Sapere aude – Capitalism and Freedom

Liberalism is an overused word whether it be in the US or in Western Europe. Refreshing memories about its original meaning will not do any harm. In that regard, I chose to sum up Milton Friedman’s book « Capitalism and Freedom ». The University of Chicago Press edited my 1982’s copy (ISBN: 0-226-26401-7).

The summary is also available in PDF format here.

« Capitalism and Freedom », Milton Friedman


Inaugural address by Kennedy: « Ask not what your country can do for you, ask what you can do for your country ». The second part of the question is paternalistic; government=patron, citizen=ward. At odds with free man’s belief in his own responsibility for his own destiny. Government is a mean, not a granter of gifts or a master to be served.

Free man’s question : « What can I and my compatriots do through government without destroying our freedom? » 2 principles in the Constitution enable government while preserving freedom:

  • the scope of government must be limited: preserve law and over, enforce private contracts, foster competitive markets. Private sector as a check on the powers of the government and an effective protection of freedom of speech, religion, thought.
  • government power must be dispersed. Subsidiarity of government power using counties, state and finally the federal government.

Great attraction of centralization to federal government. Problem: the supposed gain of efficiency is counterbalanced, as (i) the power to do good is also the power to do harm; (ii) what one man regards as good, another man may regard as harm.

A point in favor of the efficiency of a limited centralization: the great advances of civilization have never come from centralized government, but from the product of individual genius and strongly held minority views e.g. Einstein and Bohr. Government can never duplicate the variety and diversity of individual action. Imposing uniform standards may improve the average level of living, but progress would fade away and stagnation would arise as uniform mediocrity substitutes for variety.

Question: role of competitive capitalism as a system of economic freedom and a necessary condition for political freedom.

Note that each day brings new problems, and the role of the government can never be spelled out once and for all. Views in this book can be qualified as liberal.

  • 18th, 19th centuries: liberalism = freedom as the ultimate goal and the individual as the ultimate entity in society, support for reducing the role of the state in the economic affairs, representative government, civil freedoms and free trade.
  • after 1930s: liberalism = relying primarily on the state rather than private voluntary arrangements to achieve desirable objectives. Welfare and equality matter more than freedom.

Corruption of the term « liberalism », used here in its original sense.

Chapter I: The relation between economic freedom and political freedom

wide-spread view: politics and economics are separated and unconnected. Corollary: any kind of political arrangement can be combined with any kind of economic arrangement e.g. democratic socialism. Thesis: impossible to have both sovietic economic arrangements and individual freedom.

Economic arrangements: (i) freedom in economic arrangements is a component of freedom (ii) economic freedom is a necessary condition for political freedom:

  • (i) intellectuals consider it unimportant; contempt for material life, in contrast with the regular citizen, e.g. mandatory contribution to state-owned retirement fund, occupation assignment through licenses, quotas on foreign products deprive citizens from a part of their freedom.
  • (ii) competitive capitalism promotes political freedom as it disperses economic power.

Limited time span and part of the globe with political freedom. 19th-20th centuries in the Western world are exceptions. Capitalism is not a sufficient condition for political freedom, e.g. Nazi Germany.

Early 19th century: Bentham and the Philosophical Radicals considered political freedom as a mean towards economic freedom, as masses were hampered by restrictions and experienced a rising living level when restrictions were deleted. Reaction to the Benthamite liberalism after World Wars; welfare became more important than freedom. Dicey, Mises, Hayek, Simons warned that the progressive centralization of economic affairs may well be The Road to Serfdom.

History is no proof: maybe a sheer coincidence that freedom came at the same time as the development of capitalist and market institutions.

2 sets of values considered by the liberal: (i) values that are relevant to the individual in the exercise of his freedom; (ii) values that are relevant to the relations among people, where freedom is the most important one.

Basic problem of social organization: how to co-ordinate the economic activities of large number of people? All the more in modern societies, where the division of labor is extensive. Reconciling wide-spread interdependence with individual freedom. 2 ways: (i) central direction using coercion; (ii) voluntary co-operation of individuals. (ii) rests on the assumption that the transaction is bi-laterally informed and voluntary, e.g people choose to buy things instead of making them themselves because the time gain is worth the spent money.

Problem: intermediaries exist beyond households. 2 typical intermediaries are money and firms. How can we ensure that individuals are still voluntary and informed? (a) firms are private; ultimate contracting parties are individuals; (b) individuals are effectively free to enter or not to enter in any particular exchange. Economics focuses on the study of (a) and (b), which are not verified when monopolies or neighborhood effects are involved.

Competition is essential to prevent coercion. The consumer is protected from coercion by the seller because of the presence of other sellers with whom he may deal. Similarly for employer-employee relationships.

Objection to free economic affairs: it gives people what they want instead of what they ought to want according to a particular group of people. As a result, most arguments against free markets proceed from lack of belief in freedom itself.

Government decides of the rules of the game. Action through political channels requires conformity. Markets, on the contrary, are a system of proportional representation. Buying a tie of a certain color is voting with your money to express your preferences.

Political freedom: absence of coercion of a man by his fellow men. To this end, concentration of power needs to be avoided and removing economic affairs from the government’s hands goes in that direction. Economic strength acts as a check to political power instead of reinforcing it. Economic power is easier to disperse than political power.

Example: freedom of individuals to propagandize for a radical change. How could the freedom to advocate capitalism be preserved and protected in a socialist economy? 1) Ensure a living wage: how to get a job if the state holds all of them? The regime must show a minimum degree of self-denial. 2) How to raise funds? People with large incomes are government officials. In a capitalist country, all you need is to convince a few wealthy people. Similarly, a publisher cannot only publish writings he agrees with: the market needs to be large enough to make a profit. Back to the socialist country, assume there exists a bureau to subsidize radical propaganda; how to choose whom to support? Unlimited supply of radical cause advocates if it pays well enough.

