First published in The Statesman, Perspective Page Nov 22 2006
Milton Friedman, who died on 16 November 2006 in San Francisco, was without a doubt the greatest economist after John Maynard Keynes. Before Keynes, great 20th century economists included Alfred Marshall and Knut Wicksell, while Keynes’s contemporaries included Irving Fisher, AC Pigou and many others. Keynes was followed by his younger critic FA Hayek, but Hayek is remembered less for his technical economics as for his criticism of “socialist economics” and contributions to politics. Milton Friedman more than anyone else was Keynes’s successor in economics (and in applied macroeconomics in particular), in the same way David Ricardo had been the successor of Adam Smith. Ricardo disagreed with Smith and Friedman disagreed with Keynes, but the impact of each on the direction and course both of economics and of the world in which they lived was similar in size and scope.
Friedman’s impact on the contemporary world may have been largest through his design and advocacy as early as 1953 of the system of floating exchange-rates. In the early 1970s, when the Bretton Woods system of adjustable fixed exchange-rates collapsed and Friedman’s friend and colleague George P. Shultz was US Treasury Secretary in the Nixon Administration, the international monetary system started to become of the kind Friedman had described two decades earlier. Equally large was Friedman’s worldwide impact in re-establishing concern about the frequent cause of macroeconomic inflation being money supply growth rates well above real income growth rates. All contemporary talk of “inflation targeting” among macroeconomic policy-makers since the 1980s has its roots in Friedman’s December 1967 presidential address to the American Economic Association. His main empirical disagreement with Keynes and the Keynesians lay in his belief that people held the intrinsically worthless tokens known as “money” largely in order to expedite their transactions and not as a store of value – hence the “demand for money” was a function mostly of income and not of interest rates, contrary to what Keynes had suggested in his 1930s analysis of “Depression Economics”. It is in this sense that Friedman restored the traditional “quantity theory” as being a specific theory of the demand for money.
Friedman’s main descriptive work lay in the monumental Monetary History of the United States he co-authored with Anna J. Schwartz, which suggested drastic contractions of the money supply had contributed to the Great Depression in America. Friedman made innumerable smaller contributions too, the most prominent and foresighted of which had to do with advocating larger parental choice in the public finance of their children’s school education via the use of “vouchers”. The modern Friedman Foundation has that as its main focus of philanthropy. The emphasis on greater individual choice in school education exemplified Friedman’s commitments both to individual freedom and the notion of investment in human capital.
Friedman had significant influences upon several non-Western countries too, most prominently India and China, besides a grossly misreported episode in Chile. As described in his autobiography with his wife Rose, Two Lucky People (Chicago 1998), Friedman spent six months in India in 1955 at the Government of India’s invitation during the formulation of the Second Five Year Plan. His work done for the Government of India came to be suppressed for the next 34 years. Peter Bauer had told me during my doctoral work at Cambridge in the late 1970s of the existence of a Friedman memorandum, and N. Georgescu-Roegen told me the same in America in 1980, adding that Friedman had been almost insulted publicly by VKRV Rao at the time after giving a lecture to students on his analysis of India’s problems.
The other document on Mahalanobis is published in The Statesman today for the first time, though there has been an Internet copy floating around for a few years. The Friedmans’ autobiography quoted what I said in 1989 about the 1955 memorandum and may be repeated: “The aims of economic policy (in India) were to create conditions for rapid increase in levels of income and consumption for the mass of the people, and these aims were shared by everyone from PC Mahalanobis to Milton Friedman. The means recommended were different. Mahalanobis advocated a leading role for the state and an emphasis on the growth of physical capital. Friedman advocated a necessary but clearly limited role for the state, and placed on the agenda large-scale investment in the stock of human capital, encouragement of domestic competition, steady and predictable monetary growth, and a flexible exchange rate for the rupee as a convertible hard currency, which would have entailed also an open competitive position in the world economy… If such an alternative had been more thoroughly discussed at the time, the optimal role of the state in India today, as well as the optimum complementarity between human capital and physical capital, may have been more easily determined.”
