Word
Gems
What is a
man but the sum of his thoughts?
Economics:
Milton
Friedman:
An
Economist's Protest
Economic Myths and Public Opinion - January 1976
This morning I’m going to deliver a sermon. My theme comes from Josh
Billings, the famous American humorist of the nineteenth century, who said, “The
trouble with people ain’t ignorance, it’s what they know that ain’t so.”
I propose to discuss five myths about American society which are very widely accepted,
which have a great deal of influence on public attitudes and public opinions, and yet
which in my opinion are wholly false.
The Myth of the 19th Century Robber Baron
The first myth might be called the robber baron myth. In your courses in history–ordinary
political history, to a lesser extent even in courses on economic history–you will
have learned that the nineteenth century in the United States was an era of rugged,
unrestrained individualism in which heart-less monopoly capitalists exploited the poor
unmercifully, ground the helpless under their heels, and profited at the expense of the
rest of the community. The rich got richer and the poor got poorer; Wall Street was set
against the working man. You will have learned from the standard history book that the
farmers in the Middle West were being ground between the millstones of falling prices for
the products they sold and higher prices for the products they purchased. You will have
learned that that was the reason for interest in the greenback political movement, the
reason for the development of the populist sentiment in the Middle West and the South, the
reason for that magnificent speech by William Jennings Bryan in 1896, when he asked
whether mankind shall be crucified on a cross of gold.
That’s the myth, and there is hardly any myth more deeply imbedded in people’s
attitudes. The myth was spread by the reformers, the muckrakers of the early twentieth
century, by the intellectuals who contributed to the drastic change that has occurred in
our attitude toward the market on the one hand and government on the other, which has in
turn produced such a drastic change in the character of our society in the past forty or
fifty years.
There is only one element of that myth that is correct. It was an era of rugged,
unrestrained individualism. It was an era with the closest approximation to pure economic
laissez-faire in American history. It was an era in which, except for the. Civil War,
spending by the federal government never exceeded about 3 percent of the national income,
a sum which is derisory by today’s standards when federal government spending is
approaching 30 percent of the national income. It was an era in which there was, for most
of it, no ICC, no FCC, no SEC, and you pick out any other three letters of the alphabet
and it wasn’t there either.
It was a period when about the only interference with what people could do, aside
from the taxes that were being imposed to finance a small armed force, courts,
legislatures, and the like, consisted of a protective tariff on imports. Laissez-faire
economists objected then as now to such tariffs, but the level of the tariff was mild
compared to the duties that were imposed later.
This situation did not develop, interestingly enough, out of any philosophical
belief in laissez-faire. It developed much more simply. In the 1830s, state governments
throughout the country proceeded to engage in what we would call socialist enterprises.
They built canals, they set up commercial banks and extensive banking systems, they
financed railroads, they put up industries. It was a great era of government enterprise.
But in the recession, or panic, of 1837, many of these government enterprises went broke.
They turned out to be in-efficient in the same sense in which all government enterprises
have been inefficient from that day to this. By contrast with the situation today,
however, they were allowed to fail. It was this experience that set the United States on
the road to laissez-faire.
While the nineteenth century was a period of rugged individualism, almost every
other feature of the myth is false. Far from being a period in which the poor were being
ground under the heels of the rich and exploited unmercifully, there is probably no other
period in history, in this or any other country, in which the ordinary man had as large an
increase in his standard of living as in the period between the Civil War and the First
World War, when unrestrained individualism was most rugged. The evidence of this is to be
found in the statistics that economists have constructed of what was happening to national
income, but it is documented in a much more dramatic way by the numbers of people who came
to the United States during that period. That was a time when we had completely
unrestricted immigration, when anybody could come to these shores and the motto on the
Statue of Liberty had some real meaning. This was a country of hope and of promise for
immigrants and their children, and as many as a million immigrants a year came in 1906 and
‘07 and ‘08. By 1914, roughly a third of the population was foreign-born or the
immediate descendants of foreign-born.
