Swiss Mises Institute

Sonntag, 03. Juli 2011 von Dmytro S. Kharkov zu Politik

Milton Friedman’s 4 ways to spend money

The ideas of Milton Friedman are always analyzed by Austrian School economists and libertarians.i And it is very important in two aspects.
  1. From a scientific point of view it helps us to clarify this or that problem and to show that only Austrian approach is correct with its dealing with real life and action of individuals, and consequently only on this basis can be built right solutions.
  2. From a political point of view it can convert public to free markets and libertarian principles of peaceful cooperation.

This article focuses on Friedman’s classification of spending money. So according to Milton Friedman there are 4 ways to spend money.ii

Whose Money On Whom Spent
You Someone else
Yours I II
Someone else’s III IV
Table 1 - Ways to spend money (according to Milton Friedman)


In Friedman’s words:iii

Category I in the table refers to your spending your own money on yourself. You shop in a supermarket, for example. You clearly have a strong incentive both to economize and to get as much value as you can for each dollar you do spend.

Category II refers to your spending your own money on someone else. You shop for Christmas or birthday presents. You have the same incentive to economize as in Category I but not the same incentive to get full value for your money, at least as judged by the tastes of the recipient. You will, of course, want to get something the recipient will like – provided that it also makes the right impression and does not take too much time and effort. (If, indeed, your main objective were to enable the recipient to get as much value as possible per dollar, you would give him cash, converting your Category II spending to Category I spending by him.)

Category III refers to your spending someone else’s money on yourself – lunching on an expense account, for instance. You have no strong incentive to keep down the cost of the lunch, but you do have a strong incentive to get your money’s worth.

Category IV refers to your spending someone else’s money on still another person. You are paying for someone else’s lunch out of an expense account. You have little incentive either to economize or to try to get your guest the lunch that he will value most highly. However, if you are having lunch with him, so that the lunch is a mixture of Category III and Category IV, you do have a strong incentive to satisfy your own tastes at the sacrifice of his, if necessary.

First of all it should be stressed that this classification is rather psychological than praxeological. If for example we have a very moral bureaucrat who is willing to economize our money and to maximize our satisfaction than according to Friedman we have no reason to be opposed against government intervention and the only thing we need is to find such moral people to be our officials. The main problem is impossibility of economic calculation under socialism and the more government regulation we have the more distortive economy becomes. Even if Mises and Rothbard were our planners it would still be impossible to establish something more efficient than a free market economy. Price mechanism cannot be replaced by any other alternative.

Milton Friedman is also not right when discussing his Category II. His argumentation about inefficiency of spending your own money on someone else is entirely wrong. The fallacy is that Friedman looks at giving presents from physical or technological point of view. Of course from this perspective it seems that only a man himself can choose and buy the most useful thing for him. But people don’t act like this. The same thing that you can buy in supermarket or receive as a present from a dear person are two different goods. The bunch of roses and the bunch of roses from her boyfriend are two different goods for a girl; the simple picture and the simple picture drawn by her little kid are two different goods for a mother, etc.

As for Categories III and IV people can be very motivated to spend someone else’s money as much efficient as possible, and even far more effective than owners of money themselves (for instance, managers in a joint-stock companies).

In general Friedman’s analysis is a bit utilitarian. There is no a single word about legitimacy of different kinds of spending. The problem with government spending is not only its inefficiency, but also illegitimacy of using force and expropriation of property of individuals and groups of individuals.

Let’s try to finish Friedman attempt of constructing the classification of spending. We need such parties as: You, Bob (Your friend), Private company, and Government. So we have the following table (when You are the spender): in the brackets E means efficient spending, I – inefficient, J – justifiable, U – unjustifiable.

Whose Money On Whom Spent
You Bob Private company Government
Yours I (E, J) II (E, J) III (E, J) IV (I, U)
Bob’s V (E, J) VI (E, J) VII (E, J) VIII (I, U)
Private company’s IX (E, J) X (E, J) XI (E, J) XII (I, U)
Government’s XIII (I, U) XIV (I, U) XV (I, U) XVI (I, U)
Table 2 - Ways to spend money (according to Dmytro S. Kharkov). Part 1


It’s absolutely crystal clear that all voluntary transactions between individuals (for instance, between You and Bob), as well as between individuals and private organizations (You – Private company, Bob – Private company) are both efficient and justifiable (certainly, transactions between different private organizations are also efficient and justifiable; for the sake of simplicity we have only one Private company in our table). It should be noted that it doesn’t mean that any transaction between individuals or between private companies is profitable; entrepreneurs can bear losses as well, but there is always a tendency in a free market economy towards the most efficient structure of production.

It’s obviously that when you spend government’s money it is both inefficient (you acquired this money not from satisfying the consumers or as a voluntary gift, but from apparatus of coercion and compulsion; so if it was no intervention, other more productive people would have it at their disposal) and unjustifiable (government has not its money as such, all its money are withdrawn from people by taxation or by other means). The only difficult question that may rise is this: “Why the spending of your own money on government is unjustifiable? It’s understandable that it will be inefficient as the state lacks such a profit and loss mechanism as market system has, but it’s after all your own money and you can do with it whatever you want, everyone has absolute property rights.” The answer should be as follows. Of course, it’s true that everyone has absolute property rights; however spending your money on government is still unjustifiable. Why and how can it be? Let us consider an example. For instance, Bob gave n ounces of gold to Jack as a gift. Then Jack bought a gun and killed Jimmy. Is Bob responsible for this crime? Certainly not. He disposed his property, and all the blame is on Jack because he violated the property rights of other people (life is the most precious property right). Bob couldn’t know what Jack would do with this money. But when someone spends his money on government we a priori know the consequences. The methods can be different but the result is always the same: inefficient spending and what is more important use of force, violence and coercion against people. That’s why the spending of your own money on government is unjustifiable.

The situation when government is the spender is depicted in the following table.

Whose Money On Whom Spent
You Bob Private company Government
Yours I (I, U) II (I, U) III (I, U) IV (I, U)
Bob’s V (I, U) VI (I, U) VII (I, U) VIII (I, U)
Private company’s IX (I, U) X (I, U) XI (I, U) XII (I, U)
Table 3 - Ways to spend money (according to Dmytro S. Kharkov). Part 2


There is no and can not be any either efficient or justifiable spending when government is the spender.


The only important issue about spending is whether there is or there isn’t government intervention in this sphere. In the latter case we have both efficient and justifiable spending, in the former – both inefficient and unjustifiable one.

And one more thing: don’t be afraid to give presents to Your relatives and friends and be happy!


i See for example, Murray N. Rothbard, Economic controversies (Mises Institute, 2011), pp. 895-912

ii Milton Friedman and Rose D. Friedman, Free to Choose: A Personal Statement (Harcourt Brace Jovanovich, 1990), p. 116.

iii Ibid., pp. 116-17.