Chapter 19: Lack of public goods (1.4)

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1 Chapter 19: Lack of public goods (1.4) (About 4 pages.) Key concepts: Private and public goods classic division of goods in economics Free rider problem Provision of public goods Lack of public goods Using the concepts of rivalry and excludability, and providing examples, distinguish between public goods (non-rivalrous and non-excludable) and private goods (rivalrous and excludable) Explain with reference to the free rider problem, how the existence of public goods indicates market failure Discuss the implications of the direct provision of public goods by government Private and public goods classic division of goods in economics Well, it s getting late and I dearly want to head back home for steak, beer, TV news and lots of questions from the Very Small Australian Female I am married to. I could walk but hey, this is Jakarta, so I ll put on my manta ray cowboy boot and call my driver. Here s where the concept of public goods comes in: I will be using the public roads to drive home on guided by streetlights and road signs galore. I will studiously avoid any and all contact with the corrupt Indonesian police. The underlined examples above are goods which would all be under-provided or not provided at all by a competitive market. 1 Imagine if, in driving home, I had to stop and pay a fee for road use (which is actually becoming increasingly common) and then had to put a few coins into coin-operated street-lights and coin-operated road-signs along the way. (I was about to say something about having to pay the police on the way but of course that is exactly what one does here in Indonesia.)The common denominator here is that the thought of paying for one s actual unit use of the goods outlined here borders on the preposterous not to mention impossible. Roads, street-lights, road signs, police service and public broadcasting are all examples of public goods; they are publicly available (as opposed to pay per usage ). Be careful in your use of this term! It is one of many unfortunate examples of how economists have corrupted the common use of a word and created a very definite subject-specific term. When economists use the term public goods they are referring to 1 Once again, note that economists use the term goods as an umbrella; it covers tangible goods such as guns and butter but also services such as health care and banking. Public and merit goods are, in fact, often services.

2 something quite specific; a good which by its very nature is impossible to charge for on a user-pays basis. A most treasured example of public goods are ideas pasteurising milk for example, using coal/gas/uranium as a source of energy, and all forms of advances in farming technology noting, of course, that the development of the horse- or oxen-drawn plough didn t run into the highly debated current practice of patenting genetically modified organisms. The two main traits pre-requisites, actually of a public good are non-excludability and non-rivalry. Figure 19.1 classic economic division of goods Division of goods Competition in consumption (there is rivalry or diminishability in consumption) does my use diminish others use? Exclusion of non-payers (excludability) is it possible to charge users separately and based on the quantity consumed? YES YES Private goods: food, cars, houses, clothing NO Club goods : clubs, private schools, public parks, TV broadcasts NO Common access resources: natural environment, open range grazing land, fish stocks in international waters Public good: police force, lighthouses, air traffic control, street lights, fireworks displays, military defence, earthquake or tornado warning systems, flood banks (Type 4 Smaller heading) Non-rivalry By putting on my manta ray boots to go up to Toni s, I hindered others from consumption of the good, which is an example of rivalry my use of my boots bars others from use. My boots, car and MP3 player are examples of rivalry in consumption, since my use decreases the availability of the good for others. A public good, by contrast, does not have this element since the good can be used simultaneously by other people. My use of the road, road signs, police force, and streetlights does not reduce available consumption to others. Thus public goods are subject to (varying degrees of) non-rivalry, meaning that one person s use does not diminish the availability of the good for others. Get off of my cloud by the Rolling Stones is actually far more meaningful than Get out from under my streetlight! 2 (Type 4 Smaller heading) Non-excludability What about hindering someone from using the good in the first place? Yes, this is actually the definition of private goods; once the good has been provided, the provider must be able to exclude you from use in order to be able to charge you. Thus the provider can exclude non-payers from use, just like the boots, car and MP3 player. This highlights precisely the problem with goods such as roads, road signs, and street lights; once they have been provided they can be used by anyone payers and non-payers alike! This means that there is an element of non-excludability built into some goods, and this is the second prerequisite of a pure public good; once provided, one cannot exclude anyone from using it. 2 But there s no way I m not going to tell the following little story! My friend Toni lives in a gated community e.g. an area behind gates where you have to show ID to get in. After some heated discussion in the community about who was paying for the streetlights or not, the community leaders assigned streetlights! Anyone who didn t pay their bill found themselves on a very dark street. Another favourite example in economics bites the dust

