Tuesday, June 2, 2009

There's a real distinction between being in favor of free markets and being in favor of whatever business does


The Suicidal Impulse of the Business Community

November 21, 1998, San Jose, California

Luncheon Address of Dr. Milton Friedman, Nobel Laureate, Economics

Unedited Transcript

"The Suicidal Impulse of the Business Community"

Dr. Milton Friedman: When Ed Crane some time back asked me if I would talk at this occasion, I was uncertain what I should talk about. But as it happens, just at that time, about that time, there developed the idea that there was going to be a suit against Microsoft on antitrust grounds. And that led me to believe that what I could do most usefully was to recycle a talk that I gave some nine years ago to the National Association of Business Economists on the suicidal impulse of the business community. Because it seemed to me that this was such a clear case in which that suicidal impulse is being demonstrated. I first thought of retitling it "The Suicidal Impulse of Silicon Valley," but I decided that was wrong because Silicon Valley is only one example of many and the more general title is more appropriate.

There's a widespread belief and common conception that somehow or other business and economics are the same, that those people who are in favor of a free market are also in favor of everything that big business does. And those of us who have defended a free market have, over a long period of time, become accustomed to being called apologists for big business. But nothing could be farther from the truth. There's a real distinction between being in favor of free markets and being in favor of whatever business does. Those don't go together at all and that distinction was recognized from the very beginning of economics as a science.

The talk I gave at the National Association of Business Economists was entitled the "Adam Smith Address." And I started by referring to two famous statements from Adam Smith that all of you have heard, but that are highly relevant. "People of the same trade," Adam Smith wrote, "seldom meet together even for merriment and diversion but the conversation ends in a conspiracy against the public." Another statement of his which was highly relevant to all the talk about the social responsibility of business: quote, "I have never known much good done by those who profess to trade for the public good."

As a believer in the pursuit of self-interest in a competitive capitalist system, I am not going to bash business for not being socially responsible. I can't blame a businessman who goes to Washington and tries to get special privileges for his company. That's his business. He has been hired by his stockholders, as it were, to make as much money for them as he can within the rules of the game. And if the rules of the game are to that you go to Washington to get a special privilege, I can't blame them for doing that. I'm going to blame the rest of us for being so stupid and foolish as to let them get away with it.

So that's not what I'm talking about. My complaint is very different. I maintain that in their political activities, both individual businessmen and their organizations often take positions which are not in their own self-interest, but which have the effect of undermining the support for free private enterprise.

Businessmen in this respect tend to be schizophrenic. Businessmen, of whom there are many in this room I know, when it comes to your own business are looking a long time ahead, you're thinking of what the business is going to be like 5 to 10 years from now. You're making plans for them. But when businessmen get into the public sphere, and start going into the problem of politics, they tend to be very short sighted. They tend to look a year ahead, two years ahead at the most. They are not quite as short-sighted as they are in Washington where you look 10 minutes ahead, but they are easily as short sighted as they are in Washington, where they look at most two years ahead.

I have two tasks in presenting that thesis to you. The first task is to demonstrate its accuracy, and I will do that by example. But the second task is a much harder one, and I cannot succeed because I don't know the answer. The second task is, why do businessmen behave that way? Why is it that they are not more sensitive and more sophisticated in presenting public issues?

So let me start with examples. The most obvious example is protectionism. Can you name any major American industry that has really been benefited by tariffs and protection? And this goes back to the very beginning of our country. Alexander Hamilton, in his famous report on manufacturers, praised Adam Smith to the sky while at the same time arguing that Adam Smith wasn't applicable to the United States because the United States was a special case and it had an infant industry that needed to be protected, namely steel.

Steel is still being protected as an infant industry, 200 years later. And has steel been benefited by being protected as an infant industry? Very hard to see how. It might be, that if it had not been protected as an infant industry it would not be quite as big. But the people would be employed elsewhere producing goods of more value and of more use.

