Milton Friedman Is Dead,
… and really misunderstood.
Many of my colleagues are trying to find a silver lining in the outcome of the election, but for those of us concerned with energy and the environment I am afraid all we’re going find is a used Kentucky Fried Chicken napkin. There are two distinctly different, yet connected, things at immediate risk: policy and scientific research. Let’s start with policy.
Maximizing Welfare Requires Regulation, but Key Policies Under Threat
The GOP has long prayed at the temple of Milton Friedman. Friedman, who was one of the most brilliant thinkers of this past century (and my neighbor in San Francisco, albeit in a much nicer apartment), was at the forefront of arguments that markets are incredibly effective at allocating scarce resources. At the heart of (t)his argument lies the assumption that markets are “perfectly competitive”. This means that everyone has perfect information, no individual firm or person can influence price, transactions costs are low, there is no public goods or externality problem and the list goes on. If such a unicorn market is left alone, agents in it will maximize social welfare, so there is no need for government intervention.
Well, the problem is that perfectly competitive markets are about as common as Susan B. Anthony coins. Most markets are in fact not perfectly competitive, which Milton Friedman of course acknowledged. Market failures abound. The key question is whether the costs of intervening in the markets to address the failure outweigh the benefits.
The classic case of a market failure is an externality. If a power plant emits a pollutant, which causes kids in a neighboring city to fall ill, the absence of government intervention will lead to an inefficiently large amount of pollution.
Government should intervene to maximize welfare at the output level where the marginal benefit from emitting the last unit of pollution is equal to the marginal damage it causes. That amount in most cases is not zero, which upsets many folks in the environmental community, but this is economics 101. If the government does not intervene, however, the power plant produces more than the optimal amount of pollution, thereby sort of “stealing” welfare from the kids downwind.
This point is undisputed by scientists. Yes, economics done well is science. The archbishop (=department chair) in the church of Milton Friedman is …. an environmental economist! The holder of the Milton Friedman chair in economics at the University of Chicago Economics department is … an environmental economist: Michael Greenstone. Michael was a top economic advisor to President Obama and just last week was singing the praises of environmental regulation on NPR. To top this, last week he was also named head the University of Chicago’s Becker-Friedman Institute for Research in Economics, named for two conservative Nobel Prize winning economists who spent their careers there. See what I’m getting at here? The world’s top economists at conservative departments *do not* believe in laissez faire all the time. This, you would think, should make it more palatable for the GOP leadership to support sensible environmental regulation.
If the Trump administration is going to increase efficiency of environmental regulation by replacing costly standards with more efficient incentive based regulations, you will see me dance a Schuhplattler. I’ll post a video on this blog for you.
But no matter where you look, there is almost obsessive talk of “government overreach”. My excessive consumption of media coverage leads me to believe that the plan may more likely be a gutting of regulation instead. While killing off the Clean Power Plan will not bring coal back from the dead, it will certainly significantly hamper the necessary progress on the rollout of renewables and energy efficiency required to make progress towards the scientifically determined targets to avoid the worst consequences from climate change. The possible abandonment of the Paris Agreement will surely result in a higher emissions path for the US and possibly the rest of the world. (China and India only signed on because the US did.) Further, we have recently learned that the Social Cost of Carbon in federal rulemaking is at risk. The Social Cost of Carbon is a number used in federal benefit cost analysis, to incorporate the global damages from greenhouse gas emissions. The president could, for example, instruct agencies to use a domestic cost of carbon, which is a fraction of the true damages from carbon emissions. This would further increase emissions.
Finally, agencies interpret rules and I am afraid that there will be some very lax interpretations of regulations to protect the environment. I am most worried about the National Environmental Policy Act (NEPA) and the Endangered Species Act (ESA). While president elect Trump has said he likes clean air and water, his appointments would suggest that this is just hot air. Which leads me to the second point.
Purging Climate Experts from the Federal Government Would Harm Future Generations
When there is a party switch in presidents, it is normal for political appointees to go from liberal to conservative or vice versa. I have no problem with that. One would hope that appointees would have experience relevant to their charge, but even if they do not, they are, well, political appointees. I am really worried about the appointments – economists and regular people – to EPA and DOE for reasons discussed elsewhere.
But running a federal agency is tricky business as you are charged with running an organization made up of hundreds and in many cases thousands of federal staffers. These are not political appointees but instead have multi-decade careers at these agencies, working for administrations from both political parties. The staffers provide the institutional memory and know how “things work”. Many economists and statisticians at federal agencies are fellows of my profession’s most distinguished academic societies, publish in our leading journals, push science and policy forwards and do this at a fraction of the wage they would command in the private sector or the cushy bosom of academia (hey, free coffee!). On Friday, we learned that the incoming administration’s transition team is requesting names of staffers, who have worked on climate regulation at the department of energy. While there is no evidence that this questionnaire will result in these folks being fired or benched, this is alarming news.
