November 22, 2006
Keynes v Friedman: both can claim victory
By Martin Wolf John Maynard Keynes, who died in 1946, and Milton Friedman, who died last week, were the most influential economists of the 20th century. Since Friedman spent much of his intellectual energy attacking the legacy of Keynes, it is natural to consider them opposites. Their differences were, indeed, profound. But so was what they shared. More interesting, neither won and neither lost: today’s policy orthodoxies are a synthesis of their two approaches. Keynes concluded from the great depression that the free market had failed; Friedman decided, instead, that the Federal Reserve had failed. Keynes trusted in discretion for sophisticated mandarins like himself; Friedman believed the only safe government was one bound by tight rules. Keynes thought that capitalism needed to be in fetters; Friedman thought it would behave if left alone. These differences are self-evident. Yet no less so are the similarities. Both were brilliant journalists, debaters and promoters of their own ideas; both saw the great depression as, at bottom, a crisis of inadequate aggregate demand; both wrote in favour of floating exchange rates and so of fiat (or government-made) money; and both were on the side of freedom in the great ideological struggle of the 20th century. The remainder of Martin Wolf’s column can be read here (FT.com subscribers only). Discussion from our guest economists is free - click ‘Comments’ below.
Wynne Godley: It may be true, as Martin Wolf says, that “The great inflation of the 1970s . . . transformed the climate of opinion”. But it should always be remembered that the huge spike in the UK’s inflation in the mid 1970s was largely the consequence of the unfortunate wage indexation scheme (perhaps the biggest policy mistake of the post-war period) which, following the rise in oil and other commodity prices, added at least 10-15 percentage points to the increase in wage rates. The second spike at the end of the decade was the result of the huge rise in indirect tax rates in Geoffrey Howe’s first budget.
I don’t think either spike had anything to do with the putative NAIRU.
Posted by: FT Forum - Wynne Godley | November 22nd, 2006 at 5:06 pm | Report this commentMartin Wolf: I agree with Wynne that there were special factors in the UK case. But the rise in the rate of inflation in the 1970s was a global phenomenon, not a local one. The UK was merely more extreme, partly for the reasons he gives. The countries that saw the smallest increases, such as West Germany, were also the most “monetarist”. This explains the changing tide of opinion.
Posted by: FT Forum - Martin Wolf | November 22nd, 2006 at 5:07 pm | Report this commentStephen Cecchetti: As I read the obituaries and praise to Milton Friedman over the last few days, I was reminded of a scene from a tribute to the great entertainer Carl Reiner. Reiner is famous as a writer, director, and actor in both television and film. For years he worked with Mel Brooks, one of the funniest men in America. After numerous people had spoken at the hotel ballroom dinner honouring Reiner, Brooks’s turn came. He stood up and announced that there was another side to this. Not everyone thought Reiner was such a great man, Brooks announced, and then the scene cut to a small group of people outside the hotel who were walking in a circle, chanting and carrying signs that said “Down with Reiner.” It was very funny, and very strained.
Any criticism of Milton Friedman would surely be very strained. Martin Wolf argues that Milton Friedman and John Maynard Keynes are the most influential economists of the 20th century. I agree, but would make a distinction between economists that influenced public policy and economists that influenced economics. Friedman and Keynes are in the first group. At the top of the second group, head and shoulders above anyone else, sits Paul Samuelson. Friedman and Keynes changed what policymakers do and how they do it, Samuelson changed who economists are and how they think.
Samuelson, who is 91 this year, introduced formal mathematical modelling to economics. Taking techniques from engineering and physics, he showed how to formalise economics. It is impossible to underestimate the importance of the use of formal models in affecting how professional economists do their work. Models both organise and discipline our thinking, both ensuring logical consistency in our arguments and leading us to discover the unexpected. While Friedman and Keynes applied economic logic to the most important real world problems, Samuelson created the framework within which we think.
Posted by: Stephen Cecchetti | November 23rd, 2006 at 2:26 pm | Report this commentRobert Wade: Martin says that ‘Over the past two decades, a world of fiat money has supplied modest inflation and supported stable growth. This is unprecedented.’
The statement is too rosy. It is true that the advanced industrial countries have had modest inflation; their average annual change in the consumer price index was less than 5% from 1985 till today. On the other hand, their median growth rate of GDP per head fell. It was only 1.8% in the Friedman-shaped period 1980-98, against 3.5% in the Keynesian Bretton Woods period of 1965-79.
As for developing countries, the past two decades have been more unkind to them than, say, 1950-70. Their annual inflation averaged 48% in 1985-89, 53% in 1990-94 — and then plunged to 6% in 2000-04. Their growth was more unstable than in 1950-70; they were much more prone to recessions. And their median growth per head fell from 2.4% in 1965-79 to approximately 0% in 1980-98 (William Easterly, ‘The lost decades’, J. Econ. Growth, 6, 2, 2001).