Disproportionately large fraction of people involved in the defense of radical causes went into the most competitive sectors of the economy. The wheat is the same, made by a Negro of a WASP. Free markets are a protection for those people against the general dislike of their fellow countrymen. Surprisingly, these minorities fed movements against free markets.

Chapter II: The role of government in a free society.

Appropriate means to reach a political objective are free discussion and voluntary co-operation to the liberal. Any form of coercion is inappropriate. Ideal = unanimity among responsible individuals reached through free discussion.

Markets enable unanimity without conformity; it is a proportional representation system. On the contrary, action through political channels requires some conformity. Corollaries: 1) a limited number of separate groups can be represented through political channels; 2) law must be applicable to all groups. Separate enactment for for each group is ineffective or impossible. Some matters make effective proportional representation impossible, e.g. national defense and other indivisible matters.

Political channels pressure social cohesion. Joint action through political channels needs to remain on a limited scope. Political channels used on issues where men feel deeply differently may disrupt society (religious and civil wars). Conversely, the fewer the issues on which political channels are needed, the easier it is to get agreement while remaining as free as possible as a society.

Ideal = unanimity. In practice, the majority rule is the expedient. Size of the needed majority reflects the minority’s degree of resentment.

When are political channels preferable?

Government as a rule-maker and an umpire

Day-to-day activities = game. Legal framework = rules of the game.

Society members need to agree on (i) the rules, (ii) the device to enforce compliance, (iii) the means of arbitrating different interpretations of these rules. Government is needed in these because absolute freedom is impossible. Men’s freedom can conflict, and one man’s freedom must be preserved to preserve another’s. How to resolve such conflicts among different individuals? Easy case: one man’s freedom to murder his neighbor is less important than the freedom of the other man to live. Complicated cases: definition of property rights, e.g. plane fly over my land. In economic terms, government needs to set up a monetary framework and to arbitrate between freedom to combine and freedom to compete.

US: free enterprise = free to set up a firm, but not to keep out potential competitors.
Europe: free enterprise = firms are free to do what they want, including keeping out potential competitors.

Action through government on grounds of technical monopoly and neighborhood effects

Government: does what market cannot do. It is the case when voluntary exchange is exceedingly costly or impossible. This is notably the case in presence of market power and neighborhood effects.

Monopoly = absence of alternative, which implies no freedom of exchange. Sometimes, monopolies arise because they are technically efficient. Technical monopolies are common in the telephone services industry.

When monopoly arises as the result of the competitive forces, 3 possibilities: (i) private monopoly; (ii) public monopoly; (iii) public regulation.

Technical monopoly: may disappear with technological change. Public monopoly and a public regulation are more likely to be less responsive than a private monopoly, e.g. railroads in the US and the hindrance of the ICC (Interstate Commerce Commission) despite the rising competition of road and air transport.

A choice between the three evils cannot be made once for all. If the concerned commodity is essential i.e. the short-run cost of monopoly is high enough, public monopoly or public regulation may be preferable.

Neighborhood effects: action of individuals have an effect on other individuals, and it is not feasible to charge/recompense them accordingly. Difficult to assess the effects on third parties and assess their magnitude, e.g. pollution of a stream. Highways: cost of collection of a fee is crazy if enforced on all roads. Neighborhood effects justify city-owned park: no way to justify who benefits from it; windows of flats with a view on it, people going past it, seeing the nice view. National parks, on the contrary, can be privately owned as collection points are easy to set up.

One needs to remember that government actions limits individual freedom and strains the social fabric.

Action through government on paternalistic grounds

Freedom is only for responsible individuals, not for madmen or children. Paternalism is necessary for irresponsible individuals. Government intervention for madmen can be justified on neighborhood-effect grounds: I benefit from another men caring about madmen. As for children, the ultimate cell in society is the family, not the individual. To this extent, parents have to provide for their children development for them to become responsible individuals. Children are both « consumption goods » and in-embryo responsible individuals. Where should paternalism stop? Consensus on this question should be reached through discussion.


List of illegitimate activities undertaken by government in the US

  1. parity price support programs for agriculture
  2. tariffs, quotas
  3. government control of output, e.g. oil by the Texas Railroad Commission
  4. minimum wage rates, prices, interest rates
  5. rent control
  6. detailed regulation of industries, e.g. banking or transport
  7. censorship or violation of free speech by the Federal Communication Commission
  8. state-owned retirement program with mandatory spending proportion
  9. licensure w.r.t given occupation or profession
  10. public housing and subsidies to get property
  11. mandatory military conscription
  12. national parks
  13. mail services
  14. public toll roads

Chapter III: The control of money

Government has taken steps to moderate the boom and busts of the free-market economy, or to reach full employment and economic growth. The Great Depression is used as a point in favor of government intervention, whereas it is the disastrous behavior of the Federal Reserve System that made the contraction into such a catastrophe.

Government measures hinge economic growth: traffics, tax burdens, regulatory commissions, government price and wage control. It yields incentives to misuse resources and distort investment of savings.

Government is still important to implement a stable monetary framework. 2 dangerous views:

  • Charybdis: need to adapt to unforeseen circumstances requires the assignment of wide discretionary powers to a group of technicians gathered in an independent central bank.
  • Scylla: purely automatic gold standard is both desirable and feasible, would foster co-operation in a stable environment

Money: oxymoronic in the liberal’s eyes. Government has a natural role in shaping its framework, but it gives power to the government on the economy, e.g. monarchs clipping coins, stealing the people through inflation

A commodity standard

Money as a physical commodity (gold, silver). In this case, no need for government intervention. Amount of money in society = amount of commodity extracted/produced. Problem: fiduciary money needs to be exchangeable with the commodity, and costs much less to produce than extracting gold in South Africa. Moreover, there is generally long time between emission and actual exchange of money with the commodity, which leaves room for fraudulent contracts and excessive emission of fiduciary money.

