Benjamin Friedman on the Origins of Economic Belief (Ep. 114)

How religion explains where economic ideas came from

Benjamin Friedman has been a leading macroeconomist since the 1970s, whose accomplishments include writing 150 papers, producing more than dozen books, and teaching Tyler Cowen graduate macroeconomics at Harvard in 1985. In his latest book, Religion and the Rise of Capitalism, Ben argues that contrary to the popular belief that Western economic ideas are a secular product of the Enlightenment, instead they are the result of hotly debated theological questions within the English-speaking Protestant world of thinkers like Adam Smith and David Hume.

Ben joined Tyler to discuss the connection between religious belief and support for markets, what drives varying cultural commitments to capitalism, why the rate of growth is key to sustaining liberal values, why Paul Volcker is underrated, how coming from Kentucky influences his thinking, why annuities don’t work better, America’s debt and fiscal sustainability, his critiques of nominal GDP targeting, why he wouldn’t change the governance of the Fed, how he maintains his motivation to keep learning, his next big project on artificial intelligence, and more.

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TYLER COWEN: Hello, everyone. Welcome back to Conversations with Tyler. I’m very happy to be here today with Ben Friedman, who has a new wonderful book out, Religion and the Rise of Capitalism. I’m a big fan of Ben’s other books. He is a professor of economics at Harvard, a leading macroeconomist, and I’m very honored to have taken his macroeconomics class way back in, I believe, 1985. Ben, welcome.

BEN FRIEDMAN: Thank you. Delighted to be with you, Tyler, and it’s great to see you after all these years.

COWEN: To dig right in, why do so many Americans believe in ghosts? And from that, what should we infer about our economic future?

FRIEDMAN: Well, I have no idea why so many Americans believe in ghosts, to be honest with you, but I do have views about why Americans have such strong views about the way we should run our economy and what that means for our economic future.

Counter to most people, who think of our modern economics as a secular product of the enlightenment, I think that there are very deep intellectual roots behind the creation of modern Western economics, and I think those roots have resonances that are still with us today.

There are many people who complain that economics is a form of religion, and I think in a deeper sense there’s something to the idea. I think we believe — when I say we, I’m picking up on your question about Americans — we believe what we believe about markets and the role of competition and the role of capitalism in our economy because there are religious roots behind the ideas that gave us those. I think that’s important.

COWEN: But if we disaggregate religion somewhat, there’s a community side of religion. There’s what you might call an individual discipline side. There’re the ideas within the religion. There’s also a superstitious side within most religions. Do you think that the superstitious side of our religions also boosts support for liberal democratic capitalism? Or is that somehow a negative that leads us astray in other directions?

FRIEDMAN: I don’t think it particularly . . . Put it this way: the superstitious side of religion — I have to admit I’m uncomfortable with the way you described that.

There are many people who believe in what scientists would call supernatural phenomena, and I am aware that that’s a part of religion, but I’m uncomfortable with describing that as superstitious. But knowing what you mean, I don’t think that it has a lot to do with our economic views. It’s certainly not a part of my argument about the role of religion in standing behind many of our economic ideas.

COWEN: Relative to income, as you know, America is quite religious, and there also seems to be a weaker belief in socialism in America compared to, say, Western Europe. Are those two facts related? And if so, what is the mechanism?

FRIEDMAN: Yes, I think they certainly are related. To start, you’re absolutely right — compared to other high-income countries, Americans are more inclined to say they believe in religious doctrines, and the Americans are much more likely to participate in religious activities — going to church, for example.

I think this is not at all unrelated to the fact that Americans have a deeper and more active commitment to the ideas of market competition. It goes back to the question that I was raising a minute ago of where do our ideas of market competition come from in the first place? What I suggest in my book is that we got those ideas 200, 300 years ago from what were then new and hotly contended ideas about religion, theology within the English-speaking Protestant world, in which people like Adam Smith and David Hume lived.

And I think that influence is still with us today. So no, it’s not at all an accident that the country on the planet where we probably have the greatest commitment to market competition as the driver of economics, is precisely, as you say, an outlier in terms of commitment to religion and religious activities.

It’s not at all an accident that the country on the planet where we probably have the greatest commitment to market competition as the driver of economics, is precisely, as you say, an outlier in terms of commitment to religion and religious activities.

COWEN: If we think of the most influential advocates for capitalism in the mid–20th century, there’s Hayek, I would say Keynes at most phases of his career — maybe not all, Milton Friedman. They seem to be largely secular rather than religious. If we look at theologians — while there’s a great diversity of views, on average, they seem to be left-leaning. So why is it the religious thinkers lean towards socialism, and the economists are quite secular?

FRIEDMAN: I think there’s a part of the story that you’re missing, and that has to do with the coming together at mid–20th century in America, of religious conservatism and economic conservatism. I think the catalyst that brought them together was the existential fear of world communism. Here we are — call it 70 years later, and it’s difficult to put ourselves back in the shoes of Americans in the 1950s, but that was a real fear.

Communism, at least as advocated at that time, had a unique feature of being simultaneously the existential enemy of lots of things that we hold dear. It was the enemy of Western-style political democracy, but it was also the enemy of Western-style market capitalism, and importantly for purposes of this line of argument, it was the enemy of Western-style religion.

I think the religious conservatives and the economic conservatives realized that they had an enemy in common, and they took the threat seriously, and this led them to come together.