Keynes (also Polanyi) emphasised that markets, especially for credit and foreign exchange, have strong centrifugal tendencies, which have to be contained by a political framework of regulations and restrictions on the scope of market calculation. Developing countries, especially in Latin America, accepted western advice for a strategy of ‘economic growth with foreign savings’ coupled with ’structural adjustment’ towards free markets and exports. In the spirit of Friedman they relaxed regulations and lifted restrictions, allowing the centrifugal tendencies fuller rein. They have paid dearly in the form of financial crisis, slow & unstable growth, and widening income/wealth inequality (Wade, ‘Choking the South’, New Left Review, 38, Mar/Apr 2006).
Many analysts think that we in the West are also likely to experience serious financial and ‘real’ instability before long, as colossal imbalances in the nearly-free markets for credit, foreign exchange and goods and services unwind.
This is surely not what Martin has in mind when he celebrates the fact that ‘The market has indeed been freed from many of its mid-20th century shackles’. Yet the sort of ‘disembedding’ of markets that has occured around the world in the past two decades has these as likely outcomes, as Keynes and the other architects of Bretton Woods would have been first to say.
Posted by: FT Economist Forum | November 23rd, 2006 at 6:27 pm | Report this commentMartin Wolf: I agree with Stephen, which is why I deliberately used the word “influential”. I suppose there are two lines of descent from Adam Smith. One would go via John Maynard Keynes and Milton Friedman. These were people who were mainly (though not entirely) interested in economic policy. The other might go via David Ricardo through Stanley Jevons, Leon Walras and Carl Menger and then on to Paul Samuelson. These were people mainly interested in the logic of economics as an system of thought. Obviously, economics needs both.
Posted by: FT Forum - Martin Wolf | November 23rd, 2006 at 6:28 pm | Report this commentMartin Wolf: Robert Wade raises a number of broad questions about the impact of free markets on economic performance. Let me respond to a few of them.
Robert uses the median growth rate as an index of performance. This must treat Luxembourg as equivalent to the US (and, in the case of developing countries, Lesotho as equivalent to China). I don’t think it makes any sense to use such a measure. A more relevant measure would be aggregate growth. Unfortunately, I don’t have the data to hand. So I can’t make comparisons on this basis.
In the case of the developed countries, the reason for the post-1973 slowdown is largely that the exceptional opportunities of the 1950s and 1960s (particularly for western Europe) had been more or less exhausted. It is important to remember that these glorious decades had been preceded by two world wars and a great depression. There were vast opportunities, therefore, to exploit the technologies that had been developed during that period. This was what happened after the Second World War, once the Marshall Plan had reignited integration, especially in Europe. But this rapid growth could not have been sustained. Indeed, the failure to recognise this was one reason macroeconomic policy went so badly wrong in the 1970s.
What can we say about developing countries? Broadly we know that Asian developing countries (including, above all, the world’s two biggest countries, China and India, with aggregate populations of 2.4bn) have done better since 1980 than they did before and other groups of countries have done worse. I don’t suppose anybody is going to argue that China and India have done better in the past two decades because they have been moving away from the market rather than towards it.
As I have remarked in a previous post in this forum (on Larry Summers’ column on globalisation of October 30 2006), I would be more readily convinced that the problem of Latin America is that it has reformed too much rather than that it has reformed too little if Chile, the most radical reformer, had not been far and away the region’s most successful economy.
The big point, though, is that the right comparison cannot be with a previous period but with what would have happened if there had been no reform. I know we do not know this. But it means that a simple temporal comparison is illegitimate without discussing the viability of the previous path.
The difficulty of projecting past performance as the counterfactual is dramatically illustrated by the performance of Eastern Europe and the former Soviet Union. There is no question it was far worse in the 1980-2000 period than in the previous two decades. But how many people believe that these economies could have sustained their 1960-80 performance if they had persisted with Soviet economics? I do not, for one. They collapsed in large part because that path was unsustainable.
I am sure much the same is true for the east African economies I worked on in the 1970s, when I was at the World Bank: it was evident to serious observers that they were going over a cliff, whatever appearance of growth the brief burst of post-independence import substitution appeared to be generating.
Again, were the massive debt crises that the Latin Americans suffered in the early 1980s a mere accident or the consequence of the low savings, import-substitution growth model they had been following previously? I would argue it was to a large extent the result of the latter.
I agree with Robert, however, that liberalisation of financial markets creates big risks that need to be managed. On whether it would have been easy – or wise – to preserve the range of restrictions on financial markets of the 1950s and 1960s we will have to differ. Ultimately, these are a recipe for corruption and, for that reason, objectionable.
An important final point should be made on Robert’s remarks about today’s dangerous imbalances in the world economy. In fact, these are the problems one would expect in a world of massive foreign currency intervention, not in a world of free markets. They are the result of the mini-Bretton Woods in Asia, in fact, and so no advertisement for such a policy.
Posted by: FT Forum - Martin Wolf | November 26th, 2006 at 6:56 pm | Report this comment