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David Friedman
David Friedman
Hidden Order: The Economics of Everyday Life
ISBN: 0887308856
Hidden Order: The Economics of Everyday Life
Mr. Friedman talked about his recent book, Hidden Order: The Economics of Everyday Life, published by Harper Business. It elaborates on the fundamental notion that economics is about behavior and choice, not money. He talked about how economists have developed ways to predict behavior based on the idea that people will make rational choices. He also provides several concrete examples of this notion.
Hidden Order: The Economics of Everyday Life
Program Air Date: October 20, 1996

BRIAN LAMB, HOST: David Friedman, in your book "Hidden Order: The Economics of Everyday Life," you have two economic jokes, and I'm going to read the first one and ask you what it means. On page 17, economic joke number one, `Two economists walk past a Porsche showroom. One of them pointed at a shiny car in the window and said, "I want that."' `Obviously not,' the other replied.
Professor DAVID FRIEDMAN (Author, "Hidden Order: The Economics Of Everyday Life"): If he had wanted it, he wouldn't have been walking past the showroom; he would have been walking into the showroom. The point of that joke is that the way we measure values is by actions and that if I say I really want something and I don't act to get it, that's evidence that it isn't true. That's the the point of the joke.
LAMB: What's the hardest thing a about teaching economics?
Prof. FRIEDMAN: Probably the fact that people think they already know it; that economics deals with the world we're all familiar with. It uses words like `efficiency' or `competition' that we think we already understand. And the result is that people miss the fact that there's actually a reasonably rigorous, logical argument there. They see it as just talk about familiar things. They think they already understand the answer. And then when they take the midterm in the course, they suddenly discover that they got 20 percent when they thought they understood everything except the fine points.
LAMB: What is efficiency?
Prof. FRIEDMAN: I spend a chapter trying to answer that question. An efficient outcome is an outcome that can't be improved. And, roughly speaking, an improvement is a change that produces net benefits. So you have to imagine that you change something about the system and you can somehow evaluate how much that ch the effect of that change is worth to each person affected. You say, `Well, I'm worse off by a certain amount. You're better off by a certain amount.'

If you could add all of those up and you say, `The sum is positive,' then you would say that's an improvement. And an outcome is efficient if no further improvement is possible. That's a very short answer to a very complicated question.
LAMB: What's competition?
Prof. FRIEDMAN: A competitive market is one in which there are many firms but not necessarily one in which each firm, like a runner in a race, sees the other firms as opponents. If you think about competition in the way people often speak of it in common language, you would say that there's really more competition in a race with four people in it than in a marathon with 1,000 people in it, in that each of those four people sees the other three, so to speak, as his enemies, as his rivals.

But the economist would be the other way around. We would say, `A perfectly competitive market is one with an infinite number of firms, each of which doesn't care about the other firms because each of them knows that each of the other ones is a tiny player, whereas a market with only two or three firms is not very competitive.'
LAMB: Economic joke number two I thought oh, here it is. On page 300 by the way, how come only two?
Prof. FRIEDMAN: I need some more. The problem is that what I mean by an economic joke is not a joke about economics, but a joke that teaches economics, a joke that teaches some economic principle. And I thought that I had at least three in that book, so you may have missed one maybe four. But my collection of economic jokes is quite small. There's at least one that isn't in that book that I got out of a Middle Eastern cookbook that I'm fond of. But I think there are at least three in that book, but tell me what number...
LAMB: Well, I I...
Prof. FRIEDMAN: ...two is.
LAMB: Well, I'll I'll see if I can find it because I'm near the end of the book. `Two men encountered a hungry bear. One turned to run. "It's hopeless," the other told him. "You can't outrun a bear."' `"No," he replied, "but I might be able to outrun you."'
Prof. FRIEDMAN: Yes. That joke the point of that joke is that in most conflicts, the objective is not to make what the other guy is doing impossible, but to make it unprofitable. That is, we tend to think about wars or crime or almost any human conflict as if it was something like a chess game, where all I care about is beating you and all you care about is beating me. But that's not the way the real world really is; that if you're a mugger and I'm a victim, your objective isn't to hurt me. You're objective is to make money without working too hard.

If I can set up a situation so that mugging me costs more than it's worth, even though you still can, you won't. All right? Similarly in that story, chasing me is worth more than it's worth for the bear if he can catch you more easily, which is the point of that one.
LAMB: Do you use a lot of these kinds of economic jokes in your classroom?
Prof. FRIEDMAN: Well, I don't have a lot of them unfortunately. They're pretty scarce. Shall I tell you the one you've missed?
LAMB: I've found it.
Prof. FRIEDMAN: Ah, great.
LAMB: Yeah. It's rich. I d I missed it. It's near the end and it's a longer one...
Prof. FRIEDMAN: Yes.
LAMB: the reason I'd forgotten it. It's go ahead. Do you...
Prof. FRIEDMAN: Oh, sure. It's a joke the joke goes as follows: Jose robbed a bank and fled south across the Rio Grande with the Texas Rangers in hot pursuit. They caught him in a small town in Mexico, only to discover that Jose spoke no English and none of them spoke any Spanish. So they persuaded one of the locals, who knew both languages, to act as translator. And the Rangers say to the translator, `Ask Jose where he has hidden the money.' `The gringos want to know where you've hidden the money.' `Tell them I will never tell them.' `Jose says he will never tell you.' The Rangers pull out their six guns, cock them, point them at Jose's head and say to the translator, `Tell Jose that if he does not tell us, we will kill him.' `The gringos say if you do not tell them, they will kill you.' Jose starts to shake with fear, `I I I hid the the money by the bridge, over the river.' `Jose says he is not afraid to die.'
LAMB: The point?
Prof. FRIEDMAN: The point: That's the problem that economists call incentive compatibility; that in order for a system to work, it has to be in people's interest to act in the way necessary for the system to work. And in this case, it was not in the interest of the translator to tell the truth about what Jose was saying because, of course, by lying, by pretending that Jose hasn't said where the treasure is, now he hopes the Rangers will kill Jose and he will then dig up treasure.

