Judge Friedman's Advice To Pinochet Yourself

Naomi Klein makes available Milton Friedman's 21 April 1975 letter to mass murderer Augusto Pinochet.

You Got Me Babe

Here are two books one can read on-line and that I may read:

• Protecting Individual Privacy in the Struggle Against Terrorists: A Framework for Program Assessment, National Academies Press (2008)
• Nicholas Kaldor, The Scourge of Monetarism, Second Edition, Oxford University Press (1986)

The first book discusses data mining in an anti-terrorism context. Success of this tchnology in this context is difficult, while false positives are a threat to privacy. At least this is the conclusion - if I am fairly summarizing - of the Committee on Technical and Privacy Dimensions on Information for Terrorism Prevention and Other National Goals. (The National Academies Press publishes reports by the National Academies and by the National Research Council, organizations of some importance in the formation of United States policies on science and technology.)

The second book is Nicholas Kaldor's demonstration that monetarism does not work. On this blog, Kaldor should need no introduction.

Both books are in a freely readable on-line format that I find annoying. I suppose the format of the free version of the first is a business decision to encourage the purchase of the PDF version. And I blame copyright law for the format of the second.

On The Road From Mont Pelerin

I have been reading The Road from Mont Pelerin: The Making of the Neoliberal Thought Collective, a collection edited by Philip Mirowski and Dieter Plehwe (Harvard University Press, 2009). One theme I find emergent in this book is the influence of funders (e.g., Harold Luhnow, Jasper Crane) on the redirection of economic thought, without any corresponding empirical evidence.

But I'm not yet ready to offer too many thoughts on this book. Instead I'm interested in the cover photo, reproduced as Figure 1.

Figure 1: Cover Photo

I cannot find photo credits in the book. Presumably, this photo is of attendees at a Mont Pelerin society meeting, maybe the first. Can anybody identify these people? Figure 2 letters them to facilitate referring.

• F. Ludwig Von Mises
• G. Friedrich Hayek

Figure 2: Cover Photo with Annotations

Against Propaganda Being Institutionalized In Universities

In The Chronicle of Higher Education, Marshall Sahlins criticizes the proposed establishment of the Milton Friedman Institute (MFI). (Hat tip to Brad DeLong.)

The Committee for Open Research on Economy & Society (CORES) has a web site collecting criticism of the MFI.

As indicated by my post title, I think the MFI sounds like it should shame any serious university.

Koopmans On Friedman's Claimed Methodology

Over on Crooked Timber, "reason" says he likes a James Galbraith quotation I refer to. Galbraith mentions Koopmans. I suppose Galbraith is talking about this:

"Here the 'direct' implications of the postulates, their accuracy in describing directly observed individual behavior, are placed [by Friedman] in a category with which we need to be less concerned.

There are several objections to such a concept of theory construction. In the first place, in order that we shall have a refutable theory at all, the postulates then need to be supplemented by a clear description of the class of implications by which the theory stands or falls. Otherwise, every contradiction between an implication and an observation could be met by reclassifying the implication as a 'direct' one.

This objection is met by Friedman's suggestion that there should in each case be 'rules for using the model,' that is, a specification of the 'class of phenomena the hypothesis is designed to explain.' But a second objection arises out of this answer to the first. To state a set of postulates, and then to exempt a subclass of their implications from verification is a curiously roundabout way of specifying the content of a theory that is regarded as open to empirical refutation. It leaves one without an understanding of the reasons for the exemptions. The impression of ingeniousness that this procedure gives is reinforced by the fact that in each of Professor Friedman's examples he knows more about the phenomenon in question than he lets on in his suggested postulates. He is willing to predict the expert billard player's shots from the hypothesis that the player knows the mathematical formulae of mechanics and computes their application to each situation with lightning speed, even though he (Friedman) knows that most experts at billards do not have these abilities. He is willing to predict the distribution of leaves on a tree from the hypothesis that each leaf seeks a position of maximum exposure to sunlight (given the position of all other leaves), although no one has reported observing a leaf change its location on a tree.

One cannot help but feel uneasy in the face of so much ingenuity. Truth, like peace, is indivisible. It cannot be compartmentalized. Before we can accept the view that obvious discrepancies between behavior postulates and directly observed behavior do not affect the predictive power of specified implications of the postulates, we need to understand the reason why these discrepancies do not matter. This is all the more important in a field such as economics where, as Friedman also emphasizes, the opportunities for verification of the predictions and implications derived from the postulates are scarce and the outcome of such verification often remains somewhat uncertain..." -- Tjalling C. Koopmans (1957). Three Essays on the State of Economic Science, McGraw-Hill: 139-140

Koopmans also discusses methodology, in an attack on American institutionalism, in his "Measurement without Theory" (Review of Economic Statistics, V. 29, N. 3 (August 1947)). I have already pointed out some more recent criticisms of Friedman's methodology.

