People spend their own money on themselves carefully, their own money on others economically, other people's money on themselves lavishly, and other people's money on others carelessly.
Milton Friedman set it out in Free to Choose (1980): spending your own money on yourself, you watch both cost and value; your own on someone else, you watch the cost; someone else's on yourself, you watch the value; someone else's on someone else, you watch neither. He used the fourth case to explain why government spending tends to be inefficient.
In practice
- A department's year-end surplus is spent in the final week on equipment nobody asked for, because an unspent budget shrinks next year.
- A traveller on expenses books a hotel she would never choose with her own money.
- Possible explanations
- One explanation is the principal-agent problem: people spending on others' behalf bear neither the full cost nor the full benefit. Another is information, since those who spend other people's money on others know less about what the recipients want.
- In its favour
- Consistent with principal-agent theory and with Liebman and Mahoney's 2017 finding that American federal agencies spend heavily in the last week of the fiscal year, on projects rated lower in quality.
- Against it
- Professional procurement, audit and competition can make spending other people's money careful, and people spending their own money on themselves also waste it. The categories describe incentives rather than outcomes.
- Standing
- Compare the principal-agent problem and Bowen's revenue theory of cost.
- Subject
- Economics & Incentives
- Essay
- The theories behind every argument about money