Or take a more recent example. One of the few economic mistakes President Reagan made was to approve of the so-called voluntary import quota on Japanese cars, under pressure from the big three American manufacturers. Who benefited from that? The Japanese industry. We enforced the cartel for them. They were able to get higher prices than they otherwise could. They were able to accumulate capital than they otherwise would. In the long run, the automobile industry had to meet the competition from Japan. They would have been better off if they had stuck to their earlier free market guns, because when the automobile industry was predominately an export industry, it was among the strongest supporters of free trade. However, where people stand depends on where they sit. And when they became subject to import competition, they changed their position and came out in favor of protection.

Go back, I want to make one more point about the steel industry. That has come up again very recently, right now as you know. The steel industry is pressuring, by saying they are being flooded by steel as a result of the Far East crisis. You can understand the steel companies making that argument. But how is it that the business organizations, the National Association of Manufacturers, the Chambers of Commerce, how come they support the argument? Because surely, the industries that use steel, are hurt by such measures and such protection. And those industries ought to be arguing the free trade position, not the protectionist position. And yet you very seldom see any move on the part of the business community toward promoting free trade.

Let me give some other examples. I am going to take you back to an old case but a very important one. The time of the New Deal. Franklin Delano Roosevelt is in power. He proposes an undistributed profits tax. He proposes that there be a tax imposed on that part of business profits which is not distributed to their stockholders. The business community fought it like the devil and they finally got it defeated. And of course, in my opinion, they were following a policy that was against their own interest. If instead they had said, "instead of doing that, what we propose is something different. We propose that a corporation which does not distribute all its income be required to attribute to its stockholders the undistributed income. And then you can abolish the corporate tax, and impose whatever tax you want to on the individual." That would have been a far more enlightened approach than simply to oppose a corporate income tax, simply to oppose the undistributed profit tax. It would have enabled them to plow back earnings, provided that they had higher returns that way than their stockholders could get by investing the dividends.

You have another tax problem where the business community has been short-sighted all along, and that is with respect to capital gains. The business community has consistently fought for lower capital gains taxes. That is a good, right thing. I'm in favor of abolishing the capital gains tax. However, tactically, it would have been far more important to index the base for capital gains. And yet the business community never made a serious effort to promote indexing of the base for capital gains which would have done far more good.

Another example. Commercial banking. At the end of World War II, commercial banking accounted for roughly half of the total debt credit of the country, half of the capital market. Today it accounts for about one-fifth. Why has it deteriorated? Why is it that the international financial market is in London and not in New York? Surely, New York is where the international financial market ought to be.

The answer is that it is a long-term effect of the insistence of the banking industry on special government favors. In the early days, it was what was known as Regulation Q in which the government set a limit on the interest rates that banks could pay, including an interest of zero on demand deposits. And because they set an interest of zero on demand deposits, they encouraged the emergence of money market funds and the growth of substitutes and alternatives for banks. They also consistently supported fixed exchange rates. And, when the dollar got into trouble, induced President Johnson at that time, to introduce restrictions on foreign lending and interest-equalization tax. The result of that was to drive that business to London. And the result of both of these measures was to reduce the commercial banking industry from the predominant supplier of credit to a minor player. Again, a policy which was very short-sighted.

The easiest shot of all is the one I am coming to now, which is the way in which corporations make contributions. The Capital Research Center does a good job of evaluating and analyzing to whom corporations contribute. And you have a crazy picture. The oil industry contributes to conservation organizations that are opposed to oil and that are trying to destroy it. The nuclear industry contributes to the opponents, to organizations for non-nuclear energy. Recently, Capital Research Center analyzed the grants by major corporations to public policy organizations, like Cato and like the others. And they found that the major corporations made $3 in grants to the non-profit left for every dollar they gave to the non-profit right.

Why hasn't the corporate world followed the excellent example that was set by Warren Buffet? I don't know how many of you know that in his early days, the very beginning, he followed the following policy. He said in sending a dividend check to his stockholders, he said, "we are prepared to distribute X dollars on your behalf for each share of stock to charity, to some organization. Let us know to whom you would like it sent, and we will send it on your behalf."

