December 4, 2006

The Economics of John K. Galbraith and Milton Friedman

by Rodrigue Tremblay

 

 

"The modern conservative is engaged in one of man's oldest exercises in moral philosophy: that is the search for a superior moral justification for selfishness."

John Kenneth Galbraith

 

"The Great Depression [1929-39], like most other periods of severe unemployment, was produced by government mismanagement rather than by any inherent instability of the private economy."

Milton Friedman

 

"Economic freedom is... an indispensable means toward the achievement of political freedom."

Milton Friedman

 

"People of privilege will always risk their complete destruction rather than surrender any material part of their advantage."

John Kenneth Galbraith

 

 

Economist John Kenneth Galbraith (1908-2006) died on April 26, 2006 at the age of 97. Economist Milton Friedman (1912-2006) died on November 16, 2006 at the age of 94.  Along with the great John Maynard Keynes (1883-1946), these two economists dominated the field of economics during the second half of the 20th Century. There existed such an intellectual competition between the two economists—not unlike the rivalry that prevailed between President Thomas Jefferson (1743-1826) and President John Adams (1735-1826), who both died on the same daythat Galbraith's death may have influenced the time of Friedman's death.

 

Both were influential in framing the general economic debate and in steering general economic policies within their own country, but also abroad. For one, Galbraith was an advisor to Franklin D. Roosevelt, Harry S. Truman, John F. Kennedy and Lyndon B. Johnson. Similarly, Friedman's ideas strongly influenced the economic policies of, among others, British Prime Minister Margaret Thatcher, American President Ronald Reagan and Chilean President Antonio Pinochet. He also persuaded the Nixon administration to abolish military conscription.

 

John K. Galbraith's most influential book was The Affluent Society (1958), in which he proposed the idea that post-war private expenditures were generating marginal social benefits that were lower than would be derived from increased public expenditures on needed economic infrastructures and social programs. The general principle here is that public expenditures should be increased until one marginal dollar spent publicly generates the same marginal social benefit as one marginal dollar spent on private goods and services. This is still a fundamental precept of modern economic welfare theory.

 

Milton Friedman, for his part, espoused the 18th Century French physiocrats' economic philosophy that government should interfere as little as possible with the efficient functioning of free markets, according to the fundamental law of supply and demand. He advocated laissez-faire capitalism and free market economics. In his most important work, Capitalism and Freedom (1962), Friedman became the universal champion of all those who advocate low taxation and small government.

 

Both economists, just as Keynes previously, were influenced by the pressing economic problems requiring solutions at specific times. During the immediate post-war years, after the onslaught of the Great Depression, and after the war-time price controls and rationing, private wealth was increasing at a fast pace (new houses, new cars, etc.) while schools, hospitals and roads were not catching up with the new demand for economic infrastructure. The international environment was also characterized by fixed exchanges rates, a high level of trade protectionism, and controls on international capital movements. In such a context, fiscal policy was deemed to be more potent and useful than monetary policy. Thus Galbraith's fiscal approach to solving society's problems of resource allocation and economic stabilization.

 

In the 1970's and 1980's, after two damaging, successive oil supply shocks,  and the rise of inflation, the need was to isolate the economy from these external shocks, through the adoption of flexible exchange rates and through a more predictable monetary policy. Thus Friedman's emphasis on flexible exchange rates and on a more responsible management of the money supply. To a large extent, Galbraith's more Keynesian approach to economic management and Friedman's more monetarist approach to economic stabilization were a reflection of the different economic environments in which they applied their theories.

 

As far as economic stabilization is concerned, for example, that remains an empirical appreciation if, for a given economy, at a specific time, fluctuations in government surpluses and deficits are more or less efficient than fluctuations in interest rates in influencing private investment and private consumption. There are situations where private expenditures are very responsive to movements in real interest rates, i.e. to nominal interest rates minus inflation expectations. In such normal times, monetary policy alone can be relied upon to stabilize the overall economy, while public budgets remain balanced.

 

However, there arise situations of market failures when excessive market power by a few large corporations or excessive herd-like speculation by the many create destabilizing bubbles in crucial sectors of the economy. Economic psychology could become so universally depressed that no amount of monetary stimulus could jump start the economy. Japan is an economy that found itself in such a predicament during the 1990's. At that time, nominal interest rates were pushed to near zero, their absolute low, but real interest rates remained high due to a generalized deflation and high deflationary expectations. When an economy falls in such a 'liquidity trap', fiscal policy may become the only avenue left to stimulate the economy, with increased public deficits. It becomes a matter of political ideology if such deficits should be generated through tax reductions or through increased public expenditures, or both.

 

Philosophically, 'liberal' Galbraith would be more inclined to favor enlarged public expenditures, while 'conservative' Friedman would prefer to keep as much money as possible in private hands. Both would agree, however, that the government is the last arbiter when economic conditions in the private economy deteriorate, either through destructive inflation, imported or domestically produced, or through an economic slump, that generate widespread unemployment of both workers and machines. It should be no surprise if Friedman's prescriptions are more welcomed in times of prosperity, while those of Galbraith and Keynes would be readily adopted in times of economic crisis. This has been a pattern often observed in the past. For example, before the Great Depression, 'Laissez-faire' capitalism was politically dominant. However, the role of government was rediscovered when poverty, income inequalities and unemployment became widespread. This is to be expected in a democracy, where the wishes of the median voter normally carry the day. The same ambivalence toward economic policies will no doubt prevail in the future, as people ride the consequences of economic cycles. Thus, there will surely be future Galbraiths and future Friedmans in the economics profession.

 

Posted, December 4, 2006, at 5:30 am

 

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