Milton Friedman
Thomas Sowell tells the following story in his book Basic Economics: A tourist in New York's Greenwich Village decided to have his portrait sketched by a sidewalk artist. He received a very fine sketch, for which he was charged $100.
"That's expensive," he said to the artist, "but I'll pay it because it is a great sketch. But it took you only five minutes."
"Twenty years and five minutes," the artist said.
One of the main agendas in any business ethics class is to encourage individuals going into business to be socially responsible. One of the main goals in business is to make money but we also hear many times that business people also have other responsibilities. So, it may come as a surprise to read Milton Friedman’s essay where he equates social responsibility with making profits.
As some of you may know, Milton Friedman was a Nobel Prize-winning economist and a defender of free-market capitalism for many years. Needless to say, he was very much against the sort of talk that we often hear about social responsibility. He thought it was nothing more than propaganda for socialism. As he puts it, “businessmen who talk this way are unwitting puppets of the intellectual forces that have been undermining the basis of a free society these past decades.” Pretty strong talk! If you’re curious about these intellectual forces or how they’ve been undermining liberty we can talk about this later. For now, we should examine Friedman’s argument for businesses pursuing profit (and only profit) as their exclusive social responsibility.
First, we need to clarify the concept of responsibility. Can businesses have responsibilities? No, says Friedman, mainly because responsibilities only adhere to individuals. This is similar to the claim that businesses do not pay income taxes. We can address this below, but Friedman’s point here is more than just semantic. A corporation is not an individual so much as a legal fiction so it cannot have responsibilities. Rather, it is the individuals in the corporation who have responsibilities. So, the claim that a company has a social responsibility is a claim that an individual (such as a manager) has a responsibility.
So, what could it mean to say that a manager has a social responsibility? Well, in the conventional sense it must mean that the manager has a responsibility to do something other than what he is being paid to do. If it meant he had a responsibility to do exactly what he is doing there’d be nothing to talk about! But, what’s the problem with this? Why shouldn’t businesses also worry about things like unemployment and pollution as well as profits? Many times we hear precisely these claims. A business has a responsibility to keep the environment clean and provide jobs and a living wage. Friedman argues that businesses (or rather individuals in the business) have no such responsibilities. He argues this for three reasons:
First, pursuing social responsibility violates the relationship between shareholders and the company. After all, it is the shareholders who own the company and they have hired the CEO or manager to do a specific job. This job is to increase profits. By not doing this job the individual is violating the agreement. Interestingly, this argument seems to imply that if the shareholders were to hire someone specifically to fulfill social responsibility, then they would be justified in doing so. While Friedman does not address this directly, he does admit that such companies do exist for “eleemosynary purposes” (you can look this term up in our glossary on Bb). Of course, non-profit companies exist for just such purposes.
Secondly, a manager or CEO who pursues a social responsibility is infringing on the liberty of the shareholders of the corporation. This is also tied to the fact that the shareholders are the owners of the company and the capital of that company. Perhaps an analogy will illustrate Friedman’s point. Suppose you give me $5.00 and ask me to go to McDonald’s to buy you lunch. You want a Big Mac, Fries, and a Coke. When I come back I give you a salad and a glass of water. You are quite understandably confused and angry. After all, you didn’t ask for a salad. My response is simply that the lunch you ordered wasn’t good for you so I decided to get you a salad instead. Now, are you going to thank me or still be angry? In all likelihood, you’ll still be angry because I have taken your money and purchased something with it you didn’t freely choose to purchase. Of course, you could have just purchased it yourself but this misses the point of the analogy. The shareholders are hiring the CEO or manager to run their company for them which means they are merely agents of the shareholders. The shareholders have the final say as to how their money is spent. A CEO who chooses to spend it otherwise is infringing on the freedom of the shareholders to spend their money as they choose.
Thirdly, Friedman argues that there is no reason to think that the efforts of the individuals in the company who are acting “socially responsible” will even be effective. For all they know, their efforts may have the opposite effect. A good example of this is with the oil companies. Since they have become everyone’s favorite target for abuse we can spotlight them to understand Friedman’s point. Suppose a particular executive of a particular oil company (say Exxon) decides that they will act socially responsible and work to lower the price of gas. So, they choose to keep their price some measure below what the market dictates. First, will this have the intended effect? Unlikely since it is only one oil company. Second, even if the intended effect is realized what is the cost? The cost to the shareholders will be significant and so a benefit to one group is paid for by a cost to another. This sort of trade-off is very common in economics as we’ve talked about from the beginning of this class.
To put Friedman’s argument in perspective it will be useful to examine profits and the role of profits in an economy. While we have examined some of the benefits to profit and wealth before, this will allow us to take a more contemporary look at things.
What are profits? Remember Marx claimed that profits were a surplus value that should be excised from the economic system. However, profits are more accurately seen as prices, just like wages and rents, and interest. Specifically, they’re the price we pay to entrepreneurs to take risks and develop products and services for us. Since it’s very unlikely that entrepreneurs will provide this service for free (would you work for free?) these costs are necessary for any viable economic arrangement. But, as the story of the artist above illustrates sometimes it’s not obvious what we are paying for. After all, the artist only took five minutes to finish the picture! But, doesn’t he deserve to be compensated for the time he put into becoming an accomplished artist? But, how much? The next question then is what makes some profits large and others small?