So that let me give them a much perhaps an example of more immediate relevance. The standard description of how our political system works how democracy works assumes that individual voters spend a lot of time and trouble figuring out which candidates are good, which programs are good, what policies the government should follow. And then they vote for the candidates who are in favor of the policies that will make produce good results, that will make the country prosper. That's sort of an implicit assumption if you think of, sort of, the high school civics class description of democracy.

But then you think of it about it and you say, `Well, why should I go to all that trouble? I know that, as a single voter, my chance of determining the outcome of the election is very close to zero, probably about one in 10 million, roughly. It isn't worth my spending a lot of time and effort investigating the issues in exchange for one chance in 10 million of affecting the outcome.' Given that that's the case, most people won't. And the result is a system where the average voter can't name his congressman, even though the way we usually describe democracy assumes that he not only knows his congressman, but every vote he's made over the last two years.

So that's a respect in which our political system is not incentive compatible, and that's one of the reasons it doesn't work very well. Doesn't tell you if there's any better way, but it does tell you that there's a a serious problem in getting government to do the things you would like it to do.
LAMB: You worked in this town over in Congress once.
Prof. FRIEDMAN: Very briefly. I was what's called a congressional intern, which means somebody who spends a summer working for a congressman. And I one summer a little after I graduated from college, I was working for Tom Curtis of Missouri actually, he used me about one day a week and lent me out to some people who were doing work on state and local finance the other four days. But it was interesting.
LAMB: What did you learn from that experience?
Prof. FRIEDMAN: Well, the most interesting thing I learned, actually, was that intelligent people I liked could be deliberately dishonest for political reasons. That would be a somewhat long story and I don't think I want to mention any names, but it was a situation where some people I was working with were producing a fact book on state and local finance, which was supposed to tell the intelligent layman the things he had to know in order to understand issues in state and local finance.

And I produced a fact and my fact was indisputably true. It was a demographic fact about the ratio of people numbers of people of different ages. And it was a fact which had precisely the wrong implication for their purposes because the people producing the fact book thought state and local governments needed more money. And the fact I had turned out was that the peak of the baby boom was coming out of school and into the labor force, with a result that for the previous 10 years the ratio of schoolchildren to taxpayers had been going up.

So you needed higher and higher taxes in order to maintain a constant level of per pupil spending. And for the next 10 years it was going down, so that you could have a fall in taxes, since you were having more and more taxpayers per schoolchild, and still maintain spending. They did not dispute that the fact was true. They didn't dispute the fact it was important because schooling is the biggest state and local expenditure. But they refused to include it in their fact book because it had the opposite implication of what they wanted. And that was maybe I was very naive at the time. I was only about 21. But I found it shocking that intelligent people who I liked would behave in that way.
LAMB: What year were you here?
Prof. FRIEDMAN: Let's see, that would have been somewhere around '67. I don't can't give you exactly but sixty yeah, because I graduated from college in '65, so it would have been about '67...
LAMB: From...
Prof. FRIEDMAN: ...maybe '66.
LAMB: From what college?
Prof. FRIEDMAN: Harvard.
LAMB: Where do you live now?
Prof. FRIEDMAN: I live in San Jose, California, and teach at Santa Clara University.
LAMB: And what do you teach?
Prof. FRIEDMAN: Economics and law. My as would probably be clear to anybody who read my book, my interest in economics is in applications of economics outside of what most people think of as economics; that economics is a very general way of understanding behavior, and it applies to a lot of things other than thinking about the GNP and the unemployment rate. And one of the things it applies to is understanding legal rules. And so my interest for the last decade or so has been in economic analysis of law.
LAMB: What did you get your PhD well, what did you do your thesis in?
Prof. FRIEDMAN: My doctoral thesis was done at the University of Chicago in theoretical physics.
LAMB: Now is it a burden, a pleasure, a hindrance, a positive to be the son of Milton and Rose Friedman?
Prof. FRIEDMAN: Well, it's an advantage in as much as they did, I think, a very fine job of being parents, and I suspect I would understand many things less well if I hadn't had those parents. It's a hindrance in as much as it results in my being classified as my parents' son rather than as me. That's a fairly standard problem.
LAMB: Where do you differ on economic theory?
Prof. FRIEDMAN: Oh, on economic theory I don't think we do differ. Politically, my views are more extreme than my parents' views are. But that really isn't a question of economic theory because I think we would both agree about what the arguments are and the question is one of application.
LAMB: What are your most extreme views?
Prof. FRIEDMAN: Well, ultimately, I think one should have a society without government. That I think in the short run, there are some things government does that it should stop doing tomorrow and some that were will take some years to replace. But in terms of my long run ideal, it would be not a small but a zero government. That's not what this book is about, but that's sort of the clearest area where we have some disagreement.
LAMB: How close are you to politics?
Prof. FRIEDMAN: Very far. I usually don't vote for the sorts of reasons I was discussing before. When I do vote it's mostly for the fun of it. I don't spend a lot of time and I don't watch television at all, I don't own a television. But I read the newspaper when I have nothing else to do and I listen to the radio when I'm driving to work. But I really am not very interested in current politics. That I well, putting it differently, I'm interested in using economics to understand the political system. But having done so, I think that most of the time there are good reasons why the two candidates for president aren't very different and therefore it's a little hard to get excited as to which one you'd vote for.
LAMB: If you don't watch television, does that mean you never see these people speaking or...
Prof. FRIEDMAN: That's pretty close...
LAMB: ...interacting?
Prof. FRIEDMAN: correct. That is to sa yes. That is I occ I occasionally hear somebody giving a speech on the radio and sometimes it irritates me or doesn't. I seem to have gotten on the mailing list for a Republican group that sends out cassette tapes and I occasionally listen to them. I think Newt Gingrich is clearly a more interesting person to listen to than most politicians. I don't always agree with him, but he's clearly, sort of, a smart and interesting and odd guy. But, no, I don't I mean, certainly, I couldn't recognize most national politicians if I saw them on on television.
LAMB: What do you think the difference is and have you ever sat down and talked to somebody who watches a lot of television, the difference the kind of images you're getting vs. them?
Prof. FRIEDMAN: No. Don't know.
LAMB: When was al did you ever watch television?
Prof. FRIEDMAN: Oh, sure. That is my parents at some point when I was growing up got a television and I watched shows occasionally. The first point I can remember buying a television set, which was when I was a professor at VPI, it was because Atari had just brought out these video games and no, I'm wrong. At that point I had a very old television set I'd gotten somewhere, and when I attached the video game to the television set, I couldn't tell which direction the tanks were pointing. So at that point I bought a new television set. But that one, I think, got left in the basement of my house in Chicago when I moved and we haven't replaced it.
LAMB: Do you have children?
Prof. FRIEDMAN: Yes. I have two well, I have three children. One is one isn't a child. One is a is 20. And then I have a son who is three and a daughter who is six.
LAMB: What's it like for them not having a television set in the house?
Prof. FRIEDMAN: I don't know. I mean, I as think they I'm not sure that watching television interests them. They like watching videos on TV when they visit friends. On the other hand, I'm a computer enthusiast, so the kids do have their own Macintosh with a color screen to play on. And I think that's, in my view at least, a superior alternative since it involves a lot more input by them into what's happening.
LAMB: What made you decide I don't want to dwell on this very long, but what made you decide to not have a television set in your house?
Prof. FRIEDMAN: I suppose a clearer question would be why didn't I decide to have one because after for a long time, there was one lying in the house somewhere. But the basic answer is that I don't find watching television terribly interesting. There are other activities perhaps equally useless, but from my standpoint more fun such as arguing with people on the Internet, for example, which I spend a lot of time doing, which which which I prefer.

