Twilight Of The Welfare State

In 1942, the great Austria-born Harvard economist Joseph Schumpeter argued that the United States was "capitalism living in an oxygen tent" on its march to socialism. Capitalism's success would breed alienation and self-doubt, sapping its efficiency and innovation. But he was wrong. The next half-century saw sustained growth in government's involvement in the economies of North America and Western Europe along with the most impressive economic performance ever recorded.

Rapid economic growth has been accompanied by increased skepticism about government's role. Critics of government say that the state is overly intrusive; governments create monopoly; government failures are just as pervasive as market failures; high taxes distort the allocation of resources; social security threatens to overload workers in the decades ahead; environmental regulation dulls the spirit of enterprise; government attempts to stabilize the economy must fail at best and increase inflation at worst. In short, for some, government is the problem rather than the solution.

Guardians of economic freedom: Friedrich Hayek and Milton Friedman

Economists, being human, are subject to fluctuations in opinions and ideology. Because government policies seemed so successful in mobilizing the U.S. and U.K. war economies for military victory over Germany and Japan during World War II, and because active macroeconomic policies seemed to succeed in conquering the Great Depression, conservative laissez-faire ideologies came to represent only minority opinion among most free-world professional economists.

Two eminent scholars never wavered in their skepticism about the merits of heavy government intervention in the economy. Friedrich Hayek (1899-1992), of Vienna, London, and Chicago, and Milton Friedman (1912- ), of the University of Chicago and the Hoover Library at Stanford, received Nobel Prizes in economics for their scientific innovations. Their work is today highly regarded by conservative and "libertarian" economic thinkers.

Hayek's most influential work examined the efficiency of different forms of economic organization.The 1920s and 1930s witnessed a great debate as to whether resources could be efficiently organized under socialism. Oskar Lange and Abba Lerner argued that a socialist firm could use capitalist-style pricing and thereby emulate a market economy without the monopolistic tendencies of capitalism. Hayek provided an important rebuttal. He pointed out that costs and production possibilities are not known. Only with the incentives of a private, free-enterprise system could the information dispersed among the millions of economic agents be effectively mobilized and used. No system can generate innovations without the carrot of profits and the stick of bankruptcy. Modern economics, with its emphasis on dispersed and asymmetrical information, owes much to the brilliant insights of Hayek.

Hayek's best-seller, and the book that most captured the attention of the broader public, was The Road to Serfdom. In this work he warned that the road to the hell of totalitarian tyranny and economic inefficiency was paved by the good intentions of modest interferenes with free markets and private enterprises.

Friedman's statistical and analytic researches have ranged widely. He documented how small the differences are between the saving rates of rich and poor in the long run after adjusting saving for temporary ups and downs in income.This led to the permanent-income theory of consumption (which is discussed in the macroeconomic sections of this text).Together with Anna Schwartz, Friedman authored the definitive Monetary History of the United States, 1876-1960 (l993).This book launched the monetarist revolution and led to an appreciation among macro-economists of how the money supply can affect aggregate spending, prices, and output. Friedman helped convince economists that monetary policy definitely matters for overall economic activity.

During the last half of the twentieth century, everywhere—in the United States, Western Europe, and Asia, as well as in Stalin's Soviet Union and Mao's China—there has been a significant swing back toward the competitive-market pole and away from the centralized-command pole. No one within the economist guild has been more important, both as an architect and as an expositor of this shift, than Milton Friedman. His classic book, Capitalism and Freedom (1962), argues why a rational thinker might, along with advocating free international trade and maximal deregulation, deplore the minimum wage, state licensing of surgeons, and prohibition of drugs like heroin and cocaine. All thoughtful economists should study his arguments carefully.

In weighing the relative merits of state and market, public debate often oversimplifies the complex choices that societies face. Markets have worked miracles in some countries. But without the right kind of legal and political structure, and without the social overhead capital that promotes trade and private investment, markets have also produced corrupt capitalism with great inequality, pervasive poverty, and declining living standards.

In economic affairs, success has many parents, while failure is an orphan. The success of market economies may lead us to overlook the many successes of collective action over the last century, as the case of the lighthouse reminds us. Collective action has helped reduce malnutrition and conquered many terrible diseases like smallpox. Government programs have increased literacy and life expectancy. Macro-economic successes have reduced the sting of inflation and unemployment, while government transfer programs have brought health care to the poor and improved the quality of life for the aged. State-supported science has penetrated the atom, discovered the DNA molecule, and explored outer space.

Of course, these successes do not belong to governments alone. Governments harnessed private ingenuity through the market mechanism to help achieve these social aims. And, in some cases, governments were like orators who didn't know when enough was enough.

The debate about government's successes and failures demonstrates again that drawing the boundary between market and government is an enduring problem. The tools of economics are indispensable to help societies find the golden mean between laissez-faire market mechanisms and democratic rules of the road. The good mixed economy is, perforce, the limited mixed economy. But those who would reduce government to the constable plus a few lighthouses are living in a dream world. An efficient and humane society requires both halves of the mixed system—market and government. Operating a modern economy without both is like trying to clap with one hand.

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