The person I think who played the greatest role in bringing them together was Bill Buckley. Now, Buckley was not a theologian, but he was a religious man. By coincidence, he was a Roman Catholic; he wasn’t a Protestant. But I think, under the leadership of Buckley and also ministers — I think of Billy Graham as being very active in this process, but others too — religious conservatism and economic conservatism came together at mid–20th century America, and I think they’ve been together ever since.

On varying cultural commitments to capitalism

COWEN: How is it, do you think, that in the broader history of capitalism, allegiance to markets gets switched from Catholicism to Protestantism? If you think of the commercial revolution, in some regards, as restarting in Renaissance Italy, which is largely Catholic — if you think about the first real economists, they might be the school of Salamanca in the 17th century. They, of course, are Catholic theologians.

But by the time you get to the 18th century, as you note, it’s Adam Smith, David Hume. The United States, which starts off as quite a Protestant republic, obviously is very capitalistic. How does that transformation happen?

FRIEDMAN: During the course of the 16th and then, especially, the 17th and on into the 18th centuries, in Northern Europe, there was a transformation toward what we would today call a commercial economy, a competitive economy, a financial economy, a monetized economy that created something very different from what they had in the Italy and Spain context of earlier centuries that you described.

Yes, I’m aware that there were these trade fairs. Yes, I’m aware that the Italians led the way in banking. I don’t think that’s the same thing. I think these were not really market economies in the way that we know today. For that matter, 17th-century Britain wasn’t either, but it was an awful lot closer.

I think it was in Northern Europe — I think of Holland, I think of Britain — that’s where the commercial economy developed, and that’s where the great debate over not just the advantages, but the morals of a commercial economy came to the fore. It was people like Smith and Hume in the mid to latter part of the 18th century who finally, finally had a real story about why market economies work and why market economies should not be thought of as inimical to our morals.

COWEN: If you look at the Eastern Orthodox countries in Europe, both today and arguably ever, they don’t seem to have had truly stable liberal democratic capitalism that I can think of — not really one instance. Why is that? Does it have anything to do with religious ideas?

FRIEDMAN: I don’t know, but I think I would point to the century or so of dominance under Soviet Communism as the primary cause. Look, for example, at the difference in attitudes between people who are living in West Germany and the former East Germany. Look, these were the same groups of folks from years ago, but the East Germans lived under half a century of dominance by the Soviet Union and a communist system. You can’t get away from the fact that that was very important.

The good news would be that a half a century is — while not a short period of time — is nonetheless temporary. I would say the good news would be, going forward in time, we would see them — maybe not you and I in our lifetimes, but our children would see them — moving beyond their current authoritarian difficulties. But maybe not. Maybe there are forces that are deeper than just their experience under Soviet Communism.

COWEN: But even before Soviet rule, they don’t seem to have been on the same path as say England, France, or Belgium. A country such as the former Yugoslavia was never that much dominated by the Soviets, but its remnants still are marginally stable. Probably, Slovenia is. That was closest, of course, to what is now Austria.

The other parts — they’re not doing that well. They have fascist movements. They had civil wars. Whether you look at before the Soviets or cases where the Soviets weren’t that strong, there just seems to be underperformance. It’s as if there’s a line in Europe. What does that line signify? What does it correlate with?

FRIEDMAN: Well, again, in my mind, when you point to a line dividing the East and the West, the number one thing you’re talking about is the place where the Soviet Union was dominant and not.

But I understand that there are all sorts of cultural features. Look at a country like Poland, for example. Poland never had the experience of democracy the way the West did. Poland was a country that got partitioned, what? Three times in the course of the last few hundred years. Look at a country like Hungary. Hungary was part of the Austro-Hungarian Empire.

Look at, where else? The Czechs I think are doing better. The Czechs at least come out of a quasi-democratic experience. I certainly don’t want to suggest that the Soviet experience was the only thing going on there. In the same way, I don’t want to suggest that the religious influence is the only thing that was driving our Western economics at its creation. But I think these are both very important.

COWEN: Your colleague, Joe Henrich, in his new book on WEIRD — he argues that medieval canonical laws set the Western world on a unique path, in essence because the clergy discouraged cousin marriage, and that led to much weaker clan systems in Western Europe. Do you agree?

FRIEDMAN: It sounds plausible. I have to confess I haven’t read Joe’s book. I’m embarrassed, but I haven’t read it. In our department, we had a department-wide seminar with Joe as a speaker, and unfortunately, I had another commitment and couldn’t hear him, and I’m very sorry about that, but I’m sympathetic to the idea.

Another truly great book that I would point to along those lines is by my late colleague David Landes, who wrote about the cultural influence on the development of markets, capitalism, economic growth. Landes’s book was very aptly titled The Wealth and Poverty of Nations. The issue is, why do some countries, some societies flourish economically and others don’t?

Long before it was fashionable, Landes pointed to cultural influences. Landes didn’t point so much to the church, but Landes pointed to geography. What was very interesting in the beginning of his book was his story about the geography of Western Europe compared to the geography of China. He raised the following question: Suppose in, say, some period like what you’re talking about, say 1400, 1500 — something like that — somebody had come along and said, “Tyler, tell me which part . . .”

They would have had to explain to you what an industrial revolution was. Then somebody had said, “Okay, Tyler, now that I’ve explained it to you, I’m going to tell you that one region of the world is going to experience an industrial revolution, and on the strength of that, is going to dominate most of the world for the next 500 years. Which one would it be?” David’s argument was that you would probably have predicted China. Then the question was, well, why not?