In addition, there's the fact that if I pass a television set that has a soap opera on, it's very hard not to listen. It's clear the people who designed those do a very good job of making them pull you in. Not, in my view, a very good job of producing anything I would want to listen to. So in that standpoint, there's some negative feature.
LAMB: I want to show the audience this is the way you sign off the introduction and you have your is it your Web site?
Prof. FRIEDMAN: My Web site and my e mail address. In fact, I have already gotten one e mail from somebody who spotted a mistake in the book. A I would like to believe the publisher's mistake, not mine; two figures that are supposed to be different are essentially the same. And after he pointed that up, I put up on my Web page an erratum file in which I have the correction to the mistake. So the...
LAMB: Let's go back in on this so that if somebody wants to get this Web site address and they can get in contact with you. What do you use it for?
Prof. FRIEDMAN: Well, my Web site divides into what I refer to on the Web site as four worlds. One of them is my family. I have pictures of how beautiful and charming my kids are. One of them is my professional work. I have on the Web site a full list of all my publications. And some of the publications I've put onto the Web so that you can read down the list, click on the publication and you're reading the article.

I hope, in the course of the next year, to get essentially everything I've published up on the Web site so that if I'm talking arguing with somebody on the Internet, say, and I say, `Look, I explain this idea more clearly in article such and such,' all they have to do is to go up on the Web, find my Web site, click on the article and there they can read it. And that gives you I mean, there are a lot of times when you cite an article in an argument and you know nobody's going to read it because it's too much trouble to go to a library. This means you can do it in 30 seconds. So that that's second part.

The third part has to do with my political activities. And that's basically a list of some articles relevant to my not political in the sense of electing people and views on politics. And the fourth has to do with my major hobby, which is medieval re creation. It has articles and medieval recipes and things like that.
LAMB: Now is there any way you know, the the Internet is an outgrowth of Arpenet and the government's creation years ago. Is there any way to apply economics to what's happening with the Internet?
Prof. FRIEDMAN: Oh, sure. I'm not the main person who's done that, but clearly there are a lot of interesting features on the Internet.
LAMB: Well, what I mean let me just ask tha you knowing economics the way you do and looking at what's happening with the Internet, what do you what can you see happening way out there in the future?
Prof. FRIEDMAN: Sure...
LAMB: And what's...
Prof. FRIEDMAN: ...but it isn't just the Internet. The answer that is, the most the most striking non obvious thing is that current technologies are in the process of giving us a level of privacy we have never had before. And the crucial technologies there are public key encryption and computer networks and virtual reality that this would take more time than we have, but essentially there are now well known ways, available in free software, of encrypting messages so that only the intended recipient can read them. So that if the FBI intercepts them, it's gibberish to them.

At the same time, more and more human interaction is happening via computer communications. And as virtual reality gets better, as it becomes easier for people to create the illusion that they're seeing each other when they're really in different places or s can imagine having this interview that we could do it with the current technology with me in California and you're here, but it looks to me as though I'm seeing you; it looks to you you're s if you can do that, that means that most of the work done by lawyers can be done over the Net without being physically there, much of the work done by doctors, most of the work done by teachers, so you could have, in 20 or 30 years, a world where a very large part of what is now face to face interaction is happening via the network at long distance instead.

Since encryption means that can all be private, that means you can have a world where freedom of speech does not depend on the Supreme Court, where the reason you have freedom of speech is that nobody you don't want to hear your speech can hear it and then...
LAMB: What's the impact on society?
Prof. FRIEDMAN: The impact on society is a world where a large chunk of human activity, essentially all information transactions, cannot be regulated by outside parties. And that's going to be attractive in some ways and unattractive in others. The unattractive part is that it means you can get criminal enterprises operating with sort of mass production scale because it becomes possible for a firm to exist, be reachable, have a brand name reputation, even though nobody knows where it's physically located.

