Today's date:

Spring
2006

• THE GLOBAL
IDEOLOGY
OF FEAR
• THE
OTHER
• POST-NATIONAL
LITERATURE
• COLLAPSE
OR MASSIVE
CHANGE?
• THE RISE
AND FALL OF
AMERICA'S SOFT POWER
• THE
SCIENTIFIC IMAGINATION
• PUBLIC
DIPLOMACY
• THE
HEADSCARF CONTROVERSY
• SCULPTURE
AND THE
NEW SCIENCE
• BIOTECH AND
THE
NEW BABEL
• WAR
THROUGH THE
BACK DOOR
• ANTIAMERICANISM
• THE RISING
SOFT POWER
OF CHINA & INDIA
• THE BUSH
DOCTRINE
• FAIRNESS
IN A FRAGILE
WORLD
• AMERICA'S
MIGHT
• ISLAM IN
THE 21ST CENTURY
• ANTIGLOBOS
• HOT
PEACE
• MODUS
VIVENDI
• LOOKING
NORTH
• FROM WELL
HAVING TO
WELL BEING
•
POST-HUMAN HISTORY
• GLOBAPHOBIA
• THE GLOBAL
MIND
• AFTER
KOSOVO
• FROM
VIETNAM TO KOSOVO
•
DEGLOBALIZATION?
• THE RISE OF
THE MEDIA-
INDUSTRIAL COMPLEX
• BOOM
[NUCLEAR] AND
[BUST] ECONOMIC IN
ASIA
• BEYOND
CAPITALISM
• ASIAN
CRISIS
• CHINA: THE
ASIAN
RENAISSANCE
• SLOW IS
BEAUTIFUL
• ECLIPSE
OF THE BIG
PICTURE
• AFTER THE
END OF
HISTORY
• THE EAST
IS RED AGAIN
• HALF-A-HEGEMON
• THIRD
WAVE TERRORISM
• HEIMAT
• Fall
1987
• Winter
1987
• Spring
1986
•
Fall-Winter '84-'85
• Spring
1984

Free Markets and the End of History

Milton Friedman, 93, was awarded the Nobel Prize for Economics in
1976. His monetarist and laissez-faire ideas have been profoundly
influential in the past several decades with leading political figures
from Margaret Thatcher to Ronald Reagan. In late November, NPQ editor
Nathan Gardels spoke with Friedman at his hilltop San Francisco apartment
with panoramic views across the San Francisco Bay to the Golden Gate
Bridge.

NPQ | You’ve seen a lot in your long life and thought
about the big issues. What is on your mind these days?

Milton Friedman | The big issue is whether the United
States will succeed in its venture of reshaping the Middle East. It is not
clear to me that using military force is the way to do it. We should not
have gone into Iraq. But we have. At the moment, the most pressing issue,
therefore, is to make sure that effort is completed in a satisfactory way.

There is no doubt that America’s stature in the world—in large part due
to the attraction and promotion of our liberal freedoms—has been eroded as
a result of Iraq. However, if Iraq emerges in the end as a self-governing
country that is not a threat to anybody, that will have a favorable effect
on the Middle East in general. The end result then would be to increase
the prestige of the US. But that is not the case now. The effect so far
has been the other way.

NPQ | The so-called “old Europe” of France, Germany
and Italy has been stagnating with high levels of unemployment.
Germany—one of the last bastions of the Cold War Keynesian welfare
state—now has a conservative leader, Angela Merkel.

What should be done to get Germany, and by extension old Europe, back
on track?

Friedman | They all ought to imitate Margaret Thatcher
and Ronald Reagan; free markets in short.

Germany’s problem, in part, is that it went into the euro at the wrong
exchange rate that overvalued the deutsche mark. So you have a situation
in the eurozone where Ireland has inflation and rapid expansion while
Germany and France have stalled and had the difficulties of adjusting.

The euro is going to be a big source of problems, not a source of help.
The euro has no precedent. To the best of my knowledge, there has never
been a monetary union, putting out a fiat currency, composed of
independent states.

There have been unions based on gold or silver, but not on fiat
money—money tempted to inflate—put out by politically independent
entities.