A full commodity standard, as appealing as it may seem from the liberal point of view, is not feasible nor desirable as the commodity is expensive to produce.

A discretionary monetary authority

Federal Reserve System: most notable change in the US since the Civil War. National Banking Act: Federal Reserve System as a separate body with responsibility for monetary conditions. Money stock, prices and output much more unstable, World Wars excluded, ever since. Milton Friedman is convinced after study that monetary institutions are responsible for this instability. See « A Program for Monetary Stability.

Stock Market Crash in October 1929 is neither the start nor the cause of the Great Depression; the 3 % yearly decline the money stock from August 1929 to October 1929 is. In November 1930, self-fulfilling banks failing and bank runs followed.

Why self-fulfilling? Fractional reserve banking scheme: out of $1 in deposits, 85 cents are lent. When there is a bank run, banks put pressure on each other to get the money they lent to repay deposits, which explains why liquidity is essential here. The end of convertibility between cash and deposits stops the contagion. FRS failed to provide cash corresponding to banks’ assets.

September 1931: Britain leaves the gold standard. Large increase in interest rates is decided to stop the gold drain, which ends up in bank failures and bank runs again.

Overall, the money stock decreased by one third between 1929 and 1933. FRS concentrates too much power. Independence makes checks by the body politic impossible!

Rules instead of authorities

The government by law instead of the government by men enable the conduct of monetary policy with control of the public, while preventing monetary policy to undergo the day-to-day whim of political authorities.

Points against monetary policy rules:

  1. it makes little sense to tie the monetary authority’s hands, which may prevent the authority from doing better than the rule with alternative actions
  2. why not legislate the policy itself instead of a rule?

Answers: analogy between monetary policy rules and the first amendment: Why have a standard proscription of interference with free speech? Why not take each case separately and treat it on its own merits? If cases were taken separately, the majority would vote against the rights Mr. X to promote communism. On the contrary, it people were asked about free speech as a whole, they would vote for free speech. Why? Because each person feels more strongly about being deprived of his own right to free speech than depriving someone else of this very right. The right to free speech has cumulative effects, as people expect being able to exert it whatever their stance may be. In the same manner, talking about monetary policy, if each case is considered separately, decision makers do not take into account the cumulative effects of the policy. Policy rules have favorable effects on the pinning of people’s expectations.

Which rule? A price level rule is not a good choice: no clear and direct power of monetary policy to achieve it and too much leeway left to the monetary authority

Milton Friedman makes a case for a rule on the growth rate of the money stock. It curtails the discretionary power in the hands of the central bank, but still leaves leeway to the authorities to achieve the specified growth rate of the money stock, e.g. debt management, banking supervision. It is not necessarily the best rule, but one that does not threaten a free society

Chapter IV: International financial and trade arrangements

Relationship between different national currencies dealt with here.

The importance of international monetary arrangements for economic freedom

The most effective way to convert a market economy into an authoritarian economic society is to impose direct controls on foreign exchanges. For example, rationing imports leads to indirect control over the output of domestic firms that resort to imported products. This is a deep-rooted temptation in the US because of balance-of-payment problems. Remember that the first time inconvertibility of currencies was enforced is in Nazi Germany, under Hjalmar Schacht’s authority.

The role of gold in the US monetary system

Gold is a commodity as any other. Government control of the price of gold is inconsistent with a free market economy. Example:

  • 1934: $35/ounce is higher than the market price, which lead the US to hold half the world’s gold stock
  • 1933: Roosevelt required by law private holders of gold to turn over at a price lower than the market price. Why? To reap the whole paper profit from the rise in the price of gold! Such a behavior is destructive of free enterprise principles

Current payments and capital flights

Residents in the US seek to buy foreign currencies with dollars in order to purchase goods or invest in other countries. Similarly, foreigners want to buy dollars for analogous reasons. At the end of the day, the demand and the supply of dollars and foreign currencies break even. However, there is nothing to ensure that, at any given price of foreign currency in dollar terms, the number of dollars sold equals the number of dollars foreigners want to buy. The « demand equals supply » equation is an ex post statement, and reflects the mechanism that eliminates the ex ante discrepancy between supply and demand. How is it possible to equate supply and demand?

The US committed to sell gold to foreign central banks and governments at $35/ounce. Central banks, governments and residents hold large funds than can be readily sold for dollars and the corresponding amount of gold. A run on gold is therefore possible in the current system.

2 problems: balance of payments and runs on gold are related

  • balance of payment difficulties can be a major source of confidence loss int he ability to honor the $35/ounce standard
  • the fixed price of gold is a device to peg the price of the dollar in terms of foreign currencies; flows of gold are the device to resolve the ex-ante discrepancy in the balance of payment

Alternative mechanisms for achieving balance in foreign payments

Suppose the balance of payments is zero and there is a shock: foreigners are not willing to buy as many dollars as US residents want to sell:

  1. US reserves of foreign currencies deplete, or foreign dollar reserves enlarge; US gold stock diminishes.
  2. Domestic prices fall compared with foreign prices; selling foreign currencies lead to an outflow of gold, which depletes the money stock, which in turn decreaces prices and, finally, nominal income. Conversely, abroad, US goods become more attractive to foreigners, who buy dollars to buy the former. The balance of payment deficit vanishes. The latter scheme is precisely what would happen under a full-fledged gold standard. Modern central banks prevents a direct connection between money stock and gold reserves, though. A central bank may be required to allow deflation to nullify the balance of payments.
  3. Change in exchange rates instead of prices: devaluation or appreciation change the peg to which the currency is set.
  4. It is also possible to impose direct controls on trade, to prevent US expenditures on foreign products. It is the worst one from a free-market perspective.

Many government interventions in these affairs!

