(Reprinted from HKCER Letters, Vol. 23, November 1993)
Questions and Answers with Milton Friedman
Editor: The following is a slightly edited transcription of Professor Friedman's responses to the questions raised by the audience after his two recent lectures in Hong Kong. The questions have been re-ordered for better continuity.
On Economic Progress, Democracy, and Social Justice
Currently in Hong Kong there is a debate on the linkage between economic progress and democracy. What do you think about this linkage?
That is a very complex question. I believe in democracy and freedom -- political and human freedom. I think as I look across history, economic freedom tends to promote political freedom and political democracy, but unfortunately, political democracy has elements which tend to destroy economic freedom. It is really a mistake to think in terms of a dichotomy -- there is a trichotomy. There is economic freedom, there is human freedom, and there is political freedom, where, by political freedom you mean the ability to vote for someone who will represent you.
Hong Kong is a marvellous example. If you compare Hong Kong with the other colonies of Britain, it was almost the only one that was not given its political freedom when Britain divested its colonies. If you look at the other colonies of Britain which got their political freedom, almost all of them have done very badly. India retained some elements of democracy and of human freedom but it certainly did not get economic freedom and it has performed badly. Some of the former colonies in Africa, Mozambique, Kenya, you name it, one after another of these countries used their political freedom to destroy the economic freedom they had inherited. Hong Kong was very fortunate because at the same time when Great Britain was moving towards socialism and collectivism at home, Hong Kong had the great good fortune that they sent out a colonial administrator who believed in laissez-faire and free trade. It really is a paradox and a mystery that Britain should have done exactly the opposite in Hong Kong to what it was doing at home. Therefore, as the example of Hong Kong shows, you did have economic freedom and human freedom. You did not have political freedom and yet you developed magnificently.
As I say, I think economic freedom does tend to promote political democracy. Tthat is what produced Tiananmen Square in China -- and that is having the same effect now in China, and will have in the other former Communist countries. But over the longer run, it offers a danger. Once people get political freedom, they want to change things, and because of the disproportionate influence of producers over consumers, they tend generally to change in a way which destroys economic freedom. So, as I say, that is a very, very complicated question, and a very disturbing one. For somebody like myself who would like to see all three kinds of freedom, it is not an easy task to see how you combine them. That would take me too far afield to go beyond there.
You speak of socialism as if it is monolithic. Some would argue that there are different types and degrees of socialism, and perhaps when we accept that, it would not be so easy to say that socialism has failed. To put the point more bluntly, while a free economy could generate more wealth, we should still see that there is a more equal distribution of wealth and give more thought to social justice.
Well, when I give thought to social justice, do I give thought to the inequality that prevails in China and Russia? There is no capitalist country that has the degree in inequality of condition that the most extreme socialist countries developed. Even on what seems like a different level, in the Soviet Union, the wages of a foreman versus the wages of a lowest-grade worker, that ratio was higher than it was in the Western countries. And certainly, when you contrast the conditions of the ruling group in a country like the Soviet Union, with the conditions of the citizens at the bottom, it is hardly creating anything you can call social justice.
I do not know what social justice is. I know what justice to people is, I think I know. I think I can recognize when someone is treated unjustly, but what is social justice? What is social? I think I won't go on in great length, but if you really want to look into the difficulties of that concept, I recommend very highly to you Frederick Hayek's books on law, legislation, and liberty, one of which explores very deeply the meaning or meaninglessness of the concept of social justice.
Look, let me talk about something I really know about -- the condition in the U.S. The U.S. today is half socialist. Roughly half the total resources of the country are controlled by government at all levels. Almost all the progress, and improvement in the conditions of ordinary people have come from the private enterprise side, and almost all the social problems have been generated by the government side, whatever problem you take. The largest socialist industry in the U.S. today is education. It is also the technologically most backward industry in the U.S. It also has been absorbing more and more resources and producing poorer and poorer results -- declining test scores, increasing drop-outs, promoter of violence within the schools. There is no way in which you can tell me that socialism in the U.S. has been producing social justice. You must look beyond the words and the pretense of the substance. If you take all the money spent on programs that are designated to help the disadvantaged, and divide it by the number of people who are classified as living in poverty -- a very bad definition, but nonetheless take it -- the resulting sum is considerably larger than the average income in the U.S. Why? Because on the way of trying to get to the poor, it goes through bureaucracy, and the people who benefit from those programs are primarily middle-income people and not lower-income people. So I am very skeptical about the talk of socialism producing anything that could be called justice.