A few months before attending my Hawaii conference on India, Friedman had been in China, and his memorandum to Communist Party General Secretary Zhao Ziyang and two-hour dialogue of 19 September 1988 with him are now classics republished in the 1998 autobiography. Also republished there are all documents relating to Friedman’s six-day academic visit to Chile in March 1975 and his correspondence with General Pinochet, which speak for themselves and make clear Friedman had nothing to do with that regime other than offer his opinion when asked about how to reduce Chile’s hyperinflation at the time.
My association with Milton has been the zenith of my engagement with academic economics, with e-mails exchanged as recently as September. I was a doctoral student of his bitter enemy yet for over two decades he not only treated me with unfailing courtesy and affection, he supported me in lonely righteous battles: doing for me what he said he had never done before, which was to stand as an expert witness in a United States Federal Court. I will miss him much though I know that he, as a man of reason, would not have wished me to.
Milton Friedman’s extempore comments at the 1989 Hawaii conference: on India, Israel, Palestine, the USA, Debt and its uses, Erhardt abolishing exchange controls, Etc
“I don’t believe the term GNP ought to be used unless it is supplemented by a different statistic: the rate of growth of the average consumption basket consumed by the ordinary individual in the country. I think GNP rates of growth can give very misleading information. For example, you have rapid rates of growth of GNP in the Soviet Union with a declining standard of life for the people. Because GNP includes monuments and includes also other things. I’m not saying that that is the case with India; I’m just saying I would like to see the two figures together.
I have wondered about the following question for decades. What would have happened if the initial decision had been to make English the official language, and the Government had made no official statement about any of the other languages, had just allowed, as it were, free language competition? The reason I raise that is because many years ago when I was in India originally it seemed to me, that a lot of conflicts would have been eliminated, because everybody could have been opposed to English. You would have had a common opposition to it, and yet it was, in fact, the operating language of the country. If in time Hindi or any of the others had spread, they could have taken over the function. But it wouldn’t have been the subject of a political fight from then on. That may be wholly wrong, it’s just an off-hand impression. I am curious about what answer you would give the counterfactual question.
I’m just going to support Brass on the question of whether the modes of organization of the economy had anything to do with the political difficulties that were arising. I want to emphasize how important that is as an issue to be investigated, and I am not going to illustrate it with India which I don’t know enough about; I am going to give you a different even more dramatic example. I have no doubt whatsoever that a major part of the present difficulties between the occupied states in Palestine, the Palestinian organization and the Israeli government, derive from the structure of Israeli economic policies, from the socialist structure. When the occupied areas were first taken over, the generals were very wise in treating them in a completely laissez-faire manner, and they didn’t have many troubles. As you started to impose in those areas the same socialist techniques of the Israeli state, you get increasing conflict, and those conflicts have arisen until today. I think that this may be relevant to the study of political conflicts of the kind of you’re describing. Many of these difficulties arose because you were adopting economic policies which created them.
I think you have to distinguish sharply between a redistributive state and a regulatory state. I give you Sweden, which is a very highly redistributive state, but is not a highly regulatory state. As I understand it, the original Constitution of India called for a redistributive state. The ethos called for a regulatory state, and they turned out to be both very different and I would say ultimately incompatible.
I was interested in some of Dattachaudhuri’s remarks about the situation at the time of Independence and particularly about his summary of what he regarded as traditional economic development theory. I think there was an enormously important point that needs to be added to those you mentioned. That was the almost universal acceptance at that time of the view that there was a sort of technologically fixed capital output ratio. That if you wanted to develop, you just had to figure out how much capital you needed, used as a statistical technological capital output ratio, and by God the next day you could immediately tell what output you were going to achieve. That was a large part of the motivation behind some of the measures that were taken then. Secondly, you are quite right that one of the things that India inherited was a good civil service. I came back from India on my first trip there saying that in my experience, I had never met a class of civil servants who were as able as the Indian Civil Service. However, they weren’t in accord with the principles that were going to be followed. Many of them, particularly Mr HM Patel, would not have gone along, I suspect he would not have been an enthusiastic participant of the Mahalanobis Plan. I don’t know….you tell me. Am I wrong? There were people at the time who recognized fully what the consequences were going to be, the most notable example is BR Shenoy in his dissenting view on the committee of experts examining the Second Five Year Plan.
