Milton Friedman and Friedrich Hayek: Fifty Years Later

Comparing Friedman and Hayek’s Defenses of Liberty

The early 1960s were bleak for champions of the free society.  True, we had yet to experience the onslaughts of Johnson’s Great Society, the Nixon Administration, and the Vietnam War.  But the Cold War raged and following the Eisenhower administration the welfare state was entrenched and growing.

But from the rubble emerged within just two years of each other two remarkable books—first F. A. Hayek’s The Constitution of Liberty in 1960 and just two years later Milton Friedman’s Capitalism and Freedom.  In these two books rest the roots of an intellectual counter-revolution that would transform not only the United States but the world over coming decades.  Both books are simultaneously remarkable feats of scholarly and intellectual force on one hand but also inspiring in their vision for the blessings of a free society on the other.  Although authored by two titans of the economics profession—in fact, Friedman received his Nobel Prize in economics two years after Hayek received his—both books were written to reach an audience beyond the ivied walls of the academy.

Yet while the books share many remarkable coincidences beyond their timing and the distinction of their respective authors, they differ in several subtle but important ways in the agenda that they establish for how to conceive of the project of building the free society.  In this brief essay I will focus my attention on what I perceive to be an important methodological difference at the heart of the distinction between Capitalism and Freedom (CaF) and The Constitution of Liberty (CoL) and the systems that the two authors establish for preservation of the free society.  Following that I will rashly venture to offer my opinion on the bottom line question concerning these two 50 year old books: if forced to choose, which of the two books should one read and use as a guide to understanding the intellectual and institutional foundations of a free society.

Capitalism and Freedom at 50

Upon re-reading Capitalism and Freedom at 50, it is striking how many of the problems that Friedman identifies remain unsolved today.  Indeed, with respect to most of the issues identified by Friedman, conditions have worsened.  To be sure, there are some notable successes: trade and foreign investment (Chapter 4) seem noticeably freer than during Friedman’s era.  And Friedman’s advocacy of freely floating exchange rates has come into being—although I hasten to add that Friedman’s position on this point is not universally accepted among free market economists.

But in many areas, Friedman’s pleas largely have fallen on deaf ears, either because of entrenched special interests blocking their adoption in the political system or because of remaining intellectual disagreement about the merits of various policies.  Some policies—such as Friedman’s well-known advocacy of competition and vouchers for schools (Chapter 6)—fall in the former category, as political opposition from the unlikely alliance of teacher’s unions and middle-class suburban families has limited the reach of vouchers.  Friedman’s debunking of the belief that fiscal policy can be used as a sort of “balancing wheel” to keep the economy running smoothly (Chapter 5) is both devastating and completely ignored by modern exponents of Keynsian stimulus for the economy.  (Indeed, so simple is Friedman’s critique of the fiscal policy that it is one of the shortest and most persuasive chapters in the book).  In still other places—such as the plague of occupational licensing (Chapter 9)—conditions have worsened since 1962, as Morris Kleiner has shown that the number of people and professions governed by professional licensing have exploded during that period.  Because many of these policy areas remain as perverse (or worse) than when Friedman wrote, Friedman’s critiques remain powerful, timely, and uncompromising.

Moreover, the proposition which was perhaps most controversial at the time—that there is an inherent unity between political and economic liberty—is today so well-established (in part because of Friedman’s advocacy) as to be largely taken for granted.  To be sure, there has been some additional development of the core concepts and there remains some dispute around the margins as to the nature of the relationships.  For example, as Friedman notes in the Foreword to the 2002 edition the dichotomy of political and economic freedom has generally been displaced by a trichotomy of economic freedom, political freedom, and civil freedom (i.e., freedom of association and the free development of civil society organizations such as churches, clubs, and other voluntary groups).  More controversially, but I think correctly, Friedman also notes that during the intervening period he became persuaded that while economic freedom is a necessary condition for political freedom, both logically and temporally, it is open to question as to whether political freedom is necessary to economic freedom or always leads to increases in economic freedom.


