TRANSCRIPT 🔗
WEBVTT
00:00:00.880 --> 00:00:04.959
This is Mike Munger, the knower of important things from Duke University.
00:00:05.440 --> 00:00:09.759
This week, Milton Friedman and the dinner that changed economics.
00:00:09.919 --> 00:00:11.839
It was about transaction costs.
00:00:12.000 --> 00:00:15.199
The twedge, some letters, and a book at a week.
00:00:15.359 --> 00:00:18.800
Straight out of Creedmoor, this is Tidy C.
00:00:20.000 --> 00:00:24.719
I don't think I talk about a system where there were no transaction color, but it's an imaginary system.
00:00:24.879 --> 00:00:26.640
There always are transaction color.
00:00:29.120 --> 00:00:32.560
When it is costly to transact, institutions matter.
00:00:32.719 --> 00:00:35.200
And it is costly to transact.
00:00:40.560 --> 00:00:47.119
Aaron Director, founder of the Journal of Law and Economics, has invited about 20 people to his house for dinner.
00:00:47.359 --> 00:00:49.119
It's not a normal guest list.
00:00:49.359 --> 00:01:00.399
The dinner includes Milton Friedman, George Stigler, Arnold Harburger, Greg Lewis, some of the sharpest price theorists who have ever lived, all in one room, all irritated.
00:01:00.560 --> 00:01:13.599
They're irritated because one visiting Englishman named Ronald Harry Coase has just submitted a paper to Director's Journal arguing something that these men are sure is just simply wrong and in fact dumb.
00:01:14.239 --> 00:01:21.599
Before dessert is served, someone, probably Stigler, because he liked keeping score that way, proposed an actual vote.
00:01:21.840 --> 00:01:22.640
Hands up.
00:01:22.879 --> 00:01:24.560
Who agrees with Coase?
00:01:25.840 --> 00:01:28.000
20 against, one for.
00:01:29.439 --> 00:01:36.159
Two hours later, after all the plates are cleared, and after a long discussion, they vote again.
00:01:37.200 --> 00:01:40.640
21-4 Coase, zero against.
00:01:41.359 --> 00:01:46.239
Nobody in that room changed history that night by force, credential, or seniority.
00:01:46.319 --> 00:01:48.159
They changed it by persuasion.
00:01:48.319 --> 00:01:54.400
And the man who did most of the argument on the wrong side until he wasn't, was Milton Friedman.
00:01:54.799 --> 00:01:56.799
That's the story I want to tell today.
00:01:57.040 --> 00:02:11.680
But to understand why that vote flip mattered, why that persuasion mattered, why it's one of the great set pieces in the history of economic thought and in transaction costs, because it involved acquisition of new information, which is always expensive.
00:02:12.000 --> 00:02:14.080
You have to understand two things.
00:02:14.479 --> 00:02:32.319
First, who Milton Friedman actually was underneath the caricature you're likely to hold, and why, 60 some years later, he has become one of the most reliably hated men in American public life, on the left and increasingly on the right.
00:02:33.039 --> 00:02:44.879
Milton Friedman was born in Brooklyn in 1912 to immigrant parents and went to Rutgers on a partial scholarship, made his way through University of Chicago in Columbia, finishing his PhD in 46.
00:02:45.280 --> 00:02:56.479
He joined the Chicago Economics faculty that same year and taught there for most of the next three decades, with a research base at the National Bureau of Economic Research running alongside it.
00:02:57.120 --> 00:03:08.319
He's remembered correctly as one of the most influential economists of the second half of the 20th century and maybe the most influential, not named Keynes.
00:03:08.719 --> 00:03:22.719
He won the Nobel Prize in 1976, largely for his work on the quantity theory of money, the argument distilled into the line everyone quotes, that inflation is always and everywhere a monetary phenomenon.
00:03:22.960 --> 00:03:27.680
He co-authored with Anna Schwartz a monetary history of the United States.
00:03:28.240 --> 00:03:32.080
But Friedman's influence didn't stay inside monetary economics.
00:03:32.240 --> 00:03:36.240
He built a generation's understanding of price theory at Chicago.
00:03:36.560 --> 00:03:50.080
He became, through Capitalism and Freedom in 1962 and then free to choose, both the book and the 10-part PBS series, perhaps the most effective popularizer of free market economics that ever lived.
