Giving Away Money Costs More Than You Think

Release Date
February 4, 2013

Topic

Gov't Debt & Spending
Description

People and organizations incur costs when they compete for money that is “given” away. For example, if a college offers a scholarship to the student who writes the best essay on a particular subject, students competing for the scholarship will spend time and resources to create their essays and submit their applications. Although the chosen winner will likely benefit from the prize, the other students who competed for the scholarship and lost also lose the time and money they invested in getting the award. The cumulative sum of the time and effort of all the students together may in fact exceed the monetary value of the award.
Economists call these prizes rents, and the effort expended to get such a prize is called rent seeking. Rent seeking happens when money is awarded based on the result of competition. Professor Michael Munger shows how people will spend time, money, and other resources lobbying for such awards. While people may speak of the government as giving money away, they often fail to recognize the associated costs. One major cost may be that the government gives money to organizations with the best lobbyists, not necessarily those that provide the best services.

Three Ways Big Oil Spends Its Profits to Defend Oil Companies and Defeat Clean Energy [article]: Progressive exposure of how oil companies spent money on lobbying to obtain subsidies
Dollars for Sale! [comic strip]: Dinosaur Comics explains rent seeking
Rent-Seeking: A Primer [article]: A primer on rent seeking from the Foundation for Economic Education
30 Major U.S. Companies Spent More on Lobbying than Taxes [article]: An article addressing the fact that major companies spend more on lobbying than they pay in taxes

Giving Away Money Costs More Than You Think
You can’t give money away. Now that sounds crazy, but it’s true. This is even more true for government programs that try to give away money through grants, subsidies, and other handouts. Do you want to know why? To explain I’ll need to tell you about something called rent seeking.
Now if you try to give away money, unless you’re giving it to one person or group in particular without opening it up to any competition, people or firms will expend resources in order to get the money you’re giving away. In effect, they’re paying for the opportunity to get the money.
Here’s an example you’ll all recognize. Suppose a college gives a scholarship for the best 20-page essay. The scholarship is $10,000. In this case, you have to write about “what kind of flower would you like to be?” The money the college is trying to give away is what economists call a rent.
A rent is a prize, something more than you could normally get and more than you could get from any other activity. Now the rent is not the problem, or it wouldn’t be if the school just gave it away in a lottery. The problem comes when we ask people to compete for the money. That competition is called rent seeking.
All the applicants will expend a lot of time and effort trying to make their essay the best. So suppose 100 students apply for the $10,000 scholarship, and on average they spend 15 hours working on the 20-page paper. And suppose their time reading, doing chores, or working in a job is worth about $8 an hour. Let’s add the cost of this competition up.
The school tried to give away $10,000, but the students spent over $12,000 of effort without really edifying themselves in the process. The scholarship was a net loss overall. Sure the winner’s better off, but even her net benefit is slightly less than $10,000. Then she had to work so many hours to win it. In other words you can’t give away money—at least not without incurring a lot of cost in the process.
This is an extremely important lesion to remember when we talk about the government giving money away. When the government has money to give away, people or firms will spend time and resources competing for that rent through applications, proposals, lobbying, and other means.
This rent seeking wastes resources, and it leads to contracts being awarded to the companies that are the best at lobbying for the rent, not the companies that are best at producing the service we want to contract for. Worse, much or even most of the money being given away is wasted, dissipated in the competition to win the rent in the first place.
And yet so much of our political discourse focuses on how much money should be given away and to whom, without acknowledging the problem of rent seeking. It’s time for voters and politicians alike to learn that you can’t just give money away.