Did people come to this country to be ground under the heels of merciless
capitalists? Did they come to make their own conditions worse? There is no more dramatic
way in which people can vote than with their feet. The fact that East Germany had to build
a wall to keep people from going to West Germany is striking evidence of which country had
the better conditions of life. In the same way, the fact that year after year hundreds of
thousands of people left the countries of Europe to come to this country was persuasive
evidence that they were coming to improve their lot, not to worsen it. Far more effective
evidence, I believe, than any statistics on per capita real income, which show that real
income went up decade after decade at a rate of about 2, 2.5, 3 percent per year. They
came with empty hands. They came from the most deprived groups in the old world, from
Czechoslovakia, from Germany, from Italy. It was the poor and the miserable who flocked
here, and they found a home and the opportunity to improve their lot. And they found it,
not despite rugged individualism but because of rugged individualism. It was rugged
individualism that induced the developments in industry, in trade, that offered
opportunities for people.
Of course, our condition is far better than theirs. In an absolute sense, their
level of living was low. But we must compare their level of living, not to ours but to the
level they left in Europe. We stand on their shoulders. We are able to live as well as we
do because of their achievements, because of what happened during that period of the
nineteenth century. I must say, it seems to me disgraceful for so many people to denigrate
the experience of their parents, when that experience has made it possible for them to
live in free society at their present high level.
So much for economic development. What about the charge that the agricultural
community was being ground down, that it was being exploited by the Wall Street bankers?
That we needed to have a Greenback movement and a populist movement and a William Jennings
Bryan?
Again, the contrary evidence is very simple and very clear. In the first place, if
agriculture was being especially exploited, you would expect the number of people on farms
to go down, but the number rose by leaps and bounds during the period. If agriculture was
in a bad state and being exploited, you would expect the price of farmland to go down, but
the price went up rapidly. The prices of farm products did go down. But they went down
because the great fertile areas of the Middle West were being opened up and brought into
production. Output was growing rapidly, the cost of producing crops was going down thanks
to great technological innovation in the form of reapers and other agricultural machinery,
and the cost of transportation was falling. The result was a great outpouring of
production which produced a de-cline in the prices of farm products at the same time that
it produced a very rapid rise in the incomes of farmers and induced many people to enter
farming.
On a different aspect of this experience, was it a period of heartless monopoly
capitalism? Quite the contrary, it was the period of the greatest private eleemosynary
activity in the history of the United States. The period of unrestrained, rugged
individualism was a period when the modern type of non-profit community hospital was first
established and developed. It was the period of the Carnegie Libraries and their spread
through the philanthropy of Andrew Carnegie. It was the period when so many colleges were
founded throughout the country. It was the period of the founding of the Society for
Prevention of Cruelty to Animals, and the spread of foreign missions. There was no income
tax, no deductibility of contributions, so what people spent on charity came out of their
pocket and not, as now, largely out of taxes they would otherwise pay. And yet, in every
aspect of private charitable activity, it was a boom period.
So the generally accepted historical picture of the nineteenth century is an
extraordinary myth. Years ago I wrote a book with a collaborator on the monetary history
of the United States, and in the course of writing it I read many of the general histories
of the nineteenth century. As an economist, I was appalled by the level of ignorance of
economic matters that was displayed in those history books, by the extent to which the
historians were willing to take the cries and the claims of reformers and political
agitators for reality.
Everybody, of course, always wants to improve his lot. Everybody would like to see
the price of the things he sells go up, and the price of things. he buys go down. But
since what one man sells another man buys, that’s hardly a feasible situation. We
find the same inconsistency when people talk about inflation. What people mean by
inflation is not the rise in their own wages but the rise in the prices other people are
charging them. And that was the case in the nineteenth century. The people who were in the
Greenback and the Populist movements were saying, “We want to do still better,”.but
the historians have tended to take their exaggerated com-plaints for reality.
That’s Myth Number One, a myth which has done enormous harm, in my opinion,
by leading people not to recognize the true sources of the strength of this country and
the true origins of our greatness.
The Myth of the Great Depression
The second myth is the Great Depression myth, the myth that that decade-long
catastrophe—at the worst of which, in 1932—33, 25 percent of the labor force was
unemployed—reflected the failure of private enterprise. Somehow, people believe that
the Great Depression occurred because private enterprise could not organize society
properly, that it was necessary for government to step in to save society that the New
Deal and all that followed was a necessary corrective to the mistakes and disasters
produced by the deficiencies of private enterprise and unbridled competition.
