The Man Who Became Keynes

In the late 70s, when the global economy seemed out of control, and the need for a figure of commanding authority to point the way was widely felt, the plaint was sometimes heard among economists and in the press, “We need a new Keynes!”  

From the distance of 25 years, it is clear that even then we were the process of acquiring just such an economic prophet, albeit from a somewhat unexpected quarter. His name was Milton Friedman.

With his economist wife, Rose, Friedman then was preparing a ten-part Public Broadcasting System television series espousing principles of economic liberalism, “Free to Choose,” that would be broadcast around the world, beginning in the United States in January 1980.

Already his friend Margaret Thatcher had moved to Downing Street as the prime minister of the United Kingdom. By the end of end of that year, his friend Ronald Reagan would be preparing to enter the White House.

In the 40 years since Capitalism and Freedom was published in 1962 – that was the book that inspired the television series — Friedman’s ideas about the appropriate relationship between market and state slowly gathered force, until today they dominate global discourse about such topics in much the same the way that Keynes’ ideas dominated political talk in the 40 years after The General Theory of Employment, Interest and Money burst upon the world in 1936.  

Both books inspired the leading activists of one generation and served as a blueprint for the next.  They were, it is true, as different in their presentation as the messages they delivered. Trust me, said the first. Trust yourself, said the second.     

To fully understand the role that Friedman played in the economics of the second half of the 20th century, however, it is necessary to know that, like Keynes, Friedman has had relatively little influence on the profession. His fame stems not from his work as a formulator of fundamentally new economic understanding, but rather from his long career as a public figure far more successful as a diagnostician than as a researcher. 

Nor should this be particularly surprising.  Economics resembles medicine in many respects. Even a quick look at the history of medicine shows a split developing along the same lines — between clinicians, for whom sharp observation and the mastery of a basic corpus of medical knowledge is the important thing, and scientific researchers who work away in laboratories which are often far removed from hospitals, seeking to understand the underlying mechanisms of life.  

For millennia, the single most important part of being a physician was bedside manner. From the time of Hippocrates to that of William Osler, conveying confidence usually was more important than any tool in the doctor’s little black bag. Medical knowledge advanced slowly but surely, especially after 1800, mainly through the description, classification and natural history of various disorders. But there were few gains in prevention and treatment.   

Starting in the late 19th century, Louis Pasteur and Robert Koch proved that germs cause disease. Joseph Lister then operationalized their understanding with great success, sterilizing instruments in operating rooms and losing vastly fewer patients. These dominating examples of the value of pure research had enormous rhetorical effect. They led to the founding of institutions in North America whose sole purpose was research, including Johns Hopkins University’s medical school in Baltimore, the Rockefeller Institute in Manhattan and Brooklyn’s Hoagland Laboratory.  

As support for experimental medicine increased, the frontier of knowledge rapidly advanced. The tension between practicing physicians and the medical scientists, once considerable, diminished. All this is deftly laid out in Rene Dubos’ somewhat neglected biography of Oswald Avery, The Professor, the Institute and DNA – Avery being the research giant who in the early 1940s performed the crucial experiments identifying the DNA molecule as the transmitter of hereditary information.   

Today we take the dissimilarities between an MD and a PhD pretty much for granted. We understand their differing sources of authority, even if we don’t necessarily understand in any detail the circumstances of their success. 

Yet when it comes to economists, the distinction between a great clinician and a great theorist is not nearly so clearly or widely understood.  Take the case of Keynes. 

Born in 1883, he grew up in Cambridge, England, attended Cambridge University (where his father was a lecturer in economics), joined the Civil Service after graduating, became an international celebrity with his condemnation of World War I reparations policy, which he published in 1919 as The Economic Consequences of the Peace, and thereafter operated on the fringes of university economics until the publication in 1930 of his Treatise on Money.  

When that two-volume work fell flat, he dramatically rethought his approach and returned six years later with The General Theory. This time he won the day. Those who want more can see Robert Skidelsky’s three-volume biography. 

We’ll do better with Jurg Niehans, the talented theorist whose 1990 A History of Economic Theory: Classsic Contributions 1720-1980, though imperfect, is still the best available introduction to the history of technical economics. “As an economic scientist, [Keynes] was a late bloomer,” writes Niehans. “At the beginning of the [1930s], he hardly rated even a footnote in future histories of economic thought. At [the decade’s] conclusion, his contribution was seen by many as being comparable to that of Adam Smith. He was celebrated as the leading economic theorist of the age and as the man who revolutionized capitalism.” 

