“The Role of Prices” in a Free Market from ‘Free to Choose’ (Friedman, 1980)

29 11 2012

In their book “Free to Choose: A Personal Statement” (published by Harcourt Brace Jovanovich, Inc. 1980) authors Milton and Rose Friedman address the role of prices in a promoting the efficient use of a society’s resources.

Following of some quotes from Chapter 1 – The Power of the Market (pages 9-37) that are particularly relevant in today’s economic environment:

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On the relative merits of “voluntary cooperation” as opposed to “command” economic systems….

“Just as no society operates entirely on command principle, so none operates entirely through voluntary cooperation. Every society has some command elements. These take many forms.  They may be as straightforward as military conscription or forbidding the purchase and sale of heroin or cyclamates or court orders to named defendants to desist from or perform specified actions.” (page 11)

“It makes a vast difference what the mix is – whether voluntary exchange is primarily a clandestime activity that flourishes because of the rigidities of a dominant command element, or whether voluntary exchange is the dominant principle of organization.” (page 11)

“A predominantly voluntary exchange economy …. has within it the potential to promote both prosperity and human freedom. It may not achieve its potential in either respect, but we know of no society that has ever achieved prosperity and freedom unless voluntary exchange has been a dominant principle of organization.” (page 11).  

The authors go on to say that “voluntary exchange is not a sufficient condition for (personal and economic) prosperity and freedom”, but that it is a necessary condition.

THE ROLE OF PRICES (beginning on page 13)

“The key insight of Adam Smith’s Wealth of Nations is misleadingly simple: if an exchange between two parties is voluntary, it will not take place unless both believe they will benefit from it.  Most economic fallacies derive from the neglect of this simple insight, from the tendency to assume that there is a fixed pie, that one party can gain only at the expense of another.” (page 13)

“Adam Smith’s flash of genius was his recognition that the prices that emerged from voluntary transactions between buyers and sellers – in short, in a free market – could coordinate the activity of millions of people, each seeking his own interest, in such a way as to make everyone better off.  It was a startling idea then, and it remains one today, that economic order can emerge as an unintended consequence of the actions of many people, each seeking his own interest.” (pages 13-14)

Prices perform three functions in organizing economic activity: first, they transmit information; second, they provide an incentive to adopt those methods of production that are least costly and thereby use available resources for the most highly valued purposes; third, they determine who gets how much of the product-the distribution of income. These three functions are closely interrelated.” (page 14)

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The accompanying 10 part PBS TV Series titled “Free to Choose” involving Milton Friedman can be accessed at the following website: http://miltonfriedman.blogspot.com/





Guidance from Friedman’s “Capitalism and Freedom” (with commentary)

22 11 2012

In the preface to Milton & Rose Friedman’s book “Free to Choose” (Harcourt Brace, Jonanovich Publishers, 1980), reference is made to the Friedman’s earlier book “Capitalism and Freedom”.

Capitalism and Freedom examines “the role of competitive capitalism – the organization of the bulk of economic activity through private enterprise operating in a free market – as a system of economic freedom and a necessary condition for political freedom.” In the process, it defines the role that government should play in a free society.

“Our principles offer,” Capitalism and Freedom says, “no hard and fast line how far it is appropriate to use government to accomplish jointly what it is difficult or impossible for us to accomplish separately through strictly voluntary exchange.  In any particular case of proposed intervention, we must make up a balance sheet, listing separately the advantages and disadvantages.  Our principles tell us what items to put on one side and what items on the other and they give us some basis for attaching importance to different items.”

The Friedman’s are being diplomatic and circumspect in providing such advice – calling on people to look carefully at both the costs and benefits of government involvement in the functions of resource allocation markets.

In recent years rapid expansion in U.S. government regulatory oversight and in some cases inhibiting interference with the functions of free market resource allocation has occurred in a number of sectors of the U.S. economy, such as the healthcare system, energy production, automobile production, and the financial / futures industries.  Furthermore, proposed increases in regulation of agricultural production systems and consumer’s food and dietary choices are also being considered by U.S. government agencies.

As governmental dictates interfere with free market resource allocation, history shows that poorer U.S. economic performance, fewer and poorer employment opportunities, and a lower economic standard of living are the near assured end result.  Governments – no matter their good intentions to correct economic and social wrongs – do a poor job of allocating scarce economic resources in comparison to free markets.