The attractive part is a world where it's a whole lot harder for governments to control what people do. Now none of this is in this book. I can I could if you go to my Web site, I can point you at at the stuff I've written on this subject, but I'm just answering your question, which is that I think the big change is going to be to a world where a large chunk of our lives can't be controlled for technological rather than legal reasons. Where a government that wants to suppress freedom of speech simply can't do it.
LAMB: The reason I'm asking is because, in relating it to your book...
Prof. FRIEDMAN: Yeah.
LAMB: that you you explain everything according to money and economics in the book. I mean...
Prof. FRIEDMAN: Economics, not money.
LAMB: Well...
Prof. FRIEDMAN: Economics would be the same in a world without money.
LAMB: The point is, though, that that that it seems like the WorldNet is such a strange animal in this country compared to every the way anything else was ever created.
Prof. FRIEDMAN: I don't know about that. It's not that different from the English language. The English language is something out there. It's free. We don't try to establish property rights in it because it would be too costly to establish and defend property rights in words. Nonetheless, the English language is a very useful thing.

No, it's a great mistake to think that economics as being about money. What economics is ultimately about is the implications of rationality. The central economic assumption is that individuals have objectives and tend to take the actions that achieve those objectives. That's what an economist means by rationality. And you can then take that assumption, and in analyzing some markets, your conclusion is people will buy and sell and use money.

But in the case of the Internet, part of what's going on is if I suppose I send you an e mail. That e mail that doesn't mean my computer calls up your computer. That would be very expensive. My computer takes that message and sends it to a computer that it thinks is in the right direction and that computer relays it and that relays it and it goes through six computers and ends up a second later on your computer. The immediate question that will occur to you is: Why are those intermediate computers willing to forward my my mail for me? They're not charging me.

And the answer is that they have, in effect, a deal which is, `We'll forward your mail for free, you forward our mail for free.' Sounds like an odd way of doing things that most of the world doesn't run that way. Right? Most of our activities we don't say the way we get groceries is, `You give me the groceries for free and I'll teach you economics for free.' But what's going on in the Internet is that you have an enormous number of very tiny transactions.

So if they were going to charge me for forwarding my mail, they'd be charging me 1,000th of a cent each time. The cost of keeping track and billing all of those 1,000th of cent transactions is so much higher than the amount of money involved that it's turned out, so far at least, that the sensible way to run the Internet is on a, `I'll forward your mail, you forward my mail,' basis. And that's perfectly consistent with economic rationality.

I mean, there are lots of other examples. You very rarely charge for drinking water in water fountains in the US. Again, because it's very cheap to produce; therefore we give it away in association with selling other things: that you have the water fountain is in a building; in that building there are people selling services; you want people to come into the building and buy the services, so you provide a free water fountain a free men's room at gas stations. So that it's not unusual that in an ordinary market there are some things we find it's more profitable to give away than to sell and other things we find that it's more profitable to sell than to give away.
LAMB: You say when you teach, in your book, that it students would be better off if they admitted that they didn't understand what you're talking about.
Prof. FRIEDMAN: Yeah. I actually have a suggestion which I've I've never seriously tried to persuade the university to do it, though I've I've suggested it occasionally for a sort of a low tech solution to the problem. The standard problem that all teachers encounter is you're explaining something that makes perfectly good sense to you, having explained it 1,000 times, and none of the students interrupt you so you assume it makes sense to them and maybe you even stop and you say, `Does everybody follow this?' And no one says anything, so you keep going. And then when you test them on it later, you discover that none of them knew what you were talking about.

And the problem here is that each individual student is afraid that if he admits he isn't following it, he's going to look stupid both to me and to his fellow students, and therefore nobody speaks up. And my suggestion was that you rig a classroom where where each student is sitting there's a little button on the floor, just a little under his toe, where nobody can tell if he's pushing it or not, and at the back of the classroom where I can see it, the teacher, there's a sign that shows how many buttons are being pushed.

And so as I go along in my lecture, I stop and say, `Now, will everybody who followed that last point please push your button.' And the number one appears on the back of the screen and there are 60 people in the classroom, so I know 59 of them either didn't follow it or are asleep. And I then go back and go over it again. And that would be a way of trying to solve this problem by giving them a costless way of communicating the information to me.
LAMB: Popcorn.
Prof. FRIEDMAN: Popcorn. Yes, there's there's a sort of a puzzle which I set up early in the book and then run bits and pieces of it through the book. And the pop the puzzle is why popcorn is expensive in movie theaters. And as many things in economics, people the problem is people start out thinking they know the answer. And the standard answer is, `Well, look, the movie theater has a monopoly, so therefore, they can charge as much as they want for the popcorn. They make money by charging a high price.' And my reply to that is: Well, they've got a monopoly once you get into the theater. But before you get into the theater, assuming you're a repeat customer, you know whether popcorn is expensive or cheap, and the more expensive the popcorn is in the theater, the less attractive the theater is, and therefore, the less willing you are to buy a ticket to that theater. They don't have a monopoly before you come in the in the door.

And that's sort of a very brief verbal explanation, but I go through a fairly careful argument which appears to show that if you allow for the effect of popcorn price not only on revenue from popcorn but on revue revenue from theater tickets, it would be in the interest of the theaters to sell popcorn at cost. And essentially, by doing that they, in effect, maximize the combined benefit to them and the customers, and then they transfer the benefit to themselves by appropriately adjusting ticket prices. And that then creates a puzzle: Why don't they? And I then offer some explanations of that puzzle, two different possible explanations of what's going on. And finally, I offer a empirical test, which I haven't done but which somebody could do to try to figure out which explanation is right.