How? The General Theory is a complicated book, introducing a combination of new and used concepts — effective demand, liquidity preference, wage rigidity, the multiplier – to raise the possibility of a general glut. Remember, the Great Depression was entering its sixth year when Keynes’ analysis appeared; unemployment in England remained stuck at around 25 percent. 

In the 1920s there had been a great deal of optimism about the possibility that good central banking might ameliorate the business cycle through the newly-discovered (or at least freshly understood) mechanism of open-market operations (the purchase and sale of bonds by the government with a view to influencing the quantity of money).   

Keynes now argued that, open market operations notwithstanding, in fact monetary policy probably wouldn’t work. Either the money supply would have only a little effect on interest rates, thanks to spenders’ and savers’ behavior that he described as a “liquidity trap’” or else interest rates themselves would have little effect on investment because good opportunities themselves were disappearing, or maybe both.    

So if monetary policy amounted to “pushing on a string,” that left taxes. And the advocacy of “pump-priming” through government-funded public works programs was what novel about Keynes’ prescriptions – that and the stimulation of “effective demand” through the manipulation of taxes and transfers.  

It wasn’t all arm-waving, says Niehans. There was an undisputed model at the core, though it required much elaboration by other economists, beginning with a translation into more familiar terms by John Hicks. And even now it is hard to argue with the missionary enthusiasm for the doctrine of those who were then young.  

Nevertheless, Keynes’ claims to originality were exaggerated, according to Niehans. Indeed, economic theory probably differs very little today from what it would have been if The General Theory had never appeared. 

“Keynes added a solid and useful brick to the building of economic theory.  A brilliant writer, he offered this brick packed in a glittering gift-wrap, sparkling with hints, allusions, suggestions, and quotable obiter dicta.  Half a century later, The General Theory still glitters, but economic science has learned to distinguish the wrapping from the brick.”   

In 1937, a serious heart attack forced Keynes to cut back dramatically on his activities. Thereafter he concerned himself almost entirely with policy, playing a major role at the Bretton Woods, N.H., conference in 1944 in the design of the financial institutions that successfully governed international economics for 40 years after World War II.  

As a clinician he was superb. As an exemplar of bedside manner, he had no peer. As a scientific economist, however, he was a bit of a windbag – more Harley Street physician than successful theorist. He died in 1946.  

Thus one big difference between Milton Friedman and John Maynard Keynes is that Keynes died not long after making his greatest contribution, while Friedman today is a robust 91, having enjoyed 40 years of ever-increasing success in the realm of ideas. (He had open heart surgery in 1972.) 

Someday there will be a three-volume work exaggerating his accomplishments, too.  In the meantime, there is an ever-accumulating body of evidence pointing to his centrality to our times, including a charming autobiography he and his wife published in 1998.  

For the other big difference between the two is that Keynes’ instincts ran to big government and Friedman’s tastes are for small government.  In Keynes’ view, macroeconomic instability was the main problem. Friedman believed that inept and expansionist government posed a more serious threat over time. 

The entire forty-year battle of wits between the two thinkers, reformation and counter-reformation, can be interpreted in that light.    

Here is Niehans’ summary of Friedman’s early life: “He was born in Brooklyn in 1912. His parents had been poor immigrants from Carpatho-Ruthenia.  Milton and his three sisters grew up in Rahway, New Jersey, where his parents earned a modest living as merchants.  His father died when he was a senior in high school, but a state scholarship permitted him to go to Rutgers College, which was then a small private school.  

“A high school teacher had taught him to love mathematics, and, like Kenneth Arrow about a decade later, he prepared for a career as an insurance actuary. At the same time, economics courses by Arthur F. Burns, later Federal Reserve Chairman, and Homer Jones, later research director of the Federal Reserve Bank of Saint Louis, aroused his interest in economics. Eventually he majored in both fields. 

“Upon graduation in 1932, influenced partly by his teachers and partly by the Depression, Friedman chose a tuition fellowship in economics over one in applied mathematics at Brown University. He described Jacob Viner’s first-year graduate course in economics as the greatest intellectual experience of his life. One of his classmates was Rose Director, who later became his wife, his life-long collaborator, and mother of his two children.” 

