Friedman Revisited

By Julius David

Posted on 9 August 2022
10 minute read

Lessons for a New Generation of Economists

As a young scholar in Oxford, Scottish philosopher Adam Smith was one of the first modern academics concerned with the principles of economic activity. Prompted by wealth accumulation characterizing several Western European countries in the 18th century, Smith’s work challenged the organization of the factors of production, labor, capital and land. His extensive body of work has laid the de facto foundation for economics as an academic discipline today. Yet, when his much acclaimed book – “Wealth of Nations” – was published in 1776[1], the world was inarguably much different from today: Feudal, Pre-industrial, and inefficient. Likewise was the set of problems Smith was addressing.

Throughout the last 150 years economists, faced ever new issues challenging their models and the academic status quo. While they typically did not enjoy much attention during economic expansion, economists were turned to during modern history’s most devastating crises. In these challenging times, outstanding scholars of economics, such as Keynes, Hayek, and Friedman, rose to the occasion. Today, economists are once again facing a set of completely new problems. How can an economist help solve the United Nations’ 17 (!) Sustainable Development Goals[2]? How can we take urgent action to combat climate change, while also promoting inclusive and sustainable industrialisation – all without compromising future generations?

Different from Smith in the late 18th century, contemporary scholars get to study a long record of economic history and a tradition of doctrines addressing their time’s respective challenges. Yet, since the financial crisis 2008 – and failure of anticipation thereof – a new sentiment has emerged. People are asking for the end of teaching classical economic theory, breaking with the tradition of studying the past as a model for the future. A. Chakrabortty, for instance, called teaching classical economics at university a “GBP 9,000 lobotomy”, in 2014[3]. While less polemic (but just as serious), even recent voices have expressed their concerns over the study of outdated economic theory – “questioning the very foundations of [the] discipline.[4]”

While some critics make valid arguments for the revision of economic curricula at universities, their criticism also gives rise to another question. If economics has really changed that much, digging for answers in history and expanding models may simply be a poor attempt at describing a world that no longer exists. It makes us ask ourselves whether outstanding theories by Smith, Keynes, and Friedman can be relevant to a new generation of economists solving the problems of our time.

Economics in Order & Context

Since the emergence of economics as a study of the productive assets in a given society, few scholars have been studied as comprehensively as Adam Smith. The Scottish economist and philosopher is considered the “father of capitalism”[5] and effective founder of what is known as classical economics. In a series of works, Smith delved into the dynamics of markets, wealth accumulation and labor. In his lesser known work, “The Theory of Moral Sentiments” (1759)[6] Smith lays the philosophical and psychological foundation on which his well known political economic theories are based.[7] He describes the principles of “human nature” and the innate ability to form moral judgments – guiding the economic agent in their daily decision-making.

His work was intended to advise rulers and magistrates of the 18th century on how to structure civic institutions and policies to maximize public wealth and happiness.[8] In his famous example of the pin factory, he illustrates that a distribution of productive tasks among different workers, the division of labor, would put assets into their most productive state. If “one man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head, [...]”[9] much more pins could be produced as if one workman was going at a single pin alone.

Before the change of society in Western Europe from agrarian, in small localities, to large cities and large number of people working on the factory system, society was divided into a productive part (workers/manufacturers) and nonproductive part (aristocracy) – with limited economic participation by the former and a provision of rent by the latter. Smith's work could be understood as an empowerment of a formerly oppressed part of the pre-industrialized society. The “selfish agent” is a reflecting, consuming and acting part of the economy. Only within the 19th century, a division within the productive part of society, between the worker and factory owner, became internal to production. Fostering an ideological division between them, the classical economists' “laissez-faire” attitude by the government was used to justify an exploitation of an urban working class ruled by powerful capitalists. While Smith was not insensitive to the social effects of “confining”[10] workers to the performance of a simple task of their labor – his theories had no effective answer to the questions of this newly formed mass society.