Floating exchange rates as the free market solution

2 mechanisms are consistent with free market and free trad: (i) fully automatic international gold standard; (ii) freely floating exchange rates. In (ii), change rates are determined by private transactions, without government intervention. It is not very popular, even among the liberal for several reasons:

  • tyranny of statu quo
  • confusion between real gold standard, where currencies are different names for different amounts of gold, and pseudo gold standard, where differences between currencies are rigid, in rigged markets.
  • reputation: floating exchange rates are generally adopted after huge financial difficulties

The policy measures necessary for a free market in gold and foreign exchange

  1. No longer any commitment to buy or sell gold at any price
  2. Laws forbidding individuals to buy or sell gold
  3. No government intervention to influence exchange rates
  4. The government should progressively sell its reserves using auctions

Eliminating US restrictions on trade

Usual point against free trade: low foreign wages make tariffs necessary to protect high domestic wages. This is a fallacy.

Consider Japan and the US and suppose Japan produces everything in a cheaper way; the US cannot sell anything to Japan. The US pay for Japanese goods in paper dollars, held by the Japanese. Since the Japanese cannot buy any good with the dollar, the value of dollar decreases with respect to the yen. At which level the exchange rate shall settle? At the level that ensures that all Japanese exporters can sell the dollars they get to Japanese importers who use dollars to buy American goods. In other words, the level at which the value of US imports equals the value of US exports in dollars.

If an American worker is 4 times more productive than a Japanese worker, it is a waste to use him to produce any good where he is doing worse than 4 times better compared to a Japanese worker. Tariffs lower the Japanese revenues and prevents the American worker from being as productive as he could be. Note that tariffs and other trade restrictions such as quotas or subsidies on exports bear equivalent results.

Milton Friedman makes a case for unilaterally moving towards free trade, as a way to promote free trade with respect to other countries.

Chapter V: Fiscal policy

Usual misconceptions: federal budget as a balance wheel. It is a major source of disturbance and instability instead.

Secular stagnation theory: investment opportunities are scarcer, while individuals still want to save; deficit enable the government to decrease unemployment while providing assets. Same thing for taxes with the welfare state theory.

All these rely on the belief that an increase in government expenditure leads to an increase in output, as the Keynesian theory coins. Suppose that the government increases its spending by $100 and leaves taxes unchanged. Assume that households save 1/3 in any income increment. Households then consume 2/3 of $100, namely $66. These $66 end up in households’ pockets again as income after consumption has taken place, leading to another $44 increase in consumption, and so on and so forth. The total income increase boils down to $300, with a Keynesian multiplier equal to 3.

This is a spurious analysis:

  • private expenditure may well decrease by $100 as the government spends $100
  • prices increase, which leads to an unchanged real income

If government pays for something people paid for themselves, they leave people to pay with something they value less highly. People are thus expected to consume less of their total income than before; they may perfectly buy the same collection of goods as usual and save the released money. In other words, $100 more in government expenditure may well end up in $100 less in private expenditures. The only way for government not to divert private spending is to spend on things the people do not value at all.

Fiscal vs monetary stimulus: if the government borrows $100 it has no effect on private expenditure in two situations

  • if the yield of government bonds is zero, money and bonds are two different names for the same thing. It is the so-called liquiditiy trap
  • if potential borrowers are so stubborn about spending that no rise in interest rate will cut down their expenditures, i.e. if investment is inelastic to interest rates

Otherwise, anything is possible between an expansionary effect and no effect at all. In the long run, price increase and real private expenditures decrease.

A thorough textbook would be needed to address this question well.

Chapter VI: The role of government in education

Government intervention in education can be justified under two grounds: (i) neighborhood effects; (ii) paternalistic concern for children and other irresponsible individuals. It has different implications for general education and specialized vocational education. Note also that schooling and education are not the same thing.

General education for citizenship

The education of my child is good for the parents and the child, but also to other members of the society, as it promotes a stable and democratic society. It is a typical neighborhood effect, and the government may require a minimum amount of schooling with a specific program.

The best solution is for parents to directly pay for schooling. It prevents the government from administering schools and equalizes the private and social costs of having children. It is not feasible, though. A problem may be that some parents cannot pay for schooling, depending on resources and the number of children.

The « for society » neighborhood effect does not justify subsidies for purely vocational training, which increases the student’s productivity but does not train for citizenship or leadership.

The community may decide which forms of education yield the greatest social advantages and how much should be spent on them. Note that financing schools using government is not the same thing as leaving the schools in the government’s hands. The government may require a minimum level of schooling by giving parents a vouchers, which is redeemable for a maximum sum per child and per year spent on approved education services left at the parents’ choice. In this scheme, schools are thus classic private profit and non-profit institutions, while the government imposes a minimum common content in the program.

A few points in favor of nationalizing schools:

  • « it is impossible to provide the common core of values required for social stability, e.g. religious schools »: note that this point also supports compulsory attendance in state schools. In a system with both state and private schools, private schools are at a disadvantage as they do not benefit from state funds. Denationalizing schools and making the associated funds available to the parents would widen the choice available to parents, as schools would spring up to meet the demand. In the current system, it is much more costly to choose a school, as it involves paying twice for schooling if a private school is the parents’ choice, or even changing residency. There is no possibility to vote against « social dancing classes » in state-run schools. On the contrary, parents that do not value these activities may have a choice with a free market, voting with their money and their own child’s placement.
  • « private schools would exacerbate class distinction » instead of promoting « a healthy intermingling of children from different backgrounds »: State-run schools do no solve this issue. Stratification of residential areas compensate the mandatory character of schooling. Note that it is much more expensive to change residency than to pay for a high-quality private school for a poor family that would like to save on its living expenses and provide a specific education for its children.
  • technical monopoly issues in rural communities: there are too few children to have some competition between private schools, or the emergence of a proper schooling market

A drawback of state-run schooling relates to the uniform and rigid salary schedules of teachers, which are determined far more by seniority and degrees than by merit. In any bureaucratic organization, standard salary scales are inevitable as it is impossible to stimulate competition and grant wages with respect to merit. As a result, poor teachers are paid too much, and good teachers not enough; best way to attract mediocre teachers!