As we go through the works of Milton Friedman, Thomas Sowell, Friedrich Hayek, and other free market-oriented economists on this blog, the economic damage to efficient allocation of economic resources by over-regulating government actions will be a primary topic of analysis and discussion.





KC Fed Financial Stress Index => Still low U.S. Financial Stress in October 2012

15 11 2012

The Kansas City Federal Reserve calculates a monthly Financial Stress Index (here).  See the following description to by the KC Fed of the KCFSI….

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KC Fed – Financial Stress Index

The Kansas City Financial Stress Index (KCFSI) is a monthly measure of stress in the U.S. financial system based on 11 financial market variables.

A positive value indicates that financial stress is above the long-run average, while a negative value signifies that financial stress is below the long-run average. Another useful way to assess the current level of financial stress is to compare the index to its value during past, widely recognized episodes of financial stress.

How should the index be interpreted? The KCFSI is constructed to have a mean value of zero and a standard deviation of one. A positive value of the KCSFI indicates that financial stress is above the longrun average, while a negative value signifies that financial stress is below the long-run average. A useful way to assess the level of financial stress is to compare the index in the current month to the index during a previous episode of financial stress, such as October 2008.

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The most recent KCFSI report for October is available at the following web address, with exerpts from the report to follow:

http://www.kansascityfed.org/publicat/research/indicatorsdata/KCFSI/kcfsi.oct.2012.pdf

“The Kansas City Financial Stress Index (KCFSI) continues to indicate that financial stress remains low. The KCFSI measured -0.40 in October, a slight increase from September’s value but below its long-run average. This is the first increase in the KCFSI since May 2012.”

Comment by Daniel O’Brien – blog author:

These numbers seem to indicate that the U.S. economy is not in extreme financial stress in the fall of 2012 to the degree that it was in the fall of 2008.  These findings suggest that although serious financial issues are facing the U.S. economy and the U.S. consumer, at this time the U.S. is not experiencing a period of extreme financial stress.  If one political party in the U.S. was basing its 2012 election campaign on jobs and economic growth potential being lost, it may just be that some significant numbers of swing voters among the American public at large was not feeling or perceiving enough personal, kitchen table level economic stress to motivate them to change the party in presidential power.





Looking to Free Market Economic Foundations: “Capitalism and Freedom” by Milton Friedman (1962)

13 11 2012

Capitalism and Freedom.jpg

The contribution of Milton Friedman’s book Capitalism and Freedom (1962) is described in an article from the Library of Economics and Liberty website (here)

“In Capitalism and Freedom, Friedman wrote arguably the most important economics book of the 1960s, making a case for relatively free markets to a general audience. He argued for, among other things, a volunteer army, freely floating exchange rates, abolition of licensing of doctors, a negative income tax, and education vouchers. (Friedman was a passionate foe of the military draft: he once stated that the abolition of the draft was almost the only issue on which he had personally lobbied Congress.)”

A Wikipedia article (here) provides a chapter by chapter summary of Friedman’s key ideas in the book. (Great credit goes to this Wikipedia author for this summary / synopsis)

Introduction

The introduction lays out the principles of Friedman’s archetypal liberal, a man who supports limited and dispersed governmental power. Friedman opts for the continental European, rather than American, definition of the term.
1) The Relation between Economic Freedom and Political Freedom

In this chapter, Friedman promotes economic freedom both a necessary freedom and also as a vital means for political freedom. He argues that, with the means for production under the auspices of the government, it is nearly impossible for real dissent and exchange of ideas to exist. Additionally, economic freedom is important, since any “bi-laterally voluntary and informed” transaction must benefit both parties to the transaction.
2) The Role of Government in a Free Society

According to the author, the government of a liberal society should enforce law and order and property rights, as well as take action on certain technical monopolies and diminish negative “neighborhood effects.” The government should also have control over money, as has long been recognized in the constitution and society.
3) The Control of Money

He discusses the evolution of money in America, culminating in the Federal Reserve Act of 1913. Far from acting as a stabilizer, the Federal Reserve failed to act as it should have in several circumstances. Friedman proposes that the Federal Reserve have a consistent rule to increase the money supply by 3-5% annually.
4) International Financial and Trade Arrangements

This chapter advocates the end of the Bretton Woods system in favor of a floating exchange rate system and the end of all currency controls and trade barriers, even “voluntary” export quotas. Friedman says that this is the only true solution to the balance of trades problem.
5) Fiscal Policy