Over 150 years later, a handful of economists are wrestling over the heritage of the classical economists. Their theories and doctrines are part of a dynamic framework that will shape the economic policy debate of the 20th century. To understand the Great Depression triggered by the global recession in the 1930s, British economist John Maynard Keynes studied the impact of aggregate demand on the GDP of a country. His theories are based on the notion that a short run fall in total spending in an economy, would lead to a decrease in labor demand and production, which in turn would lead to a decrease in prices and wages. To break this vicious cycle, Keynes pioneered a new way of economic thinking.

Enjoying a respectable career in both academia and civic service, he soon became part of a group of young economic scholars called the “Cambridge circus”[11] during the 1930s. This Circus, with Keynes at the center, studied an increasingly struggling British economy. His ideas were not necessarily developed as an ideological response to a laissez-faire approach by classical economists, but rather as a practical solution to a policy-problem during the great recession. Critical of the austerity of the British government, the later dubbed “Keynesian economics” defends the increase of government expenditures and lower taxes in the short run to stimulate demand and “kickstart” an economy out of a recession. Published in a series of books during the ‘30s, his ideas of “counter-cyclical public spending”[12] were taken seriously by Anglo-American governments and soon found their way into economic policies in Western European countries such as Sweden and Germany.

Yet, Keynes was not the only economist watching the developments in Europe during the 1920s and 1930s with great concern. Born in Vienna, Friedrich Hayek had studied the prevailing Western European economic policies and observed Germany’s political and ideological developments in horror. Moving to Britain, His “The Road to Serfdom” published in 1945 could be considered a warning to his fellow scholars and Britain’s socialist movement of the dangers of economic control, which he considers “[...] the control of the means for all our ends.”[13]. In his view, the control over economic activity by the government culminates in totalitarianism. Compared to Keynes, Hayek’s work is less a practical solution but rather an ideological framework based on the political concerns about National Socialism.

Another prominent economist rising to fame during the latter part of the 20th century is Milton Friedman, who today, is considered the most influential monetarists of modern times. Friedman takes up where classical economics struggled to find an answer to the social questions of the 20th century. He demonstrates how the productive process itself can carry the social responsibility of an industrialized society. In his theories, he focuses on the supply-side of economics, showing that there will not be a lack of effective demand in the long run. In his views the economy gets corrected automatically – without government intervention – clearly opposed the existing theories of the time, such as Keynes, who favored government intervention during recessions. Friedman’s theories are set in a world of assumptions in which a company has no comparative advantage in socially responsible actions, the government is well-functioning and there is no uncertainty in instrumental decision-making. Under these strict assumptions, he argues that “the social responsibility of a business is to increase its profits”[14]. While often demonized, the maximization of profits simply refers to the shift of production factors into their most productive state, which in Friedman’s view is paramount to the creation of social value. Yet, this famous notion has since been hijacked to justify indiscriminate deregulation and to fuel a divide between stakeholders and shareholders. Friedman, however, never advocated for companies to exploit their stakeholders, pollute the environment or deceive their customers. In fact, his theory’s assumptions, if violated, would even justify a departure from intentional financial profit maximization[15].

In the real world, we frequently observe violations of these assumptions such as regulatory failures – most famously during the subprime lending crisis triggering the 2008 recession. While a number of factors interacted to create one of the most devastating financial crises in modern history, failure to regulate a classical principal-agent problem was at the heart of the banking collapse.

Revisited and Relevant?

However, no economic theory should be taken as an exhaustive and complete description of the world. Rather, individual economists’ contributions can be considered complements, applied to the prevailing policy questions of the time. In this sense, Friedman’s doctrine of long term profit maximization is an addition to previous works based on the information available to him at the time. But even though the world he observed was largely different from the world we live in today, Friedman's claims are based on a sophisticated understanding of a modern economy. Evidence shows that his doctrine of social responsibility might still be relevant in today's capital markets.

