Sunday, October 16, 2011

Milton Friedman's pencil: reality check

Dani Rodrik has a good comment about Milton Friedman and his pencil. This duo appeared on the cover photo of Milton and Rose Friedman's book Free To Choose. In the first chapter of the book, the Friedmans tell a story of how the invisible hand of the market wondrously produces pencils without the need of any central direction.
"I'll bet those Commies can't make pencils like this!"

As Rodrik notes (and the Friedmans footnote), the pencil story was taken from a piece by Leonard E. Read, "I, Pencil", written for the libertarian propaganda publication The Freeman, published by an outfit called the "Foundation for Economic Education" [sic]. (Anyone who has read the Wealth of Nations will recognize that its real inspiration is Adam Smith;s tale about a linen shirt at the end of the chapter one.)

Rodrik remarks that
The Friedmanite perspective greatly underestimates the institutional prerequisites of markets. Let the government simply enforce property rights and contracts, and – presto! – markets can work their magic. In fact, the kind of markets that modern economies need are not self-creating, self-regulating, self-stabilizing, or self-legitimizing. Governments must invest in transport and communication networks; counteract asymmetric information, externalities, and unequal bargaining power; moderate financial panics and recessions; and respond to popular demands for safety nets and social insurance.
Indeed. More ironically, with regard to pencils, Rodrik asks where pencils are now made and why....

A modern-day Friedman might want to ask how China has come to dominate the pencil industry, as it has so many others. There are better sources of graphite in Mexico and South Korea. Forest reserves are more plentiful in Indonesia and Brazil. Germany and the United States have better technology. China has lots of low-cost labor, but so does Bangladesh, Ethiopia, and many other populous low-income countries.Undoubtedly, most of the credit belongs to the initiative and hard work Chinese entrepreneurs and laborers. But the present-day pencil story would be incomplete without citing China’s state-owned firms, which made the initial investments in technology and labor training; lax forest management policies, which kept wood artificially cheap; generous export subsidies; and government intervention in currency markets, which gives Chinese producers a significant cost advantage. China’s government has subsidized, protected, and goaded its firms to ensure rapid industrialization, thereby altering the global division of labor in its favor.


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