The favorite model of economic development from the point of view of the Chinese leaders seems to be Singapore, namely, a large degree of economic freedom but little political freedom and democracy. Can this model work for China? Is it workable?
I don't believe it is workable in the long run. The Singapore model is a model of benevolent dictator. The trouble with benevolent dictators is that they don't remain benevolent and they don't last forever, and I do not believe that it is a feasible model for any country. I believe that it is very dangerous for any country to depend on a single individual who is going to rule either in front of the stage or behind the stage. Singapore is a very interesting case. Hong Kong and Singapore have often been matched. I have long felt that Hong Kong has a more difficult task to perform -- its population multiplied tenfold while Singapore little more than doubled, but Hong Kong has done a better job than Singapore, precisely because it too has a benevolent dictator, but one who stays out of the way. You know, the real need for government is not to do things but to get out of the way! And yet, it is very hard for any human being in the position of power not to do something, but just sit there and don't do anything. It is a very hard prescription to sell and yet that is a prescription that is necessary.
On the World Economy
Do you see the establishment of regional trading blocs as being an inevitable step towards free trade in the world?
No, I don't. I see it as a regrettable interruption in that movement. That is why I have such mixed emotions about NAFTA. The world would be much better off if all of these things were done on a multilateral basis applied to the whole world. But unfortunately, it has been very difficult to move in that direction, and these regional agreements, we hope, will gradually expand and encompass one another, but it is a long, roundabout way rather than the shortest way.
Given the combination of advanced countries skilled labor, and labor in general in developing countries, do you think that world inflation in the coming decade will stay low?
The first half of this question has nothing to do with the second half. What happens to world inflation? First of all, there is no such thing as world inflation. There is inflation in Hong Kong, there is inflation in Japan, there is inflation in the U.S. There are many countries which have different inflations but there is no world inflation. There would be a world inflation if you were back a hundred years or so and had a uniform gold standard around the world -- so you had a single currency around the world -- but you don't. You have lots of currencies around the world and their exchange rates vary with respect to one another, so you're going to have some countries inflating and other countries deflating at the same time.
Now I am going to re-interpret the question. Do I believe that inflation in most countries, or in many countries of the world, is likely to remain relatively low in the future? I believe that there is some likelihood that will happen but I think there are also obstacles to that happening. I gave a talk at the Japanese Central Bank, at a conference -- this must have been about eight years ago or so -- in which I predicted there would be a decline in the rate of inflation, and that inflation would be relatively low in many of the advanced countries in the years to come. And I made that prediction on the basis of changes. The reason you have inflation is because governments benefits from inflation. And changes have occurred which have taken the profit out of inflation from the point of view of the country's producers. Therefore, they have less incentive than they had before to inflate. I won't go into the technical details. However, that does not rule out the possibility that, under pressure, governments will look to inflation as a short-term cure, as a temporary expedience.
I think in my own country, the U.S., the policies being followed by the present administration, which are a continuation of the policies followed by the Bush administration, are very adverse to the economic health of the country. They will tend to promote the conditions for the next few years in which economic growth will be very slow or very low. At the moment, inflation is low, but come 1995, a year before the next election, can you rule out the possibility that the administration will bring every bit of pressure it can on the Federal Reserve to bring about inflation, so as to make a good election in 1996? The answer from past history is no. Will the Federal Reserve resist that temptation, that pressure? The answer from past history is no. So I will not rule out the possibility that you will see a significant increase in the rate of inflation in the U.S. some time in 1995-6-7-8, some time down the line. Nonetheless I think that there is not much likelihood that we will go back to periods of double-digit inflation. Of course, you cannot make any universal statement because right now in China, inflation is somewhere in the 20 percent neighborhood. So I think you have to consider each country separately.
On the U.S. Economy
Do you think the U.S. economy will improve and the unemployment rate will decrease in the next five years?
I think the U.S. economy is not likely to show much progress in the next five years. That is an exaggeration. All the domestic policies are working against progress. On the other hand, these international developments -- the new revolution I have talked about -- are opening up great opportunities for American enterprises. So there are two opposite forces, and I think that what you will have, probably, is very slow growth but not decline. However, as for unemployment, that is a different question. I don't believe you can predict what is going to happen to unemployment over the next four or five years because, you see, employment can go up, unemployment can go down, even though the country's income is going down. One of the reasons why we are going to have difficulties making economic progress is because the government is forcing enterprises to use a lot of money in unproductive ways. But those unproductive ways hire people! So there is no one-to-one relationship between unemployment and economic growth. I want to say one more thing. Economists have a very poor record at forecasting a few years ahead the conditions of their own countries, and I am no exception.