One part of his answer was that with its geography being relatively flat and requiring these large-scale canal water systems, the Chinese society lent itself to centralization in a way that Western Europe, with all of these mountains and other geographical features, didn’t, so that while you could travel for thousands of miles in China and you’re still under the same emperor, in Western Europe, all you had to do is go over some set of hills and you’re in a different principality. Well, I think all of these things are very important.

COWEN: What do you think of the René Girard hypothesis? That what’s special about Christianity is that Christ, who obviously is a very focal holy individual, is also a victim, so that within Christianity are the roots of a theory of individual rights. That it’s doing more than just glorifying power. It’s moving away from “might makes right.” In the long run, that’s providing the foundations for these liberal democratic societies, an idea deeply buried in the roots of Christianity.

FRIEDMAN: Well, I would say this is not unique to Christianity. Remember, the foundational Jewish tradition or myth, depending on how you want to look at it, has to do with the emergence from slavery and oppression. The idea that might doesn’t necessarily make right is not unique to Christianity.

I don’t know whether political systems are driven by the fact that we in the West have a kind of Judeo-Christian culture. We’re going to find out over time, but it does seem to be the case, at least so far. What’s certainly the case historically is that modern, liberal with a small l, democracy with a small d, originated in Protestant countries. I think what’s clear so far is that those are the predominant ones.

If we had been having this conversation, say, 20 years ago, we might have had a different view. Twenty years ago, we might have pointed to some of these data from Freedom House and other institutions and said, “Look, it started in the West, and it’s spreading everywhere.” Well, here we are. Democracy seems to be on the retreat at the moment, but I’m optimistic that that trend will turn around, too.

COWEN: If we look at Muslim countries, it seems that Muslim immigrants to non-Muslim countries, on average, both do very well and are quite likely to be involved in commerce. The history of Islam seems quite positive for commerce. Muhammad was himself a merchant. There are limitations on usury and the like, but overall, the doctrine of the religion is arguably more pro-commerce than is Christianity.

So why is it that so few Islamic nations have embraced liberal democratic capitalism? And very few are democracies, right? Malaysia, to some extent, Indonesia, but overall, the record is not that democratic.

FRIEDMAN: There are two points of view that I think are probably both right. One is that somewhere along the way, Islam took a very interesting turn that moved those societies from being at the very forefront — which they were — of scientific advance and cultural height, to a more stagnant, backward-looking orientation. Timur Kuran’s book, I think, is the key one on that, but many other people — my colleague, Noah Feldman at Harvard — have views of all of this as well.

The second view is that the Islamic view of lending is particularly inimical to economic development. Now, this is a view in which one doesn’t lend at interest, which originates in the Hebrew Bible and was taken up by the early Christian thinkers as well.

Many historians of the economic development point to the movement away from the ban on lending at interest under Luther, and then especially under Calvin, as the key step that freed Western society to move toward a more financially based, and therefore expansive, economic posture. That’s been blocked in the Islamic world by the strictures on banking and lending. I think there’s something to both of these views, but they’re very different.

COWEN: Why are Mormons so capitalistic?

FRIEDMAN: I don’t know. That’s a very interesting question. Mormons have been very successful economically in the United States, and the history of the Mormon church only goes back to the first half of the 19th century. Instead of Judaism and Christianity and Islam, we’re now talking about something that goes back not even 200 years, so it ought to be possible for people who are knowledgeable about Mormonism to have a lot to say about it.

But it is certainly true that in our American society, Mormons have been extremely successful economically.

On the moral consequences of economic growth

COWEN: It’s a common argument from historians, and sometimes Marxist historians — disputed, to be clear — that the rise of capitalism was accompanied by a rise in anti-Semitism, a rise in racism — different forms of domination — and that these were part and parcel of the same process. Do you agree? You’ve written a famous book, Moral Consequences of Economic Growth. Did religion, as it manifested itself in the form of capitalism and higher state capacity, also give rise to these very bad events?

FRIEDMAN: I don’t think so. I don’t think there’s a connection. We can certainly point to successful market-oriented societies that have had their share of religious prejudice, whether it’s against Jews or Roman Catholics. Today, whether it’s against Muslims in various Western countries. But I don’t see any connection.

In fact, I would argue the opposite. I would argue that what makes room for these people to come to societies where they are not indigenous, and to do well, and to do well in ways that integrate them in the society, is precisely the feature of economic growth.

Now, that’s an answer about economic growth, not about capitalism versus communism versus something else, but the historical fact is that we haven’t seen that kind of economic growth except under market-oriented economies, and therefore, what’s true of societies that experience economic growth, by and large, turns out to be a statement about market-oriented economies as well.

COWEN: Is that a U-shaped curve, however? We know the Dutch Republic, the later British Empire, the United States were havens for persecuted people. But also, if you look at the very early years of colonizing the world, it arguably needed economic growth to project so much imperial power — kill or kill through disease so many indigenous peoples.

Is it the case that benefits of economic growth for tolerance only kick in much later, and first you have to go through what are actually a number of centuries where economic growth is very bad for tolerance and mutual coexistence?

FRIEDMAN: The question which you’re really asking is whether colonization and imperial expansion is a necessary feature of economic growth. I think it’s hard to know because so much of the colonization to which you’re referring was in the pre-modern period.

We haven’t in recent years seen very many of the major economic powers go off and take over other people’s lands the way people did. Think of the British in Australia. Think of Europeans in South America. Think of British and French and Spanish in North America. That ultimately got sorted out in the British favor, but it’s true that in these pre-modern eras, there was a lot of colonial expansion.