At the moment, of course, Germany cannot get out of the euro. What it
has to do, therefore, is make the economy more flexible—to eliminate the
restrictions on prices, on wages and on employment; in short, the
regulations that keep 10 percent of the German workforce unemployed. This
is far more urgent than it would otherwise be if Germany were not in the
euro.

This set of policies would open up the German potential. After all,
Germany has a very able and productive workforce. It has high-quality
products that are valued all over the world. It has every opportunity to
be a productive, growing state. It just has to give its entrepreneurs a
chance. It has to let them make money, hire and fire, and act like
entrepreneurs.

Instead, what you have as a result of past policies is that German
entrepreneurs go outside of Germany for many of their activities. They are
investing abroad instead of at home because there isn’t the openness,
fluidity and opportunity they find outside their borders.

NPQ | British Prime Minister Tony Blair argues there
is a “third way”—for example, flexible labor markets without hire-and-fire
American-style. This, he argues, is more suitable to the “European social
model” with its enduring concern with social justice. Is there an
in-between way, or must it be all or nothing?

Friedman | I don’t think there is a third way. But it
is true that a competitive market is not the whole of society. A great
deal depends on the qualities of the population and the nation in how they
organize the non-market aspects of society.

NPQ | Perhaps the Scandinavian countries are a model
to look at. They are high-tax but also high-employment societies. And they
have freed up their labor markets much more than in Italy, France or
Germany.

Friedman | Though it is not as true now as it used to
be with the influx of immigration, the Scandinavian countries have a very
small, homogeneous population. That enables them to get away with a good
deal they couldn’t otherwise get away with.

What works for Sweden wouldn’t work for France or Germany or Italy. In
a small state, you can reach outside for many of your activities. In a
homogeneous culture, they are willing to pay higher taxes in order to
achieve commonly held goals. But “common goals” are much harder to come by
in larger, more heterogeneous populations.

The great virtue of a free market is that it enables people who hate
each other, or who are from vastly different religious or ethnic
backgrounds, to cooperate economically. Government intervention can’t do
that. Politics exacerbates and magnifies differences.

NPQ | The inflation rate in America as well as
globally remains historically low, even as oil prices skyrocket. Why?

Friedman | Inflation is a monetary phenomenon. It is
made by or stopped by the central bank. There has been no similar period
in history like the last 15 years in which you’ve had little fluctuation
in the price level. No matter what else happens, this will maintain as
long as the US Federal Reserve maintains strict monetary policy and
control of the money supply.

The same thing is true in Europe. The ECB (European Central Bank) has
held down the rate of monetary growth. So there have been stable prices.
The pressures in Europe, however, will be much stronger than in the US.
The main pressure is to print money and be more expansive in order to
promote employment.

What the ECB does really depends on whether Germany and France and
Italy will back it. Italy may well be the main problem. It has benefited
most from the euro by having been able to get the euro interest rate
instead of what otherwise would have been its own. That would be much
higher because Italy has been accumulating so much debt. In the past,
Italy has inflated away its debt. The virtue of the euro is that Italy
can’t do it alone. A tight ECB policy wouldn’t permit that to happen
again.

In this sense, the euro is good for Europe. But only if there is
flexibility all around. The problem is that, in a world of floating
exchange rates, as Italy was before the euro, if one country is subjected
to a shock which requires it to cut wages, it cannot do so with a modern
kind of control and regulation system. It is much easier to do it by
letting the exchange rate change. Only one price has to change, instead of
many.

But now, in the euro, that option is taken away. The only alternative
if a state has to adjust to a shock is to let internal prices vary. It has
to let wages go down, if necessary. It has to let internal interest rates
go up, if necessary.

NPQ | The US Treasury debt is held mainly by China,
Japan and South Korea. Is the huge foreign balance of payments deficit a
problem for the US and world economy?

Friedman | I don’t think so. It may well be a
statistical mirage. If you look at the balance sheet, the US is heavily in
debt. If you look at the income account—the amount of interest the US pays
abroad—it is almost exactly equal to the amount of interest that it
receives from abroad. American assets held abroad are earning a higher
rate of return than foreign assets held here.