So part of what I'm doing really is starting with what seems like a trivial problem, showing that if you consistently apply economic theory, it's not a trivial problem indeed, you would expect just the opposite of the result that you're getting and then showing how you can go on to use more economic theory to at least tentatively make sense out of out of what you observe.
LAMB: How often do you hear in the political dialogue economists saying things that you know they know is aren't true?
Prof. FRIEDMAN: Huh. That's an interesting question, and the answer is that I don't often enough hear economists who I know. I'm not sure I can think of cases where people who I know and therefore I know what they believe said things that aren't true.
LAMB: Well, let me go back then another way. Based on your experience here, when you had a fact that was not included in the report...
Prof. FRIEDMAN: Yes.
LAMB: often do you find economists who you don't know apparently trying to weave a theory through to prove their point?
Prof. FRIEDMAN: Part of the problem is the definition of `economist,' that from my standpoint that is, there are two sets of people who I don't think of quite as economists. First are the people who don't actually understand economic theory but who study the economy. Second are the people who understand economic theory but don't believe in it. I remember having a colleague and friend many years ago who clearly understood economic theory, but if you had a straightforward economic argument that implied one thing, that didn't have much effect on whether he believed that thing, because if you're clever enough, you can always think up some possible reason why the result isn't true, and he then believed whatever he would have believed anyway. So in that sense, he was sort of an economist but only in working hours he didn't really believe it whereas the real economists are economists 24 hours a day. It's it's a way of thinking, not just something you do behind a desk.

But let me let me give you a very simple example of something of a kind of argument that I don't think any economist could honestly make but where I suspect the people who make it it's not that they're dishonest, it's that they're not really economists. And that's talking about competitiveness in the way in which the newspapers normally talk about it, that the standard discussions of foreign trade assume that if we have a trade deficit with some country, first, that's a bad thing, and second, the reason is that we're not good enough at making things, that we're not competitive. And you can get left wing and right wing versions of this. The right wing version of this says the reason we have a trade deficit is we have too much regulation and too high taxes. And the left wing version of that says the reason we have a trade deficit is the government doesn't support education enough, and they don't do enough about research support and so forth.

Both of those are utter nonsense, and I would pretty much say that anyone who doesn't know they're nonsense is not an economist because both of those are based on a set of economic ideas that were convincingly challenged in 1776 and utterly refuted in 1817 so that you have essentially a picture of how foreign trade works, which seemed very natural and intuitive if you don't think about it very carefully, what economists call the theory of absolute advantage, which is the idea that trade surpluses mean you're producing well, trade deficits, you're producing wrong, and that, we know, is wrong. If you think it through, it turns out to be simply intellectually incoherent. We have understood `we' meaning economists for something over 150 years the correct theory, what we call the theory of comparative advantage. And one of the things that tells us is that our getting better or worse at producing isn't what determines whether we have trade deficits, and for that matter, that trade deficits are not an inherently evil thing. But the whole idea of talking about an unfavorable balance of payments is language that is more than 150 years out of date. That's the economic theory of the 18th century.
LAMB: What was was was it David Ricardo's 1817 theory as your...
Prof. FRIEDMAN: Yes. David Ricardo was the person who really established the principle of comparative advantage. Smith pointed out problems with the existing mercantilist theories but didn't didn't really solve the problem.
LAMB: I want to ask you about this cover before we go any farther. Did you have anything to do with this?
Prof. FRIEDMAN: No. There is no reference to a parking meter anywhere in the in the book. I think it's a very pretty cover, so I can't really complain about that. I've considered that maybe if I do a second edition, I ought to think of something interesting to say about parking meters, just to retroactively justify the cover. But my publisher got somebody to do what they thought was a striking cover. I think they're probably right. It I think it's a pretty cover, but it has nothing to do with the with any particular thing in the book.
LAMB: What level of reader did you write this book for?
Prof. FRIEDMAN: Intelligent, interested person not necessarily knowing anything about economics. That what it's really intend because the book really has two central purposes. One of them is to let the intelligent layman learn economic theory and have fun doing it, and the other is to present economics in the way that I and some, but not all, economists see it, as a very general approach to understanding a very wide range of issues. So that in the course of the book, I talk about the economics of marriage and divorce, a little bit about the economics of interactions between parents and children, the economics of crime, the economics of politics, wide var economics of war, wide variety of what most non economists wouldn't think of as economics but a substantial minority of economists would think of as economics.

