Jennifer Burns: Milton Friedman, Ayn Rand, Economics, Capitalism, Freedom | Lex Fridman Podcast #457

1. 0:00 – 0:48

   Introduction

   1. LFLex Fridman0:00

      The following is a conversation with Jennifer Burns, a historian of ideas, including the evolution of economic, political, and social ideas in the United States in the 20th century to today. She wrote two biographies, one on Milton Friedman and the other on Ayn Rand, both of which I highly recommend. This was a super technical and super fascinating conversation. At the end, I make a few comments about my previous conversation with President Zelenskyy, for those of you who may be interested. This is the Lex Fridman Podcast. To support it, please check out our sponsors in the description. And now, dear friends, here's Jennifer Burns.

2. 0:48 – 15:41

   Milton Friedman

   1. LFLex Fridman0:48

      You have written two biographies, one on Milton Friedman and one on Ayn Rand. So if we can, we will focus on each one separately. But first, let's talk about the ideas the two of them held in common, the value of individual freedom, skepticism of collectivism, and the ethics of capitalism. Can you talk about the big picture ideas they converge on?

   2. JBJennifer Burns1:11

      Yeah, so Milton Friedman and Ayn Rand, in the biggest picture, they are both individualists, and they're skeptical of collectivities and collectivism. So their unit of analysis is the individual, what's good for the individual, what works for the individual, and their understanding of society kind of flows from that. They also both use this focus on individualism to justify and to support capitalism as a social and economic system. So we can put them in a similar category. We can call them individualists, we can call them libertarians of a sort, but they're also really different in how they approach capitalism, how they approach thinking. You know, Ayn Rand developed her own moral and philosophical system to justify individualism, and to connect the individual to capitalism, and to support capitalism as a social and economic system. Friedman struggles a bit more with how to justify capitalism, and he'll ultimately come down to freedom as his core value, like his god as he says. And so freedom does connect back to the individual, but he's not justifying capitalism for his own sake. He's justifying it for its ability to underwrite freedom in a social sense and also in the individual sense.

   3. LFLex Fridman2:28

      At a high level, are there interesting differences between them? You already mentioned a few, maybe in terms of who they are personally, maybe in terms of how they approach the justification for capitalism, uh, maybe other ways.

   4. JBJennifer Burns2:39

      Yeah, for sure. So beyond this idea that, that Milton Friedman takes a while to come to his justification of capitalism, whereas Ayn Rand kind of has it from the start. She really focuses on the core quality of rationalism and rationality, and rationality is the defining feature of human beings. And so she works from there, whereas Friedman, uh, Milton Friedman eventually converges on this idea of freedom. So that's one part of it. The other is their intellectual styles are really, really different, and their interpersonal styles are really different. So Friedman has big ideas, big principles that guide him, but he's also deeply empirical. He spends most of his career doing historical research, economic research, pulling data from how people actually make economic decisions and live in the world and using them to test and refine his theories. Where Rand, to some degree we could say she's empirical in that she lives through the Russian Revolution and takes a very big lesson from that, but her style of thinking is really, um, first principles, an axiomatic approach, going from the basic, uh, idea of rationality, and then playing that out in different spheres. And so those are just very different intellectual approaches, and then they lead, in some ways, to really different ways of thinking about how you get things done in the world. Ayn Rand is a purist. She wants to start with the pure belief. She doesn't want it to be diluted. You know, one of her favorite sayings was, you know, "It's earlier than you think," in other words, we're still moving towards a place where we can really hold and express these ideals purely. Friedman, although he didn't use this terminology, was much more half a loaf guy. You know, like, "I'll take what I can get, and then I'll try to move to where I really wanna be." But he is able to compromise, especially when he moves from being an economist into being more of a political thinker. And so that's a really different intellectual style, and then it also plays out in their lives in that R- Ayn Rand is incredibly schismatic. I mean, she wants her friends to believe what she believes and support what she supports, and she's willing to break a relationship if it doesn't match. Milton Friedman, he also does tend to have friends who agree with him, yet he's always willing to debate his opponents, and he's willing to do so with a smile on his face. You know, he's the kind of... He's the happy warrior, and he actually will win a lot of debates simply by his emotional affect and his cheerfulness and his confidence, where Rand will lose debates because she gets so angry in the face of disagreement. So yeah, they have s- they have a lot of similarities and a lot of differences, and, and it's been really fascinating to kind of dive deep into both of them.

   5. LFLex Fridman5:26

      I just, uh, re-listened to Ayn Rand's, I think, Last Lecture, or at least it's called that, and just the, the confrontational nature of how she a- answers questions-

   6. JBJennifer Burns5:39

      Mm-hmm.

   7. LFLex Fridman5:39

      ... or how she addresses critics and so on, there is a kind of charisma to that. So I think both of them are very effective at winning over sort of a popular support but in very different styles. It seems like Ayn Rand is, is very cranky, but there's... I mean, it's the, the most charismatic cranky person I think I've ever listened to.

   8. JBJennifer Burns6:00

      Yeah, I mean, people talked about m- her, meeting her and coming to believe in her ideas...... in a similar way as they did with Marxism, in that suddenly everything made sense, and that when they came to believe in objectivism, they felt they had this engine for understanding the entire world. Now after a while, for most people, that then became confining, but yeah, that certainty. And, and Friedman had some of that as well. He, he clothed it differently. He clothed it in happiness, where Rand kind of clothes it, as you said, in crankiness or anger. I mean, there's also an arc to Rand. She gets kind of angrier and angrier and crankier and crankier over the course of her life.

   9. LFLex Fridman6:40

      Yeah.

   10. JBJennifer Burns6:40

       What I enjoyed about my research is I was able to get into this early moment when she was different and a little more open, and then I kind of watched her, her close and her harden over time.

   11. LFLex Fridman6:50

       Would it be fair to say that, uh, Milton Friedman had a bit more intellectual humility, where he would be able to sort of evolve over time and be convinced by the reality of the world to change, sort of, the nuances of policies, the nuances of how he thought about economics or about the world?

   12. JBJennifer Burns7:10

       Yeah, absolutely. Friedman believed in being able to say, "I was wrong."

   13. LFLex Fridman7:14

       Right.

   14. JBJennifer Burns7:14

       And there are some things he said he was wrong about. We'll, we'll delve more into monetarism and monetary policy, but he was able to talk about the ways his ideas hadn't mapped onto the world the way he thought they would. He does a really interesting interview at the end of his life where he's beginning to voice some doubts about globalization, you know, which was s- he was sort of a prophet of globalization, a cheerleader of globalization. He really thought it would lead to a better world in all respects. And towards the end of his life, it's about two years before he dies, there's a note of doubt about how globalization unfolded and what it would mean, particularly for the American worker. And so you can see him still thinking, and that to me... I had sort of assumed he became crankier and crankier and more and more set in his ways, and, and of course there's a phase where, where he does become that way, especially as he's in the public eye and there's not room for nuance. But to find in the last years of him life, of his life him being so reflective, that was absolutely not something Rand could do.

   15. LFLex Fridman8:13

       I think there's a thread throughout this conversation where we should actually also say that you're kind of a historian of ideas?

   16. JBJennifer Burns8:21

       I am a historian of ideas, yes.

   17. LFLex Fridman8:22

       And so we're talking about, today, in part, about two people who kind of fought for ideas, for an idea, like we mentioned freedom for, for capitalism, and they did it in very different ways. And it's so interesting to see sort of the impact they both had and how the, their, uh, elucidation, explanation of those ideas, like, reverberated throughout society, and how we together as a society figure out what works, you know, uh, the degree to which they have influence on the, the public, the degree to which they have influence on individual administrations, like the Reagan administration, Nixon and so on, and how it m- might return, like fade away and then come back in modern times.

   18. JBJennifer Burns9:07

       Yeah. Yeah.

   19. LFLex Fridman9:07

       And it's so interesting if you just see this whole world as a, as a game of ideas, where we were like pushing and pulling and trying to figure stuff out. Uh, a bunch of people got real excited, uh, over 100 years ago about communism and then they try stuff out and then the, the s- the implementation broke down, then we keep, we keep playing with ideas. So these are the two greats of playing with ideas. Uh, I think that, that's a thread that just runs through this. (laughs)

   20. JBJennifer Burns9:38

       Yeah, and, and of kind of pushing back against that movement towards communism, social democracy. But, but one, one difference I didn't, that I really should emphasize, Rand is a writer of fiction. She's a philosopher, but she's also a writer of fiction. So she is working almost in a mythic register, much more in a psychological register. She's creating characters that people identify with and people relate to experiences they've had, and that's one of the reasons she hits so deep. And she's also offering people, I, you know, I read all the fan letters to her. People would say things like, "I read The Fountainhead and now I'm getting a divorce." You know? (laughs)

   21. LFLex Fridman10:16

       (laughs) Yeah. Yeah.

   22. JBJennifer Burns10:18

       You know? Having just, um, uh, th- these incredible realizations.

