Class Warfare Blog

April 1, 2014

How Milton Friedman Got It Wrong and Why the Radical Republicans Love It

Today’s current crop of conservatives (and calling them conservatives is a disservice to real conservatives; really they are radicals) believe in “free markets” as if they were the baby Jesus. The economist they revere above all others is Milton Friedman, a father of the Chicago School of Economics which basically placed “free markets” on a pedestal. Dr. Friedman argued that if markets were free, everyone would benefit in a maximal way. The one thing markets needed to work properly was to be free of distortions … like government regulation. (Ah, you can see the Conservative Radical Republicans drooling now, can’t you.) Dr. Friedman argued that economies would always be in a form of equilibrium. Here’s an example: if a company made some sort of gadget, a sprocket (Thanks, Steve Martin!) and these sprockets sold at a reasonable pace but all of a sudden the demand for sprockets became significantly higher (because some celebrity wore one in a movie), the supply of sprockets in the marketplace would dwindle making them hard to find and higher priced. Because of that, the manufacturers would increase the supply by making more sprockets to meet the demand, which would cause the prices and availability to fall back closer to what they were. If the manufacturers overestimated the demand and produced more sprockets than could be sold, the markets would have surplus inventory that would reduce orders for them and manufacturers would cut back upon production until the supply of sprockets met the demand. The equilibrium of supply and demand was something markets took care of by themselves, with no need of regulation by governments, as long as those markets were not interfered with. Milton Friedman thought that the natural state of markets was that of an equilibrium between things like supply and demand (and a great many other things I don’t have time to go into) but unfortunately, Dr. Friedman was wrong.

Markets do not display the attributes of an equilibrium system, they only show some of the attributes of what are called “near equilibrium systems” which are systems that are close to being at some kind of equilibrium state, but not quite there.

To explain a real equilibrium state, I will have to appeal to science, but don’t panic; all we need is a 2-liter soda bottle fresh from the store and full of soda (you can choose the flavor). These bottles are made of quite flexible plastic. Even a four-year old could crush one if it were empty. But the fresh bottle just brought home from the store is quite firm. Interesting. So, you place it in the refrigerator to be chilled and when you pull it out, if you are sensitive (and I know you are) you will find that the bottle isn’t quite as firm as it was when you put it in. Hmmm. But you are thirsty and you crack open the bottle and, lo and behold, it hisses at you! Apparently there was some pent up gases in the bottle. It stops hissing in short order and you fill your glass and replace the cap. As you put the bottle away, you notice that the bottle is quite unfirm, having lost its plumpness in the process. Well, well, well, and this whole process is repeated the next time you open the bottle.

What is going on here? What is going on is that the liquid in the bottle (which is mostly water but contains flavors and sweeteners) has a great deal of carbon dioxide dissolved in it. When you first bought the bottle most of the carbon dioxide was dissolved in the liquid but above the liquid (in what the bottler calls the “head space”) there is evaporated water (a little) and carbon dioxide gas (quite a bit). Since there is way more carbon dioxide gas in the liquid than it can hold under ordinary conditions, the carbon dioxide gas above the liquid is there in enough quantity to “inflate” the plastic bottle (yes, like a balloon) and make it firm to the touch. The manufacturers of these plastic bottles and aluminum beer cans use some of this structural effect to reduce the weight of those containers to reduce the cost of transportation of products in them (the heavier the contents plus container, the more fuel is need to move them around) which is why they are so flimsy but do not break in transit.

When you put the bottle in the fridge, two things happened, when a gas is cooled, you lower its pressure and, at the same time, you increase the solubility of the gas in the liquid. So, there is less gas in the head space and it has less pressure so the “pumped up” feeling of the container diminishes (a little). When you cracked open the bottle, you released the gas under higher pressure (hence the hiss) and the bottle becomes quite a bit less rigid. Not only that but the gas starts to leave the liquid at such a high rate that it no longer just happens where the gas and liquid touch (the surface) but the gas leaves willy-nilly all over the place producing “bubbles.” When the cap is screwed back in place, the bubbles keep coming for a time but that eventually stops as the head space pressure grows and grows (and the bottle “pumps itself up” again whence they stop coming. We say that the bottle has reestablished an equilibrium between the gas in the head space and gas in the liquid. This is a true physical equilibrium. The property it is showing is referred to as Le Chatelier’s Principle, that if a stress is applied to an equilibrium system, the system responds to offset that stress in part or in whole. So, you relieve the pressure of the gas above the liquid (Hiss!), then screw the cap back on and the system regenerates the pressure. This can happen over and over and over, but not indefinitely.