What monetary indicators should Alan Greenspan follow, M2 or real interest rates? How come the relationship between M2 and economic activity is breaking down?
Well, first of all, it is not breaking down. It has never been extremely close. That is why I have never been in favor of fine-tuning; I have never been in favor of using ups and downs of M2 or anything else as a way of controlling the short-run movements of the economy. I have been in favor of settling on an average rate of growth of M2 and sticking to it, month by month, year by year. As to using the real interest rate to control, the question is not which is the better indicator. It is impossible to do because there is no way in which the Federal Reserve can either control real interest rates or even know what they are, because the real interest rate depends on anticipations about future inflation.
On U.S. Health Care
What advice would you give or have you given to Hillary Clinton about health care in the U.S.?
I would be glad to answer that question, because of course I have -- not directly, but I did write a small article about health care. You know the problem with health care in the U.S. is a government-created problem. It is a problem that is very serious and very unnecessary. The key issue in health care in the U.S. is a very simple one. The people who receive health care do not pay directly for their health.
You know, you won't believe this but this is a true story. The problem of health care that we have in the U.S. dates back to wage and price control during World War II. That seems crazy, doesn't it? How does one thing get to the other? Very simple. In World War II, the U.S. was so unwise as to introduce wage and price control, and of course they also inflated in order to meet war-time expenses. The result was the demand for labor went up, and the enterprises in industries, in trying to hire labor, started finding ways to get around the wage control by offering fringe benefits. One of the fringe benefits that turned out to be very attractive was the provision of health services by the employer. With the usual efficiency of government bureaucracy, the Internal Revenue Service did not recognize what was going on for about three years. So during that period, employers did not report the value of health services as part of the income of the worker, and as a result, it was not subject to tax. Finally the IRS got around to it and they started instructing employers to include the value of the medical care as part of the wages of the workers, but of course by this time the workers raised a big political fuss. The legislature then passed a law making health care provided by employers tax-exempt to the individual. That means, for an individual, if health care is provided to him by his employer, it costs a lot less than if he has to pay for it out of his after-tax income. And the result of this was that employees who get health care did not economize on it or shop for the best bargain, or in any way act like intelligent consumers.
To add to this, in 1975, the Congress passed Medicaid and Medicare. Medicaid was a program of government insurance for the poor and Medicare for the elderly. I am a beneficiary of medical care but I think it is a terrible system and ought to be abolished. The facts are that the result was a tremendous increase in cost. It is hard to believe, but from 1950 to 1990, the cost of a hospital bed per day, corrected for inflation, went up something like 26- to 27-fold. There are now seven times as many hospital employees per occupied hospital bed as there were then. Of course most of them are filling out pieces of paper and not producing health.
My recommendation is that the way to solve the problem is to eliminate what caused it, and to eliminate the special incentive. The simplest way would be to abolish the tax-exemptions and treat health care like everything else, but that is utterly unfeasible politically because, as usual, nobody is willing to give up anything that he's got. He always regards it as a God-given right. So the alternative that I and many others have proposed is something called the Medisave Account, that we extend tax exemption so that medical care is exempt whether paid by the employer or paid by the employee. And the idea would be that each individual would set up an account called the Medisave Account in which the value of what the employer is now contributing in the way of medical care would be deposited as the sum of money which the individual would then be free to control or to spend, to buy whatever insurance he wanted, if any. And if he saved money, if it wasn't all used up, it would sooner or later revert to him and he would have it as part of his income. Under that kind of a system, I have no doubt that you would very quickly get total cost of medical care down to a reasonable level. Instead, unfortunately, we are going in the other direction.
I have said often if somebody starts a private enterprise and it is a failure, the only way in which he can continue going is by digging into his pocket, and not many people are willing to do that. So if a private enterprise is a failure, it is closed down. If the government enterprise, on the other hand, is a failure, people have another recourse -- they can dig into the pockets of the taxpayers instead of themselves. Therefore, if a public enterprise is a failure, it is invariably expanded. And I challenge anybody to find an exception to that rule. Unfortunately, what the U.S. government, Hillary Clinton and her crew, are now proposing is a marvellous example of that rule. Government involvement in medical care has been a failure and therefore they want to expand it, to have more of it.
On the Hong Kong Dollar
Do you think the Hong Kong dollar should be pegged to the U.S. dollar?