   23. LFLex Fridman10:22

       Milton Friedman didn't get such letters. (laughs)

   24. JBJennifer Burns10:23

       Milton Friedman didn't get such things. Or, um, you know, I'll meet someone and, and they'll say to me, "You know, Ayn Rand is the reason I went to medical school." You know, like, like a woman, a couple woman said this to me a few years back. "It never even occurred to me that I could be a doctor until I read Ayn Rand and I said I'm gonna go to medical school." And so she has that really intense impact on people. So she thought of herself as rational and she thought of rationality as kind of what she was doing, but she was actually doing a kind of mytho- mythopoetic psychological work as well. Whereas Friedman, on the one hand, was much more rational and there's a whole set of economic thinking and he provides a rational framework for understanding the world, and it's the framework of, you know, neoclassical economics. At the same time, he does pull on mythologies, you know, of the idea of America in the Gilded Age, the frontier mythology, the individual immigrant, the settler mythology. He pulls on these, but he doesn't create them and they're, and they are... he's more kind of playing a tune he already has. Uh, whereas I think Rand really does something a little bit deeper in her ability to reach into people's psyche and then take that emotional, psychological experience and fuse it to an intellectual world and a political world, and that's really what makes her so powerful. And so I think she comes back in... to relevancy in a different way than Friedman does, because I think in some ways she's tapped into a kind of more universal human longing for independence and autonomy and kind of self-creation and self-discovery.

   25. LFLex Fridman12:03

       Nevertheless, there are still pragmatic ideas that, uh, are still important today from Milton Friedman, even just on the economics level, so let's dig in. Um, let me try... I took some notes. Let me try to summarize who Milton Friedman is, and then you can correct me.Okay. So he is, uh, widely considered to be one of the greatest and most influential economists in history. Not just the 20th century, I think ever. He was a- an advocate of economic freedom, like we said, and just individual freedom in general. He strongly advocated for free market capitalism and limited government intervention in the economy. Though you do give... I've listened to basically everything you have on the internet. You give some (laughs) more depth and nuance on his views on this and... In your books. He, uh, led the famed Chicago School of Economics, and he won the Nobel Prize in Economics in 1976. He greatly influenced economic policies during the Reagan administration and other administrations. He was an influential public intel- intellectual, highly influential, not just among economists. He lived 1912 to 2006, so that means he lived and worked through some major world events where his ideas were really important; The Great Depression with The New Deal, World War II with the post-war reconstruction, the rise and fall of the Bretton Woods monetary system as we may talk about, the Cold War and all the conflicts involved in that, sort of the- the tensions around communism and so on. So the fall of the Soviet Union, and also he has some interesting relationships to, uh, China's economic transformation-

   26. JBJennifer Burns13:49

       Yep.

   27. LFLex Fridman13:49

       ... since the 1970s, the stagflation of the 1970s, and I'm sure there's a lot more, so. (laughs) Uh, can- (laughs) can you, uh, maybe continue this thread and give a big picture overview of the ideas he is known for?

   28. JBJennifer Burns14:03

       Yeah. Sure. And that- that's a great summary. Uh, you learn, you learned fast. So let me start (laughs) with the economics and- and then I can kind of transition to how he used those economic ideas to become a real voice in the American conservative movement and the American political realm. So I'll kind of highlight four ideas or contributions or episodes. Um, one was his work with Anna Schwartz in revising our understanding of the Great Depression and that's tightly related to the second, which is the school of monetarism that he and Schwartz really become founders of. Um, then there is the prediction of stagflation and the explanation of that in the 1970s, which really is one of these- these sort of career-making predictions, and we can dig into that. And then in terms of technical economics, he's known for the permanent income hypothesis, which he develops with a group of female collaborators that I can talk about. So those are kind of four technical pieces, end up being really brought together in what becomes the Chicago School of Economics. He's- he's undoubtedly the head and the leader of the Chicago School of Economics. There's an earlier generation that he learns from, there's his generation, um, there's also a Chicago School of Law and Economics that's really profoundly influential, and then there'll be kind of a third generation that he's somewhat distinct from, but that goes on to really shape economics. But let me go back to these kind of four pieces, and let me start with Great Depression. So

3. 15:41 – 29:58

   The Great Depression

   1. JBJennifer Burns15:42

      Milton Friedman actually lives through the Great Depression. He's in college when it hits and he is... So he's in college, it's 1928 to 1932, and he's aware of the depression and he's deciding, "Should I study mathematics or should I study economics?" And he hasn't... He's had some good economics teachers, but it's really the context. It's looking around at the slow, you know, dissolving of economic prosperity, so he decides to go to Chicago. He decides to study economics, and what's really interesting is that the Great Depression is so unexpected, it's unpredicted, um, it's unprecedented, and economists are really struggling to know how to respond to it. And so he's gonna arrive at the University of Chicago when the field it's- is struggling to know what to do, so he's in this kind of really open space where the- the institutional economics of the 1920s has failed to predict... Which was focused on business cycles. This is the irony. Their big thing was charting and understanding business cycles, and then we have the biggest business cycle of all time and they haven't seen it coming and they don't have a good explanation for it. And, um, what he will get at Chicago is the remnants of a monetary understanding of the economy, and so his teachers, they don't know exactly what's going on, but they look first to the banking crisis. They look first to the- the... In 1933, it's, you know, bank runs, failures of maybe it's up to a third of American banks. It's hu- thousands of banks are failing per week, so they're focused on that. So that's the first kind of imprint he will have. The Great Depression has something to do with the banking system. The second imprint he will have is that all of his professors are profoundly concerned about the social crisis. They want relief programs. They want them now. They want bank regulation and financial reform. They're very active. This is not laissez-faire by any stretch of the imagination. So Friedman has that imprinting and then about... So that's... He gets there in '32. '36, '37, the ideas of John Maynard Keynes from Britain, which has a different explanation. Keynes has a different explanation of the Great Depression, will kind of make landfall in American economics and be very profoundly influential on most American econ- economists, but Friedman already... It's too late for Friedman. He already has a different perspective. So Keynesianism unfolds. I can say more about that, but it basically leads to...... more active federal government participation in the economy. And what underlies a lot of that, its adaptation in America particularly, is the idea that capitalism has failed, capitalism has revealed itself to have a profound flaw, in that its two, its, its cycles of boom and bust create social instability, chaos. It needs to be tamed, it needs to be regulated. And so that becomes the, the kind of baseline of politics in the United States, the understanding of the New Deal, the understanding of the Democratic Party, even to some extent the understanding of the Republican Party, and Friedman never quite, never quite sure about that. He has a hunch that there's something else going on and he does not buy that capitalism has sort of ground to a halt. Or, the other idea is that capitalism has gone through some sort of phase transition, and it worked great maybe while we had a frontier. This is a very serious argument that people were making. United States used to have a frontier, a, a place where, you know, Europeans hadn't fully settled. Of course, they're pushing out the native tribes, that's another story. But that this frontier is the engine of economic growth, and the frontier is now over, it's closed, and we're gonna stagnate. And there's a theory of secular stagnation. And so to deal with secular stagnation, we're just gonna have to have a more active state. So Friedman is suspicious of all these assumptions, and he has this idea that it has something to do with money. Money is somehow important. And so he, uh, joins together with Anna Schwartz, who is, uh, an economist. She doesn't at this time hold a PhD. She's working for the National Bureau of Economic Research, and they come together to do this study of money in the US economy. And it takes them 12 years to write the book. And, and they're releasing their ideas and they're arguing, and Friedman is writing papers, giving talks saying money is really important. Um, and nobody's really believing him. He's a crank. He's at Chicago, he's out... You know, Chicago is a well-known university but he's sort of considered a crank. And then in '63, he and Anna Schwartz publish this book, and it's, you know, 800 pages. It's a reinterpretation of the history of the United States through money. Like, the central character is money, whether it's specie, greenback, or the US currency. And they have a whole chapter on the Great Depression. And they, what they've literally done, Schwartz has done most of this, they've gone, Schwartz has gone to banks and said, "Show me your books." And then she's added up, column by column, how much money is in your vault, how much money are, is on deposit, how much money is circulating. And so they literally have graphs, you can see them in the book, of how much money has been circulating in the US at various different points in time. And when they get to the Great Depression, they find the quantity of money available in the economy goes down by a third. And in some ways this is completely obvious, because so many banks, um, have failed, and we don't have any type of bi- bank insurance, uh, at that point. So if your bank goes under, your savings are there, the money essentially vanishes. And it's fractional reserve banking, right? So you've put in, they can loan up to 90% off, on their deposits. And so Friedman and Schwartz present this argument that what really made the Great Depression so bad was this drop in the amount of money, the 30% drop in the money. They call it the Great Contraction. And then they go further and they say, "Well, how did this happen and why?" And they pinpoint the Federal Reserve, which is a fairly new institution at that time, and they say, "What did the Federal Reserve do, the lender of last resort, what did it do in the face of," what they're depicting as a massive, unprecedented liquidity crisis? And they find it's not really doing much. And they really dig into the details and they find that the, the, the Federal Reserve has gone through a sort of personnel change in some of the key leaders in the 1920s. Benjamin Strong is one of them. He's now deceased. And the dominance of the New York Federal Reserve, which, in their telling, you know, is global, it's interconnected, it's seen a lot of financial things come and go, and they believe that the New York Fed had the understanding to recognize this is a liquidity crisis, we should be very generous, we should support all the banks. Their influence has diminished for the kind of, uh, banks that are more, um... They don't say, "Like the rubes and the hicks," but it basically is. It's like the people in charge don't know what they're doing. And so the Fed pursues this kind of policy of masterly inactivity. They don't see it as a problem, they don't do much. There's an enormous liquidity crisis. And that's their version of what the Great Depression is all about, that it's a financial system meltdown, it's a liquidity crisis, and that it in some ways, well, in, in many ways, they, they argue, very strong counterfactual argument, the Federal Reserve could have prevented it, and it did not. And so it becomes then an institutional failure and a political failure, not a failure of capitalism as a system. And so this book comes out, it's a blockbuster, and even those economists who've been like, "Friedman is a crank, I don't buy it," are like, "Friedman and Schwartz are onto something. Milton Friedman and Anna Schwartz are onto something." And so that really changes the game, and this is also one of his most influential contributions. Because Friedman and Schwartz becomes the playbook for the Federal Reserve. And we have lived through this, right? The financial crisis, the Federal Reserve is ready to loan. COVID, the Federal Reserve does all kinds of new things. Because no Federal Reserve chair wants to be in Friedman and Schwartz 2.0 that somebody writes-