Capitalism and Freedom and the Free Society

What I want to focus on is Friedman’s more general points about the nature of government and his agenda for constraining the growth of government.  As I read him, here Friedman’s analysis boils down to two interrelated propositions: (1) the primacy of decentralization and diversity in economic and political affairs and (2) as a corollary, that there should be a general presumption in favor of market solutions and against governmental solutions.

At the outset of the book (pp. 2-3), Friedman identifies two propositions as his core values.  “First, the scope of the government should be limited.”  The main function of government is to protect us from external foreign enemies and provide internal law and order.  Beyond those essential and unique roles for government, Friedman identifies the rest of government’s duties as discretionary: government action is warranted when individuals find it more efficient to pursue their goals collectively through government rather than individually through markets or voluntary activities, such as to provide public goods, to internalize certain externalities, or to enforce anti-monopoly laws in order to preserve individual choice in markets.  But, Friedman cautions, “[A]ny such use of government is fraught with danger.”  As a result, a core proposition emerges for the use of government for these discretionary or expedient purposes, “We should not and cannot avoid using government in this way.  But there should be a clear and large balance of advantages before we do.”  In this sense, Friedman’s first proposition is that there should be a presumption against government intervention.

This proposition leads to a second proposition, that “government power must be dispersed.  If government is to exercise power, better in the county than in the state, and better in the state than in Washington.”  Friedman argues that federalism protects liberty by enabling us to exit jurisdictions that provide services inefficiently to others but that the threat of exit itself may constrain government behavior.  By contrast, it is very difficult to exit when Washington acts—which Friedman notes is precisely why many of those on the left prefer national action.

Friedman’s advocacy for markets over politics and political decentralization over centralization arises from his understanding of freedom, which is minimization of coercion and maximization of voluntary action.  Market decision-making is preferable to political decision-making because allowing voluntary decisions through markets increases the likelihood that every individual will be able to obtain the things that he values.  Government is implicitly a system of uniformity and coercion.  (I note in passing, but lack the space to say further here, the coincidence that a key normative principle at the heart of both CaF and CoL is a concern about government coercion, although the two define the concept of coercion slightly differently).  Markets, by contrast, respect the vast diversity among people; moreover, markets undistorted by monopoly or externalities eliminate coercion by providing consumers with a variety of sellers from whom they can purchase the goods and services that they desire.  Friedman describes markets as a system of proportional representation—every person can buy the color of tie that they prefer, rather than being forced to accept the color decided by majority vote.  Markets permit “unanimity without conformity.”  This emphasis on choice among competing buyers and sellers of products as protection against coercion also leads Friedman to emphasize the importance of anti-monopoly laws and laws regarding negative externalities.  The value of economic freedom is that it also tends to promote civil freedom, such as freedom of speech—unlike a government book publisher, for example, a publisher in a competitive market cannot choose to publish only books with political messages with which the publisher agrees because to allow other publishers to do so would lead to failure in the competitive market.

But Friedman carves out an important but necessary caveat: government action is justified in the face of externalities and monopoly.  But having defined the problem, it is not clear that Friedman has provided a limiting principle to control government action.

Hayek and The Rule of Law Compared

Hayek’s argument in CoL has important differences from Friedman’s in both tone and substance.  They share, of course, many important similarities.  They both prefer markets over politics both because markets are more efficient but also because organization through markets reduces coercion.  And they both embrace the principle of federalism.

But whereas the bulk of Friedman’s book focuses on substantive critiques of various schemes of government intervention, Hayek’s argument is fundamentally procedural in nature: Hayek seeks not to prohibit but rather to contain interventions into the market by organizing society around the principles of the rule of law, namely that government intervention should be subject to neutral, abstract, generally-applicable laws announced beforehand and applied to everyone under a constitutional system of separation of powers.