In general, profits average around 6% in any given business which is a very small price to pay for the benefit we receive. However, there is no question that some companies sometimes reap much larger profits. Why is this? The short answer is that large profits indicate important needs that are not being met. This addresses an important underlying point in Friedman’s article. Companies that make a large profit are fulfilling a need in the community. This sounds about as socially responsible as you can get! Imagine a company that finds and provides a cure for AIDS or cancer. They’d make a huge profit! They would make this profit because they would be fulfilling a need. If a company made no profit it simply means that they are producing something no one wants. To Friedman, this sounds very irresponsible.
In a free market, profits fulfill another very important role. They signal where the community’s resources need to be directed. Planned economies (like in the former Soviet Union or North Korea) have a very hard time directing resources and thus there are always problems of shortages. In a free-market economy, high profits cause other companies to come in and compete for these profits thus bringing more resources to bear on the unmet need. Sure, their motivation is profit but the net benefit is there in any case (remember Adam Smith’s invisible hand?). As one commentator pointed out recently about the oil companies, yes they’re making large profits now but not too many years ago they were operating at huge losses. In addition to this, the last time we had shortages in the oil supply in the '70s the prices were kept low and there were gas lines. Yes, you’re paying high prices for gasoline today, but at least you can purchase gas. Which brings up another trade-off: Would you rather have low gas prices and no gas to purchase or higher prices and gas in the tank? Mind you, you don’t necessarily get to choose your ideal option: low prices and plenty of gas!
Still, it’s tempting to think that companies should be doing something besides making huge profits and when they make huge profits it’s tempting to think they’re doing something wrong to make them. But, in general, high profits always indicate one thing in an economy: low supply relative to high demand. This brings us back to the issue raised in the Andrew Carnegie article about inequality of wealth. To take a fashionable example, isn’t it terrible that athletes make so much more than school teachers since the latter is far more important? The simple answer to this question about profit is that there is a higher demand relative to supply for athletes than teachers. We don’t have to like this but who is to blame? The athletes? No. The teachers? Of course, not. So who’s left to blame? Ourselves! If we demand athletes more than schoolteachers we have only ourselves to blame for their great wealth relative to schoolteachers. The same goes for the profits of oil companies, drug companies, or Wal-Mart! Companies cannot create profits out of thin air. They need people to consume their products to generate profits. Milton Friedman’s point is simply that the companies who are making the most profit are the companies who are fulfilling our most pressing demands the best. And that, in his view, is a social responsibility.
"That's expensive," he said to the artist, "but I'll pay it because it is a great sketch. But it took you only five minutes."
"Twenty years and five minutes," the artist said.
One of the main agendas in any business ethics class is to encourage individuals going into business to be socially responsible. One of the main goals in business is to make money but we also hear many times that business people also have other responsibilities. So, it may come as a surprise to read Milton Friedman’s essay where he equates social responsibility with making profits.
As some of you may know, Milton Friedman was a Nobel Prize-winning economist and a defender of free-market capitalism for many years. Needless to say, he was very much against the sort of talk that we often hear about social responsibility. He thought it was nothing more than propaganda for socialism. As he puts it, “businessmen who talk this way are unwitting puppets of the intellectual forces that have been undermining the basis of a free society these past decades.” Pretty strong talk! If you’re curious about these intellectual forces or how they’ve been undermining liberty we can talk about this later. For now, we should examine Friedman’s argument for businesses pursuing profit (and only profit) as their exclusive social responsibility.
First, we need to clarify the concept of responsibility. Can businesses have responsibilities? No, says Friedman, mainly because responsibilities only adhere to individuals. This is similar to the claim that businesses do not pay income taxes. We can address this below, but Friedman’s point here is more than just semantic. A corporation is not an individual so much as a legal fiction so it cannot have responsibilities. Rather, it is the individuals in the corporation who have responsibilities. So, the claim that a company has a social responsibility is a claim that an individual (such as a manager) has a responsibility.
So, what could it mean to say that a manager has a social responsibility? Well, in the conventional sense it must mean that the manager has a responsibility to do something other than what he is being paid to do. If it meant he had a responsibility to do exactly what he is doing there’d be nothing to talk about! But, what’s the problem with this? Why shouldn’t businesses also worry about things like unemployment and pollution as well as profits? Many times we hear precisely these claims. A business has a responsibility to keep the environment clean and provide jobs and a living wage. Friedman argues that businesses (or rather individuals in the business) have no such responsibilities. He argues this for three reasons:
First, pursuing social responsibility violates the relationship between shareholders and the company. After all, it is the shareholders who own the company and they have hired the CEO or manager to do a specific job. This job is to increase profits. By not doing this job the individual is violating the agreement. Interestingly, this argument seems to imply that if the shareholders were to hire someone specifically to fulfill social responsibility, then they would be justified in doing so. While Friedman does not address this directly, he does admit that such companies do exist for “eleemosynary purposes” (you can look this term up in our glossary on Bb). Of course, non-profit companies exist for just such purposes.