The arrangements Milton Friedman proposes now could not necessarily be desirable one century ago. Transportation was poor, which made the technical monopoly point strong. Moreover, conformity was an important criterion.

Schooling at college and university level

Grounds for neighborhood effects and technical monopoly are even weaker. Governmental institutions account for half the students attending colleges and universities and are much cheaper in tuition. Competition is unfair compared to private universities. The best thing to do is subsidizing people instead of institutions in order to promote competition between institutions.

Vocational and professional schooling

No neighborhood effects as there would be in general education. If the individual bears all the extra costs and extra benefits of some vocational training, private incentives tend to converge with social returns.

There is strong evidence that the rate of return of human capital is higher than the rate of return of physical capital. Thus, there must be some under-investment in human capital. Why is that? Investment in human capital differs from investment in physical capital, as physical capital can be sold back as an asset. On the contrary, an individual has no other security to offer than its future earnings, except when it is a slave. As a result, fixed money loans to finance investment in training are non-sense. Interest rates need to be high enough to compensate for defaults (death, physical incapacity, differences in energy and fortune).

Outright government subsidy of vocational schooling, financed out of general revenues is inappropriate. Indeed, it leads the private costs of training to be lower than the extra returns. The resulting distribution of income is perverted.

How can we finance education, then? On the physical capital size, equity investment and limited liability on the shareholder’s part are efficient. Similarly, one could buy a share in an individual’s earning prospects. Is it feasible? (i) it is equivalent to voluntary and partial slavery; (ii) it requires accurate information on incomes throughout the contract span, which is pretty long. As administration of such contracts is expensive, there is room left for government intervention on the technical monopoly and « foster competition » basis. The government could provide individuals with a given sum per year for training in exchange for extra points of income taxes. Such a program would be self-financing and the individuals would bear the whole costs and benefits of the chosen training. A limitation of this idea is that is is impossible to include non-pecuniary returns.

Chapter VII: Capitalism and discrimination

Substitution of state arrangements for contract arrangements in history: freeing of the serfs in the middle ages.

Note that the basic belief in private property is so string that despised minorities were scarcely deprived of it in history.

Free markets separate economic efficiency from irrelevant characteristics. Bread purchasers do not know the color of the wheat-maker. A business man who expresses preferences in his business activities that are not related to productive efficiency is at a disadvantage compared to business men who do not. A person who discriminate others impose costs on others, but on himself in the first place.

Discrimination is a taste for others that one does not share. We do not regard as discrimination the fact that an individual is willing to pay a higher price to listen to one singer than another, or prefers to speak to a beautiful person than an ugly one. There is virtually no difference with someone that dislikes black people. It does not mean that all tastes are equally respectable, though, and discussion is the only mean to change the tastes of others.

Fair employment practices legislation

Fair employment practice commissions aim at preventing discrimination on race, color or religion and are implemented in a few states. They typically interfere with the freedom of individuals to enter into voluntary contracts.

Example: Suppose there is a neighborhood where people do not want to be served by a black clerk in their stores. If a competent black applicant applies, it must then be hired by law. The owner of the store will lose money and may end up bankrupt. Here, the owner is prevented from supplying the service people are willing to pay for. Discriminating consumer shall pay a higher price as they limit the employment opportunities in the stores they patronize.

FEPC justifies its actions by asserting that individuals who refuse to hire black people is harming the targeted group and limiting its employment opportunities. Here, there is a confusion between 2 kinds of harm: (i) coercion; (ii) the fact that 2 individuals are unable to find mutually acceptable contracts. For example, I prefer a blues singer to an opera singer, which leads me to harm opera singers as I do not want to consume their services. There is no coercion here.

In terms of principles, FEPC is similar to Nuremberg laws. The only difference is about criteria and tastes.

Right-to-work laws

They make it illegal to require membership in an union as a condition of employment. As long as there is competition among employers, employers should be free to offer any terms to their employees. Right-to-work laws will not have any effect on the monopoly power of unions.

Segregation in schooling

Schooling is administered by the government, which must take an explicit decision between integration and segregation. Both solutions are bad, as they either harm individual freedom and decision based on skin color.

The solution is to (i) eliminate government operation in schools and allow parents to choose the kind of school they want; (ii) convince parents that integration is the right thing. Some school would be white, black or mixed, the latter playing the role of transition between two extremes. This approach enables co-operation without imposing conformity. Note that forced integration would not work as segmentation would occur via residential areas.

Chapter VIII: Monopoly and the social responsibility of business and labor

Ordinary meaning of competition: personal rivalry. Economic meaning of competition: quite the opposite. There is no personal rivalry or personal higgling in the competitive marketplace. Corollary: no one participant can determine the terms on which terms each other shall have access to goods or jobs, or influence prices, as he takes the market price as given.

Monopoly: firm/individual has enough control over a particular product or service to significantly shape the terns on which other individuals may access it.

2 classes of problems:

  • limitation on voluntary exchange, as fewer alternatives are available
  • « social responsibility »: the monopolist has power he should discharge to further socially desirable ends. The wide-spread enforcement of such a principle would annihilate a free society

Milton Friedman: wide range of problems where the economy can be treated as competitive. It remains a highly technical issue, though.