Dr. Friedman would like to think that economics worked the same way, possibly because if it did his little pea-brain could then have understood it. But here is the problem. The “system” (a soda bottle or an economy) will only achieve an equilibrium state if the system is closed, meaning the cap is on in the case of the bottle or nothing enters or leaves an economy, which one could describe as no exports and imports, capital flows, or even information entering or leaving the system.

The flaw in the thought that an equilibrium is a natural state of an economy is that not only is the system not closed but it can be opened in so many ways.

Back to the soda bottle for a minute. If you chill the bottle, it gets softer and if you warm it, it gets more firm. You can repeat this cycle almost indefinitely because nothing material ever leaves the system, only heat is entering leaving. So the state of the bottle in the form of the amounts of CO2 in the liquid and in the head space are repeated exactly the same over and over. Once you specify the temperature, the distribution of the gas in those two places can be calculated and will be exactly as calculated. But things are different when you open the system materially. Open and closing the bottle a great many times will result in less gas in the bottle and will change the distribution between the two places that gas can reside. Done enough, the soda goes “flat” and stops exhibiting the behavior of self-correction (e.g. you open the cap and there will be no hiss, no re-inflation of the bottle to its former firmness).

So, here is the key point. By selectively opening the system, you can affect the distribution of the materials in the system. This is true for real equilibrium systems and true for near or “quasi-closed” equilibrium systems. (If material is not leaving the system quickly the system will behave as an equilibrium system for a while.)

Enter greed.

In an economy, if you can manipulate the system through selectively injecting things into it or removing things from it, you can affect the distribution of money within it. The money is like the gas in the soda bottle, it seems to be moving around but is controllable (think about how they got that gas in there in the first place—tain’t natural I tells yuh!).

Now, here’s the kicker: the vast majority of market forces and government regulations have been put there not to gum up the works but at the behest of marketeers wanting to skew the distribution of wealth in the system in their favor. Yep, business are responsible for the majority of government regulations (favoring their inputs and disadvantaging the inputs of others). The tax codes are full of “regulations” favorable to this industry or that. And, what is advertising if not an attempt to manipulate markets? In Milton Friedman’s fantasy word, all “buyers” and all “sellers” have perfect knowledge. You know what the car you are interested in cost to make, what its expected lifetime is, what parts will break down first and what they will cost to replace, what it will cost to operate it, how safe it is, and what the finance charges on your loan will be. The seller knows how much money you have in the bank, whether you are worthy of a loan, etc. Right. . . . If everyone, buyer and seller, have perfect information, advertising will have no effect and hence be a waste of money. Have you noticed how little advertizing there is? No? Well, me neither. We are awash in advertizing, much of it coming from the “free market capitalist” devotees of Milton Friedman.

Consider the current state of economic affairs here in the U.S. Those with money have manipulated the system, getting it to respond how they would like, to redistribute wealth so that they have more and you have less. And the more money they have, the greater their inputs to the system, making those shifts even greater.

So, is an equilibrium a natural state of an economy? I doubt it and even if it were it would not be some benign “invisible hand” force that takes care of everybody. Instead it is a system susceptible to forces that redistribute wealth in the economy and is quite susceptible to runaway behaviors, like leaving a soda bottle on the counter with the cap off (damned teenagers!).

So, as far as I can discern, the “free market ideology” of the current Radical Republicans is just another scheme which, unlike Robin Hood who stole from the rich to give to the poor, steals from the poor to give to the rich.

We formed this country by repudiating the inherited political power of monarchy and aristocracy but we have succumbed to the power of inherited economic power of a bunch of scumbags who will do anything and say anything to keep the system functioning as it is, a siphon of wealth from those who have little to those who have way, way too much.