There was a lot of taking over of other people’s countries, and of course, when you take over other people’s countries, that’s not good for the people who were there before you got there. That’s pretty easy to see, but I don’t think of that as much of a feature of modern economic growth. I don’t see who’s being exploited in modern economic growth.

COWEN: Americans right now poll as significantly less religious than they did, say, 20 years ago. Is that affecting how we think about economics?

FRIEDMAN: I don’t think so. To be clear, we’ve been talking for the last 20 minutes, half-hour, or however long we’ve been going, about the influence of religion on economic development. Maybe I should make clear that is not the subject of the book that I’ve just written.

What I’ve written is a book about the influence of religion on economic thinking. It’s a book of intellectual history, not economic history. It’s a book about where our ideas about modern economics come from. The fact that different people with different religious orientations have participated in economics in a different way, I don’t think matters.

Now, importantly, although I characterize my hypothesis as “Weber upside down,” referring to the German sociologist, Max Weber — and I’d be glad to explain why — but one element of Weber that I do take and retain is the idea that religious impulses, religious influences on how people think are very long-lasting and persist long after people no longer believe in the particular religious impulse, to begin with.

Now, that, I think, is directly responsive to your question because even if it turns out that Americans, over time, become distinctly less religiously committed than they were, I think in this Weberian way, the fact that the country came out of a certain era of Protestant thought will serve as a catalyst, a catalyst in the sense that a catalyst is something that triggers a chemical reaction, and then after the catalyst is gone, the reaction is still there, and the result of the reaction is still there.

I think the role of religious thinking in shaping our early economic thinking in modern Western economics is going to persist, and even if the current trend continues for another decade, another half-century toward Americans becoming less religiously committed, I think it’ll still be there.

COWEN: Is there persistence in the world as a whole? If we look at China, for many decades, China’s very, very poor, maybe per capita income of $200 to $300. China, of course, over the last several decades has grown rapidly and is extremely commercial in its overall mentality.

If we think about India, people use the phrase Hindu rate of growth in a derogatory fashion. Of course, we wouldn’t talk that way anymore, but more importantly, India has had many years with high rates of economic growth, and people who leave India have done especially well earning. I believe immigrants to America from India are now, by far, the highest earners.

Does that indicate persistence? Isn’t that showing that once the environment changes, people’s ideas are quite malleable and they evolve to fit the new environment?

FRIEDMAN: Well, once again, I think there’s a difference between asking about persistence in people’s beliefs and persistence in people’s behavior. When it comes to behavior, a principle that economists have been dedicated to for well over a hundred years is that when the environment changes and the incentives and constraints that affect people’s behavior change, then the behavior changes.

Is there persistence in rates of economic growth across countries? I don’t think there is. There’s persistence in who’s rich and who’s poor, but persistence in economic growth rates is harder to pin down.

By contrast, is there persistence in the way people think, in what they believe? Well, I think there certainly is. Just look around at the way in which Americans have different ideas about lots of things than Chinese do, than Russians do.

You were asking before about the fact that Eastern Europeans have been unsuccessful for the most part in mounting stable, liberal democracies. Well, I think this is a matter of persistence of something. I was pointing to the Soviet experience. You were suggesting it’s a persistence of something from earlier on, and I’m sympathetic to that too. But I would distinguish the persistence of thinking from the persistence of behavior

COWEN: Economic growth — is Steven Pinker’s optimism about growth correct?

FRIEDMAN: You’re referring to his Better Angels of Our Nature book?

COWEN: And your book on economic growth. Do you agree with Steven?

FRIEDMAN: [laughs] I’ve never talked about my economic growth book with Steve, so I honestly don’t know what he thinks about it. I can say what I think about his book on Better Angels of Our Nature. I think it hinges heavily on how you think about the first half of the 20th century. To recall, his argument is that violence in the world has been on a downward trend and he’s optimistic that it will continue on a downward trend.

If you just drew the trend line, and you looked at what happened in World War I, World War II, and so forth, you would say, “My goodness, in the Western world, that’s an extraordinary increase in the volume of killing within the lifetime of certainly my parents and, I’m guessing, yours as well.”

So what do you do with that? Well, by and large, Steve treats this as an aberration. It would be an extreme characterization of what he does to say he throws it out as an outlier. That would be unfair. But if you remove World War I and World War II from the scatter plot, then the trend line sure points downward.

Now he’s interested in things more than just wartime deaths. He’s interested in who gets murdered walking down the street so somebody can steal his wallet. He’s interested in that sort of thing. But to me at least, it’s the wars that dominate.

COWEN: Is Christianity also the most martial of the major religions? If you look at the United States, people who sign up for the military — they come disproportionately from the South, right?

FRIEDMAN: Again, to my knowledge of the major Western religions, I would absolutely not say that. I think just about all religions have a kind of militancy to them in their initial phases.

Look at Islam, for example. In the early years of Islam, Muslim forces conquered all of Africa, conquered large parts of Southern Europe, conquered essentially all of Spain. Islamic armies went up as far as, what was it? I’m now trying to remember my high school history. Was it the Battle of Poitiers when the French finally turned around the Muslim advance? Later on, under Suleiman, the Muslim forces again conquered much of Southern Europe, going up as far as the battle at Vienna. I think Islam is certainly a very militaristic religion in its early days.

Judaism as well. Again, I mentioned a few minutes ago the foundational myth in the Hebrew Bible of the Hebrew slaves fleeing Egypt, and what did they do when they fled Egypt? They then conquered Canaan, the Holy Land. So there’s certainly a militaristic strain there. So, the answer is no, I would not particularly point to Christianity as uniquely militaristic, certainly not among Western religions.