The extent of monopoly

3 important areas:

  1. monopoly in a given industry: relative unimportance from the point of view of the economy as a whole. No clear-cut determination of whether a firm can be considered as monopolistic or competitive. Nutter and Stigler: as of 1939, 25% of the economy could be regarded as state-run. In the remaining 75%, 15% can be regarded as monopolistic. Why do we feel like that there are many more monopolies in the economy? (i) natural attention towards the big firms; (ii) overemphasis on the manufacturing sector, which only account for 1/4 of output. For the same reasons, innovations that foster competition draw less attention
  2. monopoly in labor: labor unions cover 1/4 of the working population. Same overemphasis as for monopolies. If a union raise wage rates in a particular occupation or industry, employment is less than it would be. Job seekers flow to other occupations, pushing wages down. Unions are stronger among people that would have been highly paid anyway. Well-paid workers benefit from an increase in their wage at the expense of low-paid workers. It reduces the range of opportunities to most disadvantaged workers and foster inequalities. Unions sometimes work hand in hand with industry monopolies to cartelize an industry, e.g. United Mine Workers of John L. Lewis and coal price control through strikes or working stoppages.
  3. Government-run or government-supported monopoly: direct government monopoly in production is scarce. However, the state is the only buyer of the products of many firms, which entails many problems for freedom. Government indirectly supports and enforces cartel arrangements, e.g. Interstate Commerce Commission, Federal Communication Commission, Federal power Commission, Civil Aeronautics Board, Federal Reserve Board, licensure provisions. Individuals’ freedom to enter a voluntary exchange is limited. Patents and copyrights are different from licensure, as they help to shape property rights. Without patents, the inventor will find it difficult to collect a payment for the contribution his invention makes with respect to output. Some inventions cannot be patented, e.g. supermarkets. Other are patented only to maintain private collusive arrangements.

The sources of monopoly

3 sources:

  1. Technical considerations: telephone system, water system. 3 evils: private unregulated monopoly, private monopoly regulated by the state and government operation. Government operation is difficult to reverse in case of technological change. State-regulated monopolies suffer from the fact that regulatory agencies tend to be captured by the producers. Private unregulated monopolies seem the least evil
  2. Direct and indirect government assistance: most important source of monopolies. Indirect assistance takes the form of tariffs, tax legislation, law enforcement and legislation with respect to labor disputes:
    • Tariffs protect domestic industries. Moreover, it is far easier for a few firms than for many to collude on prices, especially in the same country
    • Tax laws may provoke distortions. For example, the corporate tax rate is lower than the capital income tax rate. It creates an incentive to substitute internal investment to external investment, whereas external investment tends to be more productive. Moreover, it supports incumbent firms compared to new entrants
  3. Private collusion: generally unstable arrangements, unless there is some government support. A cartel increasing prices makes it more relevant for outsiders to enter the market. Thus, there is an incentive for each member of the cartel to undercut is partners in felony.

Appropriate government policy

  • elimination of measures which directly support monopoly, e.g. industry or labor unions
  • reform to tax laws: abolition of corporate taxes ; corporations should be required to attribute to individual stockholders earnings that are not paid out as dividends. Stockholders would have to report these non-dividend earnings on the tax return as well as dividends. This way, there is no longer any incentive to earn more internally than the stockholder could earn externally. Such a policy would invigorate capital markets, stimulate enterprise and promote effective competition.

Social responsibility of business and labor

Wide-spread acceptance of the idea that corporate officials have a social responsibility that goes beyond the interest of their stockholders or members. It is a fundamental misconception in a free market economy. If businessmen do have a social responsibility other than maximizing profits, how are they to know what this responsibility is? Can self-selected private individuals decide what the social interest is? Only the whole people cam do that.If businessmen play the role of civil servants, they will be sooner or later chosen through elections!

If all businessmen were to choose not to increase prices despite the market pushing in that direction, there would be product shortages , labor shortages and the appearance of gray markets. The government would have to intervene here.

Similarly, if a corporation makes a contribution to some charitable activities, it prevents the individual stockholders from deciding themselves how they should dispose of their funds.

Chapter IX: Occupational licensure

There has been a raise in occupational licensure in the recent years.

Ubiquity of governmental restrictions on economic activities men may engage in

Analogy with medieval guilds and the Indian caste system. In the latter, every person’s occupation is determined by its birth caste. Thus, the distribution of occupations depends on the different castes’ birth rates.

Licensure is similar to a tariff. The protected producer group is generally a specific craft, and the licensure is generally advertised as pursuing public interest. Occupational licensing boards are composed of licensed practitioners=, who have a direct economic interest in the decisions about admission and the associated requirements. Problem: if a few individuals decide whether others may pursue an occupation, all sorts of irrelevant considerations are likely to pollute the decision process. Why does licensure emerge? Because a producer group tends to be more concentrated politically than a consumer group. In other words, we consume many items, but we generally devote our time to one particular trade or craft. The surprising thing is rather that there are surprisingly few licensed occupations in that regard!

The only way to offset special producer groups consists in establishing a general presumption against the state undertaking certain kinds of activities.

Policy issues raised by licensure

3 different levels of control:

  • registration: individuals are required to have their name on a list at the expense of a tax or fee
  • certification: government can certify that someone has certain skills, but may not prevent the practice of any occupation
  • licensure: one must obtain a license from a recognized authority to practice. Licensure is more than a registration as it requires a skill demonstration through a competitive examination, for example

Under which circumstances is occupational control justified under liberal principles?


  • It may assist in the pursuit of other aims. For example, gun registration helps the police to find out who may have access to firearms
  • It may also constitute a facilitating device for taxation. The question is: is the particular tax an appropriate method to raise revenues?
  • It may protect consumers against fraud. For example, a false taxi cab is in good position to steal someone at night.

Certification: much more difficult to justify. The private market can carry out certification for itself through private certification agencies. Certification is also part of suppliers’ services; earning the confidence of consumers by investigating the quality of sold items is beneficial to the supplier.

Problem: there may be no efficient way I can require you to pay for my certification. How can I keep confidential the way I certify people or firms? There are also technical monopoly aspects of certification: the cost of making a certification is independent from the number of people to whom the information is transmitted

Licensure: even more difficult to justify. More ground left to trench upon the right of individuals to enter into voluntary contracts. Most convincing point: neighborhood effect, e.g. incompetent physician creating an epidemic. Wide-spread point: paternalism; to choose a physician intelligently, you need to be a physician yourself.