   2. NANarrator24:13

      (laughs)

   3. JBJennifer Burns24:13

      ... where they're the bad guy who let the economy melt down. So, uh, y- you know, the specifics of what they say to do have obviously evolved as the system has changed, but...This is, this is a playbook for how to deal with economic crisis. It's Friedman and Schwartz, and so it's absolutely fundamental and that is really going to be the place he makes his mark.

   4. LFLex Fridman24:33

      There's a lot of things to say here. Uh, so first, the book we're talking about is the A Monetary History of the United States, in part for which Milton Friedman won the Nobel Prize. Uh, you've also mentioned the influence of the Great Depression. If we could even just rewind to that.

   5. JBJennifer Burns24:47

      Yes.

   6. LFLex Fridman24:48

      So, he went to, I guess, college in Rutgers.

   7. JBJennifer Burns24:50

      That's right.

   8. LFLex Fridman24:51

      And he was, uh, you know, mathematical proclivities, so he was kind of wanted to be a mathematician, and so it's, it's kind of a cool crossroads. Um, it's interesting how the right time, the right person arrives, right? So, you describe this really well that, so he had the choice to be a mathematician or an economist.

   9. JBJennifer Burns25:14

      Mm-hmm.

   10. LFLex Fridman25:14

       An economist is University of Chicago, a mathematician is Brown University, whichever, and then, uh, this is also the beginnings, as you've described, of mathematical economics. So, he fits in nicely into this, using (laughs) wha- what did... I think you said the number of equations started going up-

   11. JBJennifer Burns25:35

       Yes.

   12. LFLex Fridman25:35

       ... per paper, which is a really nice way to put it. So, really, the right person at the right time, uh, to try to solve this puzzle of the economy melting down. It's so interesting, just one human. It, it just, from, uh, just zooming in on a, a single human making a decision about life, and it's, it's hard to know when you're in it that the world is melting down from an e- economics perspective, and that I could do something about this to figure out what it is, and also, I'm going to reject the mainstream narrative-

   13. JBJennifer Burns26:09

       Yeah.

   14. LFLex Fridman26:09

       ... about why this happened.

   15. JBJennifer Burns26:11

       Yeah, so, uh, the other piece of the puzzle, when he goes to Rutgers, he thinks he'll be an actuary. So, Milton Friedman's family, his parents are immigrants, Jewish immigrants from Eastern Europe. They're pretty atypical in that they don't stay in New York, you know, and, and they move to Rahway, New Jersey and they put together a fairly middle-class life as kind of, they have a shop, they do some wholesale buying and selling, and then his father dies when he's 16. His life becomes more precarious, um, but it's never as precarious as he makes it out to be. He's got three older sisters. They earn a good living. Incidentally, they, they all have, uh, better grades in high school than he does, but he's the one that goes to college. And, um, but it's actually really important that he loses his father figure because he's then looking for other father figures and he meets two at Rutgers. One is Arthur Burns, who will go on to have a huge influence in his career. No, no relation to me, by the way.

   16. LFLex Fridman27:08

       (laughs)

   17. JBJennifer Burns27:08

       (laughs) But, um, Arthur Burns is like him, a fellow Jewish immigrant boy on the make. He's older, um, and he's making a career as an economist. And then there's Homer Jones, who has gone to the University of Chicago and is studying with Frank Knight at Chicago and says, "You have to go to Chicago." So, he has these two mentors, and, and Burns in particular suggests, "Oh, I could be an economist. That could be my career path." You know, the idea to be an actuary for an insurance company, I'm not sure where he got that idea, but he just thought that was something he could do as someone who was good at math. And so the college really opens th- the perspective, opens the door. Um, and then I think it's really key that, again, he's, he doesn't get, um, he doesn't get an explanation that he buys for the Great Depression, so then he's looking for one. And the math part is really interesting aspect of his career. Now, he actually comes to Chicago to study with a mathematical economist, Henry Schultz, but he gets there and he thinks Schultz is kind of dumb.

   18. LFLex Fridman28:12

       (laughs)

   19. JBJennifer Burns28:12

       He really does.

   20. LFLex Fridman28:13

       Yeah.

   21. JBJennifer Burns28:13

       He's incredibly arrogant and he-

   22. LFLex Fridman28:15

       Oh.

   23. JBJennifer Burns28:15

       ... he just thinks, "This guy's not that smart." And it seems that, I mean, Schultz did some really important work in the early stages of mathematical economics, but a lot of the oral histories about him are like, "Yeah, he wasn't that bright." (laughs) You know?

   24. LFLex Fridman28:27

       Yeah.

   25. JBJennifer Burns28:27

       So, Friedman's-

   26. LFLex Fridman28:28

       Yeah.

   27. JBJennifer Burns28:28

       ... maybe onto something.

   28. LFLex Fridman28:29

       Yeah. Yep.

   29. JBJennifer Burns28:29

       So, he falls into the set of students who are really enthralled with this other professor, Frank Knight, and Frank Knight is against math and economics. Um, Frank Knight is, like, you know, a neoclassical economist, but not a mathematical economist. He's an old-school liberal. He's really concerned about liberal democracy, um, economic liberalism, and, and Friedman is very deeply influenced by Knight. And he continues to pursue mathematical economics, though. He'll go... For part of his graduate career, he goes to Columbia University where he actually gets his PhD from, and he works with a mathematical economist there. And so he comes out trained in what will eventually be econometrics, s- statistics and economics. His early publications are in statistics. But it's not really where his intellectual heart and soul are, and eventually, he will turn very profoundly against mathematics and economics and become a sort of heterodox strain throughout 20th century economics that says simple models are better. Um, we need to work on empirical, work off empirical data, not construct elegant models, and, um, and becomes really sort of countercultural within economics in that way.

   30. LFLex Fridman29:45

       And the test of a good model is it should actually predict stuff that happens.
4. 29:58 – 41:05

   Schools of economic thought

   1. LFLex Fridman29:58

   2. JBJennifer Burns29:59

      Yeah.

   3. LFLex Fridman29:59

      Just the basics. You mentioned neoclassical, we mentioned Keynesian economics, we mentioned, uh, what else did we mention? Well, the Chicago School of Economics.

   4. JBJennifer Burns30:08

      Right.

   5. LFLex Fridman30:08

      Where does, uh, Austrian economics fit into that pile, and Marxian economics, I m- c- and, and can we just, even just linger and try to redefine Keynesian economics and Chicago School of Economics-

   6. JBJennifer Burns30:20

      Yeah.

   7. LFLex Fridman30:20

      ... and neoclassical economics and, um, Austrian economics 'cause they, there's some overlap and-

   8. JBJennifer Burns30:26

      For sure.

   9. LFLex Fridman30:26

      ... some tension.

   10. JBJennifer Burns30:27

       Okay, so-... schools of economics. So we could start with classical economics. Classical economics, we could think of Adam Smith as kind of your classic classical economist, the founder of the discipline. Classical economics does not really use math. It's very close to political economy. It's concerned, um, with, as Smith puts it, the wealth of nations. It's concerned to some degree with distribution. It's concerned to some degree with what makes a good political system. And what tends to really define classical economics when you're looking from a great distance is what's called the labor theory of value. So where does value come from in classical economics? It comes from the labor that a person puts into it. So maybe this in some way is, uh, comes from Locke's notion of property that you kind of mingle, you know, your labor with the natural world. We can say labor theory of value. So classical economics concerned with, um, Smith is arguing against mercantilism for more free trade, um, often goes by the name of political economy to show it's more capacious. It's thinking of politics and economics. Um, you can still read these books today. The sentences are long, the words are different, but you can still follow along. So the real big transition from classical economics and political economy to economics as it's understood today comes with the marginal revolution. And the marginal revolution is a scientific revolution that happens in a couple of different places simultaneously, right? This is one of these things that you see in the history of science, like, you know, there'll be some breakthrough. Like, Darwin has a breakthrough, but like somebody else has sort of the same breakthrough at the same time, even totally, you know, differently. So there's a version of marginalism that's, um, continental. There, you know, there's a version in the German-speaking lands, in Fre- in French-speaking lands, and in Britain, and they all kind of come together. And the shift is in the theory of value. So the theory of value in marginalism is on the margin. So say you have one apple and you want a second one. How much is getting, going from one apple to two apple worth for you? Probably quite a bit. If you had 10 apples, maybe going to 11 apples doesn't matter that much. The marginal value is less. So what marginalism does, though, most importantly is it opens the door to math and economics, because it means you can graph this now. You can depict this relationship graphically. And there's some really interesting work in the history of economics that shows a lot of the people who developed marginalism were looking to physics as a model. Physics, the queen of the sciences. And so they were thinking... They, they imported terms from the natural world to describe the social world through the lens of economics, terms like equilibrium. Um, so the idea being that if you looked at a market, uh, a market would reach equilibrium, um, you know, when everybody has bought and sold all that they want, or the price will settle at an equilibrium price when it's really, the demand and supply are matching up.