COWEN: How do you think having grown up in Louisville influenced the content of your latest book? It’s a more religious area than where many of our elite scholars come from, right?

FRIEDMAN: Well, maybe that’s true. You are certainly correct. I come from Kentucky. Incidentally, I have very fond memories of coming from Kentucky. My family had been there for a very long time, and I have fond memories of the area. I never thought of it as particularly different though.

When I arrived at Harvard as an undergraduate, or when I worked in investment banking in New York, I never thought of it that I have this great difference in outlook from my Harvard classmates.

I mention Harvard because in those days, Harvard undergraduates were much less geographically diversified than they are now. When I worked in investment banking in New York, that was a pretty New York-y, New England-y culture. I never thought of myself as having a background that was terribly different from anybody else.

On the importance of maintaining economic growth

COWEN: Your argument in your book on economic growth about the moral benefits of growth — how much is it a levels effect versus a rates-of-growth effect?

FRIEDMAN: The hypothesis that I offered in that book very importantly was about the rate-of-growth effect. It’s about people realizing that they are living better than their parents lived. It’s about people realizing that the opportunities for their children are better than the opportunities that they had. It’s very much a rate-of-growth effect. The reason I say that’s important — now going back to the argument I made in that earlier book — the reason it’s important is twofold.

One, it was a warning against our being complacent. It’s a warning that no matter how rich our society is, if we get into a situation in which large numbers of people feel that they no longer have a sense of forward progress in their material lives, and they don’t see that turning around anytime soon, and they don’t have optimism either that their children will face a better economic future, that’s the circumstance under which people turn away from these small-l liberal, small-d democratic values, like tolerance and respect for diversity, generosity, openness of opportunity, even respect for democratic political institutions.

So, an important aspect of the rate-of-growth aspect of the argument — as opposed to the level aspect — is a warning about our potentially being complacent when we shouldn’t. My former colleague, Alexander Gerschenkron, had this marvelous phrase about a democracy without democrats. Well, he was referring to Weimar Germany, but I think it’s a warning for us very much today in the United States when so many people’s incomes are stagnating.

Then, at the same time, the second implication of the fact that it’s a rate-of-growth argument is some optimism that countries around the world, where income levels are far below ours, don’t have to wait until they reach our level of income before they can develop into liberal democracies.

Now, as I was saying a minute ago, 20 years ago when I wrote that book, the data gave me much more reason to be optimistic than I am — at least for the short run — now about low-income countries’ democratic prospects. But I still believe in the hypothesis in the long run.

COWEN: Aren’t there some reasons to be more optimistic? If we look at Taiwan, where median income has not really gone up since 1989 in real terms — they seem much more tolerant, much more democratic than they used to be. Japanese economic growth has slowed down. They’re certainly no less democratic, probably more democratic, definitely more tolerant.

Haven’t we seen a fairly large number of countries with much slower growth, and whatever their problems or flaws, they seem to be more tolerant — gay rights, rights of women, many different issues?

FRIEDMAN: Well, there are many aspects of the kind of liberal democratic tendencies that I spelled out in that book, and tolerance is one of them. I was very reluctant then — and I still am — to point to these small city-states as examples. People often threw up to me Singapore as a counterexample to what I was talking about. Look, Singapore is five million people, something like that. It’s really a big city. Taiwan is somewhat larger, I know, but it’s a very special situation because of its fear of the Chinese.

I would be confident that in the greater number of cases, those societies which are able to mount serious, sustained, widely distributed economic growth will do better on these dimensions — like tolerance and democracy and generosity and provision of opportunity — than those that do not.

On things under and over-rated

COWEN: In the middle of these chats, we always have an underrated versus overrated section. Are you ready?

FRIEDMAN: I’ve listened to some of your podcasts before, and it’s always struck me as surely one of the most unusual aspects of conversation, but yes, absolutely. Go ahead.

COWEN: Consumption taxes for the United States — an underrated or overrated idea?

FRIEDMAN: I would be for a consumption tax, which is, I guess, a way of saying — since we don’t have one — that would be a way of saying that it’s underrated. I would be for it, but not as a substitute for our income tax. I would be for it as a supplement to our income tax. So, I guess I’m saying it’s underrated.

COWEN: The Volcker deflation — underrated or overrated?

FRIEDMAN: I think Paul Volcker is one of the greatest heroes of my lifetime. Doing what he did, under the pressure that he sustained, in order to turn around our inflation, I think is one of the greatest acts of public service I have ever seen. So even though I am aware that lots of people, then and now, have been cheering for Paul Volcker and what he did, I would cheer even louder, and so I would say it’s even underrated.

I happened to have been working at the Federal Reserve. I don’t know if you’re — yes, you’re old enough to remember.

COWEN: Of course, I remember it all very well.

FRIEDMAN: There was a firm in Texas, a construction firm called Lone Star Industries that used to take out . . . during the Volcker disinflation. You called it a deflation, I believe. I’d like to correct that.

COWEN: That was an incorrect word. You’re right.

FRIEDMAN: There was no deflation under Volcker. It was a disinflation. During the period of the Volcker disinflation, this firm called Lone Star Industries in Texas used to take out full-page ads in The Wall Street Journal about what a criminal Paul Volcker was.

I happened to have been working in the Federal Reserve Board one summer. This was in an earlier era in which security in buildings like this was much less, so we would just come and go and walk in and out. One day, out in front of the building, this enormous flatbed truck pulled up, stacked high with lumber. We all went down and looked at it, and what was it? The truck driver gets out and he says, “I have a delivery for a Mr. Volcker.” We all said, “Well, what is that about?”