Secondly, a manager or CEO who pursues a social responsibility is infringing on the liberty of the shareholders of the corporation. This is also tied to the fact that the shareholders are the owners of the company and the capital of that company. Perhaps an analogy will illustrate Friedman’s point. Suppose you give me $5.00 and ask me to go to McDonald’s to buy you lunch. You want a Big Mac, Fries, and a Coke. When I come back I give you a salad and a glass of water. You are quite understandably confused and angry. After all, you didn’t ask for a salad. My response is simply that the lunch you ordered wasn’t good for you so I decided to get you a salad instead. Now, are you going to thank me or still be angry? In all likelihood, you’ll still be angry because I have taken your money and purchased something with it you didn’t freely choose to purchase. Of course, you could have just purchased it yourself but this misses the point of the analogy. The shareholders are hiring the CEO or manager to run their company for them which means they are merely agents of the shareholders. The shareholders have the final say as to how their money is spent. A CEO who chooses to spend it otherwise is infringing on the freedom of the shareholders to spend their money as they choose.
Thirdly, Friedman argues that there is no reason to think that the efforts of the individuals in the company who are acting “socially responsible” will even be effective. For all they know, their efforts may have the opposite effect. A good example of this is with the oil companies. Since they have become everyone’s favorite target for abuse we can spotlight them to understand Friedman’s point. Suppose a particular executive of a particular oil company (say Exxon) decides that they will act socially responsible and work to lower the price of gas. So, they choose to keep their price some measure below what the market dictates. First, will this have the intended effect? Unlikely since it is only one oil company. Second, even if the intended effect is realized what is the cost? The cost to the shareholders will be significant and so a benefit to one group is paid for by a cost to another. This sort of trade-off is very common in economics as we’ve talked about from the beginning of this class.
To put Friedman’s argument in perspective it will be useful to examine profits and the role of profits in an economy. While we have examined some of the benefits to profit and wealth before, this will allow us to take a more contemporary look at things.
What are profits? Remember Marx claimed that profits were a surplus value that should be excised from the economic system. However, profits are more accurately seen as prices, just like wages and rents, and interest. Specifically, they’re the price we pay to entrepreneurs to take risks and develop products and services for us. Since it’s very unlikely that entrepreneurs will provide this service for free (would you work for free?) these costs are necessary for any viable economic arrangement. But, as the story of the artist above illustrates sometimes it’s not obvious what we are paying for. After all, the artist only took five minutes to finish the picture! But, doesn’t he deserve to be compensated for the time he put into becoming an accomplished artist? But, how much? The next question then is what makes some profits large and others small?
In general, profits average around 6% in any given business which is a very small price to pay for the benefit we receive. However, there is no question that some companies sometimes reap much larger profits. Why is this? The short answer is that large profits indicate important needs that are not being met. This addresses an important underlying point in Friedman’s article. Companies that make a large profit are fulfilling a need in the community. This sounds about as socially responsible as you can get! Imagine a company that finds and provides a cure for AIDS or cancer. They’d make a huge profit! They would make this profit because they would be fulfilling a need. If a company made no profit it simply means that they are producing something no one wants. To Friedman, this sounds very irresponsible.
In a free market, profits fulfill another very important role. They signal where the community’s resources need to be directed. Planned economies (like in the former Soviet Union or North Korea) have a very hard time directing resources and thus there are always problems of shortages. In a free-market economy, high profits cause other companies to come in and compete for these profits thus bringing more resources to bear on the unmet need. Sure, their motivation is profit but the net benefit is there in any case (remember Adam Smith’s invisible hand?). As one commentator pointed out recently about the oil companies, yes they’re making large profits now but not too many years ago they were operating at huge losses. In addition to this, the last time we had shortages in the oil supply in the '70s the prices were kept low and there were gas lines. Yes, you’re paying high prices for gasoline today, but at least you can purchase gas. Which brings up another trade-off: Would you rather have low gas prices and no gas to purchase or higher prices and gas in the tank? Mind you, you don’t necessarily get to choose your ideal option: low prices and plenty of gas!
Still, it’s tempting to think that companies should be doing something besides making huge profits and when they make huge profits it’s tempting to think they’re doing something wrong to make them. But, in general, high profits always indicate one thing in an economy: low supply relative to high demand. This brings us back to the issue raised in the Andrew Carnegie article about inequality of wealth. To take a fashionable example, isn’t it terrible that athletes make so much more than school teachers since the latter is far more important? The simple answer to this question about profit is that there is a higher demand relative to supply for athletes than teachers. We don’t have to like this but who is to blame? The athletes? No. The teachers? Of course, not. So who’s left to blame? Ourselves! If we demand athletes more than schoolteachers we have only ourselves to blame for their great wealth relative to schoolteachers. The same goes for the profits of oil companies, drug companies, or Wal-Mart! Companies cannot create profits out of thin air. They need people to consume their products to generate profits. Milton Friedman’s point is simply that the companies who are making the most profit are the companies who are fulfilling our most pressing demands the best. And that, in his view, is a social responsibility.