So the two objectives, really one of them is to provide something that will do what an intermediate microeconomics course ought to do but usually doesn't end up after you've read it, you actually understand these ideas, and do it in a fashion that people will choose to read because it's fun and, at the same time, present economics from this perspective of a very broad approach to understanding behavior.
LAMB: Now this may not work, and we're going to have to do it quickly because we don't have much time and I want to get to other things, too. But I had I kept asking this question when I went to your dedication.
Prof. FRIEDMAN: Yes.
LAMB: I want to know who these people are, and maybe you can give us a tiny, little definition of and I'll read them I'll read the names off. It said, `This book is dedicated to my parents for early lessons in rationality.' What kind of relationship did you have with your mom and dad?
Prof. FRIEDMAN: When I had an argument, in particular with my father, who was the one who did most of the arguing, he was always entirely clear that what mattered was not which of us was older or which of us was the father but only which of us had the right arguments. Some...
LAMB: How many kids in the family?
Prof. FRIEDMAN: I have one sister. I should say my mother likes to say that when she married my father, she last half her conversation, and when I learned to talk, she lost the other half. So she...
LAMB: She...
Prof. FRIEDMAN: ...did less talking than we did.
LAMB: Did you grow up in the talking a lot and arguing a lot?
Prof. FRIEDMAN: Yes, I yes, yes. The I was told about third hand that somebody had met me and my father skiing when I was about 12 or so, and that we spent all our time arguing and that I won half the arguments. I think that's an overstatement. I don't think my score is that high. But certainly, we spent a lot of time arguing, and it was arguing not as a hostile conflict, but, `Here is the reason this idea is true,' `No, here is the reason it's false,' and go on from there.
LAMB: Was he at the University of Chicago when you were there?
Prof. FRIEDMAN: No. Well, let me let me restate that. When I was a graduate student in physics, I believe he was there. When I was a faculty fellow in the law school many years later, he was not there.
LAMB: I the reason I ask is that I wondered if you'd ever taken a course from him.
LAMB: Who's Ju...
Prof. FRIEDMAN: I've never taken a course in economics.
LAMB: You haven't?
Prof. FRIEDMAN: No. I audited a little bit of a course in economics once when I was an undergraduate. But no, the family joke when I was at Harvard was that I couldn't take a course in economics; they'd fail me because I'd give them the right answers. But that wasn't I wasn't studying economics at at the time I was an undergraduate.
LAMB: What town did you grow up in?
Prof. FRIEDMAN: Chicago.
LAMB: And that's where you went to high school?
Prof. FRIEDMAN: Yes.
LAMB: Let's see see if we can go through as many names as possible. `Julius Margolis and James Buchanan, for getting me into this business.'
Prof. FRIEDMAN: Sure. I was a postdoctoral fellow in theoretical physics at Columbia who had written a published my first book, which was on economics and political philosophy, and had also done some work on population economics. Julius Margolis was running the center for state and local government at the Fels Center at University of Pennsylvania, had seen some of my work and offered to find me a position as a postdoc there if I wanted to switch fields. So he was the first to make it possible for me to switch fields from physics to economics.
LAMB: James Buchanan's on here.
Prof. FRIEDMAN: James...
LAMB: Ju George Mason?
Prof. FRIEDMAN: Yes. James Buchanan is a fairly famous economist who was dominating the VPI economics department. I met him, we discovered we had rather similar ideas about some things that you could do with economics and he arranged for me to come to VPI.
LAMB: Now you got a whole list of I don't know if we can get...
Prof. FRIEDMAN: All of those people are people from whom I have learned at least one interesting idea.
LAMB: Adam Smith.
Prof. FRIEDMAN: Adam Smith, yes.
LAMB: Who was he?
Prof. FRIEDMAN: Oh, Adam Smith is the person usually credited with inventing economics. He was 1 Scottish economist philosopher of the 18th century who wrote a wonderful book called "The Wealth of Nations," which covers an enormous range of issues, is very entertaining and witty if you can get used to 18th century English prose, very sensible and really is is the person who, in some sense, started economics.
LAMB: David Ricardo.
Prof. FRIEDMAN: I would say the first rate economic theorist in the sense of this first person who simply said, `All right. Here is a narrow set of questions. I'm going to think them through precisely and correctly.
LAMB: Where was he?
Prof. FRIEDMAN: He England, again.
LAMB: Alfred Marshall.
Prof. FRIEDMAN: Alfred Marshall, another Englishman I shouldn't say another. Of course, Smith was Scot Scot was a Scot, not an Englishman. But Alfred Marshall is a person who, at the end of the 19th century, really put together modern economic theory, that if you read Marshall's principles, you will basically understand economics, even though you'll be missing a lot of things that have developed since.
LAMB: Harold Hotelling.
Prof. FRIEDMAN: Harold Hotelling is an economist of this century who thought up several very interesting ideas. He's the person who worked out correctly the theory of depletable resources. He's also the person who explained why both political parties nominate candidates with the same views, something called the Hotelling theorem. So he was simply a very ingenious and interesting economist.
LAMB: All right. How many of these are alive?
Prof. FRIEDMAN: The people at the bottom of the list are mostly alive. They're mostly contemporaries of mine. Most of the rest of the list are not. But they're basically all people who had at least one interesting economic idea. One of them is a graduate student at Cal Tech who is going on the job market next year.
LAMB: Which one?
Prof. FRIEDMAN: Robin Hanson, at the bottom of it. And he's a very bright and interesting guy who was working for NASA and thinking up interesting economic ideas in his spare time, and decided to go into economics full time and get a doctorate.
LAMB: Once in a while in your book, let's say, on page 99, you have things to think about.
Prof. FRIEDMAN: Yes.
LAMB: And here's one: `Social Security taxes are paid half by the employer and half by the worker. How would the effect of the tax change if it were collected entirely from the worker or entirely from the employer? Why do you think Social Security is set up this way?' And why did you ask that question? What's the purpose?
Prof. FRIEDMAN: Be because in the chapter, I've worked through the arguments which let you answer to that question. What I've sh one of the things that I show in that chapter is that who nominally pays the tax doesn't matter. And if you think of the the case I worked through in the chapter is the case where you've got a producer and a consumer, and you can imagine either saying every time the producer sells a car, he's got to give the government $1000, or you can say, whenever you buy a car, you pay $1000 sales tax. And what I show is that that is a purely cosmetic difference, that how the way the burden of the tax is really divided between consumer and producer is not affected by whether nominally it's a tax on the producer or a tax on the consumer. And, of course, the same thing applies here, that the division between employer and employee in the Social Security tax is purely cosmetic. The real affect on employer and employee would be the same if you called it 100 percent one, 100 percent the other. The reason it's set up this way is because it makes the numbers look smaller, and therefore, it makes it look as though the cost of Social Security is lower than it is.
LAMB: What kind of students do you teach? What year?
Prof. FRIEDMAN: Well, I've currently I'm teaching two different groups of students. I'm teaching law school students at Santa Clara University Law School, typically second or third year, and I'm teaching undergraduates, I would guess typically second , third or fourth year, in the economics department at Santa Clara University.
LAMB: Now all the s little stories that you have in order to help us learn the economic world, which one, when you get into that classroom, do you find the students just brighten up and get right into it?
Prof. FRIEDMAN: That's an interesting question. There there are several of which that's true. I have a dec an explanation of why armies run away that people usually find interesting. That's economics of war. The discussion of what I refer to as the marriage dating sex market usually interests them, where I start out with the fact that, you know, most markets work very well, that, you know, people want to buy bread, they go to the store and buy bread. But there is one market that we're all involved in where we observe long waiting times, lots of unsatisfied customers, and that's the marriage dating sex market, that here there are all these people who can't find girlfriend or boyfriend, husband or wife, lover and so forth. It seems very odd. Why do we do such a bad job of matching up the two halves of the market there, compared to other markets?
LAMB: Why do we?
Prof. FRIEDMAN: Because it's a barter market. The if you think about an ordinary barter market without money, on a barter market, I have to find somebody who has what I want and wants what I have. So if I want to go out and buy a car on a barter market, I have to locate someone who is selling a car and wants to learn economics, and that's very hard to do. And money splits the two halves of the transaction. I find one person who wants to learn economics, he pays me. Another person who wants to sell a car, I pay him. But the marriage dating sex market in an inherently barter market. I am married to a woman, she's married to me, so that means we've got to find a double coincidence. I've got to find a woman who both is the kind of woman I want to be married to and who I am the kind of man she wants to be married to. That's a much harder matching problem than if you could do separate halves, and that's at least part of the reason obviously I'm oversimplifying it's a very complicated and odd and interesting market. But that's at least a sizable part of the reason why that market seems to work in so much less satisfactory fashion.
LAMB: Why do armies run away?
Prof. FRIEDMAN: Because of the conflict of interest between the individual and the army. Let me give you I can give you two versions, ancient and modern. The modern version starts with one simple and rather striking fact, and that is that in 20th century warfare, the ratio of bullets fired to people killed tends to run about 100,000 to 1, just an immense number depends on the war, but that kind of number. And at least part of the reason is that from the standpoint of the individual soldier in a large battle, he correctly believes that what he does has very little effect on what happens. But what he does has a large effect on whether he gets killed. So you're in a foxhole and what you're supposed to do is to stick your head out and look carefully for an enemy and shoot him. And, of course, if you do that, you're quite likely to be killed. So what you do instead is (puts arms above head in shooting motion) `bang, bang, bang, bang, bang,' hope that'll keep their heads down, and at least it'll persuade your superior officer that you're doing your job.

