Douglas Hibbs, builds on an old idea by Kalecki that political and ideological elements would affect the business cycle. Left of center governments would lead to higher government spending and lower unemployment, and conservative governments would be concerned with inflation, and tend to promote fiscal adjustment. Public choice, more dramatically, suggested that politicians would be guided by selfish desire for re-election, which would lead to a permanent bias for deficits, and accumulation of debt. Big government, and Keynesian ideas, that had unleashed the monster, or so thought James Buchanan, one of the leaders of the Public Choice School, had to be constrained by balanced budget amendments.

When one looks at the data for the United States it is fairly clear that over the last forty something years it has been Republicans that have expanded deficits.

Deficit (% GDP)

In the graph you can see that with Carter (1977-1980), Clinton (1993-2000) and Obama (2009 to 2012 in the graph) the deficit as a share of GDP has fallen, while it did increase with all Republicans [note that with Reagan they increase, and then fall after taxes were raised]. Also, if you have any doubts, Republicans are the party of big government when it comes to spending.

Government Spending (% GDP)

The graph above shows that also spending actually falls with the three Democrats, and increases with the four Republicans (Ford, Reagan, Bush I, and Bush II). This switch on Democratic and Republican views on fiscal issues was discussed here. Obviously there are important differences between the old Democrats, from the New Deal and Kennedy/Johnson era, that wanted big government for social purposes, and the kind of big government promoted by the GOP.

Also, the political economy of why the GOP is for big government, has less to do with Partisan Theory or Public Choice, and more with the starve-the-beast theory, according to which if you cut taxes, then government will eventually be forced to cut spending.

Functional finance, an idea introduced by Abba Lerner, that could be seen as the extension of Keynesian ideas to fiscal policy (Keynes actually had little to say in the General Theory, were he refers vaguely to the socialization of investment rather than fiscal deficits), suggests that deficits should be judged on the basis of their function in the economy. Deficits that promote growth, and take place in an environment of low rates of interest, not only would be sustainable, but would be necessary to promote full employment.

By the way, by historical standards the US net debt (held by the public, i.e. not in the hands of the Fed or the Social Security Trust Fund) is not high at around 70% of GDP, below the peak at the end of the Great Depression and World-War II.

Net Public Debt (% GDP)

The debt-to-GDP ratio did increase after the 1980s, basically as a result of higher deficits on average (both the starve the beast, and more recently the massive recession), but also because until the collapse of the housing bubble rates of interest were on average higher than rates of growth of the economy. The debt-to-GDP ratio did fall in the late 1990s, as a result of the Clinton surpluses.

Mind you, two important points must be noted. First, historically the period in which rates of interest were consistently below growth rates was during the so-called Golden Age of Capitalism, roughly the post-war period up to the 1970s. In other words, in normal times the economy is in the wrong side of Domar's sustainability condition [that the rate of growth of the ability to repay, economic growth, should be higher than the growth of debt, that is, the rate of interest]. That didn't preclude governments to run deficits and accumulate debt. Note that governments have one advantage over private agents, when it comes to spending, namely: government spending is sufficiently large that by increasing general income it leads to higher tax revenue and an increase of its own income.

The second point, for those concerned with the size of the debt, is that the recession, and the collapse of the bubble have created the political conditions for a low rate of interest, which would be very hard to reverse in the medium term. That is, the Fed is unlikely to hike rates while unemployment remains high. Which basically provides space for fiscal deficits and debt on a relatively cheap basis. Of course chances of that happening are a completely different question.