A introduction to the foundations of modern capitalism. Friedman explains why free markets are not only economically optimal but also morally preferable. He offers many thoughtful arguments on how education should be run, income distributed and intervention limited.

Reading it felt like an extension of Hayek's Road to Serfdom, though with more nuances.

My Notes

1. The Relation Between Economic Freedom and Political Freedom

In the preface to the 2002 edition, Friedman admits that political freedom, though desirable, is not a necessary condition for economic and civil freedom.

• Economic arrangements are important because of their effect on the concentration or dispersion of power.
• Competitive capitalism provides economic freedom while promoting political freedom by separating both.
• For most of history, the typical state of mankind was tyranny, servitude and misery.
• History suggests that capitalism is a necessary condition for political freedom, though not sufficient.
• Collectivism imposed by the Labour Party post World War II in England imposed a centralization of power and occupations.
• There are only two ways of coordinating the economic activities of millions: central direction through the use of coercion or voluntary cooperation through the marketplace.
• In a capitalist society, the consumer is protected from coercion by the seller because of the presence of other sellers with whom he can deal. The seller is protect from coercion by consumer because of other consumers to whom he can sell. The employee is protected from coercion by the employer because of other employers for whom he can work, and so on

2. The Role of Government in a Free Society

The market gives people what they want instead of what a particular group thinks they ought to want.

• It is important to note that the existence of a free market does not eliminate the need for government.
• Government is essential in maintaining the "rules of the game" through institutions and enforce them. But the market should reduce greatly the range of issues that must be decided through political means.
• The danger comes from the centralization of both political power and economic power. Economic power can be easily distributed; political power cannot. By keeping economic in separate hands, it can serve as a counter-power to politics.

One feature of a free society is surely the freedom of individuals to advocate and propagandize openly for a radical change in the structure of the society— so long as the advocacy is restricted to persuasion and does not include coercion. How could the freedom to advocate capitalism be preserved and protected in a socialist society?

In order for men to advocate anything, they must in the first place be able to earn a living. This already raises a problem in a socialist society, since all jobs are under the direct control of political authorities.

• Markets are impersonal. It separates political views from economic activities and protect men from being discriminated.

No one who buys bread knows whether the wheat from which it is made was grown by a Communist or a Republican, by a constitutionalist of a Fascist, by a Negro or a white.

• In fact, it is minorities who have most at stake in the preservation of competitive capitalism. They are the one most subject to distrust.
• Market permits unanimity without coercition nor conformity.

The widespread use of market reduces the strain on the social fabric by rendering conformity unnecessary with respect to any activities it encompasses.

The wider the range of activities covered by the market, the fewer are the issues on which explicitly political decisions are required and hence on which it is necessary to achieve agreement.

• Like Hayek, Friedman did not call for an absolute free-market system. Instead, the role of government in a free society should include areas where absolute freedom is impossible, and where government intervention is most likely to provide the most effective outcomes.
• The following areas justify government intervention:
  • the maintenance of law and order, i.e. "the rules of the game"
  • the definition of the meaning of property rights
  • the regulation of technical (or natural) monopolies and neighborhood effects (i.e. externalities)
  • the creation of a monetary framework

3. The Control of Money

nothing to see here

4. International Financial and Trade Arrangements

We preach publicly the virtues of free trade; yet we have been forced by the inexorable pressure of the balance of payments to move in the opposite direction and there is great danger that we shall move still farther.

• Floating exchange rates are considered to be the only solution consistent with free market and free trade.
• As suggested by Friedman, the problem is not to solve a problem of the balance of payments, but it is to solve the balance of payment by adopting a mechanism that enables the efficacy of the free market system.

Floating exchange rates are wrongly associated with economic instability. But the truth is that a floating exchange rate system is more stable because economic policies are stable. If that is not the case, then the underlying economic foundations are unstable.

5. Fiscal Policy

• Friedman denounces the never-ending loop of increasing governmental expansion in the economy.
• Since 1929, every major event or crisis has unjustifiably driven the growth of public expenditures, which have never returned to their original levels.
• Now that federal expenditures are so large a part of the total economy, the government cannot avoid having significant effects on the economy.
• According to Friedman, the Keynesian multiplier is part of the economic mythology. An increase in governmental expenditures relative to tax receipts is not necessarily expansionary and a decrease not necessarily contractionary.
• The common belief is that a $100 (or $100 million) increase in government expenditures will generate $300 in economic activity, assuming people save one-third and spend two-thirds of it indefinitely (resulting in a multiplier of 3).