That is understandable because what is most attractive about the US to
people and countries with wealth is that it can provide security,
insurance really, against political instability. Nobody is afraid that the
money they place in the US is at risk of expropriation or of in some other
way being taken away. For this safety, the wealth holders of the world are
willing to accept a lower rate of return. US assets abroad, in contrast,
are riskier and thus yield a higher rate of return.

This explains why there is a rough balance in real terms. It is not
clear there really is a debt. It looks like the imbalance concerns are
misleading. It doesn’t worry me a bit that China and Japan hold so much US
debt. In a way, it seems foolish for them to do it because they get lower
returns than they might elsewhere. But that is their business.

NPQ | By pegging their currencies to the dollar,
haven’t China and Japan de facto established what is in essence “Bretton
Woods II”—that is, a stable new currency regime among most of the world’s
largest trading partners?

Friedman | Yes, for the moment, this is sort of true.
But they are not really committed to it. The Chinese currency is starting
to appreciate. The Japanese currency has moved quite a lot.

China’s productive system draws upon the other East Asian countries to
a great extent. It buys from Japan and Korea and others. So, the volume of
trade is much larger than the net amount being exported from China. China
needs substantial reserves to finance all that.

NPQ | Does the large US fiscal deficit worry you?

Friedman | Not at all. It is the spending that got us
there that worries me. If the US government spends 40 percent of the
nation’s income, as it does through either borrowing or taxes, that income
is not available for people to spend. The deficit is an indirect method of
taxation. Of course, politicians prefer to borrow instead of tax because
then someone down the road has to deal with the consequences.

If anything, at the moment, the large deficit has a positive effect of
holding down further spending. In that sense, it is a good thing. But it
is not a good thing if produced by more spending.

NPQ | China has registered tremendous growth since
1979 through what might be called a “market Leninist” model, or an
“authoritarian free-market system” like the Pinochet government you
advised in Chile. Can this model last?

Friedman | No. The same thing will happen in China
that happened in Chile. Political freedom will ultimately break out of its
shackles. Tiananmen Square was only the first episode. It is headed for a
series of Tiananmen Squares. It cannot continue to develop privately and
at the same time maintain its authoritarian character politically. It is
headed for a clash. Sooner or later, one or the other will give.

If they don’t free up the political side, its economic growth will come
to an end—while it is still at a very low level.

The situation is not all bleak. Personal freedom has grown greatly
within China, and that will provoke ever more points of conflict between
the individual and state. There is a new generation that is educated and
travels abroad. It knows firsthand the alternatives out there. So, the
authoritarian character is softening somewhat.

Hong Kong is the bellwether. If the Chinese stick to their agreement to
let Hong Kong go its own path, then China will also go that way. If they
don’t, that is a very bad sign. I’m optimistic.

NPQ | What impact has the Internet had on freedom and
markets?

Friedman | It has had a tremendous effect. Look at
what has happened in China. People can talk to each other, and the
government, despite its best efforts, can’t control it.

The Internet also moves us closer to “perfect information” on markets.
Individuals and companies alike can buy and sell across borders and
jurisdictions wherever they find the best match of supply and demand.
Undoubtedly it has reduced the possibilities of taxation. Why should I buy
something here if I can buy it from a company in Japan or England or
Brazil with a lower tax?

The Internet is the most effective instrument we have for
globalization.

NPQ | So you see the march of liberty and free markets
going forward into the 21st century, not taking a detour backward in China
or elsewhere?

Friedman | Yes. The world as a whole has more or less
embraced freedom. Socialism, in the traditional sense, meant government
ownership and operation of the means of production. Outside of North Korea
and a couple of other spots, no one in the world today would define
socialism that way. That will never come back. The fall of the Berlin Wall
did more for the progress of freedom than all of the books written by
myself or Friedrich Hayek or others.

Socialism today has only come to mean government extraction of income
from the haves and giving it to the have-nots. It is about the transfer of
income, not ownership. That is still around.

NPQ | Might the state make a comeback, though, because
of a new set of realities: demographics, the environment and the
combination of inequality and democratization?

