How to spend other people’s money. Some tips.

Four ways to spend money

Remember the four ways of spending money? If this sounds like the beginning of a joke by American political satirist P. J. O’Rourke, it is. Except that it’s no joke and O’Rourke is simply echoing the four basic rules set down by Nobel Prize-winning economist Milton Friedman. Rules that we often forget at our peril.

First, I can spend my own money on myself in which case I really take note of how much I spend and what exactly I spend the money on.

Second, I can spend my money on someone else. I could buy you a birthday present in which case I really care how much I spend but what I buy is less important.

Third, I can spend someone else’s money on myself. Here I will splash out on something grand that I really want but I don’t care so much what it costs. After all, it’s not my money.

Last, I can spend other people’s money on other people in which case, if I am honest, I am less concerned what I spend the money on and the amount I spend.

And that is government, said Friedman.

The inescapable lack of incentives by government to spend our money carefully means there will always be waste and there will always be fat. Waste and fat are guaranteed when governments spend our money. The only question is how much waste and how much fat?

Why bureaucracies grow bigger

And to answer that question, another refresher course is useful about why bureaucracies grow bigger. We will defer to Friedman who best explained the law of bureaucracies in his 1991 Wriston Lecture.

Incentives that drive those in the public sector are not too different from the private sector. In both cases, you can always count on people to act in their own self-interest. But the difference between the public sector and the private sector comes down to results.
“Just as the West Germans and the East Germans were not different people, yet the results were vastly different,” Friedman said.

Why? Here’s how Friedman explained it: If I start a business in the private sector with my money, my self-interest not to lose money means that I will want to make sure the business either succeeds or is closed down before I lose too much more money.

If I start that same business in the public sector using public funds, my self-interest means that I won’t want to admit I have failed and happily it’s easier for me to avoid making that admission when I can argue that the enterprise will work if only more money is invested. I can argue the enterprise is failing because it is not large enough and it is not receiving enough money. After all, I have a deep pocket to draw on and self-interest says I will draw on it rather than shut down a failing enterprise.

That is a government bureaucracy, said Friedman. “If a government enterprise is a failure, it is expanded,” said the man described by The Economist as “the most influential economist of the second half of the 20th century — possibly of all of it”.

Sanjeev: This reminds me of Henry Ergas’s quip: “bad apples pick you“.