Why should the corporation decide for what charitable or other purposes the income of their stockholders should be used? Why shouldn't the stockholder decide that? Personally, I am opposed to allowing corporate contributions to be deductible, in computing the tax this year, and the corporate tax. As I say, I prefer not to have a corporate tax. But if you have it, why should corporations be entitled to deduct contributions? It's people who count, individuals, not the corporation. I would like somebody to explain to me why the business community in general is so insistent on supporting its own enemies? Why does it devote so much of its contributions to those who are opposed to it?

Now I want to come to two more modern examples, and I'll finally get down to Dave in Silicon Valley. But the example I want to come to now is education. As some of you may know, I have for a long time been in favor of trying to privatize schooling through a voucher system. But what I want to talk about is a little different from that. As we all know, our public education system is a socialist enterprise. It used to be, I think next to defense, it has always been the major socialist enterprise in the United States. Although now, the health industry is beginning to match it.

Any institution will tend to express its own values and its own ideas. A socialist institution is going to teach socialism. It is going to teach socialist values. It is not going to teach the principles of private enterprise. Now this didn't used to be so bad when the elementary and secondary education was more dispersed. When I graduated from high school there where 150,000 school districts in the United States. Today there are fewer than 15,000 and the population is twice as large.

And in addition, in the interim you had the unionization of the teachers, so that today our elementary and secondary school is not only a socialist enterprise it's also an almost completely unionized enterprise. It is a monopoly, a real monopoly, not a fake one.

Now what has been the business community's attitude toward education? The business community has been well aware that it has been adversely effected by the low quality of our educational system. They are aware that it's difficult for them to get employees with the appropriate skills. So they have been concerned about education. But have they been moving in the direction of trying to promote a private enterprise education industry? Not at all. Their major activity has been to assign some of their employees to teach in public schools, to contribute computers and other things to public schools. I can't blame an individual for what he does, but when a Mr. Annenberg puts up hundreds and millions of dollars, he puts it up for government schools, for public schools, not for private schools. I have not seen any movement on the business community in general, until very recently, to try to promote an educational system under which the customer, namely the parent and the child, has final say and final choice about the schooling the child gets. Today the customer doesn't have any choice. The child is assigned to a school and the schools are run for the benefit of the monopoly.

Now let me get down to Dave and really come to Silicon Valley and Microsoft. I am not going to argue about the technical aspects of whether Microsoft is guilty or not under the antitrust law. My own views about the antitrust laws have developed greatly over time. When I started in this business, as a believer in competition, I was a great supporter of antitrust laws, I thought it was one of the few desirable things that the government could do in order to promote more competition. But as you watch what actually happened, you saw that instead of antitrust laws promoting competition, it tended to do exactly the opposite. Because they tended, like so many government activities, to be taken over by the people they were supposed to regulate and control. And so over time, I have gradually come to the conclusion that antitrust does far more harm than good and that we would be better off if we didn't have it at all, if we could get rid of it. But you do have it.

Now, under the circumstances, given that you do have it, is it really in the self interest of Silicon Valley to set the government on Microsoft? You know, your industry, the computer industry, grows so much more rapidly than the law court does, than the legal process, that by the time this suit is over, who knows what the shape of the industry will be? It will certainly not be what it is now, whatever it is. And by calling in the government on this score, you're opening the door to future regulations from the government. Let alone the fact that the human energy and the financial funds that will be spent in hiring my fellow economists, as well as in other ways, would much more productively employed in improving your products than in improving the technical aspects of the system.

It's a waste! But beyond it being a waste, you are calling in the government. And from now on the computer industry which has been very fortunate in that it has been relatively free of government intrusion, you're going to see a continuous increase in government regulation. Anti-trust very quickly becomes regulation. It doesn't become simply finding out if there is a monopoly and knocking them over the head. Here again is a case which seems to me to illustrate the suicidal impulse of the business community.