The trouble with these beliefs is that they are completely wrong. The elementary
truth is that the Great Depression was produced by government mismanagement. It was not,
produced by the failure of private enterprise, it was produced by the failure of
government to perform a function which had been assigned to it. Since time immemorial,
government has been granted the function, wisely or not, of controlling the monetary
system. In our Constitution, government is given the power to coin money and determine the
value thereof. We had the Great Depression because government failed in that task. In
1914, we had a supposedly great re-form. But experience shows that not all reforms are
improvements. In this case, the great “reform” was the establishment of the
Federal Reserve System, a central banking system. It was established supposedly to prevent
what were called banking panics.
The immediate occasion was the banking panic of 1907, when the Knickerbocker Trust
Company went broke—like the Franklin National Bank, except that unlike the case of
the Franklin National, tax money was not used to bail it out. It went broke, the public
got worried about the stability of banks, there were runs on banks, and this led to what
was called the banking panic in which the banks of the country suspended the
convertibility of their deposits into currency. Banks continued to operate, but you could
not walk into a bank, give it a check, and have it give you currency—at that time,
gold or greenbacks or national bank notes. If you gave someone a check, it would be
stamped, “payable only through clearing house.” That meant it could be deposited
to his account at another bank but it would not be honored for currency unless he was a
regular customer at the bank who d been accustomed to getting currency for payroll
purposes. That was done to prevent banks from failing. After two or three months,
confidence was restored in the banks, the pension of convertibility was ended, and there
were almost no bank failures. It was a very traumatic episode. In response to the panic of
1907, there was a Congressional investigation, and the Federal Reserve System went into
operation in 1914 prevent any such development in the future.
What was the actual course of events? From 1929 to 1933, far from preventing bank
failures and bank collapse, the Federal Reserve System actually produced them.
On December 11, 1930, the Bank of United States failed. It was the biggest bank
that had ever failed in the United States. Until then, the depression had been a more or
less garden variety recession. But the failure of the Bank of United States set off runs
on banks. According to its charter and its objective, the Federal Reserve System was
supposed to step in and enable banks to meet demands of their customers by buying bonds on
the open market or by providing currency through discounting assets of its member banks.
It failed to perform this function. On the contrary, it allowed the runs to develop and
banks to fail, until finally in March 1933 there was an absolutely unprecedented
catastrophe in which all banks were closed for a week—including the Federal Re-serve
Banks, which had been set up to prevent such an out-come but instead ended up producing by
far the worst and the most disastrous panic in American history.
From 1929 to 1933, the quantity of money in the United States fell by one-third.
For every one hundred dollars of currency or deposits that people owned in 1929, there
were 67 dollars available in 1933. One-third of all the banks were permitted to fail. This
was easily preventable, and I can say that not merely from hindsight. There were many
people at the time who were urging on the Federal Reserve System policy which would have
prevented this outcome, including some at the Federal Reserve Bank in New York. All this
documented in the book mentioned earlier, A Monetary History of the United States.
The reason for the Great Depression myth is very simple. Private enterprise has no press
agent. Government does. Every government agency will inform you that anything bad that
happens is the result of forces outside its control. But anything good that happens—who
do you suppose produced that? If it weren’t so tragic, it would be amusing to read
the annual reports of the Federal Reserve System from its inception. Every year of
prosperity, the Federal Reserve report says “Thanks to the wise and farsighted policy
of the Federal Reserve, the United States had a good year.” Every year of recession
or depression, the Federal Reserve report reads, “Despite the best efforts of the
Federal Reserve System, events beyond our control . . . .” Even in 1932 and 1933, you
have such statements in the Federal Reserve Board’s annual report.
At any rate, far from being evidence of a defect in the private enterprise system,
the Great Depression is evidence of the deficiency of governmental arrangements to manage
the economy.
The Demand for Services Myth
Let me come to a third myth: the myth of a demand for, government services. From
the 1930s onward, there has been an enormous expansion in the scope of government. In
1929, just prior to the Great Depression, total government expenditures at all levels—federal,
state, and local—were about 10 percent of national income. Today, the comparable
figure is about 40 percent. Even that greatly understates government expenditures in a
true economic sense, the control over expenditures by government.
To give a simple example: Anybody who buys a new automobile is required to spend
something like $500 to $1,000 on items that he would not voluntarily choose, the safety
and antipollution devices. Suppose that instead of government mandating that those be on
every car, government had imposed a $1,000 tax on every new car and had used the proceeds
to buy those attachments. We would then include that money as part of government spending,
and it would raise the 40 percent figure. From an economic point of view, there is no
difference between these two procedures. It might be good to have such devices on cars, or
it might be bad, but that isn’t the question. The question is what is the fraction of
the national output whose use and allocation is determined through the political mechanism
rather than through the decisions of individuals deciding separately how they want to
spend their own money. And the answer is that it’s well over 40 percent if we include
these mandated expenditures.