The way we solved this before, the last time this happened, is we taxed the hell out of inherited wealth and incomes way above normal. We must do this again, or we consign ourselves to living in a society where the few have much and the many have little if anything in the way of wealth.

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13 Comments »

  1. Nicely laid out Steven

    It seems to me to that anyone who pays close enough attention to the stock market and its high rate of volatility would have to wonder why anyone would think the so-called free markets don’t share this lack of control. The stock market reacts and often over reacts to multiple variables around the world, and if the market ever truly corrects itself, it does so way past a point where much economic damage is done and not everyone recovers at a level commiserate to where they were before

    Comment by lbwoodgate — April 1, 2014 @ 9:13 am | Reply

    • Anyone who talks about the sanctity of the marketplace, especially the stock and comodity markets, usually is someone who has figured out how to manipulate them. The latest stock market distortion is the lightning fast computer traders who used their position in line to swoop ahead of buy orders, buying what was ordered, which drove the price up somewhat, and then turned around and sold to the original buyer. All of this takes place in a millisecond or less. A classic skimming scam if there ever was one. Free markets my ass. Free to get scammed because the law won’t protect you from the Wall Street Vultures.

      On Tue, Apr 1, 2014 at 9:13 AM, Class Warfare Blog wrote:

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      Comment by stephenpruis — April 1, 2014 @ 10:15 am | Reply

  2. fine, very well written, bla nothing bla…

    Umm, just a suggestion.
    2 to 3 sentences per paragraph, and limit your post to one idea. I think you write well, but who cares if no one reads it. I am trying to be helpful.

    So, look around, think about ways to be better socially, and use your amazing content there. Blogging is not easy…

    Comment by Steven Clear — April 3, 2014 @ 4:06 am | Reply

    • Your suggestions are quite appropriate to the modern reader, uh, non-reader. Making sentences and paragraphs shorter could help the weaker reader get through a piece but it is a death spiral for reading comprehension. While I do not advocate sentences like Winston Churchill wrote, one of which ran two and a half pages if memory serves, they are just a mode of organizing thought. Complex issues require more complex communication. As Einstein said: “Everything should be made as simple as possible, but not simpler.” Cheers!

      Comment by stephenpruis — April 3, 2014 @ 9:30 am | Reply

  3. Reblogged this on Citizens, not serfs and commented:
    Good except for the bit about the soda bottles.

    Comment by prayerwarriorpsychicnot — April 6, 2014 @ 3:35 am | Reply

  4. Or you could construct an example out of sprockets. Suppose sprockets are not something that industry can increase production immediately: then scarcity of sprockets makes their prices rise, as the sprocket prices rise, people notice the upward price trend and buy more sprockets so that they could sell them later for a profit. The industry increases the production too slowly, so the prices continue to increase, attracting more people and investors into the speculation market, including many who take out loans to buy more, and the prices keep driving up. Eventually, the industry catches up, and suddenly the market finds itself in a situation when not only the industry matches the demand, but humongous qualities of previously hoarded sprockets are out for sale. But everyone’s got a sprocket and a few spare ones, no one wants to buy them anymore, and the sprocket prices crash. Those who had hoped to cash in on sprockets are wiped out, the industry is stuck with excessive supply of sprockets no one needs, and a lot of it goes bankrupt, and a large number of people in the sprocket industry lose their jobs. And if the sprocket industry is large enough, it can easily trigger a depression.

    Comment by List of X — April 7, 2014 @ 1:08 am | Reply

    • See! This is why we need Free Markets! Without them, how would the sprocket futures market ever crash the economy?

      On Mon, Apr 7, 2014 at 1:08 AM, Class Warfare Blog wrote:

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      Comment by Steve Ruis — April 7, 2014 @ 9:17 am | Reply

  5. When did Friedman argue that economies would always be in a form of equilibrium?

    Comment by trovaerdig — April 23, 2014 @ 7:27 am | Reply

    • It is a basic aspect of of supply and demand theories: if supply = demand, you have equilibrium. If supply doesn’t equal demand, the market corrects to change supply to meet the demand, etc. I will be writing more on Dr. Friedman shortly.