00:03:50.479 --> 00:04:04.960
Millions of people who never read a page of formal economics absorbed the case for markets, flooding exchange rates, school choice, and the end of military conscription, because Milton Friedman explained it to them directly, on television, in plain English.
00:04:05.599 --> 00:04:21.519
And it's worth pausing on that list because, as I recently pointed out in my essay at the Civitas Institute, Friedman himself, near the end of his life, was strikingly modest about how much of this all actually happened or mattered.
00:04:21.759 --> 00:04:34.160
When Russ Roberts on EconTalk asked Friedman to name his real policy successes, Friedman didn't reach for the whole sweep of the Reagan era, global deregulation or opening up the international markets.
00:04:34.399 --> 00:04:38.720
He named just two things, ending the draft and floating exchange rates.
00:04:38.959 --> 00:04:39.839
That's it.
00:04:40.079 --> 00:04:48.319
That's the self-assessment of a man who is treated by both his admirers and his enemies as the architect of the entire modern global economy.
00:04:49.120 --> 00:05:01.839
If Friedman's right about the two successes thing and the mostly failures thing, you'd expect him to be a marginal figure in political arguments, respected, slightly dusty name from the Reagan era, like a lot of economists.
00:05:02.079 --> 00:05:03.759
Instead, he's a live wire.
00:05:03.920 --> 00:05:10.560
He gets invoked with venom from multiple directions at once, because the venom has only intensified.
00:05:11.279 --> 00:05:13.120
Let's take the critiques in turn.
00:05:13.279 --> 00:05:15.839
They're worth taking seriously, even if they're unfair.
00:05:16.000 --> 00:05:18.720
The unfairness
Load full transcript
itself is revealing.
00:05:19.040 --> 00:05:22.560
First, laissez-faire is obsolete.
00:05:22.800 --> 00:05:26.079
This one's new in the sense that it's coming from the right, not just the left.
00:05:26.240 --> 00:05:26.639
J.D.
00:05:26.720 --> 00:05:34.800
Vance and thinkers like Orin Cass argue that Friedman's whole model of self-organizing markets is an artifact of a specific historical moment.
00:05:35.279 --> 00:05:42.000
An America that was more religiously and morally cohesive, free markets could be trusted to work without state guidance.
00:05:42.160 --> 00:05:48.639
But today, more atomized, the society, in this view, needs an active industrial policy.
00:05:48.879 --> 00:05:55.759
Vance has literally said the Republican Party's center of gravity is moving from Milton Friedman to Alexander Hamilton.
00:05:56.720 --> 00:05:59.759
Second, the shareholder value critique.
00:06:00.000 --> 00:06:15.680
Famously, Friedman in 1970 wrote a New York Times magazine essay, arguing that the social responsibility of a business is to increase its profits, that managers pursuing their own social agendas with shareholders' money is a kind of unaccountable taxation.
00:06:16.000 --> 00:06:22.639
That essay gets blamed constantly for the shareholder primacy movement, but that is just misplaced.
00:06:22.879 --> 00:06:32.240
The 1980s shareholder first ethos actually grew out of hostile takeover pressure and stock-based executive pay, not out of that essay.
00:06:32.720 --> 00:06:35.839
Third, globalization and the China Shock.
00:06:36.079 --> 00:06:50.800
Friedman was one of the most prominent unilateral free traders of the 20th century, and critics, drawing on the labor economics literature, the author Dorne Hansen China Shock papers, and others, connect his advocacy to the roughly 2.4 million U.S.
00:06:50.959 --> 00:07:01.360
manufacturing jobs that were lost between 1999 and 2011 after China's accession to the World Trade Organization.
00:07:01.600 --> 00:07:08.319
Well, that's really a critique of the whole free trade consensus that Friedman symbolized, more than that of any specific argument that he made.
00:07:08.480 --> 00:07:10.079
And it ran into an obvious problem.
00:07:10.240 --> 00:07:14.079
Friedman was analyzing trade between parties operating as commercial equals.
00:07:14.319 --> 00:07:32.480
Whether China in 2001 was operating on those terms, whether it was playing the trade game or playing a longer strategic military game, is a question that Friedman, who was a thoroughgoing empirical realist, would likely have engaged with directly rather than being caught flat footed.
