Milton Friedman - 4 Ways Money Is Spent

Campaign For Liberty has a great post about why government is so bad at spending money. It makes a lot of sense.

Milton Friedman brilliantly described the four ways that money is spent.

The first and most common way in the private sector is people spending their own money on themselves. In this case, the buyer is interested in both quality (the best product or service that he can afford) and value (getting it at the best price) because he is both the producer of the wealth being spent and the consumer of the good or service being procured.

The second way is when people spend their own money on others (such as gifts). Here they are still concerned about value (it's their money), but less concerned about service quality as they are not the consumer.

The third way is spending other people's money on yourself. Think of the rich man's girlfriend who buys herself the nicest dresses in the store on his credit card without even looking at the tag. She wants quality, but value is irrelevant since she sacrifices nothing.

The fourth way is when people spend other people's money on other people. In this case, the buyer has no rational interest in either value or quality. Government always and necessarily spends money in this fourth way. This guarantees inefficient public spending because the spenders have no vested interest in efficiently allocating those funds.

I have seen this firsthand working in government myself the past few months. The way people talk about spending huge sums of taxpayer dollars on a whim was shocking to me at first. The shock is wearing off a bit by now. One must become desensitized after awhile. Good thing I'm only going to be here a couple more months. People in government will argue that they have the "public good" in mind when spending this money, and that itself will be enough of an incentive to spend it just as wisely as they would for themselves. I don't believe this for a minute. One thing is the desensitazing issue I just talked about. I just can't be convinced that year after year, decision after decision, someone is going to hold themselves to a standard of spending large sums of money for both value and quality when the only thing to guide them is the "public good".

Misunderstanding the Free Market

I have heard a number of people claiming that the recent financial collapse shows that "capitalism doesn't work" and that it "proves we need more regulation". I couldn't disagree more. There was already loads of regulation in place. Economist Walter Williams on the subject (Hat tip to Carpe Diem):

The financial collapse of Fannie Mae and Freddie Mac is not a failure of the free market because lending institutions in a free market would not have taken on the high-risk loans. They were forced to by the heavy hand of government. The solution is not a taxpayer-financed bailout. The solution is to let them fail and allow the people who invested in them, as well as the people who purchased homes they couldn't afford, suffer the losses. Of course that takes a level of political courage that is in short supply.

Edit:
Here's more great stuff from Coyote Blog.

The George Bush of 2000

I recently read Ron Paul's book The Revolution: A Manifesto. It's a great book that I think everyone should read. The second chapter focuses on foreign policy. One page that stood out for me contains a couple of quotes from George W. Bush from a debate with Al Gore in the year 2000. Paul quotes Bush on foreign policy:

"I'm not so sure the role of the United States is to go around the world and say, 'This is the way it's got to be.' ...I think one way for us to end up being viewed as 'the ugly American' is for us to go around the world saying, 'We do it this way; so should you.'"

...

"Somalia started off as a humanitarian mission and changed into a nation-building mission... And that's where the mission went wrong. The mission was changed. And as a result, our nation paid a price. And so I don't think our troops ought to be used for what's called 'nation building.' ... I think what we need to do is to convince the people who live in the lands [themselves] to build the nations. Maybe I'm missing something here-we're going to have kind of a 'nation-building corps' from America?"

...

"If we're an arrogant nation, they'll resent us. If we're a humble nation, but strong, they'll welcome us. Our nation stands alone right now in the world in terms of power, and that's why we've got to be humble."

I didn't pay attention to the Presidential race back then so I don't remember what type of platform Bush ran on. Although I do like what he said above, I was shocked to read it. How different is that than the actions taken over the past 8 years? Of course, you can argue that "9/11 changed everything", and I can definately understand the concern after what happened in that tragic event. But didn't our nation go way beyond what was justifyable in its response? Under Bush, we became all the things that he said in 2000 that we should not become.

Paul goes into much greater detail about his reasons for a non-interventionalist foreign policy. It is a policy that was once advocated by traditional conservatives. Now, however, Republicans have become "The War Party". If the party could return to its roots, I might be able to refer to myself proudly as a Republican. At this point, however, third-party candidates seem to be the most attractive option.

Peace Corps Invitation Accepted!

I apologize for the lack of entries. I've been busy dealing with Peace Corps related stuff, as well as watching DVD's of HBO's Entourage series and some playoff baseball. The financial crisis has continued to dominate the news, and unfortunately the bailout has passed. I don't have much more to say about that at this point, check out the blogs I have listed in the left hand column for detailed explanations and reactions.

I mentioned that I was dealing with Peace Corps items lately. A week ago I received my invitation packet in the mail, and after some serious contemplation about whether I really wanted to spend 27 months of my life in a developing country, I officially accepted on Friday. I will be leaving February 24, 2009 to do Business Advising in Honduras. I am very excited as I know it will be a challenging and rewarding experience.