Now I come to the hard part. Why is there this suicide? Why do business people behave this way? I hope many of you in this room will think about it and try to come up with an answer. I will give you the few suggestions that I have. I turn to this because one reason was stated more than a century ago by a remarkable man, General Francis A. Walker. I call him a general and he was. He was a volunteer in the Civil War and he rose up through the ranks. He was wounded, and after the war he and other people like him had an honorary title of Breved General conferred on them. But Francis Walker was a remarkable economist and scientist. He was the Director of the Census. He was a professor at Yale. He was president of MIT. He wrote in one of his books: "Few are presumptuous enough to dispute with a chemist or mechanician upon points connected with the studies of labor of his life. But almost any man who can read and write feels at liberty to form and maintain opinions of his own upon trade and money. The economic literature of every succeeding year embraces works conceived in the true scientific spirit, and works exhibiting the most vulgar ignorance of economic history and the most flagrant contempt for the conditions of economic investigation. It is much as if astrology were being pursued side by side with astronomy or alchemy with chemistry."

Well, I think that may be part of the explanation. Everybody is an expert when it comes to economics, and in that area they almost always get it wrong. For a very simple reason. One of the most striking things about economics is that almost always, what's true for individuals is the opposite of what's true for the community.

You go to the store to buy some strawberries and from your point of view the price is fixed and the quantity you can buy is indefinite--you can buy as much as you want. But, it's exactly the opposite for everybody together. At any given time there is a certain quantity of strawberries. The quantity is fixed and what happens is that the price is variable. If more people decide they want more strawberries, it doesn't create anymore strawberries. It sends the price up. And the same thing is true everywhere else. Everybody in this room thinks he can have as much cash as he wants in his pocket, subject to his total resources. He just goes to the bank and draws out the cash. But there's a certain amount of cash that's been printed and that's a total. And the only way one person can have more is by somebody else having less. What's true for the community is the opposite of what's true for the individual.

Similarly, there are many relations between that and what I have been telling you about, from a point of view of individual companies, from the point of view of the steel company. If you can keep down the imports of steel that's good for the company, for that individual company. But if you take the country as a whole, it is bad for the country as a whole. So that time after time, you have the feeling that the people who are making these policies for business are proceeding on the basis of superficial economic analysis.

Schumpeter gave a very different explanation for this phenomenon. He argued that within large corporations, the people who ran it developed essentially bureaucratic socialist attitudes and institutions. That the drive and belief in entrepreneurship and private enterprise tended to drive out and to be replaced by a bureaucratic approach. I don't believe that's true either. In a competitive society there is enough pressure around to prevent that from happening. But that would be an explanation.

I think the general climate of opinion which treats government action as an all-purpose cure for every ill is probably a more important factor. However, over the last forty years, the climate of opinion has been changing. It is no longer taken for granted as it used to be forty or fifty years ago, that if there is a problem the way to solve it is to get the government involved. So we have been winning the war of ideas even though we have been losing the war of facts. Governments today are far bigger and more intrusive than they were 40 or 50 years ago even though the climate of opinion is much less favorable to government control now than it was then. But I still don't think that is an adequate explanation, so I finally confess that I have no good explanation, and yet I think it is a phenomenon that is calling for an explanation. And that it's in your self interest to find one and change the pattern of business and get rid of what is a clear suicidal impulse of the business community. Thank you.

I will be glad to be open to questions.

Question [from Ed Black, CCIA]: Dr. Friedman, the computer industry has been asking government in many areas, from decency, to cryptography, to privacy, to taxation, to forbear, leave us alone we are responsible citizens. We are able to act reasonably and rational. But one of the things that frankly hurts in that regard is the evidence that is coming out about Microsoft's behavior and a very harsh style of business which at least the evidence seems to be piling up is very substantial. And I'm not sure that in this particular case especially if the Justice Department does not revert to the style of the 80s or the 70s of the regulatory approach whether or not a reining in of behavior which brings some discredit to our ability to act rationally and reasonably would not in fact be in the interest of the industry in the long run.

Dr. Friedman: If so, it would be the first case in history. Can you name me any industry in the United States which has benefited from having the government step in and clean it up?

Comment: The computer industry, IBM.