In general, the simple answer is yes. Not because the U.S. has a good monetary policy. It doesn't. But because, bad as the U.S. monetary policy is, it is better than for Hong Kong to try to introduce its own monetary policy. This is not particularly, let me emphasize, a comment about Hong Kong. I have written extensively on this subject over many years and I have always argued that a country can either have an independent central bank or a fixed exchange rate, but it cannot have both. And I have always argued that for a large country, like the U.S., Germany, France, Britain -- none of them are going to be willing to give up their independent central banks, and therefore, the best course for them to follow is to have a freely floating exchange rate determined in the market. But for small countries, they will on the whole do better if they peg their currency, unify their currency with a foreign currency, and avoid having an independent central bank -- provided that they do it with a country which is one of their major trading partners so that a lot of their business is being done in that currency anyway. And that is the situation in Hong Kong.
The question was misworded. The question was "pegged to." The Hong Kong dollar is not pegged to the U.S. dollar, it is unified with the U.S. dollar. Those are two very different things! Consider the European Monetary Union. The various currencies of Europe were pegged to one another. They announced that their national central banks would commit themselves to keeping certain exchange rate fixed. That is an agreement that is bound to break down. It cannot last. But it is a wholly different thing to unify currencies. For example, California and New York States have a unified currency, not a pegged exchange rate, but the exchange rate is one-for-one. Similarly, Panama has a Panama dollar, but a Panama dollar is unified -- by bringing in the U.S. dollar, you can get a Panama dollar. It's unified in the same way with the currency board system such as Hong Kong has. Your Hong Kong dollar is unified with U.S. dollar, it is not pegged to it. Pegs are very unstable and will sooner or later break down, but a unified currency is fine, providing that it stays that way. From 1983 to 1988, it stayed very much that way in Hong Kong, but then the monetary authority started to move a little bit in the way of giving itself central banking powers, and if that continued for very long, then you would be in trouble.
If Hong Kong's trade with China should greatly exceed that with any other country in the world including that of the United States, would you suggest that the Hong Kong dollar should be unified with the Renminbi? Perhaps you wouldlike to comment on the relationship between the two currencies, the Hong Kong dollars and the Renminbi, both in the run up to 1997 and beyond.
Well, in the run up to 1997, I think your are going to keep your present arrangement, and you should do so. I believe when there is one country, there would be one system, and I think there would ultimately be one money. I think it is going to be very difficult to have two monies in one country. Whether it is desirable or not, that is a different question.
Do you think that the HK dollar-U.S. dollar linked exchange rate would be strong enough to withstand political turmoil that could possibly happen pre- and post-1997?
My crystal ball is too crowded to answer that question.
On China and Russia
How would you compare the economic development of China to that of Russia?
Well, as I say, let's give us some time on that. There is an enormous difference between the two. China started on the economic level and left the political level unchanged, so there has been an economic revolution or change, but no political revolution. In Russia the order was reversed. The political revolution or the loosening up of the political system has come first, and economic reform is coming later instead. Now I believe that there is a strong case that can be made that the Chinese order is better from the point of view of short-run growth, but the Russian order may well be better from the point of view of long-term growth. But that is something still to be determined.
Remember we are watching an experiment unfold in the world for which there is not prior precedent. Never in the history of the world has a totalitarian state successfully moved and converted itself into a free market economy. That has not happened. The experiment is now under way in China, in Russia, and in the former satellites of Russia. The former satellites of Russia are in some way in the best position because Communism was imposed on them from outside and because they have a heritage or background. The Czech Republic is the best case. In 1938-39, it was one of the most prosperous countries in the world. It took forty years for Communism to reduce it to Third World status, and now it is moving very rapidly toward a largely free market economy. But even if the Czechs succeed, I don't regard that as a real test of the experiment. It was not the totalitarian state in the same sense as China and Russia were. We have to keep our minds open on that question. We'll see in the next ten or twenty years which of these countries does best. But, you know, what difference does it make? We are not involved in a race. We are involved in people trying to better their conditions. The more effective the people of Russia can be in bettering their own conditions, the more effective the people of China can be in bettering their own conditions, the better for the world and for them. We oughtn't regard it as a race in which it matters which one is coming ahead and which behind.
Yeltsin just decreed the buying and selling of private land, which is still denied to the Chinese farmers. In the race towards prosperity, will Russia be the proverbial turtle that will come out ahead of China?
That is a very hard thing to say. Russia started out at a higher technological and industrial level than China. But at the moment, it is in a state of greater turmoil, particularly and primarily because of the failure to control inflation. And there is nothing that is more dangerous than to let inflation run, nothing that can do more harm to a country than to let inflation run rife. Indeed, the Communists were able to take over China in considerable measure because of the hyperinflation that occurred under Chiang Kai Shek. But so far as land is concerned, as I understand it, the Chinese system of personal responsibility is very close to real ownership. It is a question of language. The Chinese do not want to sound like they are permitting ownership. So they have something that is essentially equivalent. The relationship works the same way. I don't think it would give Russia any decisive advantage.
