Schools of Thought in Classical Liberalism, Part 2: Milton Friedman and the Chicago School

Release Date
May 9, 2012

Topic

Free Markets and Capitalism
Description

Dr. Nigel Ashford discusses the ideas of Milton Friedman, a Nobel Laureate and economist. Friedman is widely considered the founder of the Chicago School, an intellectual tradition that basis its theories on empirical and measurable evidence and theories.
According to the Chicago School, in order to assess the merits of a law, you must measure the results of that law. Laws may be well-intended, but the Chicago School demands that we measure the consequences of laws, and not just intentions.
The Chicago School admits that markets do fail sometimes. But, they also believe that governments fail as well. They contend that government failure is almost always greater than market failure. That’s why the Chicago School believes the government should be significantly limited.
What does the Chicago School say about the proper role of government? According to Friedman’s thinking, which you can find in his popular books Capitalism and Freedom and Free to Choose, the government should have four realms of responsibility:

  1. Military and police
  2. Administration of justice
  3. Public goods (like defense) and negative externalities (like pollution)
  4. Protection of children and mentally handicapped

Free to Choose (Video): In the 1980s and 1990s, PBS broadcasted a television series featuring the ideas of Milton Friedman and the Chicago School. In the 15 part series spanning two decades, Friedman looks at the success of capitalism in human history. Friedman engages in debates and discussions with thinkers from across the intellectual spectrum.
The Chicago School (Video): This short clip from the PBS documentary The Commanding Heights introduces the chief figures of the Chicago School, and the intellectual battles they fought.
Milton Friedman and the Chicago School of Economics [Article]: The Chicago School thinkers were not idle academics; they rigorously and systematically challenged widely accepted Keynesian economic theories. In this article, Richard Ebeling puts the Chicago School and Milton Friedman in historical context.
Milton Friedman [Article]: A biography of Milton Friedman highlighting his academic achievements.
Questions:
1. What is the law of unintended consequences?
2. What is a “public good”?
3. What is the case for school vouchers?