In a series of studies, Edmans (2011[16]; 2012[17]) shows that under certain conditions the social responsibility of a business can in fact comprise profits. In that sense, a business does not need to forego profits over social responsibility. Edmans demonstrates that the norms governing today’s markets create a framework in which businesses create profits exclusively through creating value for society[18]. His former study analyzes the relationship between employee satisfaction and long-run stock returns. The mechanism Edmans discovered is based on the notion that employee satisfaction is beneficial for a firm's value and not immediately observable by the market. In line with the efficiency wage theory[19], Edmans argues that in a modern firm, employees respond to satisfaction with increased exertion of intrinsic effort. But while we would expect that beneficial tangible factors would be “rapidly capitalized”, an existing body of research shows an underpricing of intangible firm characteristics. Indeed, his study finds that a portfolio of companies with high employee satisfaction ratings also exhibited significantly more positive earnings surprises and announcement returns, establishing a direct correlation between shareholder returns and employee satisfaction. This finding informs our understanding of the profit maximization in a modern economy with sophisticated capital markets. While the stock market may not fully value intangibles, there is evidence that Socially Responsible Investing (SRI) screens could maximize investment returns.

But do firms with more satisfied employees really yield higher investment returns? Or is it maybe the other way around and exhibiting positive earnings surprises simply fosters higher satisfaction among employees? As an indicator observed by the market ex-post, employee satisfaction might lack dimensionality to capture the true direction of this effect. To attenuate some concerns of this reverse causality, Edmans (2012) studies the same effect on a firm-level, directly matching companies with high ranking employee satisfaction with other stocks in the same industry or with similar characteristics such as size, value, or performance. His results resemble those of the first study: Firms with high employee satisfaction – but otherwise similar characteristics – beat their peers by up to 3.8% per year over 1984-2011. Edmans additionally finds that such companies’ future profits outperform analyst expectations systematically. The results of these studies provide an insight into the norms guiding the interaction between market participants which in return are reflected in the laws governing today’s markets. Investing in your employees’ satisfaction does not come at the expense of profits – it generates it.

But is the reverse true and creating social value can automatically generate the highest profits? From Edman’s results we would, for instance, expect that decarbonization is systematically rewarded in the market. However, studies have consistently found that more carbon emissions generate higher shareholder returns. In last year’s study for example, Bolton and Kacperczyk[20] (2020) investigate whether carbon emissions affect the cross-section of US stock returns. But although their data shows that institutional investors are significantly divesting from carbon intensive stocks, this does not affect the stock returns. The authors' results show that stock returns are in fact positively related to the level of carbon emissions, contradicting earlier studies suggesting the opposite. The contradicting evidence raises the question whether decarbonization is a suitable firm characteristic mediating the generation of social value. Certain firm’s business models and a number of industry characteristics might flaw this argument. An airline’s emissions for instance are correlated with its revenue. The more flights a given airline is operating, the higher its emissions. The decarbonization of such industries does not automatically create the highest profits. In fact, decarbonization here is often just an accounting exercise attempting to conceal the true level of carbon emissions. The conflicting results call for more research and studies may be able to reveal more about this effect in the future.[21]

Policymakers and media outlets are wrong in demonizing the general purpose of a business to generate profits and returns to their shareholders. Their quotes and anecdotes are flawed and removed from their context. We can only understand the meaning of Smith, Keynes, Hayek, and Friedman, if we place them into historical order and their respective cultural context. As Edmans and others illustrate, it might not be true today that a businesses’ only “social responsibility” is to generate profits. But shedding economic theory of some ideological heritage could inform our understanding of today’s capital markets and help us view the economy as a dynamic framework reflecting the norms of our society. In such a world, Friedman’s doctrine of “social responsibility”[22] may not be villainized by the media, but could be recognized for its dateless brilliance instead.


[1] Smith, A., & Cannan, E. (2003). The wealth of nations. New York, N.Y: Bantam Classic.