Social cost of registration, certification and licensure: they become a tool in the hands of a special producer group to obtain a monopoly at the expense of the rest of the public. Overcoming the natural concentration of producers compared to consumers is difficult. Registration is the first step into a system where individuals need to inform authorities of everything they plan to do.

Certification is far less harmful than licensure. The price wedge between certified and non-certified businesses prevents the emergence of too stringent conditions from the certifying board. It still provides a good deal of protection against monopolization and incompetent practitioners. Certification make the relevant information public.

Medical licensure

« Ought we to let incompetent physicians practice? »: no is a natural answer, but we need to think further.

Licensure: control physicians number. The American Medical Association is the trade union that controls physicians’ number. The Council on Medical Education and Hospitals is a very powerful institution. 1930s: statement that there are « too many students in medical schools » leads immediately to a decrease in accepted applications. The Council certify medical schools, which explains why the latter obey the Council’s recommendations. Beyond the direct decrease in applications, the indirect effect is to discourage future applicants.

Points in favor of the AMA:

  • « If too many people are let in, this will lower the physicians’ income so that they will be driven to resort to unethical practices to earn a proper income »: do people really need to be paid to be ethical?
  • Raising the standard of the profession: failure to distinguish between technical efficiency and economic efficiency. « No one should drive a low quality automobile » lead cars to become too expensive for some people. The phenomenon is at stake for medical care.

The AMA implements irrelevant requirements: citizenship, licensure exam must be taken in English.

Does licensure have the good effects that it is said to have?

  • does it raise standards of competence? Restriction to entry push people to escape the licensure exams. The surge of osteopathy and chiropractic bears witness of it. These alternative activities are low quality medical care compared to regular medical care, bringing down the average quality of medical activities
  • Moreover, the lower number of physicians leads to a lower total amount of medical practice time by trained physicians
  • High degree of conformity leads to an impoverished pool of researchers
  • Restriction on the power of citizens against malpractice

Solution: freedom of practice and extensive legal and financial responsibility for any harm done through malpractice

Chapter X: The distribution of income

Belief in equality of income as a social goal. What is the justification for state intervention to promote equality? What has been the effect of the undertaken policies?

The ethics of distribution

Free market society: « to each according to what he and the instruments he owns produce ». The definition of property is essential here. Free market imposes some equality of treatment:

  • differences in money income offset differences in other characteristics of the occupation or trade. The market equalizes differences to make net advantages the same, whether they are pecuniary or not
  • satisfy men’s taste for uncertainty through lotteries. A lottery consists in a group of individuals with equal endowments who agree to the distribution of very unequal prizes after a random draw. Redistributing income after a lottery denies the opportunity to enter the lottery. On the contrary, insurance expresses a taste for certainty

Point in favor of redistribution through government: the market cannot produce the range of lotteries or the kind of lotteries people desire. Progressive taxation would be a government device to implement the desired lottery. The problem is that taxes are imposed after it is largely known who has drawn which prizes, which distorts the choice to enter the lottery. Something that would bring less distortion is to vote now the next generation’s tax schedule.

If a part of income inequality stems from equalizing differences and men’s taste for uncertainty, another stems from initial discrepancies in endowment. This is a difficult ethical issue here.

General ethical distinction: differences of income coming from personal endowment are considered as acceptable, those coming from property are not. Similarly, income differences from acquired wealth are considered as acceptable, those from inherited wealth are not.

Is there any greater ethical justification for the high returns of a given occupation than for the high returns of an inherited property? When passing money to a child, one may pay for his training, set him up in business or invest in a trust fund to get rents. All paths lead to high returns. No ethical difference here! Moreover, a man is entitled to do what he wants with his money, including passing it to his heirs.

The instrumental role of distribution according to product

Product is not distributive, but allocative. Payment in accordance with product is necessary for resources to be used efficiently. It must also yield distributive justice to be accepted as such, which is the case.

Critique of this principle has come from the Marxists. « Labor is exploited because labor produces the whole of the product but only gets part of it ». « To each according to his need, from each according to its ability ». Ironically, note that labor is exploited only if it is entitled to what it produces, which requires a minimal agreement with the capitalist ethic.


  • confusion between the total product of all co-operating resources, and the amount added to product/marginal product
  • unstated change in the meaning of « labor » from the premise to the conclusion. Marx recognized the role of capital in producing the product, but regarded capital as embodied labor. The Marxist motto becomes « present and past labor produce the whole of the product. Present labor gets only part of the product »

Facts of income distribution

Wide-spread points:

  • « capitalism produce wider inequality than alternative systems »
  • « development of capitalism leads to an increase in inequality »

Stylized facts:

  • the more capitalistic a country is, the smaller the fraction of income paid for the use of capital, the larger the fraction of income paid for human services. A great achievement of capitalism is not the accumulation of property, but the opportunities it offered to people to improve their capacities
  • capitalism leads to less inequality than alternative systems of organization. It has been providing people with products and services that only the rich could initially afford

Inequality is difficult to measure. Individuals and households inequality lead very different results. Moreover, one should distinguish the temporary and long-run inequalities. A rigid society is more unequal than a capitalist one, as capitalism alters status and provides social mobility.

Government measures used to alter the distribution of income

Tools: graduated income and inheritance taxation.

High tax rates:

  • make the pre-tax distribution more unequal. Highly taxed activities are the ones with large risks and non-pecuniary disadvantages. Taxes raise returns in these activities
  • stimulate of the evasion schemes. People at the same economic level pay very different taxes depending on their income source and their evasion opportunities

Solution: lower set of nominal tax rates; more equal taxation of all sources of income; broadened base.

Personal income taxes is much less a tax on being wealthy than on becoming wealthy. Taxes limit the use of the income of existing wealth, but limit even more the accumulation of wealth. Taxation of the income does not reduce the wealth, but the potential addition to wealth. In practice, tax avoidance schemes still enable fast wealth accumulation.