Dr. Friedman: Do you mean to say that you think the computer industry was benefited by IBM having to spend what was it, 18 years, in lengthy litigation? The only industry that was benefited by that was my fellow economists who provided assistance to IBM.

Comment: There was a debundling of hardware and software, which was very valuable to many many firms in Silicon Valley and their creation.

Dr. Friedman: Maybe, I don't doubt that individual firms may have benefited but I can't believe the computer industry as a whole benefited from what was oviously an inconclusive litigation that lasted what was it, 18 years, something like that.

Comment: I can't think of any industry in the history of this country or the world that has grown more dramatically since that period of time than the computer industry.

Dr. Friedman: Yes, I agree. The industry has grown since then but the question is or you are assuming it's because of that which is false. You are entitled to your opinion on that but I believe you have a hard road to hoe to persuade very many people that the way to rein in Microsoft's behavior is more effectively done by getting government to do it than by doing it by vigorous competition from outside. You know the computer industry is changing very rapidly and the law builds very slowly.

Question: My name is Don Luskin. I have a comment that you may want to comment on. You actually asked us to share our ideas about what might explain this behavior like when a moth goes to flame, when businessmen go to Washington. I would just simply say that there might be a kind of personal consumption value that is experienced by the individuals who go to Washington. The sense of power and prestige of hanging out with highly publicized political celebrities, who get to temporarily apply the great police power of the state at the command of an executive who ordinarily is merely a servant of the marketplace. Thank you.

Dr. Friedman: I believe in what you're saying is right so far as people that go into politics and try to take a position in Washington. That's undoubtedly true. But I believe you are pointing to a different thing. There is implicit in your comment a very different thing, which plays a role. Nobody can be free of the influence of the environment which surrounds him in the world in which we live. And there was a time, and this is more important earlier than it is now, when it was simply taken for granted, especially after the Great Depression and after the 30s, it was taken for granted that business sort of a, kind of a, not very clean thing. The thing that able public-spirited people should be doing is working through government. And then to some extent you can say that businessmen absorb that themselves and they felt they really had to demonstrate that they weren't those grasping, self-seeking, greedy people they were being painted out as being. They were really socially responsible. And I believe that does have a great deal to do, in particularly, for the contributions.

Question [Dr. David Friedman, Santa Clara University]: Someone once taught me that when trying to explain inconstancies between the predictions of your theory and the observations of the real world, assuming irrational behavior was bad methodology. And I would therefore like to suggest an explanation for at least one piece of your puzzle, namely the oil companies who are subsidizing the environmentalists. That is if I am an oil company and I am giving nothing to an environmental group there is no penalty I can impose on them for attacking me instead of some other oil company. Whereas if I am an oil company and I am giving $20,000 a year to that environmental group, I can impose a $20,000 fine by reducing that to zero. I am giving $20,000 a year to that environmental group, I canSo it seems to be that this behavior is no more irrational than your behavior in handing over your wallet over to a mugger and therefore is not a puzzle for economic science.

Dr. Friedman: That is a perfectly plausible explanation. I am not going to argue here with David. I've spent a lot of years doing that. I think this one of those cases in which both of us have benefited from it. Question: John Kelly with Microsoft. Can you explain any benefits to competition or the market place in breaking up a company like Microsoft?

Dr. Friedman: I am not an expert on Microsoft or the computer industry and I really don't want to make any specific comments of that kind because I don't know enough. I don't even know what you could break it up into. I am really not confident to answer that question. But I think that if there are such advantages, I would prefer to let the market bring it about through competition rather than to have government officials who I doubt are very much more knowledgeable than I am to decide in what components to break it up into. So I am really not going to answer it directly.Question: Michael O'Donnell (New Haven Unified School District) I've heard you say on more than one occasion that the press emphasize the disagreements between economists more than it emphasizes the agreements. So I was curious. Could you name four or five big ideas upon which you and say Lester Theroux agree?

Dr. Friedman: Absolutely. That demand curves are negatively sloped. Increase in supply will tend to reduce prices. Printing enough money will always create inflation. You can go down the list. I can give you a hundred of them. Comment: All of them are considered economic phenomena.