00:07:32.720 --> 00:07:35.519
So that criticism is just an anachronism.
00:07:36.079 --> 00:07:41.759
Fourth, the one that never goes away, autocracies, especially Chile.
00:07:42.160 --> 00:07:45.519
Friedman spent two weeks in Chile in March 1975.
00:07:45.600 --> 00:07:50.319
He met Pinochet exactly once for 45 minutes at the end of a long day.
00:07:50.560 --> 00:07:54.399
Pinochet asked him to put his advice in writing.
00:07:54.639 --> 00:08:00.560
Well, I might have done that if I was tired and some economist was blabbering at me in my second language.
00:08:01.199 --> 00:08:05.040
Friedman did put it in letter and in a letter, and we have that letter.
00:08:05.120 --> 00:08:09.600
It's eight points recommending cuts to money supply growth, spending cuts, trade liberalization.
00:08:09.759 --> 00:08:15.360
It's the same template of advice, almost a Xerox, that he gave dozens of governments around the same period.
00:08:15.519 --> 00:08:20.000
Taiwan, Israel, Japan, West Germany, UK, Iceland, Estonia, on and on.
00:08:20.240 --> 00:08:23.199
And there's one that people conveniently forget: China.
00:08:24.079 --> 00:08:33.120
Friedman made two extended trips to China in 1980 and 1988, had a two-hour meeting with the Premier in the Great Hall of the People.
00:08:33.600 --> 00:08:40.799
Well, everybody says Friedman and Pinochet, but nobody says Friedman and Zhao Jang.
00:08:40.960 --> 00:08:49.679
But by any measure, the regime that was more murderous and more repressive, China, also followed Friedman's advice.
00:08:50.080 --> 00:08:52.159
That asymmetry is the tell.
00:08:52.639 --> 00:09:04.879
Corey Doctorau has called Friedman a crank, cheerleader, and enabler of genocidal maniacs, and admits in print he cheers himself up by imagining Friedman being tormented in hell.
00:09:05.440 --> 00:09:11.679
So that's an illustration of the kind of extremism in the reaction that Friedman provokes.
00:09:12.080 --> 00:09:14.960
Why the hate underneath all four critiques?
00:09:15.200 --> 00:09:21.039
Well, partly it's a genuine, serious argument about whether free markets need a certain kind of social scaffolding to function.
00:09:21.120 --> 00:09:22.720
That's the Vance cast line.
00:09:22.799 --> 00:09:24.799
It deserves engagement, not dismissal.
00:09:24.879 --> 00:09:25.840
I disagree with it.
00:09:26.000 --> 00:09:28.639
But a lot of it isn't really an argument at all.
00:09:28.720 --> 00:09:35.200
It's a caricature that survives because it has become freedmen has become a symbol.
00:09:35.919 --> 00:09:38.960
Chile becomes a synecdoche for the whole man.
00:09:39.120 --> 00:09:41.919
45 minutes stand-in for a 50-year career.
00:09:42.080 --> 00:09:51.519
The actual content of capitalism and freedom, the case for floating exchange rates, volunteer army, negative income taxes, those get erased entirely.
00:09:51.679 --> 00:10:11.360
Which is a shame, because if you want to understand who Friedman was, not a symbol, a working economist in a room full of other working economists, there's no better window into it than watching him publicly lose an argument in real time and then change his mind in front of everyone and start advocating very effectively for the other side.
00:10:11.600 --> 00:10:14.879
Which brings us to the dinner.
00:10:15.440 --> 00:10:22.559
To understand why 20 top Chicago economists
thought Ronald Coase was mistaken, you need the background problem he was writing about.
00:10:23.440 --> 00:10:24.879
Externalities.
00:10:25.200 --> 00:10:29.519
The standard economic treatment of externalities in 1960 came from Arthur C.
00:10:29.679 --> 00:10:30.320
Pagou.
00:10:31.519 --> 00:10:40.080
Going back to his 1920 book, The Economics of Welfare, Pagou's framework is intuitive and it's still what most economists think about externalities today.
00:10:40.159 --> 00:10:47.279
If a factory's smoke damages its neighbors, factories imposing a cost on society that it doesn't pay for.
00:10:47.519 --> 00:10:56.879
Private cost of production is lower than the true social cost, and so the obvious fix is to make the factory pay, tax it in amount equal to the damage.
