Sunday, November 19, 2006
Milton Friedman - economist who showed the way for Thatcher
Posted by David Smith at 10:59 AM
Category: David Smith's other articles


The last time The Sunday Times interviewed Milton Friedman, who died last week at the age of 94, was on the occasion of his 90th birthday.

The man who at the time of his death was the world’s greatest economist had, he told me, got “too damn old” to do much lecturing and had probably written his last book, but his famously sharp and agile mind was still working overtime.

At the time there were worries about whether Japan, mired in a deflationary slump that had lasted more than a decade, would ever pull out of it. But Friedman was unfashionably upbeat about Japan, arguing strongly that the rising sun would shine once again.

Japan, he said, would surprise the world by recovering strongly, on the back of the ultra-low interest rates. It did.

He was similarly upbeat about America, then still groping its way out of the economic uncertainty after September 11. Alan Greenspan was doing the right thing by cutting interest rates to low levels, he said, and the economy would respond to it by bouncing back. Again, he was right.

I first met Friedman, who stood 5 ft tall in his shoes, a quarter of a century earlier. He and his equally diminutive wife Rose, also an economist, were in London to publicise a television series he had made, and which was about to be shown in Britain.

Sitting in a room in a posh London hotel, probably doing their tenth interview of the day, they were animated and interested. The most enduring image of the series was of him standing next to a banknote printing press. The only way to stop inflation was to switch off the press.

Around that time, he also gave evidence to a House of Commons committee. The debate was raging about the Thatcher government’s experiment with monetarism.

Ralph Harris of the Institute of Economic Affairs, who also died recently, had brought Friedman over to London each year during the 1970s, and he was instrumental in persuading Margaret Thatcher and her shadow ministerial team to adopt a policy of beating inflation by controlling the money supply. But Friedman was critical of the approach adopted by the Tories in government. Controlling the money supply, he argued, did not mean crippling the economy with sky-high interest rates.

Friedman, born in 1912 in Brooklyn to poor, first-generation immigrant Jewish parents, became a bogeyman for the left, and not just for his association with Thatcher. He and other University of Chicago economists, who became known as the “Chicago boys”, provided economic policy advice to General Pinochet, the Chilean dictator. Friedman always maintained that he advocated economic freedom as the best way of helping the people of Chile, while never endorsing other aspects of the Pinochet regime. For years, Chile stood out as the sole economic success story in Latin America.

Friedman remained a Chicago boy in spirit, although since 1977 he was attached to the Hoover Institution in San Francisco.

What is less well known is that Friedman was also hugely influential when it came to the economic policy of James Callaghan, Thatcher’s Labour predecessor. Peter Jay, the former Times economics editor, later British ambassador to Washington, was a Friedman follower. The purest expression of Friedman’s economic policy prescription came with Callaghan’s speech to the 1976 Labour party conference, when Britain was mired in the IMF crisis.

You could not, Callaghan warned, “spend your way out of recession”. The option no longer existed and had probably never done so, for it only worked by “injecting inflation into the economy”. The result was: “Higher inflation, followed by higher unemployment. That is the history of the last 20 years.”

The economics behind that speech, indeed the way that all governments now operate economic policy, came from Friedman. In the late 1960s he came up with the concept of the “natural rate” of unemployment. Before that, the belief was that there was a simple trade-off between inflation and unemployment. If one was high, the other was low, and vice-versa.

Friedman’s natural rate changed all that. Unemployment, he said, was determined by what economists call supply-side factors — how flexible the job market was, whether there was a sufficient supply of labour with the right skills, and so on. If governments tried to push it down by artificial means, inflation would rise. Instead, the best way to get unemployment down was to keep inflation low, and tackle those supply-side issues.

Callaghan barely had time to try this out but the Thatcher government did, if inexpertly at times. It tried to keep inflation low, while bringing down Britain’s “natural” rate of unemployment by reducing the power of the trade unions.

If the natural rate represents Friedman’s most significant contribution, there is no shortage of other contenders. He was the inventor of monetarism, reworking the classical quantity theory of money in the 1950s. With Anna Schwartz, he rewrote America’s economic history, demonstrating that the great depression was neither a crisis of capitalism nor something that only big government could cure with large-scale spending.

The depression, he and Schwartz argued, was due to the Federal Reserve losing its nerve during the boom years of the 1920s. It slammed the brakes on, causing hundreds of bank failures and a plunge in the money supply. The surprise was not that there was a depression but that it was not a lot worse.

Ben Bernanke, the Fed chairman, told Friedman recently: “You’re right, we did it. We’re very sorry.”

But Friedman was proudest, he told me, of another piece of work, which explained what determined people’s spending. “The natural rate had more influence on the world but as a consistent programme carried through it doesn’t seem to me it was in the same class as the theory of the consumption function,” he said.

The theory postulated that household spending was determined not by the amount that people have in their pay packet each week but by their long-run or “permanent” income. It meant that people were indeed likely to look a gift horse, such as a temporary tax cut, in the mouth.

“This, more than anything, pulled the rug from under Keynesianism,” said John Blundell, current director of the Institute of Economic Affairs and a long-time friend.

Even before his death, Friedman was sometimes spoken of in the hushed tones of respect. But he hated that. Even in his nineties he maintained his irreverence and a reluctance to take on the role of elder statesman.

Last year he signed up to an international campaign to legalise cannabis, his long-held view being that the best way to control drug use was to bring it into the open and tax it, just like alcohol and tobacco.

He was, as Blundell puts it, not only the father of monetarism but also “the father of America’s volunteer army”. When appointed to a 15-man presidential commission investigating whether the army draft should be abolished, he found himself in a small minority. But he won the doubters round and regarded the post-Vietnam ending of the draft as one of his proudest accomplishments.

Friedman was the first to propose vouchers to use in health and education. Half a century ago he also proposed a negative income tax as the best way to help those on low incomes. Gordon Brown’s tax credits are a practical variation on Friedman’s negative income tax theme. He did not agree with everything the Labour government did but he applauded the chancellor for staying out of the euro, which he remained convinced would do great harm to Europe’s economy.

Last week Brown paid tribute to his “major influence” on post-war economic policy; Bank of England governor Mervyn King said he was a “towering figure”; Bernanke said he “had no peer” among economic scholars, while Greenspan said simply: “My world will never be the same.”

In the 20th century the two most influential economists were an Englishman, John Maynard Keynes, and an American, Milton Friedman.

There are occasional echoes of the great battles between Keynesians and monetarists, but something like a consensus has emerged. The battles that Friedman fought, to persuade doubters that market solutions were always preferable to government diktat, are also over but we should not forget how bitter and bloody they were.

In the half century since Keynes died, no Englishman has stepped into his shoes, nor looks like doing so. With Friedman gone, it will be a long time before we see another economist of his stature.

From The Sunday Times, November 19 2006