The ancient version imagine you are one of a line of men on foot with spears, and you're being charged by a bunch of men on horseback with spears. And you say, `Should I stand and fight or should I run?' Well, you say, `If we all stand, there's a pretty good chance we can break their charge, and most of us will survive. If we all run, they're going to ride us down and kill us. So it looks as though I should stand.' But wait a minute. That's wrong, because I don't control the rest of the line. I just control me. If they are going to stand, if I run, I'll get away free. If I stand, I might get killed. If they're going to run, my only chance is to run first. So even though we're all better if we all stand, each of us, given what the rest are doing, is better running. We run and we get ridden down. And that's the problem of the conflict of interest between the individual rationality each person correctly calculating his interest and the interest of all the people together, because my running, of course, increases the chance you'll get killed. Your running increases the chance I get killed. But each of us takes account only the effect on himself.

I've got it so the historical story, which in a way illustrates this point rather nicely and it also illustrates the fact that rationality doesn't just apply to modern 20th century people. There was a battle in the early 11th century in Ireland called the Battle of Clontarf, the battle that finally got the Vikings out of Ireland. And on one side, there was an army, mainly Irish, commanded by the high king of Ireland, and on the other side, there was an army of mixed Norse and Irish, commanded by Sigurd, the earl of the Orkney Islands. And Sigurd had a battle flag which his people believed had a sort of a two edged spell on it. As long as the battle flag flew, his army would always advance, but whoever carried the flag would die. Battle starts, Sigurd's army is advancing, guy carrying the flag gets killed, somebody else picks the flag up. Sigurd's army continues advancing, guy carrying the flag is killed.

Sigurd points to someone else and says, `Take the flag.' The guy steps forward and his friend next to him says, `Don't touch that thing, you fool.' The guy stands back again. Sigurd can't get a third man to carry the flag. Sigurd says, `It is fitting the beggar should bear the bag,' cuts the flag off its staff, wraps it around his waist so he can fight while carrying the flag himself, leads his army forward. Sigurd is killed. Nobody takes the flag off his body, all right? So in terms of their beliefs, they could win the battle as long as a handful of them are willing to die to do it. Well, after three people counting Sigurd, they ran out.

Now part of what I like about this, other than it being a good story, is people often imagine that even if we are sort of rational calculators, other people aren't, you know. Vikings are part of our sort of standard of, you know, heroic barbarian types. Whole army full of Vikings, and they could find a total of three people who were willing to die, to face what they've regarded as certain death in order that their side could win. So it looks, in fact, as though some sort of rational self interested calculation applies to a lot more people than we might might suppose.
LAMB: You have a Chapter 19, Law and Sausage: The Political Marketplace...
Prof. FRIEDMAN: Yes.
LAMB: ...and then you use the Bismarck quote...
Prof. FRIEDMAN: Yup.
LAMB: ..."Laws are like sausages: It is better not to see them being made." You say it's attributed to Bismarck.
Prof. FRIEDMAN: Yup.
LAMB: I did he say that?
Prof. FRIEDMAN: I don't know. I don't know. I don't know. I know that that's the standard attribution, but I haven't found an original source for it.
LAMB: What do you think of the way the American system works or doesn't work?
Prof. FRIEDMAN: I think it isn't just the American system. I think it is very hard, maybe impossible, to construct a political system that will work very well. And that chapter sort of works through part of the reasons why, that one of the mistakes in a lot of discussions of political issues is that people discuss them in terms of what outcome you want rather than what institutions will generate that. And let me give you a very simple example, which is the issue of redistribution, that everybody arguing about redistribution takes it for granted that what we're arguing about is whether it would be a good thing to take some money from rich people and help poor people. But there's a previous question, and that is: If the government has the power to redistribute, is that the way it'll use it?

