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Friedman vs. Galbraith Open Classroom Barry Bluestone Dean, School of Public Policy and Urban Affairs Northeastern University October 19, 2011.

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Presentation on theme: "Friedman vs. Galbraith Open Classroom Barry Bluestone Dean, School of Public Policy and Urban Affairs Northeastern University October 19, 2011."— Presentation transcript:

1 Friedman vs. Galbraith Open Classroom Barry Bluestone Dean, School of Public Policy and Urban Affairs Northeastern University October 19, 2011

2 Goals of “Great Society”  Full Employment  Stable Prices or falling prices  Economic Growth  No Discrimination

3 Milton Friedman Model 7 Assumptions  Perfect Competition  Perfect Mobility  Perfect Information  Consumers Maximize Utility  Firms Maximize Profit  No Externalities in Consumption  No Externalities in Production  Tastes are exogenous

4 Perfection Competition  Many buyers; many sellers No seller can set price No buyer can set price  No “monopolies”  No “monopsonies” All prices set in market as a result of unconstrained demand and unconstrained supply This applies to product markets and labor markets

5 Perfect Mobility  Capital can move to any industry without restriction If capital can earn a higher return in one industry or one region than another, it will move there  Workers can move to any industry or region without restriction If workers can earn higher compensation in one industry or one region than another, they can move there

6 Perfect Information  Corporations know the prices and quality of all inputs  Workers know the wages and benefits of all jobs  Consumers know the prices and quality of all goods

7 Consumers Maximize Utility  Consumers spend their income so as to maximize the value they get from the market basket of goods and services they purchase Consumers always looking for the best price for a given good or service (of given quality)

8 Firms Maximize Profit  Firms have only one objective: to maximize profit  In perfect competition, profit is always being eroded by one more competitor coming into the market  Firms are never philanthropic for attempts at philanthropy result in bankruptcy because other firms can underprice them and outsell them

9 No Externalities in Consumption  The consumption of a good or service by one individual confers no utility on another individual  The consumption of a good or service by one individual confers no disutility on another individual My consumption of product X has no positive or negative effect on you

10 No Externalities in Production  The production of a good or service creates no positive utility for those who do not purchase the good or service  The production of a good or service creates no negative utility for those who do not purchase the good or service No “pollution”

11 Tastes are Exogenous  Individuals make rational decisions about what to purchase  Individuals are not unduly swayed by advertising or propaganda  Therefore, all purchases are made to maximize utility free of compulsion or undue influence  Producers do not control consumers

12 Average Cost Curve Decreasing Cost Increasing Cost

13 Price, Cost, and Profit Price Cost Total Cost Profit

14 With Price above Cost:  Excess Profits  New firms enter  Drive down price to minimum cost point  Therefore, competition keeps prices down – No Inflation

15 Price, Cost, and Profit Price Cost Total Cost Profit P1 P2 P3

16 Once Profits decline, new firms enter market with new lower cost technology  In short run, new firm gets the entire market because it can charge a lower price than its competitors  But this competition produces new products and economic growth

17 Price, Cost, and Profit Price Cost Total Cost Profit P1 P2 P3 P4

18 If Wages too high …  Unemployment results  But with flexible wages, wages are bid down  Employers hire unemployed workers  The result is that everyone who wants to work at the market wage gets a job  Those who refuse to work at the market wage are not unemployed … they are out of the labor market

19 Wages & Employment W1 Supply Curve Demand Curve W equilibrium S1 D1

20 Wages & Employment W1 Supply Curve Demand Curve W equilibrium S1 D1 Unemployment

21 If firms discriminate … Firm A Firm B Supply (Whites Only) Supply (No Discrimination) Wage B Wage A

22 Firm A has lower Wage Costs  With lower costs, it can charge less for its product  Firm B cannot compete with Firm A given Firm A’s lower wage costs  Result: The discriminating firm goes out of business

23 Conclusion  If we develop a market which obeys the Friedman assumptions, we will have the best of all possible worlds  What should government do?  What should government NOT do?  Are there any problems with this model?