   11. LFLex Fridman33:50

       And some of these ideas are things we would pick up at a microeconomics class?

   12. JBJennifer Burns33:55

       Oh, yes. Ex- this is still out there.

   13. LFLex Fridman33:57

       Okay.

   14. JBJennifer Burns33:57

       This is sort of the basic foundation of microeconomics, marginal analysis. And so in the German-speaking intellectual tradition, this is the root of Austrian economics, and people picking up the marginal revolution in the German-speaking lands are opposed to the historicists, um, who are thinking in a more evolutionary way about how societies kind of grow and change, and they have a vision of economic ideas as applying differently to different types of social arrangements. Where the marginalists, remember, are inspired by physics, and this is a set of natural laws that applies anywhere to any s- sort of human society. So that's this first really big fissure that we'll see again and again. Are you historically minded? Do certain traits of economic life, um, inhere, adhere, and become expressed in certain types of societies, or are there universal economic laws that flow through any type of society? So that's kind of a, a juncture, a break. And so marginalism... First, people start using really geometry to kind of graph things, but marginalism is also opening up to the possibility of calculus and the possibility of creating models. But at that point in time, late 19th century, a model is something like a physicist does, like think of like an inclined plane and how fast does a ball roll from one to the other. It's a physical representation of the world, and eventually economists will start to create mathematical representations of the world. But we're not quite there yet. So we're late 19th century and we have this f- we have this fissure, we have this introduction of marginal analysis that marks the, the juncture from classical economics to economics. So let's say now we, we have economics, but we still have this fissure between historical thinking and l- let's call it, you know, nat- natural law thinking. That's not quite right, but physical laws versus contingency. Um, and then in the United States, this ends up mapping onto debates about capitalism, and so more historically minded economists, um, tend to be interested in the progressive movement and which is invested in taming and regulating industrial capitalism and changing its excesses, you know, um, factory safety laws, wage laws, working conditions laws. Um, yet in general, American economists...... all use marginal analysis, just in different ways. The ones who are more drawn to marginal analysis become known as neoclassical e- economists. They're neoclassical, the neo is because they're using marginal analysis, the classical is because they don't think we need to change the way the economy operates or the government operates, they're not progressive. Whereas the progressives are saying things like, "The, we need to use, um, social control, uh, the, the state and the people collectively and democratically need to control, uh, the way economics unfolds and, and make sure things are fair and equal." So that school of thought becomes known as institutional economics in the United States by the 20th century. So it's part of the progressive movement late 19th century, into the 20th century it really becomes institutional economics. And it's quite dominant, and the neoclassical economists are still there but they're very much a minority. And Frank Knight, Milton Friedman's teacher, is one of the minority neoclassical economists, and the institutionalists are much more progressive, um, still.

   15. LFLex Fridman37:38

       Is it fair to say that the neoclassical folks, and even the classical folks, versus the institutional economics folks, it's they have a disagreement about how much government intervention that should be in the economy? So neoclassical is less intervention, and then an institutional, uh, economist, the progressive folks, has more intervention.

   16. JBJennifer Burns37:58

       Yes. Yes, exactly right. So this is the situation in the 1920s but, um, the other piece I should mention is the first generation of progressive economists were very radical, they were to- closely allied with the socialist movement, with labor radicalism, and many of them lost their jobs at universities. This is con- kind of connects to the early, the dawn of academic freedom, this is before academic freedom, and they became, they were chastened, they became much more mainstream. By the time we get to the 1920s, we don't really have radical critiques of society coming from economists. Much smaller profession, much less important than it is today, and fairly peaceful because the 1920s are a fairly peaceful decade in the United States. So this is a situation when the Great Depression hits, and as I mentioned before, the head, the kind of most important institutional economist is Wesley Mitchell and he has said, he's, he's written a whole book on business cycles but he doesn't see this business cycle coming and it hits and he doesn't have a good explanation for it. Now perhaps the preeminent neoclassical economist was Irving Fisher. Now Irving Fisher is big into the stock market and Irving Fisher says sometime in late summer 1929, "Stocks are going ever higher and will continue to go ever higher forever." And so he loses his reputation after the stock market crashed. So, so Milton Friedman is stepping into a field in which the greats have been discredited and there's an enormous economic crisis all around.

   17. LFLex Fridman39:38

       And everybody's struggling to figure out why the crisis happened.

   18. JBJennifer Burns39:42

       Yes, and the other thing he's stepping into is a world where in the United States there's a great deal of anger at capitalism, at the system, unemployed people on the street; in Europe there's rising fascist movements, in Asia there's rising fascist movements. And so everyone's very concerned about this and Friedman is seeing a lot of this through the lens of Frank Knight who feels like we are maybe reaching the end of what he calls liberalism, he calls himself an old-fashioned liberalism, we're reaching the end of representative democratic government because representative democratic government cannot solve these social problems. And it ha- and capitalism as it has developed, Knight is very pro-capitalist but he says it's generating inequality and this is putting too many strains on the system. So Knight will become one of the people who helps Friedman think, "How do I develop a new theory of capitalism that works in an era of mass democracy where people can vote and people can express at the ballot box their unhappiness with what's happening economically?" So this, this larger movement will generate, of which F.A. Hayek is a part, Friedman is a part, that becomes the very early stirrings of trying to think about a new sort of liberalism which will eventually be called neoliberalism.

5. 41:05 – 48:53

   Keynesian economics

   1. LFLex Fridman41:05

      Okay. So if we can just linger on the definitions of things. So we mentioned what neoclassical is and the institutional economics is. What's Keynesian economics? In the Chicago school of economics, I guess, is a branch of neoclassical that's a little bit more empirical versus-

   2. JBJennifer Burns41:25

      Yeah.

   3. LFLex Fridman41:25

      ... maybe model-based? And Keynesian is very model, model-heavy, more intervention of government.

   4. JBJennifer Burns41:31

      Yes.

   5. LFLex Fridman41:31

      And there's a, that's... So the real battle is Keynesian versus everybody else.

   6. JBJennifer Burns41:36

      That is what eventually comes to pass in the United States and in the kind of overall developed, m- kind of developed profession of economics. The other piece of the puzzle here is the introduction of mathematics and it's been around the edges, um, but it will pick up speed in the 1930s, like the Econometrics F- uh, Society is founded, they start publishing, um, people start using more statistical and mathematical tools to think about economics and they're given a boost sort of inadvertently by the rise of Keynesian economics. So, so Keynes is trained in the neoclassical tradition, um, he's a absolutely fascinating figure, he's been there in peace negotiations at Versailles, he basically calls World War II. He's like, "Hey, we're gonna have another war here, uh, caused by Germany because this peace treaty has been, you know, done in such a vindictive way and people have made such bad decisions." He's there, he sees it happening. And so-When, um, the Great Depression unfolds, he basically comes up with a new theory for explaining what's going on. And the previous neoclassical understanding is sort of things go up and things go down, and when they go down there's a natural mechanism to bring them back up. So when the economy's going down, prices are going down, wages are going down, everybody's losing money, but eventually firms are going to realize, "Hey, I can hire people cheap. Hey, I can buy stuff cheap. I don't have a lot of competition, maybe I should get in the game here." And then others will start to get in, and then you regenerate prosperity in that way. And so Keynes says, "Sure, that's one theory, but something different is happening right now." Part of why it's happening is because we have work- the working class is more empowered now. They're not simply going to just take low wages and ride them down to the floor. We might not hit the floor. But also, he says, "People might become too anxious to spend. They might not want to invest." And, you know, Keynes has these discussions of animal spirits, right? He's still enough of a political economist to think not just in terms of human rationality, but what are some other things going on in- in human beings? And people might decide to sit on their money. They might not invest it. And so what happens then is you could get stuck in a bad equilibrium. So in the neoclassical model, the equilibrium kind of restarts and resets itself, and he says, "No, we could get stuck here. We could get stuck in the Depression." And in that case what has to happen, he says, "The government stimulates investment and the government itself invests." And then he argues that, you know, uh, this is a student of his, Richard Kahn, says, you know, as the government invests a dollar, it has, like, a multiplier effect. A dollar spent by the government kind of ramifies out throughout the economy. So it takes the government and puts it in the center, as opposed to, say, the banking system or the financial system, which would be the more Friedman analysis. And for many economists of Friedman's generation... And he's a weird generation 'cause it's- it's the- the generation that becomes dominant is just, like, four years older than they would become Keynesian economics, but that four years is really important because they come into grad school of economics and they get exposed to the new ideas of John Maynard Keynes and they, you know... Pa- I think it's Paul Samuelson calls it, like, it was like a South Sea virus that, (laughs) that attacked all of the young- all of the younger economists immediately succumbed and, like, no one under 50 ever got the disease, right? 'Cause their- their thinking's already set. And so, um, Keynesianism, Keynes himself is very suspicious of math and economics and- and he and Friedman, it's fascinating, one of the first books by Jan Tingerman, a Dutch economist, to use math in economics. It's huge volumes. Volume one, um, Keynes pans it. Volume two, Friedman pans it. So they're- they're in the same page, but what happens is as Keynesianism arrives in the United States, Franklin Roosevelt is not really a Keynesian, he's kind of an- an accidental or experimental Keynesian is- Keynesian? And there's a bunch of different ideas in the United States that- that are very similar to Keynesianism. They're not theorized, but they're similar ideas that the government has to do something. So this all comes together and American economists realize that you can construct models in the Keynesian perspective and if you can use numbers in these models, you can go to Washington DC with numbers and you seem like you have a l- you have a lot more authority. And so math becomes really twinned into Keynesian economics.

