Friedman’s Critics Miss The Mark

Thursday, September 24, 2020
Milton Friedman

On September 13, 1970, the New York Times Magazine published an article by Milton Friedman titled “The Social Responsibility of Business Is to Increase Its Profits.” The article made quite a stir. It still does. The editors of the New York Times invited a number of economists, business people, think tankers, union officials, and others, twenty in all, to comment on specific sentences in Friedman’s article for the September 13, 2020, issue of the Times. Of the twenty commenters, six, including Hoover fellow Russ Roberts and me, basically agreed with Friedman’s views (although I had a criticism that I’ll mention later); one, Harvard economics professor and Nobel Prize winner Oliver Hart, was arguably neutral; and thirteen ranged from negative to very negative. Editor Andrew Ross Sorkin wrote a short, neutral introduction. The editors lined up Kurt Andersen to write a longer piece. Andersen’s piece was quite long and quite negative.

My take on reading the thoughts of Andersen and other critics is that most were uninformed, either about Friedman’s views, the factors that drive stock prices, or the nature of free markets. So here’s my chance to set the record straight. I’ll start with a story I told editor Adam Sternberg that he encouraged me to write up but decided not to use. It’s my story about how I “got” Friedman’s point eight years before his article.

To understand my story, you first need to understand Friedman’s basic point. Here it is in a nutshell: Managers are employees of corporations. In the decisions they make with corporate resources, they should be responsible to the corporation. That means being responsible to the stockholders, who, after all, are the corporation’s owners. The vast majority of stockholders want the corporation to, in Friedman’s words, “make as much money as possible.” Thus Friedman’s claim that the social responsibility of a corporation is to make money. Friedman was clear that he wasn’t advocating breaking the rules. He stated that the managers should conform “to the basic rules of the society, both those embodied in law and those embodied in ethical custom.”

I learned Friedman’s point in a personal way when I was eleven. My mother had raised us to help others. I liked doing that and didn't see it as a heavy obligation. But when I was eleven, my brother, Paul, who was fourteen, bought a cheap set of golf clubs and hired me to caddy for him. When we were on the eighth hole of a nine-hole course near our summer cottage in Minaki, Ontario, we saw a golfer hunting in the rough for his lost golf ball. I thought I should stop and help, so I did.

Paul had a different view: he wanted to play through and I was working for him and so I should do what he asked. We had a big argument and I finally gave in. When we got home, my brother complained to my mother that I hadn’t kept my side of the bargain. I was sure my mother would support me. She didn’t. “When Paul hired you,” she said, “you were working for him. When you’re on your own you can stop and help someone find his ball, but when you’re working for someone, he has the right to decide whether to let you.”

The lesson stung, but I ended up agreeing. That’s why the most important part of Friedman’s essay spoke to me. It’s simply wrong, when you’re working for someone, to use his resources for your ends when they don’t promote his ends. In the case with my brother, I was using my time to help others but my time was really his time: he was paying for it. In the case of corporations, managers might be using both their time and the corporation’s resources to help others even though shareholders own those resources and own the manager’s time that they are paying for.

Point and Counterpoint

So what parts of Friedman’s argument and bottom line do the negative commenters disagree with? Here are the most common ones.

Corporate lawyer Martin Lipton, who made his reputation helping corporations repel hostile takeovers, states that the “Friedman doctrine precipitated a new era of short-termism, hostile takeovers, junk-bond financing and the erosion of protections for employees and the environment to increase corporate profits and maximize value for shareholders.” Lipton doesn’t say how. But his charge of short-termism is strange because it contradicts his view that the “Friedman doctrine” led to an era of maximizing value for shareholders. The market value of a company is based on shareholders’ expectations of the future stream of earnings—that’s the ultimate in long term. There is no doubt, for example, that Merck could have way more short-term profits if it cut research and development to zero and never again developed a new drug. But would Lipton maintain that doing so would increase Merck’s share value? That’s hard to believe.

Two chief executives, the Ford Foundation’s Darren Walker and BlackRock’s Larry Fink, make a disturbing claim. Walker states that “we, the people” grant businesses “their license to operate—which they, in turn, must earn and renew.” Fink states that “companies need to earn their social license to operate every day.” But to state that companies must “earn” their license to exist is to say they have no right to exist. I have a right to exist simply because I do exist and haven’t violated other people’s right to exist. I don’t have to earn that right. Neither should corporations.

Alex Gorsky, chief executive of Johnson & Johnson, claims that things have changed because many of a company’s employees are also its shareholders, and “they are calling on leadership to take action on societal issues.” Economist Oliver Hart makes a similar point. He writes, “Instead of assuming that shareholders always want more money, companies should ask them if they are willing to sacrifice some profit in exchange for the pursuit of environmental and social goals.” In short, Gorsky and Hart actually agree with Friedman that managers should work in the interests of shareholders. Their disagreement is about whether shareholders want managers to sacrifice profits to pursue other goals.

Because Friedman died in 2006, we can’t ask him if he agrees with Hart, but his own reasoning suggests that he would. After all, Friedman thought that managers work for the stockholders. Friedman would probably have been skeptical, though, of managers like Gorsky who seem to think that because one group of stockholders, the employees, wants a change, therefore such a change is in the interest of the majority of stockholders. Friedman, always the empiricist, would have wanted to see Gorsky’s evidence.