00:10:57.039 --> 00:11:00.879
It will either reduce its pollution to the efficient level or pay for the privilege.
00:11:01.039 --> 00:11:04.320
So the polluters at fault make the polluter pay.
00:11:04.639 --> 00:11:15.039
Kose's 1960 paper, The Problem of Social Cost, which was published in the second volume of Director's Journal of Law and Economics, took a can opener and just opened that framework up.
00:11:15.360 --> 00:11:19.759
Coase's argument starts with a deceptively simple example, not smoke, but cattle.
00:11:20.000 --> 00:11:23.919
Rancher's cattle stray onto a neighboring farmer's land and damage his crops.
00:11:24.159 --> 00:11:26.639
Pegovian instinct is to ask who's at fault?
00:11:26.720 --> 00:11:28.000
Should the rancher be libel?
00:11:28.399 --> 00:11:32.240
Coase points out this is the wrong question because the harm here is reciprocal.
00:11:32.480 --> 00:11:35.759
If we stop the rancher's cattle from straying, we harm the rancher.
00:11:35.919 --> 00:11:38.399
If we let them stray, we harm the farmer.
00:11:38.639 --> 00:11:41.440
There's no metaphysically correct assignment of blame.
00:11:41.519 --> 00:11:45.440
There's only a question of which arrangement produces more total value.
00:11:45.759 --> 00:11:50.480
And there is Coase's actual claim, the one that detonated in that dining room.
00:11:50.799 --> 00:12:03.600
If bargaining between the rancher and the farmer is costless, if they can find each other, negotiate, and strike a deal without any friction, then it literally doesn't matter for the purposes of economic efficiency which way the court rules.
00:12:03.840 --> 00:12:06.879
Say the judge rules the rancher is liable for crop damage.
00:12:07.039 --> 00:12:16.879
Fine, but if the rancher's cattle raising is worth more than the crops he'd be damaging, he'll pay the farmer to accept the damage, or he'll pay for offense, whichever is cheaper.
00:12:17.039 --> 00:12:20.159
The efficient amount of cattle grazing will happen anyway.
00:12:20.320 --> 00:12:22.159
Now say the judge rules the other way.
00:12:22.320 --> 00:12:25.679
The farmer has no claim, the rancher owes nothing.
00:12:26.000 --> 00:12:34.879
If the crops are actually worth more than the extra grazing, the farmer will pay the rancher to keep the cattle away, again, reaching the efficient outcome.
00:12:35.039 --> 00:12:38.399
The farmer might even pay to build a fence if that's the cheapest result.
00:12:38.960 --> 00:12:43.039
So again, we reach the efficient outcome through a different set of side payments.
00:12:43.120 --> 00:12:48.240
Either way, same amount of cattle, same amount of crops.
00:12:48.559 --> 00:12:53.679
The law determined who paid whom, but it didn't determine the efficient outcome.
00:12:54.320 --> 00:13:00.559
That's what economists later dubbed the Coase theorem, though Coase didn't invent that name, George Stigler did.
00:13:00.720 --> 00:13:07.279
Coase later grumbled, the whole thing was widely misunderstood because he wasn't trying to talk about a world with no transaction cost.
00:13:07.360 --> 00:13:15.600
And in fact, the first voice in the music at the beginning of this podcast is Coase saying, But there always are transaction costs.
00:13:15.840 --> 00:13:24.480
But still, at this dinner, Coase was able to show that it was the transactions cost that were important, not the assignment of property rights.
00:13:24.799 --> 00:13:27.519
Coase considered this result obvious.
00:13:27.759 --> 00:13:32.559
Decades later, asked about the reaction to his paper, he said, with genuine puzzlement.
00:13:32.960 --> 00:13:40.080
People were impressed that he changed their views, but he wasn't particularly impressed with himself because all he was doing was stating the obvious.
00:13:40.320 --> 00:13:54.000
To Kos, once you actually specified the problem correctly, once you asked what happens when two parties can bargain freely over mutually affecting activity, the invariance result just falls out of ordinary rational actor logic.
00:13:54.080 --> 00:13:55.039
It's obvious.
00:13:55.279 --> 00:13:58.720
Any legal assignment that left value on the table would get traded away.
00:13:58.879 --> 00:14:04.000
It's not a special theory, it's what rational and costless mean in words.
