Over the years, I have been introduced to several two-by-two matrixes that are offered as frameworks for which to consider difficult issues. One of the more useful ones came from the American economist, Milton Friedman who offered a 2 x 2 matrix referred to as the Four Ways to Spend Money. We’re either spending our own money or someone else’s and it’s spent either on something for our own benefit or that of another. The four resulting outcomes are:
- Your money for your benefit.
- Your money used to benefit someone else.
- Someone else’s money for your benefit.
- Someone else’s money to benefit someone else.
We like using our own money for our own benefit. There’s no one that knows us better. We know how hard we’ve worked for the money we’ve earned and saved. We are motivated to be careful with how we spend our precious resources. The connection between caring for resources and the desire to maximize personal benefit couldn’t be closer than in this situation.
An aspect of determining how to allocate our own resources is an assessment of our resources. How secure and sustainable is our income stream? If security of income is suspect, then we’re reluctant to release resources. If we use up our hard-won savings, how long will it take to replenish? If our pile of coins will be hard to rebuild, we’ll work harder to preserve what we have and avoid allocating. In these circumstances, scarcity can be seen as strength. The less we have, the more diligent we are in our decision making. A sole proprietor running their business knows what pennies he has to spend. He knows how hard he worked to pool these pennies. He will work long and hard to make sure that he’s spending them in places that are likely to bring about the best return for his business.
If we’re using our money to benefit someone else, we’re doing something nice for them. This can be a fun allocation of resources. After all, it’s said that it’s better to give than to receive. Giving to others feels good. If we’re using our own money to benefit others, we will be motivated to spend carefully. We want to guard our resources and ensure that however we spend them, we do so judiciously, maximizing what we get in return for them. We’ll try and maximize value as we understand it for the other person while minimizing the spend. Some value may result. The risk in this scenario is that we won’t be able to best predict what our recipient will value. This can even be the case where we have a close relationship to our receiver. We may think we know them, and we may be highly motivated to make them happy. Yes, we may nail it and get the perfect gift. Nonetheless, in most cases we won’t be as good at picking something for someone else as they’ll be able to for themselves. Can a secret Santa ever provide a gift for someone better than the person can provide for themselves? This is more the case the more distant we are from our beneficiary. If we’re seeking to do something for someone we’ve never met, how can we possibly get them exactly what they need? We’re left to making guesses about “practical” or “essential” items that everyone needs. Surely, we can’t go wrong getting a gift card to xyz store, we think. But what if our recipient doesn’t live anywhere near xyz store or doesn’t use the things xyz store sells? We can’t know. We can’t get it right 100% of the time. We can at best get close.
If you’re able to use someone else’s money to buy something for you, this can be fun. However, you’re less likely to make a prudent purchase. If you use Bobby’s money to spend on something for yourself, you’ll happily spend to get a few extra features for yourself. Only the best will do in this circumstance. You’re not looking for sale prices or bargains. Instead, you’re looking for the prestige brand, seeking maximum benefit. What is another word for an inheritance? Windfall. Sometimes we get a win that falls from out of the sky. This is the realm of inheritances. We get resources from someone else which become ours to use for our benefit. Using other’s resources to benefit ourselves doesn’t lead to frugal decisions but to frivolous ones. This is a risk of expense accounts. Politicians show their colors when they max out expense allowances staying at grand hotels eating meals they never would purchase with their own money. This approach leads to more money being spent.
Finally, if you’re spending someone else’s money to purchase something for a third individual, you’re likely to be disinterested in taking the time to purchase wisely. The decision is being made by someone disconnected from both the resource as well as the beneficiary. Since the resource isn’t yours, you’re less concerned about getting bang for your buck. Your separation from the source of giving will lead you to be less diligent in its distribution. You won’t be looking for discounts, sales, or savings.
Maybe you’ll care about making the most of the contribution to someone else. This is the case where you care for the recipient. What if the beneficiary is a stranger? Will you care about allocating the available resource effectively for a stranger? How can you possibly know what’s best for the stranger? It’s safe to offer that others won’t want what you want. How can you know what they want? How can you know what they know? How can you know what they value? It’s tough to be in a position of deciding for someone else.
If you use Bobby’s money to buy something for Susie, you’re using something that’s not yours to buy something you don’t truly care about. Are you likely to make a careful, considered choice? The result of spending someone else’s money on someone else is that the end recipient is likely to be disappointed and extra cost expended. Little value is added here. Yet isn’t this exactly how governments are spending money? Can a bureaucrat sitting thousands of kilometres away from you best allocate resources for which they did nothing to earn? The economist and writer Thomas Sowell observed, “It is hard to imagine a more stupid or more dangerous way of making decisions than by putting those decisions in the hands of people who pay no price for being wrong.” This sounds exactly like how decisions in this quadrant are likely to result. Distributors of government resources care little about where the money came from and where it’s going. Is their compensation connected at all to spending less or delivering more value? Are they in any way accountable for either the resources they’re responsible for managing or the value they’re seeking to deliver? The net result is waste: overspend for little value.
As we noted earlier when discussing how we spend our own money for ourselves, related to resource distribution is the concept of replenishment. If we’re getting funds from somewhere else to distribute and we’re confident there’s both an abundance of funds and regular incoming funds, then we’re happy to spend and spend. Rigorous research and restrained allocation aren’t needed. Our governments view their source of funds as, effectively, limitless. They have untold pockets to pick. They can pursue taxes from people, businesses, property, activities, and more. They even have access to the ultimate option of the printing press. Money isn’t seen as scarce and, inherently, is seen as less valuable to those that see it as not theirs and ever available.
Of the four ways to spend money, spending someone else’s resources for someone else results in the most inefficient allocation. If the most efficient allocation of financial resources is seeking to obtain the highest level of value at the lowest cost, then using someone else’s resources for either another or your own benefit isn’t the best approach. Because, as Milton Friedman offered, “Nobody spends somebody else’s money as carefully as he spends his own.” The best outcomes are reserved for where we’re spending our own money for our own benefit. Here we will seek to maximize the reach of our own resources and will be in the best position to know what it is we’re after. This is the ideal quadrant to seek for as many resource allocation decisions as we can.
A distinction between the four ways to spend money lies in the responsibility involved at each level. Where the resources and beneficiary are connected the responsibility is high. These decision makers have skin in the game. They care about both what’s being spent and what will be gained in return. Where there’s distance between the resources and beneficiary, responsibility is lower. There’s no skin in the game. What’s being spent isn’t theirs, nor are any benefits. The result is a “who cares” attitude on the part of the decision maker. Where there’s no skin in the game, things are like Thomas Sowell described, “It’s hard to imagine a more stupid or dangerous way of making decisions than by putting those decisions in the hands of people who pay no price for being wrong.”
In essence, the four ways to spend money shows differences between the burden/risk shared. How close is the connection between provider of resources, decider of allocation, and beneficiary of allocation? The closer the connection, the greater the argument that “we’re in this together.” The greater the distance between the provider of resources (the risk taker) and the decider, the worse the decision outcome is likely to be and the less likely a claim that “we’re in this together” can be made. As we’ve noted before: Know this NOCLYS. No One Cares Like You Should. Own it. The suggestion is that a driver of decent decisions is responsibility. Those seeking to allocate their own resources for their own benefit are going to take responsibility for the decision and these types of decisions will lead to better quality outcomes.