The Nobel laureate economist Bob Solow has noted that one way to severely hinder economic growth is to damage capital and slow down the growth rate of its productivity. These staffers represent the productive capital of the federal government. NASA’s climate research branch, DOE and its national labs, EPA, NOAA, Interior, State all have staff conducting research on climate and the environment. These research and policy groups have produced models, tools and insight that have pushed forward our understanding of the environment and how to write policies that increase global welfare.
While we do not know how the Trump administration will use the information It requested, gutting these agencies of their climate, energy and environmental staff would represent an irreparable and irresponsible setback, robbing current and future generations of welfare that is rightfully theirs. Neither side of the aisle condones theft.
I have said this before. The GOP is the party of markets. Most environmental and energy economists love nothing better than a good market based regulation. I hope that the GOP and Trump administration will relearn what free market economics is all about. It’s not about the absences of regulation. It’s about sensible regulation. We have no right to steal from our fellow humans alive now or in the future. That said, I’m not optimistic. I will now go back to breathing into my paper bag.
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Maximilian Auffhammer View All
Maximilian Auffhammer is the George Pardee Professor of International Sustainable Development at the University of California Berkeley. His fields of expertise are environmental and energy economics, with a specific focus on the impacts and regulation of climate change and air pollution.
Energy Institute Blog 
Its time for Academia and government to slim down and do something more productive. We the taxpayers dont want to pay for more fake studies and politicized analyses we want lower taxes and cheap energy. The chemical engineers like myself know how to do this with fracking and established pollution control technology. The academia led exercises in energy provision have resulted in me paying 39 c/Kwh for my electricity. Facts are Facts and unfortunately for academia there is a still a free market in information.
You are about to get your wish thanks to the president elect. I specialize in fake studies that try and make everyone’s life harder. So does everyone I know. It is good that someone is protecting future generations from the likes of myself. Good luck with that cheap electricity. Also, the price you quote is the marginal price, not average.
“The chemical engineers like myself know how to do this with fracking and established pollution control technology.” I’m quite sure you do, but how do we make sure that every firm involved in fracking does what they’re supposed to do? All it takes is a single bad actor willing to cut corners in the interest of profitability to ruin a drinking water supply, and chances are it’s not going to be the water they rely upon. Believe me I’m no friend of regulation and we wouldn’t need it if people followed the Golden Rule that says, “Do not do unto others that which you would not have them do unto you” instead of the all too common, “Do unto others before they do unto you”.
“At the heart of (t)his argument lies the assumption that markets are “perfectly competitive”. This means that everyone has perfect information, no individual firm or person can influence price, transactions costs are low, there is no public goods or externality problem and the list goes on.”
This isn’t at all what Freidman argued.
We need to distinguish between the “Church of Friedman” and Friedman. Greenstone and Friedman are no more members of that Church than economists are members of the Church of Environmentalism. Friedman: “The way to do it [internalize pollution externalities] is to impose a tax on the cost of the pollutants emitted by a car and make an incentive for car manufacturers and for consumers to keep down the amount of pollution…not to have bureaucrats in Washington write rules and regulations…” He noted elsewhere that the reason for the tax is the missing market for emissions. He did believe (e.g. Freedom to Choose) that the excesses of government are usually worse than the excesses of markets.
While as Western economists we probably generally agree “tax it, solve it” approach, there are two problems with Friedman’s general attitude. First, it still takes the government to define and enforce the property rights in emissions. And markets don’t just spontaneously arise–that was the biggest mistake after the fall of the Berlin Wall that we didn’t go in and help set up those market institutions throughout Eastern Europe. Second, even these markets are messy and complex. There’s a reason why the property rights in GHG emissions aren’t clearly defined. Every tried to measure cow farts? So I’ve grown increasingly weary of economists who think they have the solution but ignore the institutional and physical details along the way. We are never starting from scratch and need to be cognizant of what goes before us.
Hi Richard,
Friedman was well aware of transaction costs and institutional details. To my knowledge, he never lost an argument, with the possible exception of the famous dinner featuring Ronald Coase vs. the U. Chicago Dept of Economics. The Church of Friedman only knows about the first-best level of analysis (absent transaction costs) and does not fully understand even that level. But Friedman could seamlessly switch to the 2nd-best level of analysis in response to arguments about transaction cost barriers. And when people brought up political economy, he could switch again to issues of rent-seeking and the iron-triangle of politicians, bureaucrats, and special interests (which Dixit calls the 3rd-best level of analysis). I have had the dubious pleasure of experiencing this first-hand, being on the losing side of an short-lived debate with him.
Jim
So what you seem to be saying is when Friedman lost the first level of an argument, he would concede and move on to the second level to argue his point. I’m just taking on the first level here.
Except that he doesn’t concede and you don’t notice that he’s moved on.