In the process of going from 10 percent to well over 40 percent, the myth
developed that these expansions in programs occurred in response to an overwhelming public
demand, that the government has had to step in because the failure of private markets
produced a grass roots demand that government do these things. This is a myth that could
not be farther from the truth. Almost every expansion of govern-mental activity has had to
be sold to the populace at large by misleading advertising that would make Madison Avenue
blush. The community has had to be brought kicking and screaming to approve them.
Let me give you the greatest sacred cow of them all, Social Security. In the first
place, it has nothing to do with social, and it has nothing to do with security. It’s
an utter misnomer; it’s a program whereby you impose a very bad tax in order provide
very inequitable benefits. In the Orwellian language used to sell Social Security, what
you and I would call tax are called contributions. Is an involuntary payment a
contribution? The tax you and your employer pay under Social Security is so labeled. If
you buy an insurance policy or a retirement annuity or a pension, and you ultimately get
your pension, that’s a benefit, you paid for it. But if I get it from other
taxpayers, ordinarily I would call it a subsidy. But under Social Security, subsidies are
called benefits.
Much more fundamentally, the program was sold to the American people under
essentially false pretenses, on the ground that the ordinary people were so shiftless, so
little concerned with their own future that unless they were compelled by government to
contribute to a fund and paid a pension afterward, they would all become charges of the
state. The situation of the Great Depression, when people became charges of the state
because of the state’s mismanagement of money, was presented as typical. It was
factually false that, the Great Depression aside, any significant number of people had
become charges of the state because they had failed to provide for their own old age. Yet,
that was the argument used to sell Social Security.
Again, maybe Social Security is a good thing. I’m not for the moment talking
about that. I happen to think it is not. I think it’s a terrible program, but maybe I’m
wrong. I’m here concerned with the myth. Did Social Security reflect a grass roots
demand for services? The answer is no. It was sold under false pretenses, and has since
been expanded under similar false pretenses year after year by people who are in the
business of selling government programs to the country.
Let me give a much simpler and more recent example, which I have already referred
to: the safety and antipollution provisions for automobiles. Mr. Nader ran a crusade a few
years ago that cars were unsafe and that we ought to have an all-wise government agency
step in and protect us from ourselves, require us to have safety devices on the car,
require us to fasten seat belts. Again, was there a grass roots demand for government to
intrude into that area? Not a bit, it was a manufactured crusade which produced laws, the
results of which most people don’t like. Indeed, the absurd interlock system whereby
you can’t start your car unless you have first mastered the mechanics of the gremlins
that the manufacture -built into your seat belts, led to such a national outrage that
Congress repealed it. I doubt that people realize how extraordinary an episode that is. As
a connoisseur of govern-mental intervention, I have tried to accumulate over, the years
the occasions on which an intervention has been eliminated. The list is very short. It
includes postal savings, it includes Prohibition. It now includes the repeal of the
provision for compulsory interlock. You will find it hard to add many to that list.
Consider another simple example. I was in Florida not long ago, just the week
after Congress had passed a mass transit bill providing for billions of dollars to be
spent in local communities on mass transit. There was a story in the local paper about a
proposal to expand bus service, which had been put up to the local voters three years in a
row in the form of approval of a bond issue. Three years in a row it had been turned down.
Any student of democracy would say that that was pretty dear evidence that it was not
something which the populace desired. But what happened? The newspaper story was, “Now
that Washington has passed a mass transit bill, we’ll be able to have that bus
system,” because the money will come from Washington. That surely was not a case
where here was a grass roots demand.
The Free Lunch Myth
This leads to my next myth—the myth that government can spend money at nobody’s
expense. What was really involved in that last story was that somehow the local people do
not pay out the money coming down from Washington somebody else does. Of course, the truth
is that the money makes a round trip between Florida and Washington, and there is a
discount taken off for cash as it passes through Washington. Some of you may remember that
wonderful description of government by the French economist, Frederic Bastiat, who said
that government is that fiction whereby everybody believes that he can live at the expense
of everybody else.