2 different problems: (i) raising funds to finance government spending; (ii) redistribution. (i) may resort to graduated taxation. On the contrary, graduated taxation for the sake of (ii) is coercion to take from some in order to give to others.

Best personal income tax structure is a flat-rate above an exemption threshold, with a broad definition of income and a strict deduction policy. Flat-rate income tax provides less incentive for tax avoidance and reporting failures. The top bracket tax rates are too high, and their yields are very poor. Very competent people find evasion schemes, which is a waste of resources.

Chapter XI: Social welfare measures

Miscellaneous welfare measures

Public housing

Alleged neighborhood effect: slum districts impose higher costs on the community in terms of fire and police protection. The only thing that would solve this externality is to tax this kind of housing to equate the private and social cost of this additional fire and police protection. Public housing does not solve this neighborhood effect; it is a paternalistic welfare policy. Indeed, providing cash to the involved low-income households would tackle the poverty problem and leave households free to spend the extra money in goods they value, including the tax correction the aforementioned neighborhood effect. With public housing, society paternalistically decides that low-income households need to spend the extra money in housing.

Lessons from past programs:

  • more destruction of housing units than creations of new ones, which lead to a higher number of people per dwelling unit. This also made worse the people that did not have the chance to get a public housing unit.
  • increase in juvenile delinquency: the income limits to live in public housing lead to high concentrations of broken families, which itself leads to more juvenile delinquency. This had very averse effects on nearby schools. Cash grants do not come with this drawback!

Minimum wage laws

Minimum wage rates to fight against low wages. The state can legislate a minimum wage, but it certainly cannot force employers to hire at that wage. People that used to be paid below the minimum wage become unemployed as employers have no longer any interest in pursuing the productive relationship. This is all the more cruel that the dismissed people generally cannot afford to lose some income.

Note that the helped people are visible, as in public housing, but the harmed people are kept invisible. People getting the minimum wage are perfectly identified, while people fired because of the same minimum wage are much more difficult to circumscribe.

Farm price supports

Based on the idea that farmers have a low income. Ironically, farm prices support help the wealthiest farms who produce the most, as the support is proportional to the amount sold. Moreover, a large part of the money ends up in the pockets of suppliers of storage capacity or agricultural products.

in the end, the consumer pays a higher price for food in addition to the tax to finance the program. The farmer is highly controlled and bureaucracy expands. The impact on international relations is significant as well, as the change in the farm price support program may well nullify the returns of investments farmers abroad carried out.

Old age and survivor’s insurance

« Social security » program involves a large-scale invasion into the personal lives of a large fraction pf the nation.

Old Age and Survivor’s Insurance (OASI): payroll tax and payment to persons that have attained a certain age

  1. requires that a wide class of persons must purchase specified annuities
  2. the annuity must be purchased from the government
  3. redistributes income, as the annuities are not equal to the paid taxes

Income distribution

A first aspect of redistribution takes place from those who entered the system young and those who entered the system old. Regardless the economic status of the old, there are no grounds on which one may justify such a transfer. A second aspect of redistribution comes from the deficit that may arise from OASI, and a tax on general revenue might be necessary to bridge it. Again, no clear ethical justification arises. Why should we help people poor people with a given age instead of the poor in general? Is OASI an efficient enough policy against poverty to justify the raising of a tax on general revenue?

Nationalization of he provision of required annuities

Suppose redistribution is avoided: each person pays for the annuity he shall get. There is no room for a government intervention. The only reason why government should get the annuities is redistribution. Another potential justification is the economies of scale nationalization may provide, but this does not prevent the existence of a private market for old-age insurance. If these economies of scale were as large as supposed, private companies would go bankrupt as the state is able to undercut the competitive market prices.

Compulsory purchase of annuities

Paternalistic justification: people are short-sighted and improvident. Nonetheless, freedom also includes freedom of individuals to make their own mistakes. If a man knowingly prefers to live for today, to use his resources for current enjoyment, by what right do we prevent him to do so?

Possible justification on liberal principles for compulsory purchase of annuities: the improvident will impose costs on others, as he will become a public charge. This point is strong if many people end up being burdens on the society’s shoulders. If only 1% were to become public charges, why should the freedom of the 99% others be restricted?

Chapter XII: The alleviation of poverty

Extraordinary economic growth during the past two centuries in the West. Despite this economic expansion and the joint development of private eleemosynary institutions, many people still live in poverty.

With the rise of governmental welfare activities, a corresponding decrease in private welfare activities follows. Still, private charity might be insufficient, as its effects also improve the utility of people that do not contribute to charity. Such a neighborhood effect can justify governmental action in the alleviation of poverty. How should the government proceed?

First, the program needs to target the poor, regardless their employment status (not a minimum wage) or age (not OASI). Second, the program should operate through the market without distorting or impeding it.

The best policy is a negative income tax/a subsidy. It does not incur excessive administrative costs as it may rely on the existing management of the personal income tax. Moreover, it may replace all the rag bag of measures directed at the same end, reducing the overall administrative cost. Main problem: will the majority vote in favor of taxing themselves and subsidize a minority? If yes, will it be a stable system?

Liberalism and egalitarianism

The liberal sharply distinguishes between equality of rights and equality of opportunity on the one hand and material equality and equality of outcome on the other. The alleviation of poverty may come as a by-product of private enterprise and voluntary action, and the liberal may regret any compulsory expedient to voluntary action. The egalitarian goes further; he may defend taking from some to give to others for the sake of « justice ». Such a view comes into conflict with freedom, and one must choose. One cannot be both a liberal and an egalitarian.


There is a tendency to regard any existing government intervention as desirable and the market as evil. Dicey: « The beneficial effect of State intervention, especially in the form of legislation, is direct, immediate, and so to speak, visible, whilst its evil effects are gradual and indirect, and lie out of sight […] Few are those who realize the undeniable truth that State help kills self-help […] The mere decline of faith in self-help is of itself sufficient to account for the growth of legislation tending towards socialism ».

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