Friedman argues against the continual government spending justified to “balance the wheel” and help the economy to continue to grow. On the contrary, federal government expenditures make the economy less, not more stable. Friedman uses concrete evidence from his own research, demonstrating that the rise in government expenditures results in a roughly equal rise in GDP, contrasting with the Keynesian multiplier theory. Many reasons for this discrepancy are discussed.
6) The Role of Government in Education

The policy advocated here is vouchers which students may use for education at a private school of their choice. The author believes that everyone, in a democracy, needs a basic education for citizenship. Though there is underinvestment in human capital (in terms of spending at technical and professional schools), it would be foolish of the government to provide free technical education. The author suggests several solutions, some private, some public, to stop this underinvestment.
7) Capitalism and Discrimination

In a capitalist society, Friedman argues, it costs money to discriminate, and it is very difficult, given the impersonal nature of market transactions. However, the government should not make fair employment practices laws (eventually embodied in the Civil Rights Act of 1964), as these inhibit the freedom to employ someone based on whatever qualifications the employer wishes to use. For the same reason, right-to-work laws should be abolished.
8) Monopoly and the Social Responsibility of Business and Labor

Friedman states, there are three alternatives for a monopoly: public monopoly, private monopoly, or public regulation. None of these is desirable or universally preferable. Monopolies come from many sources, but direct and indirect government intervention is the most common, and it should be stopped wherever possible. The doctrine of “social responsibility”, that corporations should care about the community and not just profit, is highly subversive to the capitalist system and can only lead towards totalitarianism.
9) Occupational Licensure

Friedman takes a radical stance against all forms of state licensure. The biggest advocates for licenses in an industry are, usually, the people in the industry, wishing to keep out potential competitors. The author defines registration, certification, and licensing, and, in the context of doctors, explains why the case for each one of these is weaker than the previous one. There is no liberal justification for licensing doctors; it results in inferior care and a medical cartel.
10) The Distribution of Income

Friedman examines the progressive income tax, introduced in order to redistribute income to make things more fair, and finds that, in fact, the rich take advantage of numerous loopholes, nullifying the redistributive effects. It would be far more fair just to have a uniform flat tax with no deductions, which could meet the 1962 tax revenues with a rate only slightly greater than the lowest tax bracket at that time.
11) Social Welfare Measures

Though well-intentioned, many social welfare measures don’t help the poor as much as some think. Friedman focuses on Social Security as a particularly large and unfair system.
12) Alleviation of Poverty

He advocates a negative income tax to fix the issue, giving everyone a guaranteed minimum income, rather than current measures, which he sees as misguided and inefficient.
13) Conclusion

The conclusion to the book centers on how, time and time again, government intervention often has an effect opposite of that intended. Most good things in the United States and the world come from the free market, not the government, and they will continue to do so. The government, despite its good intentions, should stay out of areas where it does not need to be.

From the article “Excerpts from Milton Friedman, Capitalism and Freedom (Chicago: University of Chicago Press, 1962), Chapter 1,…” (here), come the following relevant quotes….

“Economic arrangements play a dual role in the promotion of a free society. On the one hand, freedom in economic arrangements is itself a component of freedom broadly understood, so economic freedom is an end in itself. In the second place, economic freedom is also an indispensable means toward the achievement of political freedom.”

“Viewed as a means to the end of political freedom, economic arrangements are important becuase of their effect on the concentration or dispersion of power. The kind of economic organization that provides economic freedom directly, namely, competitive capitalism, also promotes political freedom because it separates economic power from political power and in this way enables the one to offset the other.”

“Historical evidence speaks with a single voice on the relation between political freedom and a free market. I know of no example in time or place of a society that has been marked by a large measure of political freedom, and that has not also used something comparable to a free market to organize the bulk of economic activity.”

Web references:

1) Wikipedia article: “Capitalism and Freedom”   http://en.wikipedia.org/wiki/Capitalism_and_Freedom

2) Library of Economics and Liberty Article:  “Milton Friedman (1912-2006)”  http://www.econlib.org/library/Enc/bios/Friedman.html

3) Excerpts from Milton Friedman, Capitalism and Freedom (Chicago: University of Chicago Press, 1962), Chapter 1, “The Relation Between Economic Freedom and Political Freedom,” pp. 7-17.   https://www.mtholyoke.edu/acad/intrel/ipe/friedman.htm