Reasons why this analysis does not hold:

• Government expenditures can divert private ones (if it was meant to finance a project that would have otherwise been financed by private companies)
• Government expenditures can be added to one’s savings (especially when spent on something individuals were obtaining for themselves).
• The rise of government expenditures — as money borrowed — will be offset by a decline in private expenditure on the part of those who lend the funds or of those who would otherwise have borrowed the funds.

Under the assumption that the amount of money people wish to hold depends on their income rather than the interest rate, an increase in government expenditures simply leads to a decrease in private expenditures.

Empirically, Friedman observes that the U.S. is closer to a scenario where government spending is ineffective, meaning that the Keynesian multiplier falls well short of one.

6. The Role of Government in Education

Friedman makes the case against the nationalization of the education system.

Education provided a neighborhood effect that benefits the society at whole, but the way it has been administered lacks effectiveness.

There is a distinction between:

• general education that provides positive externalities
• vocational training that gives most benefit to the person paying it

It is much more relevant to subsidize the former rather than the latter.

Governmental institutions play a smaller role in higher schooling than at primary and secondary levels. Yet they grew greatly in importance.

Subsidies to state-administered only universities cannot be justified for they prevent an effective allocation of resources.

Additionally, Friedman points out a major issue (not exclusive) to the United States: the rigidity of teachers' wages. Wages are too uniform. Bad teachers are paid more than they should; good teachers less.

If one were to seek deliberately to devise a system of recruiting and paying teachers calculated to repel the imaginative and daring and self-confident and to attract the dull and mediocre and uninspiring, he could hardly do better than imitate the system of requiring teaching certificates and enforcing standard salary structures that has developed in the larger city and state-wide systems. It is perhaps surprising that the level of ability in elementary and secondary school teaching is as high as it is under these circumstances. The alternative system [referring to the voucher program] would resolve these problems and permit competition to be effective in rewarding merit and attracting ability to teaching.

7. Capitalism and Discrimination

It is a striking historical fact that the development of capitalism has been accompanied by a major reduction in the extent to which particular religious, racial, or social groups have operated under special handicaps in respect of their economic activities; have, as the saying goes, been discriminated against. The substitution of contract arrangements for status arrangements was the first step toward the freeing of the serfs in the Middle Ages. The preservation of Jews through the Middle Ages was possible because of the existence of a market sector in which they could operate and maintain themselves despite official persecution. Puritans and Quakers were able to migrate to the New World because they could accumulate the funds to do so in the market despite disabilities imposed on them in other aspects of their life. The Southern states after the Civil War took many measures to impose legal restrictions on Negroes.

The maintenance of the general rules of private property and of capitalism have been a major source of opportunity for Negroes and have permitted them to make greater progress than they otherwise could have made.

• Markets in a capitalistic society does not reward personal tastes.
• People who feel strongly against a specific race or religion bear the costs of paying more.

8. Monopoly and the Social Responsibility of Business and Labor

Two problems raised by monopoly:

• limitation on voluntary exchange through a reduction of alternatives
• lack of "social responsibility" to meet desirable ends, which Friedman later criticizes

There are three areas of monopoly that require a different consideration.

• Monopoly in industry: more common than we estimate, often arise because of efficiency
• Monopoly in labor: labor unions are responsible for raising wages of its members, thus reducing others’ wages and overall employment in the economy
• Government monopoly: cartels and other similar types of government-supported companies have rapidly grown in the century, distorting the mechanism of free exchanges

Three major sources of monopoly:

• Technical considerations: in such case, the best solution is to let private individuals operate since they are more likely to adapt to the market dynamics
• Government assistance: monopoly that grows out of support from the government.
• Private collusion: unstable, brief and easy to break unless government does not intervene

There is on and only one social responsibility of business — to use its resources and engage in activities designed to increase its profits as long as it stays within the rules of the game, which is to say, engages in open and free competition, without deception or fraud.

Few trends could so thoroughly undermine the very foundations of our free society as the acceptance by corporate officials of a social responsibility other than to make as much money for their stockholders as possible.