00:14:04.159 --> 00:14:07.519
The Chicago economists at directors' table did not find it obvious.
00:14:07.679 --> 00:14:11.679
In fact, they thought it was wrong, and they were all really smart and frankly a little bit arrogant.
00:14:11.840 --> 00:14:17.519
And so they were outraged that Coase would simply flatly deny their awesomeness.
00:14:17.919 --> 00:14:25.679
Their instinct, the Pegovian instinct, trained into every economist of that generation, was that liability rules change outcomes.
00:14:25.840 --> 00:14:26.559
Full stop.
00:14:26.720 --> 00:14:29.200
That's the entire point of having a liability rule.
00:14:29.440 --> 00:14:40.639
Coase's paper had been sent to Director for a review before publication, and Director and several colleagues thought they'd caught Coase in an actual arithmetic level error in the passage laying out this argument.
00:14:40.879 --> 00:14:42.799
Director wrote back and asked him to cut it.
00:14:42.960 --> 00:14:51.600
Coase refused, and this was a long time before email made everything instant, offered to come to Chicago in person and defend himself.
00:14:51.919 --> 00:14:55.840
So in the spring of 1960, Coase flew to Chicago.
00:14:56.000 --> 00:15:02.159
He presented first at George Stigler's workshop, a warm-up round in front of an audience that was entirely unconvinced.
00:15:02.399 --> 00:15:07.600
That evening, the Real Confrontation, dinner at Aaron Director's house.
00:15:07.919 --> 00:15:18.639
Guest list, as I said, included director Stigler, Friedman, Harburger, Martin Bailey, Ruben Kessel, Greg Lewis, John McGee, Lloyd Minz, about ten other people.
00:15:18.799 --> 00:15:22.720
They were there to take this arrogant Englishman apart.
00:15:23.039 --> 00:15:30.320
Stigler recounted the evening in his memoir, Memoirs of an Unregulated Economist.
00:15:30.639 --> 00:15:35.279
It's actually worth quoting him directly because nobody has improved on the description.
00:15:35.440 --> 00:15:36.639
This is Stigler.
00:15:36.960 --> 00:15:39.200
We strongly objected to this heresy.
00:15:39.360 --> 00:15:42.480
Milton Friedman did most of the talking as usual.
00:15:42.720 --> 00:15:45.039
He also did much of the thinking as usual.
00:15:45.279 --> 00:15:53.679
In the course of two hours of argument, the vote went from twenty against and one for coast, that is Coase voting for himself, to twenty-one for coast.
00:15:53.919 --> 00:15:55.519
What an exhilarating event.
00:15:55.759 --> 00:15:59.759
I lamented afterwards that we had not had the clairvoyance to tape it.
00:16:00.000 --> 00:16:01.039
End of quote.
00:16:01.279 --> 00:16:03.679
Think about the mechanics of that sentence for a second.
00:16:03.759 --> 00:16:06.960
It tells you exactly what kind of economist Milton Friedman was.
00:16:07.200 --> 00:16:13.279
He didn't lead the room to Coase's side by being polite or by yielding ground or finding a diplomatic synthesis.
00:16:13.519 --> 00:16:16.320
By every account, he came out swinging.
00:16:16.559 --> 00:16:23.200
He was, in one retelling, the one interrogating Coase the hardest of all, started throwing the sharpest elbows in the room.
00:16:23.360 --> 00:16:25.519
He wasn't a pushover, he wasn't there to be nice.
00:16:25.600 --> 00:16:27.519
He was there to find the hole in the argument.
00:16:27.759 --> 00:16:30.960
And over two hours, he discovered he couldn't find one.
00:16:31.200 --> 00:16:44.159
Every time the Ruth, the room, threw a standard Pegovian objection at Coase, but surely the rancher should be libel because that's the whole point of tort law, Coase had an answer, and the answer survived every attack.
00:16:44.399 --> 00:17:03.039
At some point in that two-hour argument, Friedman's own logical abilities, the rigorous, relentless, take no prisoner's price theory he'd spent 15 years teaching to Buchanan, Becker, every other student that came through his course, turned on the room's initial assumption instead of on coast.
00:17:03.360 --> 00:17:16.079
If you trace out what actually happens under costless bargaining, with each party maximizing and no impediment to trade, exchange, and negotiation, the liability rule really, really doesn't change the allocation of resources.