   7. LFLex Fridman46:24

      So the numbers are used as a kind of, um, a symbol of expertise. "We- we- we really know what the hell is going on because we have some numbers." Right?

   8. JBJennifer Burns46:32

      Right. And we can create a model-

   9. LFLex Fridman46:34

      (laughs)

   10. JBJennifer Burns46:34

       ...and so we can say, "Okay, in the model, the interest rate is here and taxes are here, so let's play with government spending."

   11. LFLex Fridman46:40

       Right.

   12. JBJennifer Burns46:40

       Let's make it up, let's make it down, and then we can get an estimation. It'll spit out, "Here's predicted GDP." So the other piece of the Keynesian revolution is it really gets people thinking kind of holistically about the economy as, uh, one conceptual unit and you then have what Paul Samuelson will end up calling the neoclassical synthesis, and this is still in economics today. If you take micro, you're gonna get supply and demand, scarcity, marginal analysis. If you take macro, you're gonna get a very different approach and that's more Keynesian-based. And so the idea is that, and this makes sense, I mean, you can think of this from statistics, right? The way things act individually versus when they're all added together can be very different. So- so there's this kind of uneasy peace where economists are using kind of neoclassical tools to analyze individual behavior and individual market behavior and they're shifting to a different paradigm when they think about the economy as a whole. And in this paradigm of the economy as a whole, the federal budget, the taxing and spending power of the federal government become paramount. And that is called the fiscal revolution and that's really the essence of Keynesianism. But the key thing to remember is that Keynesianism and Keynes are different. And there's (laughs) this famous episode where John Maynard Keynes comes to DC and he goes to dinner and he comes back and he says to one of his friends in London, he said, "Oh, yeah, it was really interesting. I was the only non-Keynesian there."

   13. LFLex Fridman48:13

       (laughs)

   14. JBJennifer Burns48:14

       (laughs)

   15. LFLex Fridman48:15

       Yeah.

   16. JBJennifer Burns48:15

       You know?

   17. LFLex Fridman48:16

       Uh, so Keynesianism is more government intervention fiscal policy, so put the government at the center of influencing the economy, and then the different flavors of whether it's Austrian economics or Chicago school of economics is saying, "No, we have to put less government intervention."... and trust the market more. And, and the formulation of that for Milton Friedman is trust the money more. The, the, not trust, but the money supply is the thing that should be focused on.

   18. JBJennifer Burns48:52

       Yes. So,

6. 48:53 – 56:43

   Laissez-faire

   1. JBJennifer Burns48:53

      so the Austrians and the Chicago schools see economic prosperity and growth comes from individual initiative, individual entrepreneurship, kind of private sources. The private market is what drives economic growth, not the public sector. And so for Friedman then, the question is, what is the government's role? And because he's lived through the Great Depression, he's not laissez-faire and he won't ever be laissez-faire. Now interestingly, Hayek living through the Great Depression, at first is laissez-faire and he's like, "Sure, like let it rip." And things get so bad that Hayek's like, "Okay, that's not gonna work." (laughs)

   2. LFLex Fridman49:33

      Can we actually define laissez-faire? So what, what do we mean? Like what's the free market? What's laissez-faire? What's-

   3. JBJennifer Burns49:38

      Yeah. Laisse-

   4. LFLex Fridman49:38

      ... what's the extreme version here?

   5. JBJennifer Burns49:40

      So yeah, laissez-faire means leave it be in France. It's more often used as an insult than as an actual... Um, very few people are completely and totally laissez-fair. That would be like the pure laissez-faire would be the sort of pure, maybe pure anarchist position, like the state does nothing, or the state isn't even there. Um, but it tends to, if I could maybe make it more precise, it would be focused on freedom of contract would be essential. And that means, um, like the, the buyer of labor and the seller of labor must have absolute freedom to contract. So that means no minimum wage law, no working hours law, um, no employment law, things like that. That, that was... And all, this is all pre-progressive movement. A lot of things are that way, right? You, you know, imagine you're in 19th century America and you have a farm and you hire someone to help you on the farm. You offer the money, they take it. If they fall off a ladder and break their back, maybe you help them out, maybe you don't, right? But there's not (laughs) a whole apparatus of legal liability and, and safety and things like that. Um, so that would be one piece. Another piece of laissez-faire would be free trade amongst nations. Um, so no regulation of who can invest in a nation or who can take money out of a nation. So Nippon Steel could come and invest in US steel and there would be no grounds in which to reject that. Um, or you could, as a billionaire in the United States, relocate you and all your money to another country and the United States couldn't try to keep you and, and nobody else could stop you from coming in. Um, and so, and then in the context of economic crisis, laissez-faire would, would not encompass centrally provided relief, because in the pure theory, again, very seldom applied purely, but in the pure theory, the wages need to come down far enough and people need to be desperate enough to start taking work and to start the machine again. So the theory would be if you give people relief, they might not go back to work. Now, almost nobody says that in the Great Depression because the situation is so bad and it's, it's, uh, you know, people are starving on the street and people feel, uh, for humanitarian and ethical reasons, it's not okay to say that. The Austrians though at first, Hayek and Lionel Robbins, are like, "This is a business cycle and it needs to run its course, and it will be detrimental if we intervene." And then pretty soon, Hayek has to change his tune.

   6. LFLex Fridman52:18

      So the Austrians are the most hardcore in terms of laissez-faire.

   7. JBJennifer Burns52:21

      Absolutely.

   8. LFLex Fridman52:22

      Yeah.

   9. JBJennifer Burns52:22

      And so Hayek will make the turn towards accepting more of a state and then will come to talk about how the state needs to support what he calls a competitive order. But his mentor, Ludwig von Mises, still remains very hardcore and is not, um, really open to things like unemployment insurance or, um, other, other state-based interventions.

   10. LFLex Fridman52:46

       What does von Mises say about like human suffering that's witnessed in the Great Depression, for example? Like, uh, what are we supposed to, as economists, as humans that define policy, what are we supposed to s- see when people are s- like suffering at scale?

   11. JBJennifer Burns53:01

       Yeah, I wish I knew an answer to that question. I don't know enough about von Mises and, and his reaction in the Great Depression. I think I would hazard that he would look more to the, down the road and say, "Well, if you start here, you're going to go places that are, are bad." But I, I don't, I don't factually know what he said in response. I do know that Hayek's position doesn't last very long. It's not, it, it's not a position you can hold to. Maybe you could hold to it in other cycles. The other thing that was interesting is I found very few Americans, um, saying this. Uh, most who were, were kind of small town electeds or the most famous is Andrew Mellon, quoted by Herbert Hoover. So, so not directly. Uh, we don't have him on record saying this, but apparently Hoover records in his memoirs that Mellon said something like, "Liquidate real estate, liquidate stocks, you know, purge the rottenness out of the system. People will live a healthier life." And certainly there were members of the Federal Reserve who felt like it would create, they didn't say moral hazard, but it would create what we now call moral hazard, bad habits, were we to intervene and to save failing banks, because failing banks need to be taught a lesson. They need to be taught discipline. And so a lot of people, I think, saw it in the context of discipline. This is discipline. And if you remove the discipline, um, you'll be taking away something fundamental in society.

   12. LFLex Fridman54:34

       So Milton Friedman never quite went all the way to laissez-faire?