Milton Friedman's Elegant Tombstones

"Professor Friedman's demonstration [in Capitalism and Freedom] that the capitalist market economy can coordinate economic activities without coercion rests on an elementary conceptual error. His argument runs as follows. He shows first that in a simple market model, where each individual or household controls resources enabling it to produce goods and services either directly for itself or for exchange, there will be production for exchange because of the increased product made possible by specialization. But 'since the household always has the alternative of producing directly for itself, it need not enter into any exchange unless it benefits from it. Hence no exchange will take place unless both parties do benefit from it. Cooperation is thereby achieved without coercion'...So far, so good. It is indeed clear that in this simple exchange model, assuming rational maximizing behavior by all hands, every exchange will benefit both parties, and that no act of coercion is involved in the decision to produce for exchange or in any act of exchange.

Professor Friedman then moves on to our actual complex economy, or rather to his own curious model of it:

'As in [the] simple model, so in the complex enterprise and money-exchange economy, cooperation is strictly individual and voluntary provided: (a) that enterprises are private, so that the ultimate contracting parties are individuals and (b) that individuals are effectively free to enter or not to enter into any particular exchange so that every exchange is strictly voluntary...'

...Proviso (b) is 'that individuals are effectively free to enter or not to enter into any particular exchange', and it is held that with this proviso 'every exchange is strictly voluntary'. A moment's thought will show that this is not so. The proviso that is required to make every transaction strictly volunatry is not freedom not to enter into any particular exchange, but freedom not to enter into any exchange at all. This, and only this, was the proviso that proved the simple model to be voluntary and noncoercive; and nothing less than this would prove the complex model to voluntary and noncoercive. But Professor Friedman is clearly claiming that freedom not to enter into any particular exchange is enough: 'The consumer is protected from coercion by the seller because of the presence of other sellers with whom he can deal...The employee is protected from coercion by the employer because of other employers for whom he can work...'

One almost despairs of logic, and of the use of models. It is easy to see what Professor Friedman has done, but it is less easy to excuse it. He has moved from the simple economy of exchange between independent producers, to the capitalist economy, without mentioning the most important thing that distinguishes them. He mentions money instead of barter, and 'enterprises which are intermediaries between individuals in their capacities as suppliers of services and as purchasers of goods'...as if money and merchants were what distinguished a capitalist economy from an economy of independent producers. What distinguishes the capitalist economy from the simple exchange economy is the separation of labor and capital, that is, the existence of a labor force without its own sufficient capital and therefore without a choice as to whether to put its labor in the market or not. Professor Friedman would agree that where there is no choice there is coercion. His attempted demonstration that capitalism coordinates without coercion therefore fails...

...The logical humanist liberal will regret that ... and the fallacies make Capitalism and Freedom not a defense but an elegant tombstone of liberalism." -- C. B. Macpherson, "Elegant Tombstones", Canadian Journal of Political Science, March 1968.

Suppressed Empirical Results

"An overwhelming majority of the entrepreneurs thought that a price based on full average cost (including a conventional allowance for profit) was the 'right' price, the one which 'ought' to be charged...

...the procedure can be not unfairly generalized as follows: prime (or 'direct') cost per unit is taken as the base, a percentage addition is made to cover overheads (or 'oncost' or 'indirect' cost), and a further conventional addition (frequently 10 per cent.) is made for profit. Selling costs commonly and interest on capital rarely are included in overheads; when not so included they are allowed for in addition for profits." -- R. L. Hall and C. J. Hitch, "Price Theory and Business Behavior", Oxford Economic Papers, (May 1939): 12-45

These findings motivated Milton Friedman in his badly-argued work on methodology.

Friedman Blinded Me With Science

Scientists aspire to develop theories that observations can potentially demonstrate to be wrong. Here I examine whether this aspiration can possibly be achieved when economics is practiced in keeping with one of two views on methodology, the deductive-nomological or the instrumental view. I get the argument below from Donald P. Green and Ian Shapiro, Pathologies of Rational Choice Theory: A Critique of Applications in Political Science (Yale University Press, 1994).

Consider the covering law model, also known as the deductive-nomological view of scientific methodology. In this view, scientists formulate universal laws, in some sense. In an application of a scientific law, the hypotheses or antecedents are asserted to be true. That is, the statement of scientific law is conjoined with initial conditions. One then checks that the consequent holds. If observation is inconsistent with the consequent and one is sure that the initial conditions are true, the law is refuted.

Milton Friedman advocates instrumentalism, in which the assumptions of a scientific theory are false. (Actually, his famous essay, "The Methodology of Positive Economics", is so incoherent, Friedman can be interpreted as advocating almost any methodology you care to name. But let's stick with a widely argued view.) In Friedman's view the antecedents are always false in a significant theory:

"Truly important and significant hypotheses will be found to have 'assumptions' that are wildly inaccurate descriptive representations of reality, and, in general, the more significant the theory, the more unrealistic the assumptions" -- Milton Friedman

Thus, if one holds that economic theories state covering laws and that economists are and should be instrumentalists, economic theories cannot be refuted by observation. The logical implications of false antecedents need not be true.

