Wednesday, 24 March 2010

How to spend money

For the sake of argument, let us accept what most people in the UK believe: that the government is morally justified in confiscating a portion of our wealth to spend on a range of 'public goods'.

Two problems remain:
  1. How to choose the 'public goods', and prioritise between them
  2. How to ensure that the money allocated to each 'public good' is spent efficiently
The first of these is an impossible task. As Jamie Whyte has explained, nobody knows the value of everything.

Our political leaders decide how 42 per cent of our money should be spent, dividing it between battleships, schools, roads. But they cannot explain how they know which deserves more and which less.

Politicians don't spend our money wrongly because they fail to identify the correct “importance ranking”. There is no such thing, only how important things are to individuals. Any centralised spending plan is sure to be wrong for everyone on the receiving end.

Whatever your political affiliation, it is difficult to argue with this analysis. The only solution is to let people to spend their own money according to their own priorities.

But ours is a suboptimal world, and you can't always get what you want. Having accepted the principle that the government should take our money to spend on 'public goods', most people ultimately accept, with varying grudgingness, the government's prioritisation. Their allocation might not be perfect, but it's not wrong enough to trigger a revolution. Content that something is being done about the important issues, we proceed with clear consciences to spend our time and remaining money on the little things that make life worthwhile.

Unfortunately, our peace of mind is short-lived. Too frequently, we receive news of government waste. We find that the cost for the London Olympics has trebled, from £2.375 billion to £9.325 billion, and hear suggestions that it might reach £20 billion. Even before the bank bailouts, we saw a trillion pounds of additional spending under New Labour, with little to show for it in education, healthcare, and law enforcement. But although they have pushed profligacy to new heights, this tendency is not unique to Labour. Governments throughout history, and the world over, are notoriously improvident. This is the second challenge: having chosen its projects, why is the government so bad at getting value for money?

There are many answers, but I think Milton Friedman explains it best with his four ways to spend money:

1. Spending your own money on yourself

2. Spending your own money on someone else

3. Spending someone else's money on yourself

4. Spending someone else's money on still another

Government spending is in this last category. Even with the best intentions, it will never be efficient, and whereas inefficiency can be fatal for corporations, governments can simply confiscate more wealth, honestly through taxes, or stealthily through inflation.

The solution is to reduce the domain of government to the absolute minimum, leaving people free to spend their money prudently on the things that they consider important.

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