Eventually, we got to see the letter that came with it. I can’t remember whether it was from the same firm, Lone Star Industries, or not, but it was from some construction company. Basically, the note said, “Paul, because of you, I can no longer use this lumber. So here, you take it. You take it.” Well, this was the kind of stuff [laughs] that was going on.

Was Paul Volcker overrated, underrated? As much praise as he received, I think he’s one of the most underrated people I’ve ever known.

COWEN: Annuities — why do the markets for them function so poorly? Is it an underrated thing, more people should buy them? Or it’s just never going to make sense?

FRIEDMAN: The idea of annuities is underrated — the idea that people should be able to buy themselves out of a very important risk, namely, the financial risk of how long they’re going to live. Annuity is just the flip side of an insurance policy. When we buy insurance, we’re insuring against the risk of dying too early. When we buy an annuity, we’re buying insurance against the risk of living too long.

Why doesn’t the market for annuities work better? It’s because of what economists call adverse selection. That is to say, people who sign up to buy annuities have knowledge about themselves that the sellers of annuities don’t. If you look at the data on who buys annuities in the United States, annuity buyers have a distinctly longer mortality experience than the general population. They know that they’re going to live longer.

Now, once that experience becomes clear, then the sellers of annuities have to price the annuities not on the assumption that their customers will be ordinary Americans, but that their customers will be long-lived Americans. Well, that just makes the annuities even less attractive for ordinary people and makes the adverse selection even worse.

COWEN: But the long-lived people don’t buy them either, as far as I can tell, right? You could apply Big Data, figure out who’s going to live long — well, the Japanese-American woman in New Jersey — sell her annuities priced fairly, but she also doesn’t do it.

FRIEDMAN: I think this process I described, in which the special information people have about themselves leads to this adverse selection in the customer base, which leads to higher pricing, which leads to more adverse selection, has gone on to the point at which we are in a very bad equilibrium. Very, very few individual Americans buy individual life annuities.

So what is the market for annuities? It’s a market with groups. Why does that matter? Because if some annuity provider like TIAA, the big insurance company, provides annuities to the universe of all college professors in the United States, then they at least have some way of getting around the adverse selection. But I think we are in a bad equilibrium, and individuals are not attracted to individual life annuities. I think it’s because of the adverse selection, and it’s very unfortunate.

COWEN: Lucas critique — overrated or underrated? I think I know your answer.

FRIEDMAN: [laughs] I think it’s way overrated. For the benefit of your listeners who don’t know what the Lucas critique is, it refers to Robert Lucas, a University of Chicago economist who won and very much deserved the Nobel Prize in his field. The idea is that people — not just economists, not just financial wizards — ordinary people know enough about how the economy works that they are going to undo, in their private behavior, the effect of any government policy intervention.

Take your most recent question as an example. Suppose the government provides some enhanced form of life annuity. We already have a form of life annuity provided publicly in the United States. The word for that is Social Security. But suppose there was some big change in the Social Security system.

The Lucas critique idea would be that people will understand the implications of this for their own and everybody else’s behavior and, as a result of that understanding, will take actions that, once everybody has taken that action, will undo the intended effect of whatever the policy reform is. I think that just places much too much burden on the knowledge and understanding of ordinary citizens, and therefore, my answer is “Overrated.”

COWEN: Victor Niederhoffer as a squash player — underrated or overrated?

FRIEDMAN: [laughs] You probably are referring to the fact that for many years, I was a squash player. I wasn’t good enough to play with Vic Niederhoffer. I would love to have done that, but I wasn’t good enough. I understand he was mighty good, so I would say if anything, he was underrated.

On debt and fiscal sustainability

COWEN: Fiscal sustainability. Paul Krugman and others argue that because interest payments, as a share of US GDP, are stable or sometimes even declining, that our current path is fiscally sustainable. Do you agree?

FRIEDMAN: No, I don’t. It is certainly true that if long-term interest rates remain — by which, I mean real interest rates, interest rates net of inflation — remain at or near their current levels, or even go down, then the fiscal burden associated with any given debt level that the government — or for that matter, a business, or for that matter, a homeowner — has is much more sustainable.

A question that I put to my students now that it would never have occurred to me to put to you and your classmates 30-odd years ago is the following. You are a young graduate student just getting married, and you and your wife would like to buy a house. Or you and your husband would like to buy a house. Because nowadays, unlike when you were a student, we have lots of women graduate students, which is a good thing.

You and your wife or husband would like to buy a house, and some bank is willing to lend to you to buy that house at a zero interest rate. How big a house do you buy if somebody is willing to lend to you at a zero interest rate? Well, it’s an extreme version of what you’re saying. If interest rates remain super low, then government, business, households can all afford higher levels of debt without it becoming in any way unsustainable. Now, I kept emphasizing if interest rates remain low, and we don’t know that they will.

Now, if I can put in a plug for a policy idea, this is why I have been recommending to anybody who will listen that this is a great time for the United States Treasury to lengthen out the maturity of the US government’s outstanding debt. The average maturity of the outstanding debt is around six years, and we happened to have super-low interest rates, it would be lovely to think that they’re going to be here forever.

Some economists think they will be. I’m more cautious. I would use the current market environment as a way to lock in those interest rates because we know that we’re going to have a high government debt level for a very long period of time and much better it not be a burden.