Essentially, your paper was in this great tradition of the hero theory of history versus the deterministic theory of history. Does a great man make a difference? Do personalities make a difference? Either extreme is untenable. In the particular case of India, I would say that in the early days, I have no doubt that personalities made an enormous difference. If Mr Mahalanobis for example had had a slightly different background, had been persuaded to slightly different things, you might have had a different result. You don’t have to look at the whole structure.
In my opinion, the most serious problem of India in the economic sphere can be pinned down very quickly. It has to do with the pegging of the exchange rate and the existence of change controls. My view on this is based not only on India alone; it is based on country after country. There is no other measure which opens itself so much to corruption than to spreading from one regulation to another. In some ways, if you could pull that pin out, much of the rest of the superstructure would collapse. On that particular issue, it was initially an open issue in India.
Now I agreed completely that in order to make reforms, you have to establish a base of support. You have to get a political basis to support you. But one mustn’t take that to mean that this is the best of all possible worlds and you can’t do anything about it. Let’s be clear about what our role is. Our role as economists and intellectuals is not to figure out what is politically feasible and then recommend it. Our role as economists and political scientists, in my opinion, is to look at what could be. Given the background, given the institutional limitations. It’s wrong to go to utopian solutions, but we ought to lay out what are alternative possible changes in the circumstances, whether we think at the moment or not that there is any possibility of getting backing for it. What you find in history time and again is that major changes almost never come except when you have a crisis. And when you have a crisis, things become feasible that you would have dismissed in advance as not feasible. I think you’re much too unadventuresome in your willingness to conceive of rather radical departures.
I don’t believe floating exchange rates will solve all the problems, far from it. But I do believe that exchange control is a particularly pernicious and widespread form of control.
I might be mistaken about this but I think the exchange control was ended in 1950 when they adopted the Dodge Plan for monetary reconstruction, and their recent progress might be traced from that date. Yet over and over, in country after country, you find that exchange control is the answering wedge for widening controls. I believe that the most important thing China could do right now would be to end exchange control.
The other point is that it’s an open invitation to corruption.
I want to comment on both papers also.
With respect to the debt, a balance sheet has two sides. One side is the assets and one side is the liability. A consideration of a debt problem that considers only one side is bound to be incomplete. The question of whether a high debt ratio is good, bad, or indifferent depends on what the debt was accumulated for. It is no different for a nation than it is for an individual. If I go out and borrow in order to maintain a stable of mistresses, I’m going to get into trouble. I’m a little old for that, but think of a younger person. On the other hand, if a man goes out and borrows in order to build a plant which is going to be very productive, he is not in trouble at all.
Similarly for a nation. The talk in the U.S. about the U.S. being a foreign debtor is a bunch of nonsense, because we have always had net private savings, and the debt isn’t debt, anyway, it’s acquisition of assets in the U.S. by foreigners. That acquisition has been of productive assets, and thus has increased our total capital. Similarly, if we go back to India, the question of whether the debt ratio is too high or too low is a question of what assets there are that have been created in the process of accumulating the debt, and what income they generate. We don’t ask in the U.S. or anywhere else what the private debt ratio of a country is without asking what is the private asset ratio. You don’t look at a particular individual company and say what’s the ratio of debt, you look at debt to assets. Similarly, therefore, it seems to me your paper needs to be (this really ties very much into what Seiji Naya said before about inefficient public enterprises.) If the debt was accumulated in order to finance public enterprises….I don’t like the word public; let me be precise….government enterprises….(Stanford University is a public university, but it’s not a government university.)… If debt was created to build government enterprises which were yielding a net income, the debt would be no burden at all. It would be a source of strength. It would provide the government with additional funds for other purposes. The plain fact is, of course (and I shouldn’t be saying this because I’m not up to date on the situation in India) but my impression is that the plain fact is that most government enterprises are a drain on the budget rather than contributing to it. Therefore, the debt is a real problem regardless of whether it’s 10 percent of the GNP or 60 percent of the GNP. Not because it’s 60 percent or 10 percent, but because you have to look at the other side of the balance sheet and see whether it’s been created for productive or nonproductive uses.
