Milton Friedman’s Magical Thinking

Markets are the essence of a market economy in the same sense that lemons are the essence of lemonade. Pure lemon juice is barely drinkable. To make good lemonade, you need to mix it with water and sugar. Of course, if you put too much water in the mix, you ruin the lemonade, just as too much government meddling can make markets dysfunctional. The trick is not to discard the water and the sugar, but to get the proportions right. Hong Kong, which Friedman held up as the exemplar of a free-market society, remains the exception to the mixed-economy rule – and even there the government has played a large role in providing land for housing.

The image most people will retain of Friedman is the smiling, diminutive, unassuming professor holding up a pencil in front of the cameras in Free to Choose to illustrate the power of markets. It took thousands of people all over the world to make this pencil, Friedman said – to mine the graphite, cut the wood, assemble the components, and market the final product. No single central authority coordinated their actions; that feat was accomplished by the magic of free markets and the price system.

More than 30 years later, there is an interesting coda to the pencil story (which in fact was based on an article by the economist Leonard E. Read). Today, most of the world’s pencils are produced in China – an economy that is a peculiar mix of private entrepreneurship and state direction.

A modern-day Friedman might want to ask how China has come to dominate the pencil industry, as it has so many others. There are better sources of graphite in Mexico and South Korea. Forest reserves are more plentiful in Indonesia and Brazil. Germany and the United States have better technology. China has lots of low-cost labor, but so does Bangladesh, Ethiopia, and many other populous low-income countries.

Undoubtedly, most of the credit belongs to the initiative and hard work Chinese entrepreneurs and laborers. But the present-day pencil story would be incomplete without citing China’s state-owned firms, which made the initial investments in technology and labor training; lax forest management policies, which kept wood artificially cheap; generous export subsidies; and government intervention in currency markets, which gives Chinese producers a significant cost advantage. China’s government has subsidized, protected, and goaded its firms to ensure rapid industrialization, thereby altering the global division of labor in its favor.

Friedman himself would have rued these government policies. Yet the tens of thousands of workers that pencil factories in China employ would most likely have remained poor farmers if the government had not given market forces a nudge to get the industry off the ground. Given China’s economic success, it is hard to deny the contribution made by the government’s industrialization policies.

Free-market enthusiasts’ place in the history of economic thought will remain secure. But thinkers like Friedman leave an ambiguous and puzzling legacy, because it is the interventionists who have succeeded in economic history, where it really matters.

Dani Rodrik, Professor of International Political Economy at Harvard University, is the author of The Globalization Paradox: Democracy and the Future of the World Economy.

Copyright: Project Syndicate, 2011.www.project-syndicate.org

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