00:17:16.400 --> 00:17:19.200
Changes the distribution of wealth, who pays whom.
00:17:19.519 --> 00:17:21.680
But that's always true of ownership.
00:17:22.000 --> 00:17:24.000
Doesn't change the efficient outcome.
00:17:24.160 --> 00:17:33.039
By the time the plates were cleared, Friedman had not just conceded the point, he had become the person making Coase's case for him to the rest of the room.
00:17:33.119 --> 00:17:34.880
That's a formidable advocate.
00:17:35.039 --> 00:17:48.480
And that's why 21 for Coase, not 20 holdouts that were grudgingly outvoted by one loudmouth, genuine, complete conversion, consensus, led by the man who'd been arguing hardest against it three hours earlier.
00:17:48.720 --> 00:17:55.680
Milton Friedman publicly changed his mind, admitted he was wrong, and then became an advocate for the new position.
00:17:56.079 --> 00:17:59.519
Well, two things came out of that dinner, and they're both worth naming.
00:17:59.680 --> 00:18:01.119
First is the paper itself.
00:18:01.359 --> 00:18:14.640
Coast went back, informed by that discussion, wrote the version of the problem of social cost that actually got published in 1960, the one that's now the single most cited article in the history of legal scholarship.
00:18:14.880 --> 00:18:23.920
And critically, the famous zero transaction cost result, the theorem part, which was never the point of the paper, even though it's only the only part most people remember.
00:18:24.240 --> 00:18:26.640
Kose's real argument came in the second half.
00:18:26.799 --> 00:18:40.079
Since transaction costs in the real world are never actually zero, the whole question of how you assign property rights and design legal institutions matters enormously, precisely because bargaining is costly, slow, sometimes impossible.
00:18:40.319 --> 00:18:44.079
The frictionless world was a benchmark to show you what to explain.
00:18:44.319 --> 00:18:50.559
What causes the significance of liability is not morality, it's transaction cost.
00:18:51.839 --> 00:19:01.440
Coase spent the rest of his career frustrated that economists fixated on the fictional zero cost half of the argument, mostly ignored the point he actually cared about.
00:19:01.839 --> 00:19:09.200
Second thing that came out of that dinner is Milton Friedman's character on display, in a way the Chile letter and Prophet's essay never quite capture.
00:19:09.599 --> 00:19:22.799
Here's one of the most confident, combative intellects of the 20th century, sitting across the table from a visiting Englishman with no Chicago pedigree and losing an argument publicly in real time.
00:19:22.960 --> 00:19:30.480
And instead of digging in, pulling rank, trying to change the subject,
said, You're right, I was wrong, and here's why.
00:19:30.720 --> 00:19:40.160
And then he spent the rest of the evening, and arguably the rest of his career, as one of the most energetic promoters of the idea that just kicked his butt.
00:19:40.400 --> 00:19:46.640
That's not the Friedman of the Doctor O cartoon or the other caricatures.
00:19:46.799 --> 00:19:48.160
That's a scientist.
00:19:48.400 --> 00:20:08.000
Whatever you think of the rest of his career, monetarism, deregulation, free trade, letters to Pinochet, that dinner in Aaron Director's dining room in 1960 is as good a demonstration as exists anywhere in the history of economics, what it actually looks like to be a serious scientific economist.
00:20:10.799 --> 00:20:14.079
Whoa, that sound means it's time for the twedge.
00:20:14.799 --> 00:20:25.680
A giant in physics and mathematics, Stanislav Ulam, who worked on the Manhattan Project, used to tease social scientists about the weakness of their fields.
00:20:25.839 --> 00:20:37.759
He famously challenged Paul Samuelson with this prompt Name me one proposition in all of the social sciences, which is both true and non-trivial.
00:20:38.000 --> 00:20:41.119
Eventually, Samuelson gave his answer.
00:20:41.519 --> 00:20:42.880
Comparative advantage.
00:20:43.039 --> 00:21:04.079
Samuelson argued that David Ricardo's law of comparative advantage is mathematically true, entirely non-trivial, as evidenced by how many highly intelligent people still don't understand or believe it, and it's the fundamental law that explains how international trade benefits countries even if one is better at producing absolutely everything.