   13. JBJennifer Burns54:38

       No. No, he didn't see that. And what's really interesting is-... the number of incredibly radical proposals that he and his teachers were floating. So I've mentioned Frank Knight. Another really important influence on Friedman was Henry Simons, who was (laughs) a junior professor at Chicago. And Simons had this idea for what he called 100% money, which would be a law that says, "Banks have to hold 100% of the deposits they receive. They can't loan them out on the margin." So this would completely and totally have overhauled the US banking system, and he would have said, "There's a category of things called banks where you get deposits, and then there's going to be a category of sort of..." he didn't say investment banks, but investment vehicles that will invest. So similar to what did happen in some ways in the banking reforms, in that in the 1930s, the, the investment banks were split from the deposit banks, and the banks that took deposits were much more highly regulated, and they were supported by the FDIC. But the point being, the Chicago School had these very radical proposals for reform, go off the gold standard, um, you know, restrict the currency, you know, change the banks, um, immediately r- relief payments now. What is important to note though is that they thought of all of those as emergency measures to get through the emergency, not as permanent alterations in the state of, of what had to be and not permanent alterations between state and market. Where the Keynesian assumption is things have changed, times have changed, we're in a new dispensation, and we need a new relationship. So Friedman is very, uh, Milton Friedman is very open to doing things differently in a state of emergency. He will have different ideas during World War II than any other time, and that's why I argue I think he would have been supportive of at least the first rounds of coronavirus relief, because I think he would have put his emergency thinking hat on. So in that way, he was definitely more flexible.

7. 56:43 – 1:02:01

   Friedrich Hayek

   1. JBJennifer Burns56:43

   2. LFLex Fridman56:43

      You mentioned Hayek. Who is this guy? What's his relationship to Milton Friedman in the space of ideas and in the context of the Great Depression? Can we talk about that a little bit?

   3. JBJennifer Burns56:55

      Sure. So F.A. Hayek is an Austrian economist who takes up a posting in London, and, you know, he's, he's in, uh, a mentor, uh, a mentee rather of Ludogore Mises. He's writing about business cycles, um, Austrian capital theory, and the Depression hits, and he's one of the few, you know, economists who, in the beginning, really is not calling for much intervention. Although as he realizes how politically unpalatable that is, he will develop a more softened version of Austrian economics that has room for a whole range of social services. What's significant about Hayek is that he is also watching what's happening in Austria, what's happening in Germany, and he's really worried the same thing is going to happen to the Western democracies, and he sees the root cause of this is socialism, the shift towards an expanded role for government, which we've been talking about. It's happening in the United States. It's also happening in Britain. And so he writes this book that becomes incredibly famous, The Road to Serfdom, basically saying taking these steps towards a, a, a planned economy or an economy that's a modified form of capitalism is going to, could, he's very clear that this is not an inevitability, but if, uh, the same steps are taken, and people follow the same line of thinking, we may end up in a sort of coercive, um, totalitarian state. So this becomes enormously popular in the United States. First of all, he's in good touch with Friedman's teachers even before this book comes out. They see them as kindred spirits. Frank Knight is in touch with him. Henry Simons is in touch with him. They all see themselves as liberals. They call themselves old-fashioned, unreconstructed liberals. And so even before he becomes famous, Hayek will be trying to kind of organize thinkers and intellectuals who he believes shares his values of what we would call today classical liberalism and to kind of create a counter-consensus to the one that's gathering. Now Hayek also chooses not to argue against Keynes, and he feels that this is a huge missed opportunity, that he should have staked out the case against Keynes, and that because he did not, people come to believe there is no case against Keynes. Keynes is literally unanswerable. So Hayek will have this great regret. He will channel some of his regrets into sort of community building, specifically developing the Mont Pelerin Society, um, and it will fall to Friedman to really make that case against Keynes. But Hayek will end up at Chicago, and Hayek really influences Friedman to think about what Hayek calls the competitive order and how the state can and must maintain a competitive order, that is, the system of laws, of norms, of practices, that makes it possible for markets to function. And this is one of these key differentiators between the older philosophy of laissez-faire and the newer reconceptualization of liberalism, which says, "Yes, we need a state. We need a state that's not intervening in markets under social democratic auspices, but is structuring and supporting markets so that they can function with maximum freedom, keeping in mind that if there aren't basic social supports needed, the market is apt to generate the type of either inequality or social instability that will call the whole system into question." So Hayek is really key in promoting this modified liberalism. But from being a very prominent economist in the 1920s and 1930s, as mathematics becomes the language of econ- economics, Hayek is completely left out in the cold. Now Friedman, to some degree, is left out in the cold, but Friedman at least has proved to the mathematical economists that he knows what they're up to, and he's rejecting it from a position of expertise and knowledge.... and he literally drives the mathematical economists out of Chicago. They're clustered in a group called the Cowles Commission, and he makes their life hell. They, they, they have to, they flee. They flee the Friedman onslaught.

   4. NANarrator1:01:09

      (laughs)

   5. JBJennifer Burns1:01:10

      But then when Hayek arrives at the University of Chicago, he would like to be considered for a position in the economics department, and Friedman, Milton Friedman says, "No way. You're not really an economist because you're not empirical, because you just develop these theories." So, so he has an appreciation for Hayek as a social thinker, but not as an economist. So what Friedman decides to do, his answer to Keynes will be deeply empirical, but it will also be theoretical and it will create an alternative intellectual world and approach for economists who aren't satisfied with Keynesianism. And almost single-handedly, Friedman will introduce sort of political and ideological diversity into the field of economics, because from his beachhead in Chicago, he will develop the theory of monetarism.

8. 1:02:01 – 1:16:46

   Money and monetarism

   1. JBJennifer Burns1:02:02

      So what is monetarism? The easy way to summarize it is this famous dictum of, of Milton Friedman's, "Inflation is always and everywhere a monetary phenomenon." And it's fascinating that he becomes an expert in inflation, because the first research and the first major research product of monetarism is that theory of the Great Depression in A Monetary History of the United States, and that is a theory of a deflation, all prices going down. And he will go back to an idea that Irving Fisher had popularized, but a very old idea, almost a truism, the quantity theory of money, which says the level of the price level is related to the amount of money circulating in an economy. So if you have more money, prices go up. If you have less money, prices go down. Now this seems like very basic and almost too basic to bear repeating, but Friedman is saying this very basic relationship holds true even in an advanced industrial economy, and that is what people have started to doubt. And if you think about money, you think about banks, you don't think necessarily about the federal budget, spending, and taxation. And what you see happens in American economics, the textbooks previous to the Keynesian revolution, they spent a lot of time on money, they spent a lot of time on interest rates. You can count, you can do word counts and, and other scholars have done the word counts. And the word count for money after World War II just plummets, and you start seeing things like taxation, budget, those things go up. So that, the, what happens is the, the economics profession shifts its attention. It just looks away from money to other things, and Friedman is one of the few who's saying, "No, money still matters. Money still counts." And it's a very counterintuitive argument to make. It's a very historical argument to make, and this is absolutely fascinating to me. With Anna Schwartz, he develops this 150-year timeframe. He also has students working on episodes of hyperinflation in different periods of time. He's also looking back to, like, ancient history, inflationary episodes there. And he's saying this is, uh, this is a law of economics. This is something that recurs throughout time. It's not historical, right? It's not contingent. It's a law of economics. And, you know, his Keynesian counterpoints are saying, "No, that's not relevant any longer." Maybe once it was relevant, but it's not relevant today. Now in some ways they have a point because the, in order to pay for World War II, the federal government sells a lot of bonds. It issues a lot of debt. And it wants to pay this debt back at a low interest rate and it wants people to keep buying it. It wants the low interest rate to be competitive with other interest rates. So it wants, in general, low interest rates throughout the economy. And the Federal Reserve has been so discredited by the Great Depression that the Treasury basically runs the Federal Reserve and says, "Keep interest rates low." And so that's what it's doing, and so the Federal Reserve has stopped being an independent entity. It's, it's just a sub, sort of department of the Treasury. But in 1951, they negotiate what's called the Treasury-Fed Accord, and the Federal Reserve gets its independence, but it doesn't really use it. But statutorily, it now has it. And so most economists are just observing a regime in which the Federal Reserve has no power, a regime in which there is really little inflation. The inflation that is seen is post, there's a little burst of inflation in the Korean War. Um, and they're saying inflation's not really important, it's not really relevant, and money's not really relevant and important. And so to break through and to make the argument, that's why Friedman and Schwartz go to history and they're able to make that argument for history. So then Friedman is coming out with a variety of papers that are saying, you know, "When I look at economic fluctuations," he maps them side by side of fluctuations in the money supply and says, "Look, they fit." And other economists, remember, they're building complicated mathematical models and Friedman's doing extremely simple stuff, and they just think it's dumb, it's not interesting, it's not true. They just, they don't buy it at all. And so, um, but after A Monetary History of the United States, they have to pay attention. So it's really in those years Friedman is hammering this idea of monetarism and it starts to become something respectable, bordering on respectable for other economists to look to and think about. And that's really the beginning of a kind of Keynesian-monetarist split, where if you start to give Friedman any credence, you're heading towards a monetarist position. Now, at the same time...Freeman comes out very publicly in 1964 as a supporter of Barry Goldwater, and Keynesian economics has found a home in the Democratic Party. Its probably brightest moment in the sun is the administration of John F. Kennedy, who brings in a lot of Harvard and Yale professors to the Council of Economic Advisors. He proposes a series of spending programs that are really guided by the Keynesian philosophy. And Barry Goldwater is tremendously controversial, part for his votes against civil rights, which Friedman really supports, in part because he's a hardcore libertarian in an age when that's not in the political mainstream or not discussed in the political mainstream. And I mean, he's just tremendously unpopular, particularly in all the educated precincts where Friedman lived. So Friedman is, like, an outcast and a pariah for his support of Goldwater. And so that actually really affects monetarism because people feel that this is now becoming a package deal, and so there's a great reluctance to embrace Friedman's ideas because it seems like you would then have to embrace his politics.