3 Is it non-rivalrous even in daylight? Free rider problem This is also known as the free rider problem and should be well-known amongst students who have ever done a group paper where three students did all the work and the fourth was a useless slacker. The term free rider is actually taken from public transport, where the provision of a bus service would be free for those who didn t pay the fare yet provided for by those who did. Hence free rider. Definition: Public goods A public good is distinguished by high positive externalities but also non-rivalry (my use does not diminish your use) and non-excludability (non-payers cannot be excluded once provided) in provision. It is very difficult to charge individual users and is thus often provided by public monies. Provision of public goods There is a very noticeable common denominator amongst the examples of public goods above, namely that they are in fact considered of such importance that they are supplied! There are in other words goods which cannot really be charged for much less limited to users only yet are provided for in virtually every modern society. Why? How? The answer to the first question is by now self-evident; any good which is considered to be of such obvious gain to society roads, lighthouses, drainage systems, water filtration, electricity grids, military and civil defence, air traffic control, police force, judiciary system, etc will ultimately be both desired and supplied somehow. The remaining question, How? must enable potential suppliers to be able to provide the good economically in spite of not being able to charge for its use. This would exclude the private (free market) sector immediately. The answer is taxation and public sector provision of the good. Everybody pays since everybody benefits. End of story. As everyone is reaping the benefits of consumption it is only fair that everyone pull a straw from the stack and help pay for it.

4 Free rider? On a rhetorical note, one must include a few weighty objections to the concept of a pure public good. Anyone who s been stuck in gridlock in the outer city access roads is well aware that your use does, in fact, diminish my use something that any number of drivers in Athens will gladly attest to! The same goes for getting hold of a police officer to investigate a break-in to one s garage at the same time the community is swamped by either football hooligans, a rock festival or anti-globalisation demonstrators. It is also evident that increasingly sophisticated pay-per-use systems allow communities to charge for the use of inner-city roads and access routes. In truth, there are very few examples of goods which would fulfil the criterion of non-rivalry and non-excludability to 100%. Public goods also come with large positive externalities, yet with the troublesome attachment of being very difficult to charge users for. As outlined earlier, few goods could be considered to be pure public goods. Roads can be toll-roads (= pay per use ) and police services can be unavailable at peak times which means that the non-rivalry and non-excludability criteria are not met. Examples of pure public goods would perhaps be defence, air traffic control and lighthouses. Since the private benefits would be very small (or non-existent) compared to the public benefits, competitive markets would fail quite massively here. The good would simply not be provided in many cases and the social welfare losses would be very large. This is probably why the debate on whether public goods should be supplied by public monies is much more subdued. In fact, virtually all countries have a degree of government supply of public goods. It seems that there is broad agreement that lighthouses come with sizable social benefits such as not having an oil tanker grounded on a holiday beach or the nesting ground of a seal population. And seriously, can you see air traffic control demanding that an of-course airplane outside of Washington pay a fee in order to be brought in safely? What is potentially contentious is the quantity to provide since there is no market mechanism to gauge demand. The market fails to achieve optimal resource allocation and so society must make up for it. This is another example of how the planning element cannot ever be completely discarded all economies must have a mixture of private and public it seems. Yet, once again, it is quite common for public goods to be supplied (as in produced) by private firms which have been contracted by government. Municipal government pays private mountaineers to dynamite overhanging snow-shelves in the Vorarlberg alps in Austria to avoid avalanches while on the other side of the earth the central government in Laos one of the world s last centrally planned communist states pays a private Swedish company to build 600 km of road, Highway Apparently Japanese firms have been contracted to build the bridges across some 15 rivers. Unfortunately, while many stretches of road have been completed, none of the bridges have been built! This might be a good example of when central planning/provision might be superior to private.

5 Summary and revision 1. Public goods have two basic characteristics other than high positive externalities: a. Non-excludability once the good has been provided it is impossible to prevent non-payers from consuming the good b. Non-rivalry on person s consumption does not diminish (or rival) another person s consumption 2. Free rider problem means that it is possible to consume a good or resource without paying for it. This is a problem common to public goods and thus precludes provision by a free market. 3. Examples of public goods are police force, lighthouses, air traffic control, street lights, fireworks displays, military defence, earthquake or tornado warning systems and flood banks 4. The solution to market failure in the case of public goods is to provide the goods via taxpayers money.