Posner is Right About Why Friedman is Wrong, But…

It’s worth reading Eric Posner on why Milton Friedman was wrong. My issue is with the historical setup to the argument.

The shareholder theory is usually credited to Milton Friedman, the University of Chicago economist and Nobel laureate. In a famous 1970 New York Times article, Friedman argued that because the CEO is an “employee” of the shareholders, he or she must act in their interest, which is to give them the highest return possible. Friedman pointed out that if a CEO acts otherwise—let’s say, donates corporate funds to an environmental cause or to an anti-poverty program—the CEO must get those funds from customers (through higher prices), workers (through lower wages), or shareholders (through lower returns). But then the CEO is just imposing a “tax” on other people, and using the funds for a social cause that he or she has no particular expertise in. It would be better to let customers, workers, or investors use that money to make their own charitable contributions if they wish to.

Friedman’s theory was wildly popular because it seemed to absolve corporations of difficult moral choices and to protect them from public criticism as long as they made profits. At the same time, it took CEOs down a peg—yes, they were resented even in 1970—by denying that they were visionaries with public responsibilities. And Wall Street saw dollar signs in the single-minded devotion to corporate profits.

Of course, Friedman never mentions “the CEO” in his 1970 article. Friedman uses “managers,” “businessmen,” and “corporate executives” to discuss the agents who enter into “voluntary contractual arrangement” with the corporation’s principals or owners: e.g., “the key point is that, in his capacity as a corporate executive, the manager is the agent of the individuals who own the corporation or establish the eleemosynary institution, and his primary responsibility is to them.” As I’ve observed in a number of posts, the acronym “CEO” would not come into wide use until about five years later, and then only in business journals. The general public would not start hearing about CEOs until the very late 1970s and early 1980s.

So while business executives might have been “resented even in 1970,” CEOs strictly speaking were not. If this is a quibble it’s a revealing one. It allows us to see the CEO historically, and as the creature of Friedman’s wildly popular doctrine.

Though they, too, may have been targets of public criticism and resentment, by the 1980s CEOs were also being made into celebrities and held up as models of American leadership. And as “the single-minded devotion to corporate profits” — and rapidly rising CEO pay — came to be celebrated as “visionary” in its own right by the fledgling business press, the words “visionary” and “vision” would come in for decades of abuse.

1 thought on “Posner is Right About Why Friedman is Wrong, But…

  1. Steve Timmer

    One of Posner’s best insights:

    “Indeed, the notion that the big public corporations are tribunes for the free market is quixotic. Big corporations are islands of socialism within our market economy: Their bigness protects them from competition for customers and workers. Because investors of capital benefit when product and labor markets are monopolized, CEOs are only too happy to accommodate them.”

    Businesses try to limit competition, not expose themselves to it. They erect barriers to entry in a variety of ways that are not competition related, including intellectual property. IP is not entirely dedicated to that, of course, but it’s one element of it, especially in the patent field.

    Reply

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