The rich-country populations are growing old. With the rise of the
individual and demise of the family, the state will be called upon to
ensure health care and pension security. With the scientific consensus on
climate change, there will inevitably be demands for more state regulation
on the environment. The spread of global free markets has also meant
rising inequality. Inevitably, as democracy also spreads, the majority who
are less well off will demand transfers from the wealthy to address social
injustice.

Friedman | Sure, the state might come back. The only
reason free markets have a ghost of a chance is that they are so much more
efficient than any other form of organization. When you argue for free
markets, you are arguing against the trend. When something goes wrong, the
natural tendency is to say, “By God, we need to pass a law and do
something.”

The argument for the free market is a complicated and sophisticated one
and depends on demonstration of secondary effects. I have confidence
market efficiency will win out. But there is no doubt that the problems
you raise are all there. And there is no doubt there will be tremendous
pressure to pull in the government as the answer.

At the end of World War II, government spending was 15–20 percent of
national income. Then it went up dramatically so that by 1980 it hit 40
percent largely because of programs ranging from Medicare to environmental
regulation to Social Security. From 1980 until 2005, it has remained
static. We haven’t beaten the tendency or rolled it back. We’ve just
stopped the growth. This is an argument that supports your thesis, I’m
afraid.

On aging societies, there is no reason why a country that has a lot of
old people can’t be prosperous if, during their working lives, individuals
provide for their retirement. The only reason there is a crisis about
Social Security in the US and pensions in Europe and Japan is that you
cannot maintain a “Ponzi” scheme indefinitely. We have collected from
today’s young to pay today’s old and counted on tomorrow’s young to keep
doing so. That was a fine scheme as long as the number of young people was
rising faster than old people. When that ratio comes to an end, such a
system also has to end. It all would have been much better if individuals
saved for their own old age.

Why is it that private insurance companies are not in trouble because
people are getting older? Aren’t they subject to the same demographics?
The difference is that they’ve accumulated a fund, not a pay-in, pay-out
system.

NPQ | Even in the free market US, President Bush, at
the height of his power, couldn’t convince the American public to move
toward privatizing Social Security.

Friedman | There is no doubt this aging issue will
test the argument over the efficiency of the market versus political
demands for government to step in.

On the question of whether inequality of the market might lead the
less-well-off democratic majority to push for state control, I’m not so
sure. The important issue is not how much inequality there is but how much
opportunity there is for individuals to get out of the bottom classes and
into the top. If there is enough movement upward, people will accept the
efficiency of the markets. If you have opportunity, there is a great
tolerance for inequality. That has been the saving grace of the American
system.

In the US, the problem now is primary and secondary education. We’ve
had such an increase in inequality because a quarter of American kids
don’t finish high school! In the current world, with the skills needed,
those dropouts are condemned to being members of the underclass. In my
view, this is a fault of the American school system, which is a government
monopoly.

NPQ | With globalization, are we seeing the freest
world economy we’ve ever seen?

Friedman | Oh no. We had much freer trade in the 19th
century. We have much less globalization now than we did then.

Will we go ahead back to this freedom of the 19th century? I don’t
know. We have a freer world because of the collapse of the Soviet Union
and the changes in China. Those two have been the main contributors to
freedom in our time. The countries that have risen and separated out as a
result of the collapse of the Soviet Union are, on the whole, following
freer economic policies. Most of these states have freer government and
less restrictions on trade.

This free-market base will likely expand from there by example to
others not so free. Everyone, everywhere, now understands that the road to
success for underdeveloped countries is freer markets and
globalization.

NPQ | In the end, your ideas have triumphed over Marx
and Keynes. Is this, then, the end of the road for economic thought? Is
there anything more to say than free markets are the most efficient way to
organize a society? Is it the “end of history,” as Francis Fukuyama put
it?

Friedman | Oh no. “Free markets” is a very general
term. There are all sorts of problems that will emerge. Free markets work
best when the transaction between two individuals affects only those
individuals. But that isn’t the fact. The fact is that, most often, a
transaction between you and me affects a third party. That is the source
of all problems for government. That is the source of all pollution
problems, of the inequality problem. There are some good economists like
Gary Becker and Bob Lucas who are working on these issues. This reality
ensures that the end of history will never
come.