As a result, Hayek’s philosophy is more tolerant of wrong-headed interventionist laws than Friedman.  Hayek would permit a substantially wider range for government intervention and for politics to hold sway than Friedman does.  Indeed, Part III of CoL is often read as containing a series of interventionist policy proposals endorsed by Hayek.  Although it may be true that Hayek agreed with some or all of those policies, in fact that is not the purpose of that part of the book: instead, Hayek’s discussion is intended more as a thought experiment to describe the contours of how those policies can be attained consistent with the principles of the rule of law (I am grateful to Bruce Caldwell for pointing out this important distinction in reading).

Hayek’s true concern in CoL is executive discretion and legislative arbitrariness rather than interventionist laws themselves.  So long as the executive and legislature are confined by neutral, abstract, generally-applicable laws, Hayek considered them to be a reasonable use of the coercive powers of the state.  It is only when they become subject to the discretionary application by the executive that the rule of law gives way to the rule of men, which Hayek sees as improper coercion.

Which System Better Protects Liberty?

Obviously Hayek was concerned about the substance of laws and bemoaned unwise interventions; similarly, Friedman was concerned about the rule of law and constraining governmental action.  So the distinction drawn here is dramatized in order to illustrate the underlying question: which system provides a more reliable guide to arranging our constitutional and political affairs to preserve liberty over the long-run?

On this point, I suggest that the historical record tends to support Hayek.  As the government’s response to the financial crisis once again demonstrated, crisis is the accelerant for the growth of the state.  For crisis, whether a financial or national security crisis, gives rise to executive discretion, which is the vehicle by which government grows most dramatically (recall Rahm Emmanuel’s famous dictum, “Never let a crisis go to waste.”).  As the government’s response to the financial crisis has further reminded us, once governmental discretion is initially unleashed, it is difficult to put back in the bottle.  Rather, as the excesses of Dodd-Frank demonstrate, the government subsequently codifies and consolidates the discretionary powers that it has previously seized.  It is certainly true that government grows through legislation as well—witness Obamacare—but even then, much of the implementation is done through discretionary executive action.

Moreover, discretion matters because it is the real instrument of rent-seeking and cronyism.  Interest groups exert their influence in the details and interstices of the law, usually thorough a narrowly-targeted loophole or carve out from generally applicable laws.

So what does this mean about the Friedman v. Hayek question?  As I read history, Hayek seems correct that executive overreach is the long-term threat to freedom, at least in the United States.  Friedman’s argument is fundamentally a consequentialist argument about economic efficiency and market failures.  And the logic of governmental intervention during the financial crisis was the need for government intervention to rectify a market failure.  Although this argument is, of course, dubious, in practice it was necessary for it to hold sway for only a short time before it was seized upon by opportunistic politicians such as Hank Paulson and Barney Frank to justify rampant intervention and cronyism.

And therein lies the potential weakness of the Friedman’s instrumental approach: for decades the defenders of the free society had placed all their eggs in the basket of defending the free society because it “delivers the goods.”  But when the financial crisis arose and the public, rightly or wrongly, concluded that the free market no longer efficiently delivered the goods, politicians seized on this climate of opinion to do what they always want to do—to grab power.

In this sense, I suspect that Hayek’s approach may be more robust to the true dangers that underlie the growth of the state—executive discretion and its accompaniments.  Thus, while Hayek’s approach may implicitly permit a higher level of government intervention in ordinary times, in times of crisis his insistence on regularity, certainty, and the rule of law may prove more robust against executive discretion than Friedman’s.  And that may be more important for the long term preservation of the free society.

None of this detracts, of course, from the importance of CaF as a valuable and timeless book.  As noted, despite Friedman’s trenchant criticisms of interventionism, government has continued to grow in the areas of licensing and provision of social services and Friedman’s impeccable arguments for limits on monetary discretion have been largely ignored by the Fed, spawning the consequences that we have reaped in recent years.  In that sense, Friedman’s book remains more relevant than ever.