Despite his obvious brilliance, there was nothing easy about Friedman’s first fourteen years in economics.  It took that long to land a good job.  For a time he shuttled back and forth between Chicago and Columbia, where he learned mathematical economics from Harold Hotelling. Though his dissertation was complete before World War II broke out, Columbia didn’t actually grant him his Ph.D. until 1946 because his findings about the salutary effects on physicians’ incomes of various restrictive practices were “controversial,” especially among doctors. He was the victim of an ugly episode at the University of Wisconsin, where he taught for the year before the war, involving anti-Semitism, cupidity and just plain stupidity. The war itself he spent in the U.S. Treasury Department and the Statistical Research Group at Columbia.  

The University of Chicago finally asked him to return to a tenured job in 1946, after he had  spent a year at the University of Minnesota – despite the ruckus that had been raised over a pamphlet he co-authored there with  his friend George Stigler attacking war-time rent control (“Roofs or Ceilings” – meaning take your choice: Roofs over heads? Or ceilings over rents?)  Coming back to Chicago, he writes, “was like coming home.”  

Research was in the air in those days, and Friedman paid his dues, with a contribution known as permanent income hypothesis to the emerging Keynesian consensus.  (Franco Modigliani described much the same phenomenon with his life cycle model of consumption and savings.) He immediately began to remake the Chicago department in his own image, running off the profoundly anti-mathematical Frank Knight and hiring in due course his friend Stigler, Zvi Griliches, Gary Becker and a host of other stars. 

But he was more interested in practical results than in adding another nuance to what he considered a broadly erroneous doctrine.  Confronting a generation of economists who were determined to control recessions by taxing and spending, Friedman began to concentrate instead on monetary policy. His doctrine became known as monetarism.  

“[Friedman] himself did not relish this label,” writes Niehans, “because he did not mean his message to be narrowly confined to money.”  He would have preferred all along to be known as a “radical liberal,” Niehans continues, but the adjective “liberal” had been appropriated by the Keynesians. So Friedman’s ideas, “though proposing change rather than conservation, were commonly labeled conservative.” 

His big breakthroughs came in the 1960s.  First there was Capitalism and Freedom, a broad manifesto about the place of government in a free society that took up where Friedrich von Hayek’s The Road to Serfdom had left off 18 years before. “The control of money” was only a single chapter.  

Other chapters dealt with antitrust policy, trade policy, occupational licensure, the public schools, remedies for discrimination, social security and the amelioration of poverty. Libertarian principles were clearly written on every page. Among the measures he advocated were an all-volunteer army, the legalization of drugs, educational vouchers, floating exchange rates, the privatization of social security.

(In a  40th anniversary edition last year, Friedman wrote, “If there were one major change I would make, it would be to replace the dichotomy of economic freedom and political freedom with the trichotomy of economic freedom, civil freedom and political freedom.” The example of Hong Kong, he wrote, had persuaded him that political freedom, “desirable though it may be,” was not a necessary precondition for economic and civil freedom.) 

In 1963 came the Monetary History of the United States 1867-1960, written with Anna Schwartz of the National Bureau of Economic Research and nearly a decade in the making. This massive tome, with its supplementary volumes on monetary statistics, argued powerfully that federal bank regulators had all but caused the Great Depression by abruptly tightening in the early 1930s when they should have eased. Misguided monetary policy had done far more harm over the years than enlightened monetary policy had ever done good, argued Friedman. A policy of rules rather than central bankers’ discretion was what was needed. 

Finally, Friedman used his presidential address to the American Economic Association in 1967 to underscore a point that both he and Edmund Phelps of Columbia University had made earlier – that, contrary to prevailing dogma, there appeared to be no dependable trade-off between inflation and unemployment. Faster monetary growth would soon find its way into expectations of inflation, and the unemployment rate would remain where it was before. 

In fact, writes Niehans, “[The point] was familiar to many economists and financial writers who had not been trained in the short-run perspective of Keynes.”  But the effect of Friedman’s treatment was to drive another nail in the concept of “fine-tuning” in mainstream economics.  

(In The Academic Scribblers, William Breit and Roger Ransom begin their illuminating profile of Friedman with what they say is the motto of the Texas Rangers:  “Little man whip a big man every time if the little man’s in the right and keeps a’comin’” (Friedman is barely five feet tall; Keynes stood six feet six inches.) 