This is fundamentally a subversive doctrine. If businessmen do have a social responsibility other than maximizing profits for their stockholders, how are they to know what it is? Can self-selected private individuals decide what the social interest is?

According to Friedman, businesses have no social responsibility but the maximization of their profits.

The argument might have seemed plausible back in the days, but given the extent of influence of modern companies, it is unlikely, and unthinkable, that companies bear no social responsibility whatsoever.

9. Occupational Licensure

There are three levels of professional control:

• Registration: individuals list their names in register before engaging in an activity
• Certification: certify, but not prevent, any individual to exercise certains skills
• Licensing: obligation to obtain a license from a recognized authority to engage in an occupation

According to Friedman, and on par with liberal principles, only registration seems to have a consistent justification.

• Registration helps with tax collection.
• Registration protects consumers against fraud.
• Certification is difficult to justify because the private market can do it for itself.
• Licensure raises the concern of individuals freedom in the pursuit of a specific occupation.
• Friedman also exposes his argument against licensure in medicine.

When all this is said, many a reader, I suspect, like many a person with whom I have discussed these issues, will say, "But still, how else would I get any evidence on the quality of a physician. Granted all that you say about costs, is not licensure the only way of providing the public with some assurance of at least minimum quality?" The answer is partly that people do not now choose physicians by picking names at random from a list of licensed physicians; partly, that a man's ability to pass an examination twenty or thirty years earlier is hardly assurance of quality now; hence, licensure is not now the main or even a major source of assurance of at least minimum quality. But the major answer is very different. It is that the question itself reveals the tyranny of the status quo and the poverty of our imagination in fields in which we are laymen, and even in those in which we have some competence, by comparison with the fertility of the market.

10. The Distribution of Income

• It had been widely argued that there is a distinction to be made between inequality in personal endowments and in property.
• Inequalities arising from the former seems much more acceptable than the latter. But Friedman clarifies that there should be no such distinction.
• A parent who had wealth that he wishes to pass on to his child can do so in different ways.
  • finance his child’s education or training
  • set him up a business
  • set up a trust fund yielding him a property income
• In any of these cases, the child will have a higher income than he otherwise would. Only that in the first case, it would be through personal capacities; in the second, profit; in the third, inherited wealth.
• What seemed to be a plausible way for redistribution of income through inherited wealth does not make a true difference.

Are we prepared to urge on ourselves or our fellows that any person whose wealth exceeds the average of all persons in the world should immediately dispose of the excess by distributing it equally to all the rest of the world’s inhabitants?

• A capitalist system is characterized by considerable inequality of income and wealth. This is misinterpreted to mean that capitalism produce wider inequality than alternative systems.
• This misconception implies that capitalism has increased inequality. This might seem plausible at the top of the distribution, but it is misled by the failure to distinguish short-term and long-term inequality.

The great achievement of capitalism has not been the accumulation of property, it has been the opportunities it has offered to men and women to extend and develop and improve their capacities.

• Short-run inequalities allow for social mobility; long-run inequalities don’t, implying that the social structure is fundamentally rigid.

Noncapitalist societies tend to have wider inequality than capitalist, even as measured by annual income; in addition, inequality in them tends to be permanent, whereas capitalism undermines status and introduced social mobility.

• Government measured to alter the distribution of income has not proven to be effective.
• High rates of taxation have stimulated tax evasion and discouraged entry into activities.
• Actual rates imposed are thus far lower than nominal rates.
• The gradual tax structure are much less taxes on being wealthy than on becoming wealthy. It gives an incentive to avoid risk and embody existing wealthy in stable ways.
• In consequence, effects of taxation would be to protect existing holders if wealth from the competition of newcomers.
• Friedman suggests a flat-tax rate for personal income and an abolition of corporate income tax, with the requirement that stockholders pay such income in personal taxes.
• Instead of redistributive measures to reduce inequality, Friedman points out that limiting government monopoly, tariffs and extending education opportunities are much better alternatives.

The heart of the liberal philosophy is a belief in the dignity of the individual, in his freedom to make the most of his capacities and opportunities according to his own lights, subject only to the proviso that he not interfere with the freedom of other individuals to do the same.

Concentrated power is not rendered harmless by the good intentions of those who create it.