FRIEDMAN DEMONSTRATES THE POWER OF MARKETS WITH A NATURAL EXPERIMENT


It’s often been said that economists are at a disadvantage because they can’t create controlled experiments with economies to test their theories.

Great economists simply identify natural experiments that illustrate their ideas. That’s what 1976 Nobel laureate Milton Friedman did in his tribute to another legendary economist at the second annual George J. Stigler Memorial Lecture May 14.

“The experiments nature throws at us are the most fascinating and instructive lessons I know,” said Friedman, A.M. ’33 (Economics), asserting that the postwar economic fortunes of Hong Kong, Great Britain, and Israel formed “a nice controlled experiment” that demonstrated the superiority of market economies.

Once a tiny, poor colonial backwater of only 600,000 people and few assets, Hong Kong’s average per capita income was about one-quarter of the average income in Great Britain and 60 percent of Israel’s. The historical accident that assigned a disciple of Adam Smith to be governor of Hong Kong set the tiny colony on a different path. “Britain went for socialism. [Hong Kong} went for laissez faire free markets,” with no tariffs and low taxes, Friedman explained.

“In 1996, the average income in Hong Kong was one-third larger than the average in Britain,” said Friedman, 84. “It’s easy to say that; it trips off the tongue, but I want you to contemplate that a bit. Here is Britain, a world power and until recently the greatest economic force in the world, outperformed by Hong Kong, this tiny spit of land. How do you explain that?”The only answer, he asserted, was that Hong Kong’s free market system outperformed Britain’s socialism.

Postwar Hong Kong and Israel shared some similarities. “Both countries had small populations and were flooded with refugees so that their populations grew tenfold. Both were populated by races who had a reputation for being commercially competent,” Friedman said. Here, too, economic fortunes diverged.

“Israel had what would be regarded as an advantage, although I don’t regard it as such–foreign aid,” he noted. Cash from governments and supportive Jews around the world has funded the majority of Israel’s defense budget. This has allowed government spending in Israel at times to approach 100 percent of national income. That has stifled the economy while Hong Kong flourished. Hong Kong citizens now earn, on average, 70 percent more than Israelis, even though Israel has more land and resources. “It’s very hard for me to see any other way to explain the difference but for free markets,” he said.

“The last [per capita income] figures I saw showed that Hong Kong today is a tiny bit above the United States,” Friedman added. “That’s an incredible fact. Here we are, this country stretching from sea to shining sea with 200 years of experience [with free enterprise] and enormous resources, yet on this crowded strip in the Pacific, 6 million people are roughly equal with us.

“The explanation for this is straightforward,” he continued. “Our government spends directly or mandates indirect spending of 50 percent of our national income, while Hong Kong spends only 15 percent. The right way to look at this is that with 50 percent of our resources, we’re doing what Hong Kong is doing with 85 percent of theirs. The real lesson of Hong Kong is that we have opportunities we’re throwing away by using our resources poorly.”

Asked to predict the impact China would exert on Hong Kong after the handover from Britain in July, Friedman noted that there are complicated relationships between economic, civil, and political freedom. “Hong Kong had almost complete economic and civil freedom but had almost no political freedom. India has civil and political freedom but no economic freedom. Political freedom in democracies like the United States may have the effect of reducing economic freedom,” he explained. “China’s impact on Hong Kong may be to destroy civil freedom; that will have an impact on economic freedom. I cannot say I believe Hong Kong will escape unscathed.”

 


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