Part 2: Milton Friedman and the Chicago School
Now I want to look at Milton Friedman and the Chicago school. Milton Friedman, of course, the famous former president of the American Economic Association, Nobel Prize winner, wrote best-selling books, Capitalism and Freedom and Free to Choose, the latter of which was turned into a popular television series. They approach the question by using an empirical methodology. That is, for them it’s about testing the power of theories.
So they approach it by presenting a hypothesis: we predict that X will result in Y. So for example, if you increase the minimum wage, the result of that will be that lower-skilled workers will find it more difficult to find employment. And you can test that with empirical evidence. Why do they think government should be limited? It’s because they believe that there is such a thing as market failure—markets sometimes fail—but there’s also such a thing as government failure, that governments often fail. And they say if you compare those two things, usually government failure is much greater than market failure.
So whereas what happens in so much public debate, they identify, politicians identify a market failure and therefore assume that a perfect government can come in and solve that problem. Whereas the Chicago school says, that’s not right. What we need to do is to compare imperfect markets, with all the imperfections the Chicago school recognizes, with imperfect government, with all of the problems that government have. And they say, normally when you do these two things, government failure is so much greater than market failure.
So what there is is a gap between the intentions of policymakers and the actual results and consequences of what they advocate.  Sometimes, for example, policies lead to the opposite to that of which was intended. Perverse incentives. For example, the idea of rent control is to provide more opportunities for poorer people to provide housing. But by reducing the price of rental property, what you actually do is reduce the supply of rental property. It actually makes it more difficult for poor people to find housing. It has the opposite effect to what’s intended.
Then there are many other government policies, which might actually achieve their goals, the positive, intended consequences of polices, but it ignores the negative, unintended consequences of those policies. So for example, raising the minimum wage, there are some people who benefit from that; they get a higher income because of it. But it ignores the negative, unintended consequences. That is, larger numbers of people can’t get jobs at all. And so we need to compare both the positive consequences, which were intended, and the negative, unintended consequences.
And the Chicago school argues that normally the negative, unintended consequences are greater than the positive, intended ones. But it’s an empirical question; we have to examine what the evidence say. And why is there this gap between intentions and consequences? They argue it’s because policymakers’ failure to take into account the importance of self-interest in explaining peoples’ behavior. They ignore human nature.
What should be the role of government according to the Chicago school? Well, Milton Friedman identifies four main areas of government responsibility. First of all, to protect us from our enemies, both internal and external enemies. We need a military to provide us with defense against our foreign enemies; we need a police force that the government provides to protect from our internal enemies, such as criminals.
Secondly, government should provide the administration of justice in order to achieve peaceful reconciliation of conflict. Inevitably, if you live in a society with other people, we will come into conflict with each other. We will disagree about certain things; that’s a contract, what the meaning of a contract is.
One possible way of resolving any sort of conflict is, easy, we could beat up with the other person. Presumably, though, we don’t want to live in a society where every time there is a disagreement, we try and have a physical fight with the other person. So we want some neutral arbiter that we can go to that is not connected with either side, and they will be an arbiter and say, yes, this is what the contract means; this means you were right and the other person is wrong. So it’s the job of the government to provide these courts that we can go to.
The third area that Friedman argues is that there are some things, not many, but there are some things that the marketplace, through voluntary exchange, cannot provide satisfactorily. They take two different forms. First of all are what economists call public goods. This is not the same thing as necessarily being good for the public; public goods for economists have a very particular meaning.
Public goods have two characteristics. First of all, you can’t exclude people from the benefits of this program. And the second thing is they’re nonrival. The fact that I consume more of it does not mean that you have less of the product. Best probably illustrated by an example: the classic example of a public good is defense. I’m not yet an American citizen, but I live on American soil. Suppose that I didn’t want to pay my taxes towards defense. I would prefer to be defended by Her Majesty the Queen and therefore I’m not going to pay my taxes for defense.
The problem with that is I do live on American soil. That means the American military are going to defend me whether I want it or not. I can’t be excluded from American defense. But it’s nonrival. The fact that I am protected means, the protection of me  doesn’t mean any less protection for anyone else. So that’s a classic case for a public good. I could say, well I don’t want to pay for it, but I will still benefit from it. But it doesn’t mean any less for anyone else. So if you left it, just not going to work in the voluntary system; people would simply not contribute to public goods. So it’s an argument you have to have the government that provides the public goods.
The second main area that Chicago school will talk about are negative externalities. That is, when people interact with each other, it may have consequences for third parties. The classic case of that is pollution. I may be producing a good, but I produce pollution, which then affects the people who live in the neighborhood. So it’s argued, Chicago school says we need some way of controlling these negative externalities, such as pollution. More controversially, Freedman argues that the poor are a negative externality. That is that we don’t want to live in a society where we walk down the streets where there are people begging and starving on the streets. So he argues it’s a negative externality to live in a world where there are lots of poor people, and therefore he justifies, as dealing with a negative externality, some form of social safety net.
And the fourth area he says that government needs to act is to protect the irresponsible, those that we assume are not capable of looking after themselves. Classic case of that of course are children; we assume they’re not in a position to make decisions for themselves. Normally we can allow parents to make their decisions, but we have to keep an eye. Not all adults treat children properly. And then we assume that there are some people who are mentally incapable of making decisions on their behalf; the government has to make sure that their interests are protected.
So Friedman is very clear, these are the four areas that government should be active in or necessary to carry out. They’re important, but they’re still significantly limited. This approach is often called the Social Market Approach. Friedman believes that what governments, governments have these responsibilities, but as far as possible, they should use market mechanisms to achieve these ends. So for example, it is a responsibility of government to make sure every child is educated, but that does not mean that government has to provide the schools. Government, for example, could give vouchers or some form of school choice, private schools, but parents can chose whichever school they want to go to. So government has a social responsibility; it doesn’t necessarily have to directly provide what those social responsibilities are.