In his long essay, Kurt Andersen also discusses Friedman’s 1962 book, Capitalism and Freedom, which he calls a “cri de coeur for pure coldheartedness.” He also claims that Friedman, in his 1970 essay, was telling businesspeople they ought to emulate Ebenezer Scrooge and Mr. Potter, the grasping banker of It’s a Wonderful Life. But here Andersen shows how he misses Friedman’s point. Both Scrooge and Potter owned their own businesses and had no shareholders to answer to. Their wealth was theirs to dispose of as they saw fit, so Friedman would have had no objection to their donating to charity.

As for “coldheartedness”—well, that wasn’t Milton Friedman. Of the hundreds of economists I’ve ever known, he must have been in the top ten in terms of warmheartedness.

One commenter, economist Dambisa Moyo, agrees with Friedman’s overall point but finds something she disagrees with. Friedman had stated, “They [corporate managers] can do good—but only at their own expense.” In context, Friedman was discussing cases where managers put their own social goals above those of the shareholders. That sounds like the point my mother made to me when I was eleven. But, notes Moyo, “The pursuit of profit does not need to run counter to what will benefit society. In some cases the interest of the corporation is absolutely married to the social good.” She gives an example of a pharmaceutical firm working on a cancer drug; the manager would produce good while making money for the company. Friedman would have agreed. Like Adam Smith, he believed that in pursuing their own self-interest the butcher, the brewer, and the baker help us by giving us our dinner.

Robert Reich, a public policy professor at UC-Berkeley, comments: “The ‘free market’ has been taken over by corporate bailouts and corporate welfare.” He’s not totally wrong. Although hundreds of thousands, and probably millions, of shareholder-owned firms get no handouts, both Republican and Democratic politicians in Washington have handed out a lot of corporate welfare, especially during the pandemic. But then Reich writes, “Shareholders and top executives have done extremely well, but almost no one else has.” That’s false. Almost everyone else has. Even growth pessimist Branko Milonavic recently admitted that in the thirty-year period starting in the late 1980s, real middle class incomes increased by 20 to 30 percent. And he got that number by using the Consumer Price Index, which, by insufficiently adjusting for new goods and consumers’ ability to substitute between goods, notoriously overstates inflation.

Commenter Felicia Wong, president and CEO of the Roosevelt Institute, notes that Friedman wrote when America’s “overwhelmingly white” fears were about Watts, Detroit, Vietnam, Kent State, Jackson State, and the assassinations of Martin Luther King Jr. and Robert Kennedy. Hmm. I recall that when King and Kennedy were murdered a lot of black people were upset, too, particularly by King’s murder. She alleges, “Just beneath Friedman’s prose was a promise: business(men) would restore prosperity and order, saving the American family, white-faced and picket-fenced.” In short, Wong passively aggressively accuses Friedman, without evidence, mind you, of appealing to racists.

The Cost of Discrimination

This brings me to my comment that the New York Times published. On rereading Friedman’s article for the first time in years, I noticed something interesting in the first paragraph. Friedman criticized businesses that feel responsible for “eliminating discrimination.” I now find that strange. When Friedman wrote that, he was familiar with his colleague Gary Becker’s work on discrimination. Indeed, he made Becker’s point in his 1962 book Capitalism and Freedom. Becker argued that an employer who exercises his own taste for discriminating against black people gives up the chance to hire a productive black person and, thus, gives up potential profits. This can show up in two ways. Either overall discrimination against black people causes wages to be lower for black people than for equally productive white people and so the employer gives up the chance to hire a productive person at a discount; or, if the employer has a wage schedule for a particular position, the employer who discriminates will give up a chance to hire a more-productive black person at the same wage at which he hires the less-productive white person.

That means that the employer who doesn’t try to reduce racial discrimination is actually failing to act in the interest of shareholders. That employer is either paying too much or getting too little.

Interestingly, Friedman understood this in his own role as an employer. In a talk he gave at Stanford University circa 1989, he told how he noticed that at a certain wage, the black women he could hire as assistants were more productive than the white women. So he ended up hiring black women. I met one of them when I first visited him at the University of Chicago in May 1970 and later I met Gloria Valentine, his longtime assistant at the Hoover Institution in the early 1980s. Observing her over twenty-five years, I can vouch for her productivity. She and Friedman enjoyed a long, caring, and productive relationship, one that was so important to him that he acknowledged her value to him in his and Rose Friedman’s autobiography, Two Lucky People. Hiring a black woman? What a coldhearted man.

I’ll end by noting an ironic argument in Friedman’s essay that I don’t agree with and I wonder if even he would agree with today. Fortunately, it doesn’t undercut his case against corporate social responsibility. In stating that managers shouldn’t use corporate resources at the expense of shareholders, even for purposes that a huge percentage of us would agree are good, Friedman argued that we should leave those functions to the government. He wrote:

On the level of political principle, the imposition of taxes and the expenditure of tax proceeds are governmental functions. We have established elaborate constitutional, parliamentary, and judicial provisions to assure that taxes are imposed so far as possible in accordance with the desires of the public—after all, “taxation without representation” was one of the battle cries of the American Revolution.

That ignores what we have learned, and Friedman learned, from the “Public Choice” school of economics, led by James Buchanan and Gordon Tullock. Government’s incentives are usually perverse and we see the bad results almost daily. There’s much more hope, and I think Friedman shared that hope, for private voluntary activity.