24 What Should Government Do?  Maintain law and order  Define and protect private property rights  Adjudicate disputes about property rights  Enforce contracts  Promote competition  Provide an appropriate monetary policy  Engage in activities to counter technical monopolies (e.g. electric utilities)  Overcome negative externalities  “The consistent liberal is not an anarchist.”

25 What Shouldn’t the Government Do?  Parity price supports for agriculture  Tariffs on imports or restrictions on exports  Government control of output as in farm programs  Rent control  Legal minimum wage rates  Detailed regulation of industry such as through the Interstate Commerce Commission  Control of radio/TV by the FCC  Social Security  Occupational licensing  Public housing  Military draft  National parks  Prohibition of carrying mail for profit  Publicly owned and operated toll roads

26 What’s Wrong with the Friedman Model?

27 Problem #1: Assumptions do not hold in real world  But with global competition, perfect competition and perfect mobility are coming true  With new technology, perfect information is coming true  Consumers really do try to maximize utility  Firms really do try to maximize profits  Externalities are a problem, but with a little regulation, these can be minimized  Some consumers can be fooled by advertising, but most consumers are rational

28 In the Friedman world …  Government intervention in the marketplace is the problem Minimum wages Too much regulation that limits competition  Support for labor unions  Occupational licensure  Trade restrictions Too much taxation that limits profit motive

29 So the answer is …  Wipe out government regulation of the marketplace  Eliminate “Market Imperfections” such as unions, occupational licensure, trade barriers  Cut the size of government and the need for taxes

30 What is the Real Problem with Friedman?  He’s a Utopian!  He believes that humankind thrive in competition and will not try to create market imperfections to protect themselves from virulent competition  What would happen if we passed a magic wand over the U.S. and instantly wiped out every “market imperfection”?  Answer: Almost instantly, people would begin to recreate them!

31 Galbraithian Model The Theory of Countervailing Power

32 Assumptions  Huge powerful interests Massive monopolistic corporations with price-setting power Powerful trade unions to represent labor Powerful consumer “organizations” like Walmart and Stop & Shop Just the opposite of Friedman’s “perfect competition”

33 Galbraithian Model Corporations Unions Consumers (Retailers)

34 Galbraithian Model Corporations Unions Consumers (Retailers)

35 Galbraithian Model Corporations Unions Consumers (Retailers) Prices too high Wages too low Profits too high

36 Galbraithian Model Corporations Unions Consumers (Retailers) Wages too high Prices too high Profits too low

37 The Role of Government  To restore countervailing power by: Weaken corporate power  Anti-Trust Strengthen labor  Wagner Act Strengthen Consumers  Consumer Protect Laws  Truth in Lending  FDA, etc.

38 The Role of Gov’t – Con’t  Redistribution of Economic Opportunity Public Education through College  Redistribution of Economic Outcomes Progressive Income Tax Anti-poverty programs Earned Income Tax Credit  Macro Fiscal Policy to maintain full employment  Extensive government intervention to limit negative externalities Environmental protection

39 Galbraithian Model Corporations Unions Consumers (Retailers) G

40 What’s Wrong with Galbraithian Model?  Assumptions do not hold Corporations are no longer strong Unions are no longer strong Consumers have never been that strong The new reality of power is closer to the Friedman model of perfect competition

41 What’s Really Wrong?  Model works IF Government is truly neutral Moves to strengthen weak side Moves to weaken strong side  But if Government is captured by one side, it makes the imbalance even worse

42 Galbraithian Model Corporations Unions Consumers (Retailers) G

43 Galbraithian Model Corporations Unions Consumers (Retailers) Wages too high Prices too high Profits too low

44 If Government is not neutral …  Then perhaps better to keep it small  Can government be made neutral?  What does it take to keep government neutral?  Galbraith is a Utopian!

45 Where does this leave us? If Friedman and Galbraith are both Utopians, what is to be done?

46 Need Careful Reasonable Policy  Vigilance about redressing unequal power  Concern about unintended consequences  Reliance on “people power” to raise issues of: Private sector abuse Public sector abuse

47 Tea Party/Occupy Wall Street  Tea Party is focused on what it sees as abuse by government  Occupy Wall Street is focused on what it sees as abuse by the private sector  Need more light and less smoke  Need fair and balanced popular media to call attention to real abuses  Role of the Open Classroom


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