Friedman’s presidential address may be the last time he published an influential article in a professional journal.  After that, his efforts were increasingly directed at the public.  There was the widely-read column he wrote in Newsweek from 1967 until 1984, taking turns for many years with Paul Samuelson and Henry Wallich.   

In 1980 came the famous television series, by which time he was ready to acknowledge that other economists had done much of the work in creating the “fresh approach” to political choice that he was espousing. In the book version of Free to Choose, he mentions Anthony Downs, James Buchanan, Gordon Tullock, George Stigler and Gary Becker.  (Significantly, he omits Douglas North, Mancur Olson and Ronald Coase.)    

Ironically, however, Friedman chose to zero in on the behavior of a particular monetary aggregate at the very moment that central bankers began to turn the tide against inflation – and at a time when money substitutes of various sorts were exploding.  The result was that Friedman was systematically, often wildly mistaken in most of the most of the forecasts he made about inflation in the years he made after 1980.   

It was Paul Volcker, more than anyone, who ultimately demonstrated the truth of Friedman’s longtime contention that “money matters” in the performance of economy as a whole. And it was Alan Greenspan who showed just how effective short-term stabilization efforts undertaken through the banking system could be.  Friedman’s embarrassment within the community of monetary economists didn’t matter much to those outside the profession. And by the time Friedman had been shown to be out of touch with developments, he had retired from the University of Chicago and moved to San Francisco.   

There he has divided his time between the Hoover Institution at Stanford University and the  Federal Reserve Bank of San Francisco and otherwise lived the life of a grand old man. The cream of his jest has been to stand Keynesian economics completely on its head. Where Keynesian economists once espoused big deficits as a way of promoting stability and growth, Friedman now advocates tax cuts leading to big deficits as the best way of keeping government small. This “starve the beast” tactic seems no more likely to be a successful long-term strategy than was Keynesian deficit spending in its time (“We owe it to ourselves”). Yet it is Republican Party policy at the moment.    

To get some idea of just how far-reaching Friedman’s influence has been  you have only to look at the Festschrift presented by Federal  Reserve Bank of Dallas last month celebrating “The Legacy of Milton and Rose Friedman’s ‘Free to Choose.’”  The papers describe the impact of their advocacy on everything from environmental policy to education, from financial markets to the markets for idea, in countries all around the world. Truly his influence is as great as that of Keynes.   

But if you really want to know something about current thinking about the foundations monetary policy, have a look at Michael Woodford’s long-awaited treatise Interest and Prices, currently making its way through critical appraisal of the journals. (Warning:  The proofs alone run to 120 pages.) Ben Bernanke gave the Dallas Fed a fine appreciation of Friedman’s influence in changing the terms of stabilization debate. But Woodford sums up the current research consensus – inflation targeting, policy inertia, welfare analysis of price stability and all.     

For just as happened in modern medicine, where the frontier of knowledge long ago surpassed the art of both the country doctor and the Harley Street physician, so economics has moved beyond both Friedman and Keynes. Only the principle of the Conservation of Curiosity requires that we “need a new Keynes” at all – in this case, the widely-shared desire on the part of the general public that that a guru should be tapped to communicate research findings to the public, if only as a kind of forfeit device.    

Hence the difficulty of seeing Milton Friedman in proper historical perspective, perhaps because political opinions lie so near the surface.  Niehans, for example, distinguishes between art and economic science and allows that Friedman’s contribution to science “is difficult to pin down.”  

He was neither a scientific innovator of note, he says, nor a great builder of theoretical models.  Yet as an artist – as a clinician, we would say – Niehans considers that Friedman represents economics “in all its diverse facets.”  

“He knows how to use theory as a guide to action, he is as decisive and an army commander, as lucid as a teacher, and as articulate as a lawyer. He has a legislator’s understanding of institutions, a statistician’s respect for figures, and an econometrician’s ability to draw inferences.  He derives lessons from the past as a historian does, can talk the language of the small businessman, and has the social mission of a missionary.”   

It is a wonderful encomium. And all of it is true. Niehans himself compares Friedman’s place in the second half of the 20th to that of Adam Smith two centuries before – but that seems to involve a serious misreading of Smith.  

Milton Friedman’s nemesis was the clinician Keynes, the trickster who wrote The General Theory. It is to Keynes that the author of Capitalism and Freedom eventually will be compared.