Can economics be a science if it is practiced in keeping with Friedman's strictures?

The (??) Natural Rate of Unemployment

Milton Friedman defined the natural rate of unemployment, also known as the Non-Accelerating Inflation Rate of Unemployment (NAIRU), at least at the level of abstraction of this post:

"The 'natural rate of unemployment' in other words, is the level that would be ground out by the Walrasian system of general equilibrium equations, provided there is embedded in them the actual structural characteristics of the labor and commodity markets." -- Milton Friedman (1968), as quoted in James K. Galbraith (1998)

Two mathematical mistakes are embedded in the above definition.

First, what does Friedman mean by the "Walrasian system"? At the time of his statement, the Arrow-Debreu model of intertemporal equilibrium was becoming the canonical statement of general equilibrium theory. But the Arrow-Debreu model is a very short run model, in which the initial quantities of capital equipment are among the given endowments. Consequently, a solution to the model yields neither a rate of employment nor a rate of unemployment, independent of time. Rather, these rates are time-varying. So he cannot mean to refer to that model.

Now, Walras himself presented a model with given quantities of capital goods and a supposed steady state set of prices and quantities. But this model was just logically inconsistent. In consistent long-run economic models the set of capital goods are found by solving the model, not taken as givens. Thus, the logic of such models is not about allocating given resources among alternative ends. To refer to such a model as "the Walrasian system of general equilibrium" is dubious.

Second, Friedman's definition relies on an implicit mathematical theorem: that the equilibrium solution of whatever model he is talking about is unique. But no reason exists for such a theorem to hold in either the Arrow-Debreu model or a long run equilibrium model with many markets. I have myself created a model with multiple equilibria.

Here, then, is another example of right-leaning economists giving decades of policy advice based on theoretical claims with no support in economic theory. Unsurprisingly, the policy did not work empirically either, as can be seen by looking at results in the 1980s and 1990s. (These claims are not new. James Galbraith made my second point long ago.)

Have mainstream economists ever addressed this failure? Did they not mostly just continue their mistake with Dynamic Stochastic General Equilibrium (DSGE) models?

References

• Milton Friedman (1968) "The Role of Monetary Policy", American Economic Review Papers and Proceedings (May): pp. 1-17
• James K. Galbraith (1998) Created Unequal: The Crisis in American Pay, The Free Press.

Madrick on the End of an Age

Jeff Madrick has a Huffington Post column titled, "The End of the Age of Milton Friedman".

Since this is short and popular, one could think up lots of caveats. I'll go first. "Crisis in the 1970s" does not explain why Friedman's ideas became popular. Economists had available another account of stagflation. Something else remains of Friedman's academic contributions other than "the overstated natural rate of unemployment philosophy". I think most working economists would still echo something of Friedman's views on methodology, despite their rejection by specialists in the field.

Some British Nineteenth Century Controversies In Monetary Theory

Britain suspended convertibility during the Napoleonic wars. During that period, until 1821, money in England was paper, unbacked by gold. The restoration of convertibility was followed by a stagnant period in British development, with a crisis in 1825 and a reform in 1844 called the Bank Charter Act.

This post recalls some debates in monetary theory among British political economists while these events were occurring. (I don't consider myself expert on monetary theory during the Classical period.) Table 1 shows some schools of thought in monetary theory. The term schools is traditional with respect to the currency and banking schools, but should not be interpreted too strongly for any groups in the table. These schools, unlike, say, the Physiocrats, do not have a recognized leader, followers, popularizers, etc. Rather, they are more like the Mercantilists, a diverse set of pamphleteers and politicians grouped together by later writers.

Table 1: Some "Schools" and Example Members

Years	Contending Schools
1797-1821	Bullionists Henry Thornton David Ricardo	Anti-Bullionists Robert Torrens Robert Malthus
1825-1844	Currency School Robert Torrens Samuel Jones Lloyd Mountifort Longfield	Banking School Thomas Tooke John Stuart Mill
2nd Half of the 20th Century	Quantity Theory Milton Friedman	Endogenous Money Nicholas Kaldor

In each period shown in the table, I have listed two schools. Economists in the first school in each row argued that the money supply was exogenous and that the price level varied with amount of money issued by central bank. Economists in the second school in each row argued that the money supply was endogenous, that is was not capable of being controlled by the central bank, and that it varied with demand for it. The details of these arguments varied among these and other economists.

The last row suggests that these arguments are still current. In fact, advocates of Modern Monetary Theory currently argue that the money supply is endogenous.