COWEN: Pandemic aside, if, on average, G is greater than R, can’t we just grow our way out of the debt? As you mentioned, now borrowing rates are negative in real terms, right? Economic growth, on average, is positive, so just keep on plowing straight ahead. Let the clock tick.

FRIEDMAN: There are two parts of the sustainability question, and you hit one of them correctly. If your economy is growing in real terms faster than the debt, then you can grow your way out of any debt. But there’s another side of it, and that’s how rapidly are you taking on new debt?

Let’s take your question seriously and say we’re going to put the pandemic aside. In the year before the pandemic — we’re talking about the government’s fiscal year 2019, so ended September 30, 2019 — none of us had talked about pandemics yet. In that year, the US government spent $4.5 trillion, and it only took in, in revenues, $3.5 trillion.

That $1 trillion deficit, even at a time of a fully employed economy and, of course, before the pandemic hit, that was nearly 5 percent of our national income — even though our economy was growing nicely, more rapidly than the rate of interest that the government was paying on the debt, we were on the other side of the equation, adding new debt so rapidly that the debt-to-income ratio was going up instead of down.

So simply pointing to the so-called R-minus-G factor, I think, is a very incomplete way to look at the question of sustainability.

COWEN: Again, pandemic aside, but have we been seeing crowding out in recent years with high fiscal deficits? Or crowding in, perhaps?

FRIEDMAN: On balance, I would guess that there has been neither. The reason is that interest rates have been super low — going back to that. The idea that when the government issues debt, this might crowd out private investment — a subject that I wrote a lot about years ago when interest rates are higher — that’s not just some arithmetic or mechanical relationship. There has to be a mechanism involved. The mechanism is the availability and the cost of financing for business investment, or for homeowners that want to build a house or buy one.

With interest rates as low as they’ve been in the last few years, I think it’s very difficult to point to a crowding-out story and say that somehow, magically, because the government has issued a lot of debt, businesses haven’t been investing or homeowners haven’t been building houses. Because credit has been pretty available, the rate of interest on that credit has been low.

Again, I was asking my graduate students about the hypothetical example of a zero interest rate, not a prohibitively high one. So, I would say, no, I don’t see the story whereby there’s been a lot of crowding out.

COWEN: And no crowding out from the Fed paying interest on reserves? That of course is a form of fiscal policy. It lowers the velocity of some of the monetary aggregates, presumably discourages banks from making loans? Won’t that crowd out some private investment?

FRIEDMAN: I think the answer is the same, Tyler. The interest rate at which the Federal Reserve has been crediting reserve balances held by the commercial banks is super, super low. Now, the economics behind your question is correct. No bank is going to lend to Tyler Cowen to start a new business, or to Ben Friedman to buy a new house at a rate lower than it can get by leaving the reserves on deposit at the local Federal Reserve bank and drawing the credit.

But those interest rates are just super, super low, so if you had had an idea for a business and had wanted to go in and get a loan, I don’t think the fact that the Federal Reserve was crediting reserve balances would have made any difference whatsoever.

COWEN: Now, as you know, we have a much more explicit form of price inflation targeting than when you wrote your earlier papers on credit as a leading indicator. There’s been a switch of regimes to some extent. Do you think that in the current world that credit as a good leading indicator still makes sense?

FRIEDMAN: No, I don’t. I think the empirical basis for the argument that I made — you’re going back now 30-odd years ago — is no longer there. I would say it’s very much in parallel with what happened to things like monetary targeting. Famously, at the end of his life, Milton Friedman acknowledged that monetary targeting had been a failure. That was his words in this famous interview that he gave. The reason was the empirical breakdown of the relationship between various monetary aggregates, whether it’s so-called M1, M2, whatever.

Levels of economic activity — back when Milton did his great work in the 1950s and 1960s, there had been, for quite some years, a very stable, reliable relationship between at least long-run rates of growth of money and long-run price inflation. My contribution — I still like to think it was a contribution at that time — was to point out that similar relationships, just as empirically valid, were there for at least some measures of credit. Importantly, not just bank credit, but broader credit, including the bond market.

Now, over time, these measures lost their close relationship with the national income, prices, whatever. Therefore, I wouldn’t recommend either one today — neither money nor credit.

On NGDP Targeting

COWEN: What do you think of nominal GDP rules?

FRIEDMAN: You mean targeting nominal GDP?

COWEN: Sure, or rate of growth and a level.

FRIEDMAN: First place, I don’t think targeting nominal GDP levels makes any sense. There is some argument for targeting the price level, but I don’t think that carries over to targeting the nominal GDP level. Targeting the rate of growth of nominal GDP is not a bad idea. It’s a simplified form of saying that we’re targeting real growth and targeting inflation together. We’re just adding them together and treating them as the same thing.

I would prefer to be somewhat more sophisticated about the analysis. I would prefer to think of real economic growth as separate from price inflation. When real economic growth, or when the level of economic activity is far below full employment, that’s a time when real economic growth doesn’t have the cost of potentially creating inflation pressures. By contrast, in a fully employed economy, we do have to worry about price inflation.

I would prefer to keep those two items separate in the analysis, so I’m not a fan of nominal GDP targeting. It’s not the worst idea ever, but I would prefer to do it in a more sophisticated way.

COWEN: How would you change the governance of the Fed, if at all?

FRIEDMAN: I don’t think anybody today would design the Federal Reserve in the way in which it was designed a hundred years ago, with a board of governors, and these 12 regional reserve banks, and these presidents of the regional reserve banks who are not confirmed by the Senate playing the key role in establishing monetary policy.