[2] United Nations. (n.d.). The 17 goals | sustainable development. United Nations. Retrieved July 19, 2022, from

[3] Guardian News and Media. (2014, May 9). University economics teaching isn't an education: It's a £9,000 Lobotomy | Aditya Chakrabortty. The Guardian. Retrieved July 19, 2022, from

[4] Crash and learn: Should we change the way we teach economics? Financial Times. (n.d.). Retrieved July 19, 2022, from

[5] BBC. (2017, November 21). The forum, Adam Smith: Father of capitalism. BBC World Service. Retrieved July 11, 2022, from

[6] Smith, A. (2002). Adam Smith: The Theory of Moral Sentiments (Cambridge Texts in the History of Philosophy) (K. Haakonssen, Ed.). Cambridge: Cambridge University Press. doi:10.1017/CBO9780511800153

Evensky, J. (2005). Adam Smith’s “Theory of Moral Sentiments”: On Morals and Why They Matter to a Liberal Society of Free People and Free Markets. The Journal of Economic Perspectives, 19(3), 109–130.

[7] Smith, A. (2002) The Wealth of Nations. Oxford, England: Ltd. [Web.] Retrieved from the Library of Congress,

[8]Historical context for the wealth of nations. Historical Context for the Wealth of Nations | The Core Curriculum. (n.d.). Retrieved July 11, 2022, from

[9] Smith, A., & Cannan, E. (2003). The wealth of nations. New York, N.Y: Bantam Classic.

[10] Historical context for the wealth of nations. Historical Context for the Wealth of Nations | The Core Curriculum. (n.d.). Retrieved July 11, 2022, from

[11] Kahn, R. F. (2011). The making of keynes' general theory. Cambridge University Press.

[12] Keynes, J.M. (1936) The General Theory of Employment, Interest, and Money. John Maynard Keynes.

[13] Hayek, Friedrich A. von (Friedrich August), 1899-1992. (2001). The road to serfdom : the condensed version of The road to serfdom by F.A. Hayek as it appeared in the April 1945 edition of Reader's Digest. London :Institute of Economic Affairs

[14] Friedman, M. (1970, September 13). A Friedman doctrine‐- the social responsibility of business is to increase its profits. The New York Times. Retrieved July 11, 2022, from

[15] The social responsibility of business includes profits. Oxford Law Faculty. (2021, October 29). Retrieved July 11, 2022, from

[16]Edmans, A. (2011). Does the stock market fully value intangibles? employee satisfaction and equity prices. Journal of Financial Economics, 101(3), 621–640.

[17] Edmans, A. (2012). The link between job satisfaction and firm value, with implications for Corporate Social Responsibility. SSRN Electronic Journal.

[18] Edmans, A. (2022). Grow the Pie: How great companies deliver both purpose and profit. Cambridge University Press.

[19] Akerlof, G., Yellen, J., 1986. Efficiency Wage Models of the Labor Market. Cambridge University Press, Cambridge, UK.

[20] Bolton, P., & Kacperczyk, M. (2020). Do investors care about carbon risk?

[21] Gillan, S. L., Koch, A., & Starks, L. T. (2021). Firms and Social Responsibility: A review of ESG and CSR Research in corporate finance. Journal of Corporate Finance, 66, 101889.

[22] Friedman, M. (1970, September 13). A Friedman doctrine‐- the social responsibility of business is to increase its profits. The New York Times. Retrieved July 11, 2022, from

About Julius

Julius is a recent graduate of the University of St Andrews. He finished his joint degree programme with a BSc in Psychology and Economics. During his studies in Scotland, he gained work experience in equity research and investment management — interning in Germany and the UK. Meanwhile, his academic programme allowed him to develop a passion for strategic decision-making and behavioural economics. Since June, Julius is interning with Irithmics. He studies the economic processes governing Irithmics’ business and conducts research on the consequences of dynamic investor norms for index constituents. His work will be published as articles in our newsletter. This fall, Julius is starting a master’s programme at the New York University. There, he plans to specialise in psychological processes mediating economic and social decision-making.

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