On the Future of Hong Kong
In the December 1988 issue of Forbes magazine, you raised serious questions about the future of Hong Kong as a financial center after 1997. What is your current view of the viability of the "one country, two systems" concept?
I feel exactly the same way as I did in 1988. When I came back from China in 1988. In a news conference, I was asked what I thought about it. I said, "You can have one country and one system but you cannot have one country and two systems." And the question for the long run is whether the one system would be more like the Hong Kong system or more like the former Chinese system, and I have not changed my views in that in any respect. In particular, I continue to believe that while Hong Kong may in many ways do very well after the Chinese take over complete sovereignty, it cannot do very well as a particular kind of a financial center, as a center in which people deposit funds and hold them there, because for that you need a degree of political security and stability that will not be possible.
On China's Economy and Economic Reform
Knowing what you know about China's reform, would you have done anything differently?
Absolutely. I would have unified the exchange rate. I would have eliminated the exchange control. I would have eliminated price control all over. I would have privatized all state enterprises within six months.
What is an effective way for China to get rid of corruption?
That's very easy. Eliminate all regulations and rules that lend themselves to corruption. In country after country -- you don't have to go China -- there is nothing that has been a greater source of corruption than exchange control and multiple exchange rates. There was the case after World War II when many European countries had multiple exchange rates and exchange control. In every case, it led to corruption. There is a lot of money here to be made, and if there is a lot of money to be made, people will try to make it.
Indeed let me say a good word in favor of corruption. In many cases corruption is really an introduction of market forces into a controlled economy. Again, I don't have to go to China. In 1947, George Stigler, my wife's brother Aaron Director, and I went to Europe for the first time after the War. We came out with the conclusion that Britain was being strangled by law and obedience, and France was being saved by the black market. Because what is a black market? It is a market. It is a free market, and so what is called corruption is sometimes, not always (there are various species of corruptions), simply introducing a black market that undoes the harm which is being done by the attempt by government to interfere with market processes. You have the wrong exchange rate. Do you think it will be good for China for all exchanges to be made at the official exchange rate? You can't do it. The only way you can do that is by having extensive control over every transaction. Pardon me if I have said a few good words about corruption.
After your recent trip, are you more or less optimistic about China's future than in 1988?
I guess in a way I am slightly less optimistic because after the 1988 trip -- that occurred before Tiananmen Square -- at that time, everything seemed to go, except for the problem of stopping the inflation. And I thought at that time there was a very, very real chance that the bureaucracy, the ruling powers in China, would be able to extend the market mechanism beyond the rural area and extend to the industrial area. The progress between 1988 and now is larger than I would have predicted in 1988. In that sense it has been more impressive, but that refers to my capacity to predict, but not to my confidence. And with respect to confidence, I am more disturbed now than I was then, by what I see as a lack of change in the political structure, the lack of change in the central government bureaucracy. You know, there seem to be no fewer bureaucratic agencies than there were then, there seem to be no fewer bureaucrats than there were then. It is very hard for me to see any progress in what I think ultimately will be essential for the fullest development of China, which is the central government should get out of the way, and that is the one sense in which I am less optimistic.
You people, many of you are involved in China, many of you who have invested intensively in China are in a much better position to answer that question than I am. I am an outsider. I came, I looked, I saw, but I have only been there for a little while. I don't understand the language. I am not fully knowledgeable about the details. If I bring anything, it is not special knowledge about China but the fact that I have observed many other countries, I have studied the developments in many other countries. Although every country thinks it is unique, no country is unique. There are laws of economics just as there are laws of physics, and they apply whether you are talking about Kazakhstan or whether you are talking about Sichuan. That is the only thing I can say I bring to it.
You people have much more intimate knowledge of what is going on in China, and I hope that I am wrong and that you'll prove me wrong. And what you do will have a great effect on whether I am proved wrong, because you have the opportunity to influence what goes on in China. There is no doubt that without Hong Kong, it is inconceivable that China could have had the development it has had over the past twenty years. You can infuse China with the kind of spirit, of entrepreneurship and risk-taking that has made Hong Kong a modern miracle. So don't let me discourage you from doing that. It is a great task, and one which deserves the best of your efforts.
What are the major factors that have contributed to your success as an economist?
Well, I guess my wife, and in addition, the University of Chicago has a little to do with it. Thank you.
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