And the answer is very unclear, that if you look at real governments, sometimes governments buy the votes of poor people with money from rich people and sometimes they buy the votes of rich people with money from poor people. Sometimes, you know, they do both at the same time, so that you think not about what outcome you want but about how to construct institutions that can produce the outcome. It's quite hard, I think, maybe impossible, to construct political institutions that will work at all well. That's why ultimately I would like to have government do as little as possible and, in the long run, nothing at all. So it is so it isn't specific to our system. I mean, I think the same problems would exist with England or France or Germany or whatever, that if you think about ordinary democracy, the problem is rational ignorance. The problem is that an individual voter would have to know a great deal to do a good job of deciding who should be congressman or president, knowing that great deal would take him a lot of time and effort. The individual voter gets no payoff other than whatever his own feeling of having done his duty is from that time and effort, and thus, most people don't do it.

Let me give you an analogy that I find striking. Suppose the way we bought automobiles was you create a group of 10,000 people and you say, `All right. In two weeks, we're going to have an election. Whichever model of car wins, you all get one.' In that system, you would not spend the next two weekends test driving because you would say to yourself, `With 10,000 people out there, even if I figure out what's the right car for me, which is going to take quite a lot of time and effort, reading Consumer Reports, test driving and so forth, my vote is very unlikely to decide it. I'm going to get what the rest of them want anyway.' So none of us are going to make much effort to figure out what car we want and we'll get whatever car we happen to have seen an ad for recently, something of that sort. Well, same thing in the political system, except the number is much larger than 10,000. And I think that's really an inherent problem, and you may or may not be people can argue about how many things whether there are some things that have to be done that way. But I think even if you believe there are some things that have to be done by the political system, you should assume they will then be done badly, because I don't think we have good mechanisms for getting political systems to work.
LAMB: Friedman's second law is there a Friedman's first law, too? And is that...
Prof. FRIEDMAN: If I remember correctly, Friedman's fir what I like to call Friedman's first law, which is from my first book, is that it costs the government about twice as much to do anything as it costs anyone else. Now I realize the Pentagon has gotten higher scores in a few notable cases, but sort of it's a good rule of thumb. And Friedman's second law...
LAMB: The government...
Prof. FRIEDMAN: I think it takes some explanation. It's essentially it isn't even entirely with the government. It's that you can't give things away. And...
LAMB: You say here, `The government cannot give anything away.'
Prof. FRIEDMAN: Yes, yes. That is an overstatement, but the basic argument is that if the government offers something for free, there are always more people that want it than the government's willing to give out. Consequently, people start competing to get it in some fashion, whether by lobbying their politicians or appearing particularly deserving. The people who want to get the something increase the amount the costs that they bear in the process of trying to make sure they're the ones who get it until they have competed away the game.

And this this argument really originates with an article that Gordon Tullock wrote a very long time ago. It gets its the next version of it, I think, I invented in my first book, but it gets its name from an article then written by Anne Krueger called The Political Economy of the Rent Seeking Society, and what she was considering was the case of developing countries such as India and Turkey, where the government was giving away import permits. An import permit gave you permission to exchange local currency for dollars at the official rate, which gave you many more dollars than the local currency was really worth in order to imp to buy foreign goods and import them. These import permits were very valuable. The result was that companies within the country spent a lot of resources competing to get them and thus competed away the free the freebie they were in effect getting. And she concluded that India and Turkey were wasting something on the order of 10 percent of their GNP in this fashion, so it was a very costly activity for poor countries.
LAMB: The last it's not a theory, but it's a statement I want you to explain. You write this near the end of your book: `What surprises me is how little is spent on political campaigns, considering the stakes.'
Prof. FRIEDMAN: Sure. I think the figures, roughly speaking, for this election I was looking at some of the numbers are that the presidential campaigns in total are going to spend less than $200 million. I know there's probably some additional money being spent by people who are really spending it for the candidates, but not official. Figure I don't know what the total numbers are exactly, but roughly speaking...
LAMB: The last figure I saw was $1 billion for everything.
Prof. FRIEDMAN: For that's what I was going to say. But the rough rough sort of rule of thumb is that all candidates are going to spend something like $1 billion. Well, what are they fighting over? They're fighting over control of a government which spends $1 trillion a year more than $1 trillion, but well over $1 trillion now, but past that a while ago. So that means that means the total amount they're spending to get control of these resources is tiny compared to the value of what they're getting control of. So the puzzle is: Why don't you say, `Well, you're willing to spend $200 million to be president. I'll spend $400 million. You're willing to spend $500 billion to elect $500 million to elect your con congressman. I'll spend $1 billion and I'll get the White House, I'll get Congress. I'll spend all that money on me and my friends, and I will make much more than I spend.' You think about the political system as a sort of a marketplace. It's an odd kind of marketplace, but it is a marketplace. People in the political system spend money, votes, other resources in order to get things, in order to get the ability to control legislation and expenditure and so forth. It seems surprising that we seem to spend such a small amount on such a very valuable prize as control over the US government. And I offer some possible explanations in the book.
LAMB: Which book is this for you?
Prof. FRIEDMAN: This is my third commercially published book, and I also have one self published book that my wife and I produce, which has to do with our medieval hobbies.
LAMB: What does your wife do for a living?
Prof. FRIEDMAN: At the moment, what she does for a living is to take care of two small children. She's a geologist by training, worked for Shell Oil at the point I married her, but currently, she's a full time child rearer.
LAMB: And do you have plans for a next book?
Prof. FRIEDMAN: Yes. I've got at least two more book well, one book partly written and one book that's thought about, neither of which is aimed really at a general audience. One of them is a textbook in economic analysis of law, which I think I want to write because I'm not entirely happy with any of the ones that I have to use in teaching it. And one of them is a treatise, working out some of my ideas on economic analysis of law. If this book does well, I may eventually write a sequel to this one aimed at general audiences. This book is aimed and I've got some ideas about that as well, but that I really haven't started on that, whereas I have in some sense started on two other books.
LAMB: David Friedman is our guest. Here's the cover of the book. It's called "Hidden Order: The Economics of Everyday Life." And we thank you.
Prof. FRIEDMAN: And I thank you.

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