      Comment by Steve Ruis — April 23, 2014 @ 8:35 am | Reply

      • Hi again.

        Thank you for the reply.

        “If supply doesn’t equal demand, the market corrects to change supply to meet the demand”

        If one accepts this as an assumption made by supply and demand theories, then I don’t see how one can possibly hold the view that economies would always be in a form of equilibrium. The first statement contradicts the latter.

        Comment by trovaerdig — April 23, 2014 @ 10:10 am | Reply

        • Your confusion is the difference between equality and equilibrium. Consider a two pan balance or scale. With equal weights in the two pans the pans will adopt the same level. If you tap on the pans they will rise and fall, rise and fall and yet come back to the original position. But this is a static equilibrium, not a dynamic one. If you put an extra weight on one pan, that side will go down permanently. There will be no returning to the original position.

          In a dynamic equilibrium system, changes occur all of the time but the system always comes back to a balance, albeit a new one. In economic systems, since the population and hence the numbers of customers, continuously increases, there is a “normal” situation of increasing demand, but short-term conditions can result in total demand going down (such as exist now, even with a growing population). A true equilibrium system will eventually correct for such short term stresses and create new (but different) balance points. My point is that true equilibrium systems have to be closed to the outside. If they are not, they can be overwhelmed by external inputs (like the balance example), and no economic system is even close to being closed so they must be managed carefully to work properly.

          On Wed, Apr 23, 2014 at 10:10 AM, Class Warfare Blog wrote:

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          Comment by Steve Ruis — April 23, 2014 @ 11:04 am | Reply

          • Thank you for your response

            Unfortunately the statement you put forth explaining that one can not have equilibrium in an open system is wrong. In an open system it is indeed possible to have equilibrium if whatever flows in to the system is equal to the that which flows out.

            Also I simply do not see how Milton Friedman could be wrong just because the real economy is unlikely to reach equilibrium, as long as you at any given moment are converging towards an equilibrium state – supply and demand explains this adequately.

            Comment by trovaerdig — April 26, 2014 @ 4:23 pm | Reply

            • You misunderstood the argument. The state referred to in an open system is a “quasi-equilibrium system,” one that temporarily shows some of the behavior of an equilibrium system, but which can be driven to extremes by outside inputs. (Closed systems have no “outside” inputs.) In other words markets are manipulatable. But it is not that which is my point. A true equilibrium system will balance out internal changes, but a false equilibrium system will not. Why should an economy be an equilibrium system? It has none of the characteristics. The observation that supply and demand interact is not proof of an equilibrium system. A forest fire shows supply and demand, but is not an equilibrium system. In fact the choice of using a description of economies as being equilibrium systems is wrong, so claims of their behavior based upon the behavior of such systems are also wrong.

              Friedman was such an extremist that he believed that only “free markets” could work which means that people would not be allowed to advertise their products and that perfect information needs to be available for every transaction. He wanted our government to sell off all government owned property (national parks, range land, nature preserves, national monuments, etc.) as they would function better as private enterprises. The record of corporate fuck-ups of epic proportions makes the level of government fuck-ups pale by comparison, so where this idea could come from is a mystery. We are treated to a steady stream of news of corporate bad behavior (dumping nuclear waste illegally, dumping toxic coal ash waste illegally, using questionable business practices (Wall Street, etc.) shows that a pure profit motive leads to quite bad unintended consequences and no “market forces” will correct such things. Free Marketites claim that no corporation would do such things as it would damage their reputation and hopes of future profits, but corporations regularly disincorporate and reincorporate under another name (a protection corporations invented to do just that). In other words, a simple examination of markets shows, as a natural experiment, none of the characteristics of the descriptions of Friedman. His claim was that the reason it did not was because markets were not truely free. Well, he got his wish for the experiments he wanted to do. Watch for a future post on just this topic.

              On Sat, Apr 26, 2014 at 4:23 PM, Class Warfare Blog wrote:

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              Comment by Steve Ruis — April 27, 2014 @ 9:32 am | Reply


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