   2. LFLex Fridman1:08:08

      Ah. So it's associated with, with conservatism?

   3. JBJennifer Burns1:08:12

      So this is the years when conservatism, there is a movement that calls itself conservatism, and Friedman is very tightly allied with this movement from the beginning, partly through his friendship with William F. Buckley. And a lot of people say to me, "Yeah, but Friedman's not conservative." And this is, like, a bigger, we could have a whole separate podcast on this.

   4. LFLex Fridman1:08:33

      Mm-hmm.

   5. JBJennifer Burns1:08:34

      But for now I'll just say that conservative in the United States becomes a political brand that contains elements of conservatism that are recognizable across time and space, embrace of tradition, more comfort with hierarchy, et cetera, and it also has something new and different, which is Friedman's ideas about Milton Friedman's advocacy of more free markets, less government regulation, and the benefits of capitalism, and the benefits of freedom. And that gets folded into American conservatism in part because Milton Friedman is such a powerful intellectual figure. And after his advocacy of Goldwater, the media realizes, "This guy is really smart. He has really interesting things to say. He makes great copy. He makes a great guest." And he starts writing a column for Newsweek Magazine, which is a very big deal in a much more consolidated media environment. And he's quoted in all the newspapers, and so his public profile really starts to rise right as he's pushing monetarism as an alternative to the Keynesian synthesis.

   6. LFLex Fridman1:09:38

      Can we just linger on, what is monetarism? So-

   7. JBJennifer Burns1:09:42

      Yes. Okay, I didn't-

   8. LFLex Fridman1:09:43

      Like, once, once again-

   9. JBJennifer Burns1:09:44

      ... I didn't give into it.

   10. LFLex Fridman1:09:44

       So, like, what... (laughs) Okay, the money supply.

   11. JBJennifer Burns1:09:47

       Yes.

   12. LFLex Fridman1:09:47

       So money is this thing that can... Think of it a no- like a, like a no- notion where people buy and sell stuff, and there's this fascinating complex dynamical system of people, um, contracting with each other in this beautiful way. I mean, there's so many pothead questions I want to ask here-

   13. JBJennifer Burns1:10:06

       Yeah, yeah.

   14. LFLex Fridman1:10:06

       ... about, about (laughs) the nature of money. I mean, money is fascinating in that way, and for, I think for, for Milton Friedman, uh, trusting the, the, the flow of money is really important.

   15. JBJennifer Burns1:10:18

       Yeah.

   16. LFLex Fridman1:10:18

       And th- the signals that pricing and money in general provides is, is, uh, really important.

   17. JBJennifer Burns1:10:25

       So, yeah. And some of this, uh, uh, I could take some of this back again to Frank Knight. So one thing Frank Knight said to all his students was, "The market is the best allocation mechanism we have."

   18. LFLex Fridman1:10:38

       Mm-hmm.

   19. JBJennifer Burns1:10:38

       The market is what allocates resources in a situation of scarcity. The market allocates them the best. And Hayek will add to that by saying, "Prices are information signals, and a price sends information to buyers and sellers about how they should act." And these are the, two of the strongest arguments for why the government should not intervene in the price system, because it will blur information or because it will allocate less efficiently than market allocation will. And so what Friedman is really gonna add to that is maybe going up a level and thinking in the macro about the whole economy and how money circulates through that economy as a whole. And so what he and Anna Schwartz do is they construct what are called monetary aggregates. This is adding together, say, all the money that's on deposit in banks and all the money that's believed to be circulating in people's wallets. And you also have to really go back in time. You know, we don't have credit cards. Um, there is a stock market, but it's tiny in terms of the number of people who invest. There aren't mutual funds. Uh, you know, like, when traveler's checks are introduced, this is, like, a big deal. Um, so we have a much, a very simple monetary system. And so, um, Schwartz and F- and Milton Friedman start measuring what they call the monetary aggregates. They focus on M1 and M2, and their favorite aggregate is M2, which I believe is encompassing sort of deposits and circulating medium. The other thing to recall, I- i- there's some fine distinctions between, um, uh, money in savings accounts and money in checkings accounts. And money in savings accounts can earn interest and is generally believed not to circulate, where money in checking accounts does not at that time bear interest and cannot legally bear interest and so is thought of as circulating. And then there's different institutional architectures of postal savings banks and credit unions. So, but Friedman is, one, taking the focus to these aggregate amounts of money and saying, um, "These really have a lot to do with economic booms and busts." When we have-... an expansion in the amount of available money, we see an expansion in economic activity. When we have a contraction in available money, we have a contraction. And so he says, at this stage, the government, through the mechanism of the Federal Reserve and its influence on interest rates, can either make money more cheaply available and more freely available in the economy or can make money more expensive and slow things down. But the, the central core idea of monetarism is this is potentially very bad. If the government can hit the gas and then hit the brake and hit the gas and hit the brake based on, say, what a politician wants or what somebody at the Federal Reserve wants, you have a lot of instability in the system. And so one of the core policy proposals of monetarism is, let's grow the money supply at a steady rate. And in the beginning, Friedman just says, "K percent." He doesn't even put a number on it because he says a number doesn't matter. What matters is the steadiness in the growth rate. Because if it's a steady growth rate, it will fade away and then people will make economic decisions based on the fundamentals, not based on what they think is gonna happen, not based on hedging against inflation or hedging against deflation. They'll just be able to function. So this is sort of the paradox of monetary policy. When it's happening right, you don't see it, you don't notice it. When it's happening wrong, Friedman argues, it can just fundamentally destabilize everything. It can cause the Great Depression, can cause an artificial boom. And so he's taking monetary policy at a time when most economists think it's completely irrelevant and saying, "This is the central game of the economy." Now we live in a world where we believe this and the Federal Reserve Chair can't open their mouth without headlines being generated. But Friedman is saying this at a time when the Federal Reserve is like a mysterious and secretive organization. It's not well known. It's not deeply appreciated. Some of the only people who appreciate the Fed's power are, like, hardcore rural populists, um, who have constituents, you know, who think the banks and money power are the problem, who are, like, you know, throwbacks from the frontier days. So Friedman, in the beginning, has no constituency for this policy. He has no constituency for this analysis. And so just going back to summarize monetarism, it's looking, it's using the quantity theory of money to analyze the macro economy. It's proposing a policy of slow and steady growth in the money supply, and then it is arguing that inflationary episodes, when they emerge, are profoundly driven by changes in the money supply, not by anything else.

   20. LFLex Fridman1:16:06

       I mean, and going even up a level as we started, how epic is it to, uh, develop this idea, to hold this idea, and then to convince the United States of this idea that money matters? Uh, that today we believe is mostly correct, uh, for now. (laughs)

   21. JBJennifer Burns1:16:30

       Yeah.

   22. LFLex Fridman1:16:31

       And so, like, just this idea that goes against the experts and then eventually wins out and drives so much of the economy, the biggest, the most powerful economy in the world. So fascinating.

   23. JBJennifer Burns1:16:43

       Yeah. So, I mean, that's a fascinating story,

9. 1:16:46 – 1:21:39

   Stagflation

   1. JBJennifer Burns1:16:46

      and so what happens is Friedman has advanced all these ideas. He's roiled the economics profession, he's built a political profile, and then he becomes the head of the American Economics Association and he is asked in that role to give a presidential address. And so he gives this presidential address December 1967 and he says, um, "I'm gonna talk about inflation and I'm gonna talk about the trade-off between inflation and unemployment." And this is what's generally known as the Phillips Curve. And the Phillips Curve in its original form is derived of post-World War II data. So it's derived of about 12 years of data and it shows that when inflation goes up, unemployment goes down. And the idea, m- you know, would make sense that as the economy is heating up and lots of things are happening, more and more people are getting hired. And so this relationship has led policymakers to think that sometimes inflation is good, and if you want to lower unemployment you could let inflation kind of go a little bit. And in the crude forms it becomes to seem like a menu. Like, you could take your model and you could plug in, "I want this much unemployment," and then it would say, "Well, great, this is how much inflation you should do." And so then you would target that inflation rate. So Friedman gets up and he says, "This is wrong. This might work in the short term, but it's not gonna work in the long term because in the long term, inflation has... First of all, it has a momentum of its own." Once it gets going, it tends to build on itself. The accelerationist thesis. It accelerates. And once inflation gets going, it... And the reason it gets going is because, um, you know, workers go to the store and they see the price level has gone up. Things have cost more. They ask for the wages to go up. Then, um, you know, people... Eventually the wages will go up too high and they will no longer be hireable or companies will decide, "At these high wages, I can't hire as many workers. I'd better lay off." So if inflation keeps going, eventually over the long term, it will result in high unemployment. So he says theoretically you could end up in a situation where you have-... high inflation and high unemployment. This hasn't been seen, but he says theoretically this could happen, and then he goes and he says, "And the government has started expanding the money supply. It started expanding the money supply in 1966. So we're going to get a bunch of inflation, and then we're going to get a bunch of unemployment." And he s- he estimates about how long it will take, and then he says, "Once this all happens, it will take about 20 years to get back to normal." And-

   2. LFLex Fridman1:19:33

      And he predicts the stagflation of the 1970s.