I have found that many people are not very familiar with what the Peace Corps actually does. When I mention that I am going to be serving, they often mention that they know someone who did it at one time or another, but that is often as far as their knowledge of the organization goes. I think it is important to distinguish that the PC involves more than just building houses or other types of physical labor. While these things are helpful in the own right, one goal of the PC is to leave people in the host country with skills and resources that they will (hopefully) retain long after the the volunteer has left. I think this will be important for me to keep in mind. While foreign aid in the form of money sent to developing countries may or may not be well-intentioned, there are a number of issues which show that it is not nearly as helpful as one would hope, and in fact may even be harmful in some cases. This is because countries may become reliant on money being supplied to them, and a dependence on these cash gifts can become a hindrance to further development. Also, foreign aid is put into the hands of that country's government officials, who can often be corrupt and find ways to keep the money/use it in a way that was not intended. Finally, foreign aid often comes with the stipulation that the receiving country use it to buy goods from the country that provided it. So, many industries in the recipient country lose out on this possible revenue. I still have a lot to learn about the subjects. But the bottom line is that aid to developing countries in any form is a tough issue. I think that, while the Peace Corps is certainly not perfect, it is a better vehicle for development than sending over a lump sum of cash.

I am planning to keep a blog while I am in Honduras to keep friends and family informed of what I am doing while I'm away. I am not yet sure if I will be able to use this one for that purpose or if I will have to start another one, but I will let you know.

Econ in One Lesson, Good and Bad Economists

A few posts ago I mentioned that I would post more from Henry Hazlitt's Economics In One Lesson. Well that is what I am doing now. These quotes come from the first chapter, which is called The Lesson. And here is that lesson:

The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.

Very concise and an idea that would seem simple, and yet so often it is overlooked or forgotten. A page earlier is another great paragraph, in which Hazlitt describes good and bad economists:

The bad economist sees only what immediately strikes the eye; the good economist also looks beyond. The bad economist sees only the direct consequences of a proposed course; the good economist looks also at the longer and indirect consequences. The bad economist sees only what the effect of a given policy has been or will be on one particular group; the good economist inquires also what the effect of the policy will be on all groups.

In Today's News

Mrs. Pelosi continues to build her rep as a great speaker of the house. The article begins:

House Speaker Nancy Pelosi has directed nearly $100,000 from her political action committee to her husband's real estate and investment firm over the past decade, a practice of paying a spouse with political donations that she supported banning last year.

Many comments below that article saying she should step down, I tend to agree. And while this further solidifies my already present disdain for Pelosi, this issue is just one of many we have become accustomed to hearing about our politicians. Current administration on both sides is making it a better time than ever to be an independent. The term "Republicrats" is becoming more and more applicable. What are the current approval ratings? Something like 30% for Bush and 10% for Congress? How do we keep getting duped into electing people we don't like? Could it be that we are so trained into thinking that there are always really only going to be two options, and that any other vote will not matter? That mentality needs to stop. Fortunately I think there are many people who feel the same way, and the independent movement is growing. I for one don't think either Obama or McCain are going to bring about real "change" in Washington, unless bailouts of Wall Street with taxpayers' money, an unnecessary presence in countries all over the world, huge amounts of government spending, and an unsustainable budget deficit are "change". I previously was trying to decide between not voting, or figuring out which of the two major candidates is the "worst of two evils". I have since changed my thinking. I have heard about so many people who do not actually like either candidate in this race and yet will end up "settling". But it is because of a mentality like prevents independent candidates from becoming a viable possibility. Perhaps it is not the people who are "wasting their vote" on an independent candidate that we need to be angry about, but those who are allowing a system of two bad choices to continue by supporting one of them.

My friend David Carlson has more on this subject. An excerpt:

It is important to note that our political system will not change if people who are not happy with a candidate and STILL chooses to vote for them. The precedent they are setting is one of indifference to those individuals opinions, as politicians and parties will figure they have your vote no matter what because the only other alternative is a more conservative/liberal candidate.

Matt Is All Over the Place

That's from www.wherethehellismatt.com, hope you enjoyed it if you haven't seen it already. I always get a good feeling watching that video (as well as little jealous he gets to travel to all those places). Another cool thing to check out are the comments by people who have danced with him.

The Times They Are a-Changin'

Wow, I just found a link to this article at the top of the Drudge Report. I only skimmed it but from what I can tell he's got some good stuff to say. I'm just a bit shocked to see an article at the top of one of the most popular news sites that agrees with so much of what I've been reading in my little known economics blogs (opposition to the bailout and the views of Austrian Economics in particular). Let the exposure begin.

The Housing Bubble in One Lesson

Yesterday I was at Borders and I picked up the book Economics in One Lesson. It's by Henry Hazlitt and the basic idea of the book is that there are a number of fallacies which have plagued much of economic thinking throughout the years. These in turn leads to misguided and harmful governmental policies. I should say that the book was written in 1946, and fortunately I believe some of the fallacies discussed have been accounted for in more modern Economics texts. However, the book is in no way irrelevant. I think many of the fallacies still are believed today by much of the general public. These fallacies are sold as truths everyday by politicians. Later I would like to post Hazlitt's lesson as well as what he says makes a good economist and a bad economist. But right now I want to quote some passages from chapter six, Credit Diverts Production. Here he explains how the government makes bad loans (a contributing factor to our current financial mess). He also goes on to point out the often overlooked fact that the money used for these bad loans could have been used somewhere else:

There is a decisive difference between the loans supplied by private lenders and the loans supplied by a government agency. Each private lender risks his own funds. (A banker, it is true, risks the funds of others that have been entrusted to him; but if money is lost he must either make good out of his own funds or be forced out of business.) When people risk their own funds they are usually careful in their investigations to determine the adequacy of the assets pledged and the business acumen and honesty of the borrower.