00:21:04.640 --> 00:21:10.720
Now, the physicist's view is that the universe is a closed system governed by the first law of thermodynamics.
00:21:10.960 --> 00:21:14.720
You can't create matter or energy out of nothing.
00:21:14.960 --> 00:21:18.720
The economist's view is that the economic world is governed by scarcity.
00:21:18.960 --> 00:21:23.279
You can't create goods and services or time out of nothing.
00:21:23.599 --> 00:21:27.279
But time does have an opportunity cost.
00:21:27.680 --> 00:21:44.640
Now, that answer that Samuelson gave, comparative advantage, has over time come to be replaced by an answer that supposedly Milton Friedman gave, although there's no evidence of that, and that is there is no such thing as a free rent, free lunch.
00:21:44.960 --> 00:21:51.680
And that's evidence of the economist's view that scarcity that's actually equivalent to conservation of energy.
00:21:51.839 --> 00:22:11.759
So over decades of academic storytelling and campus jokes, the real life exchange, where Ulam demanded a non trivial truth and Samuelson said Samuelson said comparative advantage, frequently gets remixed now by professors and students into the punchier, more intuitive version that you've heard.
00:22:12.079 --> 00:22:19.200
A physicist demands the law of economics, an economist said there is no such thing as a free lunch.
00:22:20.079 --> 00:22:22.880
This week's letter is from WH.
00:22:23.519 --> 00:22:25.759
Dear knower of important things.
00:22:26.000 --> 00:22:29.200
The Regime Uncertainty Podcast was excellent.
00:22:29.519 --> 00:22:40.319
I understand your point of view of constantly changing rules causing uncertainty leading to increased transaction cost as well as other intended and unintended consequences.
00:22:40.880 --> 00:22:46.880
Somewhat related would be the proposition of tax time horizon, which is more of a certainty issue.
00:22:47.200 --> 00:22:59.440
A short time tax horizon, like a one-time tax rebate, has little effect on consumption and investment behavior, but politicos sell the idea as jump starting the economy.
00:22:59.759 --> 00:23:01.119
Pause the quote for a moment.
00:23:01.200 --> 00:23:12.880
This is exactly Milton Friedman's point in his famous theory of permanent income.
00:23:13.039 --> 00:23:22.000
The permanent income hypothesis would claim that only if the change is going to be permanent and predictable does it have any real effect.
00:23:22.319 --> 00:23:23.440
Back to the letter.
00:23:23.599 --> 00:23:30.240
The short tax horizon tells the consumer and firms that it'll be taxes as usual after the one time or a short-lived tax event.
00:23:30.480 --> 00:23:32.240
Behavior remains the same.
00:23:32.480 --> 00:23:51.759
On the other hand, a meaningfully long tax horizon, for example, a tax change is for the next seven years, causes behavior to change because certainty allows consumers and firms to make consumption and investment decisions calculating their choices, knowing taxes will remain the same over an extended period.
00:23:52.000 --> 00:24:03.839
Regime uncertainty has similar aspects to short-term tax horizons regarding expected results, while regime certainty has expected results that are similar to long-term tax horizons.
00:24:04.079 --> 00:24:05.359
I'm just saying.
00:24:05.680 --> 00:24:09.839
By the way, greetings from the Great White North, WH.
00:24:10.240 --> 00:24:11.680
Well, thanks, WH.
00:24:11.759 --> 00:24:16.960
That is an important point, and it's one that Friedman certainly thought was important, so thanks for bringing it up.
00:24:17.039 --> 00:24:20.559
It connects well with this week's podcast.
00:24:21.200 --> 00:24:27.920
The Book of the Week is I've been reading it over the past week and it's quite a page turner.
00:24:28.240 --> 00:24:29.359
Mary Roach.
00:24:29.759 --> 00:24:38.240
The book is Bonk, B-O-N-K, The Curious Coupling of Science and Sex 2008, published by Norton.
00:24:38.480 --> 00:24:41.920
The book is hilarious, but you'll also learn a lot from it.
00:24:42.000 --> 00:24:51.680
And of course, well, Mary Roach herself participated in some experiments, and her description of that is worth it.
00:24:54.720 --> 00:24:56.640
Well, that's it for this week.
00:24:56.799 --> 00:25:00.559
I'll talk to you again next week on The Answer is Transaction Costs.