Dr. Friedman: Well no, no those are phenomena. Demand curves being negatively sloped is an empirical observation. It's a fact. It may be also a theoretical construct. But I think what you would want to do is ask, why do we differ, for example, about minimum wages. Or why do we differ about something else like that? And then you would ask whether we are using different theories? Or are we assuming different premises in respect to that? And I think in most cases you would find that our differences are not in respect to the kind of theory we're using. They are in respect to whether we are taking a long view or a short view, what particular group's interests we're putting most emphasis on and things like that.

Question: Luke Nosek, SmartCalendar. Thank you for your talk and for this issue. I have a potential explanation for why this has been maybe so short sighted while they are in trade association and why they are not even pursuing what appears to be their own self-interest. Perhaps it is because when a trade association is governed it is in a very shortsighted way. A person comes in to be a president, he is not out for the long run of that trade association. He is out there to make a few contacts, political allies, look good in front of the industry. He's certainly not looking for what's going to happen to that association 10 years from now. They are governed as nonprofits as someone else mentioned in the panel previously. If trade associations were governed as for-profits as one possible suggestion, perhaps those shareholders would look out to what would happen in the industry 10 years from now. Whereas the way they are right now with this revolving door nonprofit system, they are certainly not out for the interests of that association. I wonder what you think.

Dr. Friedman: That may well be the case. I think that is entirely reasonably. However, in general, the basic policies of trade associations are established by the groups that are represented by them rather than by their officials. You are right, the officials tend to be passing ... from year to year. But the policies those associations follow have a good deal more consistency over time. I don't believe that explains why in their public policy advocacy they do some of things they do.Question: Bob Levy from the Cato Institute. You quoted from Adam Smith's oft quoted line that people in the same trade seldom meet together even for merriment diversion but the conversation ends in conspiracy against the public or some contrivance to raise prices. Now I take it from that quote that the criterion for government intervention in the antitrust field would be whatever makes the market work better or more competitively. But I wonder what you think of the very next sentence in Adam Smith's book, which says "It is impossible indeed to prevent such meetings by any law which either could be executed or would be consistent with liberty andJustice."

Dr. Friedman: Well that next sentence essentially says he is not in favor of antitrust. And I agree with him on that. That is exactly the position I expressed. That it is a business matter. It is true that if businessmen have a chance to set prices and fix prices they are going to do it. I don't blame them. That's in their self-interest. But the question is what do you count on to get rid of it? See the important factual thing I believe in judging all this is that it is hard to find any monopoly empirically which has succeeded over any length of time unless they have had government support and government benefits. The DeBeers diamond monopoly is astandard example the other way and I don't know enough about that to know what the explanation is. But beyond that monopolies last if and only if they can get the positive support of government. And that is essentially what Adam Smith is saying there. He says they are going to meet together and construct these conspiracies but we can't really stop them. And he is right. Thank you. Question: Steve Dasbach. Another example of the type of irrational behavior you talk about are the contributions that businesses make to candidates and parties that are acting in opposition to their own interest, which I would argue has been exasperated by the current campaign financerestrictions. What kind of impact do you think adopting something like McCain-Feingold would have on that kind of behavior?

Dr. Friedman: Well, I think that particular legislation was very ill-advised legislation, which would not have done a thing on that. You know, I believe that the only thing that makes sense as far as contributions are concerned is complete openness, anybody can contribute anything he wants but it has to be made public and people have to know about it. I think that all of these attempts to try to restrict what can be done tend to be perverse and to do far more harm than good. Just think, you know it's a terrible situation we are in. This has nothing to do with what we have talking about. But the idea that the idea that the only way you can run for office is by either having a fortune yourself or by being able to raise $20 million dollars in terms of small contributions is a terrible way to choose people for office. Why shouldn't a wealthy man be able to say, well, instead of having to run himself he finds somebody who would be a good candidate, why shouldn't he be able to support him? I find it hard to argue seriously about McCain-Feingold except there is a mistaken expression of the inevitable tendency for government to try to run everything."

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