Reader Discussion

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on May 05, 2012 at 14:27:47 pm

Let me concur on the risks inherent in accepting the "market failure" rationales for government intervention. Implicitly, it presumes that knowledge of the more efficient exchange can be known in the absence of actual market exchanges. Recall the late Warren Nutter's statement: "Markets without property rights are a grand illusion." Absent markets, we have no way of knowing whether the purported negative or positive externalities (pollution or education, for example) justify the costs involved in their political creation. This point is discussed in two less well known articles by the (sigh, also late) Aaron Wildavsky in "Culture and Social Theory" (Chapter 2: "Why the Traditional Distinction between Public and Private Goods Should be Abandoned" and Chapter 3: "At Once Ubiquitous and Elusive, the Concept of Externalities is either Vacuous or Misapplied").

I also agree with Todd's point that the externality concept too easily becomes an easy argument favoring statist intervention everywhere. In a world of pervasive externalities, government intervention will also be pervasive.

Recall also (in my view of his work) the observations of Ronald Coase who argues that many potential exchanges that do not become realities as the consequence of high transaction costs. A myriad of possibly wealth-enhancing exchanges are always under consideration. Those seeking to make them realities - entrepreneurs -- must find ways of lowering the transaction costs. That fact is well understood when the cost problems reflect labor, capital or input costs but far less well realized when the costs involve trust, security or enforcement costs. Western grazing lands became more productive, for example, when the invention of barbed wire made pastures easier to protect. Externality theory would have assigned government responsibility for managing the commons (a role not easily managed by political institutions).

Coase, as I interpret him, argues that innovation is incentivized by the potential of a wealth enhancing exchange blocked by transaction costs. Entrepreneurs seek institutional and technological innovations (more creative contracts, escrow accounts, for example) that would make these exchanges viable. Government can "do something" quickly but, absent real exchanges, how can we have any assurance that such interventions will enhance societal welfare?

Thus, along with Hayek and Friedman, I would add the insights of Coase who enriches their work by his insight that the economy is always in flux, always seeking ways of expanding its scope. That rather than focusing on some putative inefficiencies (market failures), we examine those policies that block the evolution of those innovations. The Progressives great success was less in destroying the Institutions of Liberty (although in time, they did weaken most of them) than in derailing their evolution where they did not yet exist. Note that few if any resources that were in government hands in 1880 (western lands, wildlife, ground water, the electromagnetic spectrum, fisheries) have moved into the private sphere via the expansion of property rights. As these resources became more valuable, the lack of private property rights encouraged the market failure arguments now used to expand statist control of the economy.

Fred Smith

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fred smith
on October 26, 2015 at 20:12:22 pm

I generally subscribe to idea that markets are better at allocating resources over time and that they are far better at vindicating individual choice than the alternatives. If nothing else, markets generally allow for far more data to be processed, for more honest data to be included, for adjustments to occur far more frequently, and, ideally, for changes to be free of biases such as political corruption. All of these are very difficult to incorporate effectively into other, more planned systems.

That said, the results that arise from the strong forms of market theory are dependent on a series of assumptions that may be seriously flawed. Even without challenging the basic assumptions, game theory has identified market failures in some situations based solely on rational behavior of the participants. Externalities are another source of failure and may be far more pervasive than admitted by market proponents.

Yet more problematic, however, are fundamental challenges to the assumptions. Are people acting rationally, are they capable of adequately processing the information that is available (related, is the cost of information processing low enough), do markets or regulations actually make the relevant information available to participants, do individuals consistently judge their own preferences properly, are there systemic biases in how individuals predict the outcomes of their decisions, are there actually a sufficient number of competitors to allow markets to function (particularly labor markets), do the "goods" supplied in the market actually behave like theorized (eg, are addictive products more common than assumed), can sellers exploit psychological biases to induce non-rational behaviors?

We need a far deeper analysis of how well markets actually work in the face of such flaws. It may be that the outcomes are actually so bad (consider the marketing of cigarettes) that these markets should not be permitted to continue operating.

Even starting with the core assumption that markets are generally better in both an economic sense and from a perspective of individual liberty, there are some situations that seem to violate both of these goals (cigarettes particularly), and we really need some way to rigorously identify these and regulated them strongly.

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Harry Singh
on November 11, 2019 at 07:52:10 am

[…] Zywicki succinctly summarized Friedman’s argument at Law & Liberty in […]

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Exit Stage Right

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