   3. JBJennifer Burns1:19:37

      Stagflation of the 1970s.

   4. LFLex Fridman1:19:38

      How gangster is that for an economist to do that?

   5. JBJennifer Burns1:19:41

      (laughs)

   6. LFLex Fridman1:19:41

      Again, against the, the mainstream belief represented by the Phillips Curve.

   7. JBJennifer Burns1:19:47

      Yeah, and what's really, what really makes it happen is that many of the economists who most deeply dislike Friedman and most deeply dislike his politics in the 1970s as, as they're running their models, they start to say Friedman's right. They start to see in the data that he's right. And a very parallel process happens in Britain. Britain is going through a very similar sort of burst of spending, burst of inflation. And so Friedman is vindicated in this very profound way, in the way that he himself said would be the ultimate vindication, which is my theory should predict. So that prediction of stagflation is really this sort of final breakthrough of his ideas and also, you know, their importance to policy, um, and to thinking about how we should intervene or not in the economy and what the role of the Federal Reserve is, because he's saying the Federal Reserve is incredibly powerful. And finally people start to believe him.

   8. LFLex Fridman1:20:43

      And I don't know if we said but to, to make clear, stagflation means high unemployment and high inflation, which is a thing, like you mentioned, has not, was not seen before.

   9. JBJennifer Burns1:20:54

      Yeah.

   10. LFLex Fridman1:20:54

       And he predicted it accurately. And it also disproves the sort of, the, the relationship, the inverse relationship between, um, unemployment and inflation.

   11. JBJennifer Burns1:21:05

       Yeah. No, I should say, the Phillips Curve is still out there. It's been expectations-augmented and it is relevant in the short term, but Friedman's warning is still very much apt, that if you get too focused on unemployment, you can let inflation out of the bag. And so until very recently, the Federal Reserve's tradition has been focusing on inflation, believing that's fundamental and that will keep unemployment low, rather than trying to lower unemployment at the cost of raising inflation.

10. 1:21:39 – 1:25:35

    Moral case for capitalism

    1. JBJennifer Burns1:21:39

    2. LFLex Fridman1:21:39

       Can we go back to, uh, Frank Knight and the big picture thing we started with, which is the justification of capitalism?

    3. JBJennifer Burns1:21:46

       Yes.

    4. LFLex Fridman1:21:46

       So as you mentioned, Milton Friedman searched for a moral justification of capitalism. Frank Knight was, um, a big influence on Milton Friedman and including on this topic of understanding the moral justification of capitalism. I, I think you spoke about Knight's case for capitalism was grounded in the idea that the ability to act in the face of uncertainty creates profit, and it should because taking risks should be rewarded. So, like, this idea that taking risks in the face of uncertainty should create profit, and that becomes a justification that it, the, the ethics of capitalism. Can you just speak to that?

    5. JBJennifer Burns1:22:26

       Yeah. So Knight is talking about where does profit come from, and to his mind it comes from the entrepreneurial function and the risk-taking function. And so he kind of weaves that into why, you know, capitalism works, "works" best and why it's the most effective allocation machine and why it, it assigns responsibility in a way he believes that a, a socialist system never could. Now, Knight, though, is not a booster of capitalism. It could be in part because he's just a darkly pessimistic, kind of depressive guy. And so he's afraid that capitalism is going to collapse and socialism or fascism is going to take over, or communism. And so he kind of descends into darkness there. Friedman, as, as the more optimist, believes with Hayek that you can develop a different approach to capitalism that would preserve the price system, preserve allocation, but build in social supports, build in a social minimum, things like this. But there's a moment in his career where he's really struggling to figure out, like, "How do I make this case for capitalism?" And basically, uh, the whole sort of conservative movement, or people who we later call the conservative movement, are struggling to make this case. And he starts thinking about what makes capitalism work is that if you put forth effort, you get a reward. So then you could say, "Well, people get what they deserve under capitalism." But then he kind of stops and he says, "That's not really true because we're born with such different endowments and there's a huge quotient of luck, right? So some people are just in the right position and some people aren't. So if I say capitalism is moral because people get what they deserve, that's not really true." And he also kind of has, like, a, an ethical reaction, which he ends up calling, like, an aesthetic reaction. He's, he's kind of like, "It just doesn't feel right to say that." Mm-hmm.

    6. LFLex Fridman1:24:16

       And so he struggles for a while with, like, "What do I say?" And then he basically says, "Capitalism, it can't be the core. Discipline of the market can't be the core to your ethics. It has to be something else." So that's when he will decide it's freedom, it's individual freedom that's really the ethical core, and capitalism makes individual freedom possible because capitalism is dedicated to maximizing that. And so the defense of capitalism comes through freedom, and at his stage in history, he's able to set aside Knight's worry about inequality and say, "When I look at the data," and this is true for the, the macro data at mid-century, "incomes are actually converging," right? And it, also if you look historically, if a country goes from, say, a more, uh, feudal agrarian society to a more market-based society, incomes will converge. Now, then they might start to diverge, but Friedman's in the moment when he's seeing the convergence, and so that's what he's really focused on. So he believes...

    7. JBJennifer Burns1:25:15

       He can justify capitalism through the ethic of freedom, and he also believes that inequality, um, is a problem that can be addressed through specific policies, and it's not a fundamental feature of capitalism. In other words, he doesn't see capitalism as an engine of inequality they way that Frank Knight did, and the way that, you know, maybe some critics

11. 1:25:35 – 1:30:34

    Freedom

    1. JBJennifer Burns1:25:35

       on the left would.

    2. LFLex Fridman1:25:36

       How did he conceive of freedom? So individual freedom, economic freedom, political freedom, civil freedom. What was the tension, the dynamic between those different freedoms for him?

    3. JBJennifer Burns1:25:47

       So he really begins focusing on economic freedom, and he says it's really important to focus on economic freedom because in the United States we don't value it enough. So by economic freedom, he means the ability to, um, keep what you've earned, um, the ability to make decisions about your business, the, the ability to make decisions about the work that you do. So this will translate into things like, um, there shouldn't be a minimum wage. He believes the minimum wage has bad social effects, but he also believes you should be free to accept a job at a wage that you yourself have determined is acceptable to you. Um, and there should be very minimal regulation, questions around safety and other things, because the market will ultimately, if you create an unsafe product, it won't sell, and that will be... that's sort of your incentive. So, so he, he really centers economic freedom because he thinks especially, and he's really speaking from his vantage point in the universities and speaking to the kind of liberal consensus of the '50s and '60s, he thinks economic freedom has been undervalued in the American context. So he really wants to push that forward. He's really kind of taking political freedom for granted. Now later in his career when he becomes famous, he's traveling the world, he spends time in Chile, and this country is now being ruled by a dictator, uh, Augusto Pinochet, who starts introducing economic freedom, but there's no political freedom. And Milton Friedman believes eventually these two things are gonna go together, and tells Pinochet, "You've got economic freedom, and eventually it's gonna bring, it's gonna mean political freedom." Pinochet's like, "Okay, fine, not really interested in that. I wanna know what I should do about inflation."

    4. LFLex Fridman1:27:23

       (laughs)

    5. JBJennifer Burns1:27:23

       (laughs) But then when Milton Friedman leaves Chile, he is attacked and vilified for having been a supporter. Okay? He's, it's interpreted that he's a supporter of the regime, which he's not, but he realizes he has talked too much about economic freedom, and he hasn't talked enough about political freedom. He's kind of assumed political freedom because he's come from the American context. So then he starts recalibrating them and saying, "You know what? If you don't have political freedom, you're never gonna be able to hold onto economic freedom." So he sees that they need to go together, and they don't naturally go together, and so he starts to become more clear in talking about political freedom. Now let's fast-forward to the end of his life, and he's witnessing the emergence of what we call the Asian tiger, so capitalist economies that are doing very well, but they don't have political freedom. But then he observes they don't have political freedom in that you can't vote in a free and fair election, but they also don't have a Stasi. They don't have a KGB. They're not, you know, hauling people off for their wrong opinions. So then he says they have something called civic freedom, and so he kind of defines this third sphere, civic freedom of, you know, debate, discussion, interpersonal relations, but you can't be political. So, uh, this is a late-in-life addition. I don't think it's fully theorized. I think what it shows is that during the Cold War, he very much believed economic and political freedom, you know, capitalism and freedom, democracy, the United States, capitalism, this all went together. And he starts to see at the end of his life the emergence of different social systems that are using market trading and allocation but aren't giving people similar freedoms, and he's kind of puzzling over that. Now he always believes that China will democratize, and he thinks China's on the path to democratization, in part because Chile does democratize. E- eventually Pinochet is voted out, and it's become a democratic capitalist and very prosperous country. And he thinks that's exactly what's happening in China. He sees Tiananmen, and he doesn't live long enough to get to where we are now, in which doesn't look like political or civic freedom is coming to China anytime soon.

Episode duration: 3:54:13