If the government operated by the same strict standards, there would be no good argument for its entering the field at all. Why do precisely what private agencies already do? But the government almost invariably operates by different standards. The whole argument for its entering the lending business, in fact, is that it will make loans to people who could not get them from private lenders. This is only another way of saying that the government lenders will take risks with other people's money (the taxpayers') that private lenders will not take with their own money. Sometimes, in fact, apologists will freely acknowledge that the percentage of losses will be higher on these government loans than on private loans.

And now my favorite part. Later in the chapter Hazlitt explains (in a simplified manner) our housing bubble 60 years before it happens. If you are familiar with Fannie Mae and Freddie Mac the accuracy will be chilling:

The case against government-guaranteed loans and mortgages to private businesses and persons is almost as strong as, though less obvious than, the case against direct government loans and mortgages. The advocates of government-guaranteed mortgages also forget that what is being lent is ultimately real capital, which is limited in supply, and that they are helping identified [recipient] B at the expense of some unidentified [recipient] A. Government-guaranteed home mortgages, especially when a negligible down payment or no down payment whatever is required, inevitably mean more bad loans than otherwise. They force the general taxpayer to subsidize the bad risks and to defray the losses. They encourage people to "buy" houses that they cannot really afford. They tend to eventually bring about an oversupply of houses as compared with other things. They temporarily overstimulate building, raise the cost of building for everybody (including the buyers of the homes with guaranteed mortgages), and may mislead the building industry into an eventually costly overexpansion. In brief, in the long run they do not increase overall national production but encourage malinvestment.

More on all this later. But in the interest of keeping posts at a somewhat readable length, that's it for now.

First Post

Hey everyone, first blog post here. I am planning to post on a variety of topics, from updates on my personal life to economic/political issues to music and what not. Over the last half year or so I have become an avid blog surfer and have found a few that I like to read just about every day. This blog will serve as a way for me to link to those posts which I find the most though-provoking. Believe me, the blogs to which I provide links will be able to argue about things in the economic/political realm much more eloquently than I ever could. I hope you find some of the ideas as interesting and eye-opening as I do.

Today has been quite a day. I received an invitation packet in the mail today from the Peace Corps! I have been invited to serve in Honduras starting in February, in a Business Advising program. This is something I have wanted to do for over a year and it's a bit surreal now that it is all coming to fruition. I have 10 days to accept or decline the invitation. I'll probably post more on this later.

In other big news today, the House of Representatives voted against a $700 billion dollar bailout of the financial industry. This has been all over the news so I won't get into details, but I am pleased with the decision to reject the bailout. The financial industry was not exactly my specialty when studying economics in college, so as usual I turned to the blogs of economics professors to get a better understanding of the situation. I found plenty of reasons to oppose the bailout, and I've read a plethora of articles stating those reasons. Perhaps I will link to some of my favorites in another post. Anyhow, what sticks out to me about our current situation is that the opposition seems to be coming from everywhere: The average citizen who does not want their tax dollars to be used to clean up for the mistakes of people on Wall Street (a good way to summarize what we would be doing is "privatizing profits while socializing costs"). There are also many economists who oppose the bailout because it will create "moral hazard", a situation where firms realize that if the government is likely to bail them out in the future, they are able to take risks they would not under normal market conditions, knowing they have a safety net if they end up failing. Finally I have seen some convincing arguments from congressman Ron Paul and Austrian Economics, the economic school of thought with which he identifies. While I was hesitant to embrace the ideas of Austrian Economics at first (it goes against a lot of what I just spent 4 years learning in college, can you blame me?), after recent events it has become quite convincing to me. The argument of economists from this school of thought is that because the Federal Reserve has been printing money and artificially lowering interest rates, they have created a "false prosperity" for our nation. The false prosperity can only last so long, however, as has become much more obvious in recent weeks. (The abuse of the mortgage market through "government sponsored entities" is also part of the story of how we got to be in this situation, but that is for another time). A bailout would only prolong the correction that needs to take place to restore the market to more normal conditions. While there will be some painful shocks to our economy if the bailout does not pass, the argument is that the recession/depression will be longer and worse if the bailout does past. Based on the fact that Austrian Economists have tended to be much more accurate at predicting economic trends in the past, I am going to take their word for it on this one at this point.

I'll leave you with a link to commentary by Ron Paul on CNN.com (it's about time he got some media coverage, unfortunately it has taken a financial crisis to spark it). He gives a good summary of the current situation, how we got here, and why there should not be a bailout, from the Austrian point of view.