The Power of Choice

Monday, October 30, 2006

Milton Friedman’s scholarly work and its enormous impact covered a huge range of subjects and ideas. His work on macroeconomics and monetary policy and his writing on freedom are perhaps best known. And for good reasons. But his work on microeconomics and policy issues has been and continues to be very influential.

I think of the major theme of his microeconomic and policy research as incentives. It could reasonably be argued that a good part of economics is concerned with incentives in various systems and with the consequences of incentive structures for outcomes and performance. No one was better than Milton at understanding incentive structures and at identifying incentive problems in a whole variety of plausible sounding systems, structures, and policies. He understood and constantly reminded us that flawed incentive structures were doomed and would fail to produce the desired outcomes. There are many applications: choice in the context of schooling, the persistent performance problems of monopolies (whether public sector or private sector), the unlikelihood of good performance in centrally planned or partially centrally planned economies. He understood and taught us that freedom (which prominently includes choice) and efficiency are intimately linked.  

One can think of a good part of the twentieth century as consisting of a variety of experiments in forms of economic organization. And a reasonable conclusion is that the forms with the best static and dynamic performance are those in which there was maximum decentralization consistent with the achievement of collective interests such as security, financial stability, and education.  

Milton understood and constantly reminded us that flawed incentive structures were doomed and would fail to produce the desired outcomes.

Milton understood that much of economic performance is determined by the choice that society and government make about where the boundary line between the public and private sector is drawn. This issue continues to be imperfectly understood. In many developing countries, the boundaries are hazy or vague or are drawn in the wrong places with adverse effects on incentives and performance. Many successful reform programs (as in China and India) consist in significant part of redrawing the boundary of the government to make more room for the private sector and to clarify the rules-based context in which the private sector operates.