That said, I would leave it alone because my sense is that, with the current politics of our country, I am sorry to say, I think if we open that box, we are much more likely to come out with something that’s worse than what we have. So, while I don’t know anybody who would defend, in the abstract, the structure we’ve got, I wouldn’t change it, at least not now.

COWEN: Let’s close with a few questions about you. How is it you stay so motivated to learn new things when not everyone in the economics profession is the same way?

FRIEDMAN: That’s a good question. As you’re suggesting, my style of economic work is very different from other people. I tend to undertake these long-range projects that take me such a long time because I have to go off and learn a lot of things that I didn’t know.

In the book that I’ve just written, if my readers had grown up in a rigorous Presbyterian Sunday school, the book would have been 100 pages shorter because I wouldn’t have had to walk my readers through all sorts of things. If I had grown up in a rigorous Presbyterian Sunday school — which I didn’t — I could have written the book at least two years more rapidly because I wouldn’t have had to go off and learn all that stuff. But I did, so I undertake these projects.

Why do I learn these things? In part, because enjoy learning about them, but in part, because I think they’re important for the questions that I want to answer. I didn’t start this most recent project from the direction of saying, “Let’s think about the influence of religion.” I started from the other end. I started by saying, “I want to know. I want to explore where our current modern Western economics came from.”

That then led me to seeing the importance of these religious influences on our economic thinking. Then I realized that I had to go off and learn a lot of things that I didn’t know about. Well, I did it.

COWEN: Who first spotted your talent and how did they do it? What did they see?

FRIEDMAN: Who first? I would assume my mother, I suppose. [laughs]

COWEN: But in your career — was it a professor or a friend of the family who said, “Ben, you seem like you’d be great at economics.” How did that happen?

FRIEDMAN: No, I came into economics, I wouldn’t say by accident. As of the time when I graduated from college, I had no intention whatsoever of being an economist. I assumed that I was going to go to law school. When I was a senior in college, the only two graduate schools that I applied to were two law schools, and that was the end of it.

But it so happened that I won one of these fellowships to study abroad for a few years. This was in Britain. Once I got there, I had to study something. Since I had been doing economics as an undergraduate, and I had found it interesting, I kept going with economics.

By the time I’d done economics at a graduate level for a couple of years in England, then I said, “Well, this is really more interesting than what I think my lawyer friends do, and so I’m going to stick with it.” It wasn’t that anybody particularly steered me into economics. It was more by happenstance.

COWEN: When you look at graduate students, what non-obvious qualities do you look for as markers of their talent? Smarts, hard work, of course, but non-obvious qualities.

FRIEDMAN: I like to look for people who get their questions from looking at the world, rather than from looking at the literature. I understand that there are certainly plenty of very successful economists who got their start, and even continued their trajectory, by reading the professional economic literature and saying, “Here’s this important paper, and I think I can improve on what so-and-so did in his or her analysis.” That’s just never been very tempting to me.

To me, economics is interesting because it’s about the world, and the world is throwing up all sorts of interesting questions. Whether it’s about why economies grow. You’ve asked in this conversation about price inflation, about how we conduct monetary policy, about fiscal policy. Many of my colleagues are interested in more microeconomic issues of labor markets and education and health and how industries organize themselves.

But I try to encourage our graduate students to look at the world, look at what’s interesting out there. There’s so much we don’t know, so much we don’t understand, so much we’d like to explain. Get their questions from there, and then turn to the literature to see if you can figure out how to come up with some answers.

COWEN: What’s the most important idea you have taken from religion?

FRIEDMAN: The most important idea I’ve taken from religion . . .

COWEN: It may even be Protestantism, though you are probably not a Protestant, right? But we all are, in a sense, as Americans, if ideas are persistent.

FRIEDMAN: If you’re asking now, not about the most important implication of religion for our economic thinking — which is what I’ve written about — but the most important implication of religion more generally, I would say it’s in how we lead our lives.

I once had a conversation with an older man, and we went on for some time. He just thought about life in a very different way than I did. The more we went at it, the more it turned out that this was somebody who didn’t himself have any kind of religious background, religious affiliation, religious commitment, religious training.

That didn’t make him right, didn’t make him wrong, didn’t make me right, didn’t make me wrong. But what that conversation drove home to me is that he just had very different ideas about how to live life than I do. Surely, that’s got to be the most important thing people take away from it.

COWEN: Last question — what will you do next?

FRIEDMAN: Well, my next project, I think, is going to be one on which I recently read one of your papers. I recently read an interesting paper of yours in the National Bureau of Economic Research conference volume on artificial intelligence. Thought you had a lot of interesting things to say about AI and distribution and how AI changes the constraints on our society.

I have persuaded myself that the greatest economic challenge… or to put it the other way, the greatest societal challenge we will be facing over the next generation that stems from the economic sphere is going to come from our increasing reliance on robots and AI. I’m not pretending to reinvent myself as a labor economist any more than in this new book, I’ve reinvented myself as a theologian. I didn’t. Or in the previous one, I didn’t reinvent myself as a social historian.

I’m going to learn a lot about things like that. But I think I would like to see if I can say something about how we can handle the challenges to our society, to our politics, to our way of moral thinking that I think are going to come from automation and AI. It’s a tough challenge. I’ve started, but I haven’t made much progress.

COWEN: The new book, again, listeners, is Benjamin Friedman, Religion and the Rise of Capitalism. Do also buy Ben’s older books. Ben, thank you very much for coming with us today.

FRIEDMAN: Thank you, Tyler. It’s a pleasure to see you again.