That is a widespread myth, that it is possible to spend money with nobody paying
for it. You have everybody screaming that we ought to have new, bigger, more generous
government programs. Where are we going to raise the money? Tax business. But business
corporations can’t pay any taxes. A corporate executive may sign the check, but where
does he get the money? From his stockholders or from his customers or from his employees.
Unlike the federal government, he doesn’t have a printing press in his basement. So
the only way he can pay money to the government is imposing a burden on somebody.
Government cannot spend money at nobody’s expense, which in turn leads me to my final
myth.
The Myth of Helping the Poor at the Expense of the Rich
Maybe government cannot spend money at nobody’s expense, but, after all, we
all know that government spends money to benefit the poor at the expense of the rich.
Again, however, this is a myth. It is a myth which is promoted because everybody wants to
do things for good purposes. We all are in favor of helping the poor—provided you and
I are defined as the poor.
I was at the recent summit conference President Ford called in Washington. I was
amused by the parade of special-interest spokesmen who came to the platform, and one after
another said, “It is absolutely essential that we cut the government budget to beat
inflation. I will tell you how to cut the government budget: spend more on me.”
The elementary fact is that almost all government programs are either a complete
waste and help nobody, or they benefit the middle and upper-middle classes at the expense
of both the very poor and the very rich. That proposition could be the subject of a longer
talk, so here I can only il-lustrate it.
Consider the case mentioned earlier—Social Security. That is a program widely
regarded as helping the poor at the expense of the middle and upper income classes. The
facts are, first, that the tax which finances Social Security is the most regressive tax
in our system. It’s a payroll tax on wages up to a maximum, the reverse of what is
regarded as a graduated tax. The benefits are related hardly at all to the amount of taxes
anybody has paid, and in any event are to a large extent inequitable. A man who has a
million dollars of income a year from securities will receive his full Social Security
benefit after age 65. But if between ages 65 and 72 he works and gets income from labor,
then not only does he get no benefits if he earns more than a modest amount, but he also
has to pay additional taxes on the wages.
Much more fundamentally, youngsters from poorer families go to work and start
paying Social Security taxes at age 16 or 17. People who are going to be in the upper
classes go to college and graduate school; they don’t start paying Social Security
taxes until 24 or 25 or 26. On the other side of the picture, it is a demographic fact
that richer people live longer than poorer people, so they will receive Social Security
benefits for more years. The poor fellow at the bottom has been suckered into paying taxes
for more years in order to provide better-off people with benefits for more years—and
that what is known as a program of helping the poor at the expense of the rich.
I have been making this statement for many years, so I am delighted to note that a
recent study by the Brookings Institution, which can hardly be regarded as biased on my
side, has documented the charge in great detail. It has demonstrated beyond a shadow of
doubt that on average the effect of Social Security is to redistribute income from lower
income groups to middle income groups.
Take any other program you name, and you will find similar distributional effect.
There is only one program I know which probably gives more money to people in lower income
classes than to the people who pay taxes, and that is one of the worst programs we have,
namely, direct welfare. It’s a bad program, not because it gives money to the poor,
but because it produces poor people, because it encourages people to be on welfare instead
of being on wages. I don’t blame them. If you and I are fools enough to make it to
their advantage to subsist on welfare rather than work, they would foolish not to take
advantage of it. Nonetheless, I have a great deal more sympathy for that program than for
almost any other, because it is about the only one that really contributes to people in
lower income classes rather than to the people who pay the taxes.
The great scandal of our times, in my opinion, is government expenditure on higher
schooling. There is no other program so perverse in its distributional effects. In the
great state of California, which has one of the most extensive public higher education
systems in the country, over 50 percent of the students at the colleges and universities
come from the 25 percent of the families by income. Five percent come from the bottom 25
percent. When I want to be demagogic, I say that’s a system under which the people in
Watts send to college the children from Beverly Hills.
One could go on and on along this line. But I conclude urging you to be more
skeptical of some of these myths, be skeptical of the myth of the robber baron, the myth
of the Great Depression, the myth that there is an underlying demand for government
services, the myth that government can spend money at nobody’s expense, and the myth
that government has benefited the poor at the expense of the rich. We have been moving in
a direction in which we have an increasingly limited control over our own lives, and that
movement has been nourished by a series of arguments which, quite simply, are untrue.
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