Actually the one climate-related “silver lining” in the last week has been the increasing chatter that Trump wants to appoint Rex Tillerson as Secretary of State. Yes he has been view as Public Enemy #1 by many environmentalists but he has repeatedly said he supports a revenue-neutral carbon tax, he has pulled Exxon Mobil back from the depths of denial, and he does appear to believe in international engagement. It was the Secretary of State who reported negotiated the key deals behind the Paris Agreement. And as breitbart.com has savaged the idea of appointing Tillerson, maybe “the enemy of our enemy is our friend.” Considering some of the other possibilities we’ve heard, this one ain’t so bad. Lately, “ain’t so bad” is good. Of course, the only response to the Russian hacking scandal might be to scotch this idea.
A Michael Greenstone is named as a co-author on a 2003 paper that made the claim that if economic variables are taken into account that decreasing air pollution did not decrease deaths, which is a major paradigm of the EPA. In fact the EPA claims that 85% of the financial benefit of reducing air pollution is due to decreasing deaths. We have just completed a re-analysis of the Chay et al. 2003 data set and we also find there is no decrease in deaths when air pollution is reduce.
SYoung
Can you forward where I can find the Chay et al. 2003 data and your recently completed work in the area? I have been interested in this area for some time. Thanks
I’m not sure which paper you’re referring to, but the evidence regarding infant mortality is overwhelming. Look at Matt Neidell’s work or the dozens of recent papers in the top economics journals (Schoenberg and Walker would be an excellent start).
And do us a favor: post your results, data and code and let a jury of your peers determine the quality of your “proof” that pollution doesn’t matter for health.
I looked at another study cited as evidence of the benefits of reduced PM emissions, Pope & Dockery 2006. In digging into the analysis in the paper, I found that when the results were broken down by region, reducing PM emissions in the West (a defined region of the U.S. not specified in the actual paper), the mortality rate INCREASED. Clearly this was a some underlying measurement or analytic problem, but it illustrates the lack of substantial data on this benefit.
I reject your claim that “the GOP is the party of markets”. I suggest that you modify your claim to state that ‘the GOP is the party of markets, so long as markets produce a convenient result’. In this way, it is not much of a stretch to see the overwhelming similarity between the two major U.S. parties.
To better understand what economic research has to say about the attitude of republicans or democrats toward markets, look at the work of James Buchanan. Each of us can find examples where the government failed to act to promote the public interest. Buchanan challenged the thesis that the government even tries to act in the public interest. Buchanan showed that the relevant market is the market for government regulation. Government officials, be they elected, appointed or hired, act to promote their individual self-interest. To different degree, they sell government authority. In this way government officials are not magically more or less self-serving than are the rest of us.
So you infer that the GOP is turning its back on markets and you wonder why this would be so. I suggest that you are talking about the wrong market. And the wrong Nobel prize winner.
I wrote in a chapter in a World Bank book on water irrigation pricing on how differences in voting rules among California agricultural water agencies affected management decisions. As they should, elected water officials reacted to how their constituencies’ preferences. And those constituencies generally aligned their choices along predictable economic incentives. None of this should be a surprise–that the “public interest” is actually a reflection of the relative economic benefits from governance. The question is how much influence should accrue to particular interests compared to others. The answer is reforming the governance rules, not trying to reach some mythical “public interest” that is somehow divested from the economic interests in society.
Adam smith also said you needed governance of imperfect real markets. Too often we see private sector using govt for their own needs.
Another excellent post, timely and well said. I first studied economics with a student of Friedman’s, although I landed on the institutional side (political science). Economists always dance to pricing. 🙂 But efficiency improvement and innovation can still happen within certain protective constraints and performance standards that address market failures but allow for competition among solutions.
And here is Friedman in his own words talking about the government picking winners and losers (think Carrier, Boeing, and trade…). http://freetochoosenetwork.blogspot.com/2013/04/friedman-on-government-picking-winners.html
In the early 1980s, I had the “opportunity” to debate Milton Friedman on the conventional wisdom regarding cartels: that they will always and automatically fail due to cheating. I noted that my doctoral research had discovered cartels that didn’t fail, in the Wilhelmian era of Germany (mid-1890s to WW1). Friedman’s response was “no, you didn’t”. In other words, the facts didn’t matter to him. Sounds like the Republican party today. This interchange led me to dismiss Friedman’s intellectual corpus entirely. If the facts didn’t matter, then what does?
I’m not sure I would advise that one dismiss all of Friedman’s work because of a single exposure. And while one would not characterize Friedman as an empiricist, he also did not ignore facts. But he required much more rigor of facts than did most economists; to a frustrating degree for many economists.
Now, for purpose of full disclosure, I was able to spend time at Hoover as a post-doc when Friedman was older and likely more ‘relaxed’. But he still believed in theory and when data did not support theory, he looked for holes in the data before looking for holes in the theory.
A good theorist should not ignore robust empirical evidence. However, Friedman’s work is of a caliber that, when data and theory do not happily meet, efficiency will drive me to first look more closely at the data.
Reminds me of the economist’s joke: “Sure it works in practice, but does it work in theory?”