On a very different subject that you touched in your comment, I share completely with you the outrage at the picture of extraordinary ostentation in the midst of extraordinary poverty. I venture to predict that if you ask where the money comes from that finances that ostentation, you will find in almost every single case it comes from government favour. It is created by the present system of planning. The idea that the present system of planning is directed at egalitarianism is, I think, an absurd idea… I remember an incident which I think is very amusing. I once was in Hong Kong ten years ago, and I was entertained at the home of a very wealthy Hong Kong Indian businessman. He’s the person who owns the Hilton, Hare Nina. It was at his home. This is a man who has 50 people to dinner every night. One of the people who was present there was an Indian capitalist who would be an absolutely perfect image for a New Yorker cartoon of a bloated capitalist sitting on a pile of money. He was big, fat and just looked the image.
We ended up the evening with a vigorous argument between him and me, me defending capitalism and him defending socialism, and for understandable reasons. He was fat because of socialism. If you really want to attack that unproductive ostentation, and improve the lot of the individual people, there’s only one way that’s ever been proved to do it. That’s by setting those people free, to use their own resources as they see fit and not having around them the kind of controls that are involved in the Indian planning process. We have to separate objectives from means.
I want to go back for a moment about two comments about T.N.’s. One is, there are certain words which are red lights to fallacies. One of those words is “need”. I do not know any sentence that anybody ever uses with “need” which doesn’t turn out to have a fallacy embedded in it. The word that leads me to is not need but “essential”. “Essential import”. Every economist knows that if you have adjusted your resources properly, every item you buy is essential at the margin. It is a distinction between marginal and average. The word “essential” is a meaningless word, and any place you see it used, you can be sure there is a fallacy. The same thing with the word “shortage”. I noticed that when T.N. came to the word shortage, shortage of foreign exchange, he hesitated. He said an “alleged shortage”. Economists may not know much, but there is one thing we know very well. That is how to create shortages and surpluses. Tell us what you want a shortage in, and we’ll create it. The only thing you have to do is set a maximum price that is below the market price, and you’ll have a shortage. If you want a surplus, we’ll produce that, too. We’ll give you a case in which we’ll offer a price higher than the market price. We’ve got a surplus of wheat for that reason in the United States, and we’ve got a shortage of housing in New York for that reason. The talk about a shortage of foreign exchange is always an evasion of a problem. Some how or other, economists ought to get into the practice of never using the word shortage without accompanying it by at what price.”
One more point and I’ll be through. You say that you want to dismantle the exchange rates over a ten year period. I think you’re wrong. There are some things you want to do immediately overnight and some things you want to drag out. There are two aphorisms that bring out the point. One is: don’t cut a dog’s tail off by inches, and the other is haste makes waste. They’re the opposite of one another, but each is right in some occasions. It seems to me as a generalization with respect to any price control that it should be done instantly. You should cut the dog’s tail off at once. If you’re going to abolish exchange control, it ought to be announced on a Friday or Saturday night to be done on Sunday morning. Just as Ludwig Erhardt in the German reform announced overnight, over a weekend, he did it on Sunday because the American and British control offices were closed and so they couldn’t countermand his order. That is why he did it on a Sunday. He did it at one full stroke, all price controls abolished. Margaret Thatcher abolished exchange control in Britain overnight. Exchange control, it seems to me, is one of those things you have to abolish overnight. If you stretch it out, you will never abolish it.
With power, the product is sold. Power is something that can be provided by the private sector, it is sold, you are not giving it away. It may be infrastructure, but it’s the kind of infrastructure which ought to pay its way.
I don’t think we ought to get involved in words, and I don’t mind if we drop the word socialism. I would say that a system of detailed controls or whatever you call it, is a system which generates inequality. The private ownership of property is not enough. Some of the main beneficiaries from your controls are private enterprises and moreover as I cited in my example, they also support the system of controls and regulation. What I say is that the combinations of controls and regulations, whatever you call it, produces inequality, and chief among them is the foreign exchange control. If you could eliminate the foreign exchange control, you will eliminate a good bit of the harm which is currently being done by all your regulations.
If I might say, I have enormous sympathy with this view that it’s the same old story. It is! Exactly, and that’s what’s distressing about it. It’s a shame that in 40 years, there been no real major change in the structural characteristics of the Indian economy. That’s the real tragedy.”
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