Wednesday, November 30, 2005

Public Goods

Yesterday's blog entry may have left the impression that I am a free-market purist (somebody who believes that Adam Smith's 'invisible hand' can do no wrong). Anybody who puts me in that particular pigeon hole will not be able to understand much that I write.

I believe that one should use the best tool for the job. In some instances, free-market institutions are the best tool. Compared to political processes, they convey information and provide incentives for a shift in policy based on that information far more rapidly and accurately than political institutions. Furthermore, they are far less corruptible, since it inherently rewards those who do the best job selecting the best policy.

On the basis of these principles, I fear that Democrats who are pursuing a policy of keeping the price of oil artificially low, I fear their effect will be to set future generations up for a massive economic calamity. (See the blog entry, “Energy Prices and the folly of Price controls”). The power of a free market also suggests that emissions trading would be the best tool for limiting CO2 and other greenhouse gases.

However, there are areas where the free-market tool does not work very well. One family of issues where this is a problem is in the realm of public goods.

A public good is a good that is freely available. If it is made available to one person, everybody else (or a large group of others) can obtain the same benefit without paying for it. Because people can obtain the benefit without paying, people tend not to pay, and an important good gets under funded in the free market.

National defense is a paradigm example of a public good. A private military company cannot go through a city and say, "Well, this guy is paid up, so we'll defend his condo, but we won't protect the condo next door because they are behind on their military protection dues. Meanwhile, the people on the fifth floor are buying their military protection from our competitor so let the competitor protect that floor."

Because national defense benefits are a “public good”, if we were to depend on voluntary benefits, we would have little national defense. There would be too many people who will seek to harvest the benefits without covering the cost. In fact, those who do not pay will ultimately be better off than those who do. Corporations who do not contribute to the national defense will have a better bottom line, and individuals who do not pay will enjoy a higher standard of living. So, where contributing to national defense has all of the markings of a penalty, many people would not pay.

We solve this problem by putting the government in charge of the military, and forcing people to contribute through taxes. This way, there are no free riders.

Even though military protection is a public good, the government can use the benefits of free market mechanisms in some aspects of providing for a national defense. There is economic value in requiring the military to pay a competitive wage so that labor forces are more efficiently allocated. Similarly, having the government buy materials on the open market allows the free enterprise system to more efficiently allocate the resources that go into producing those goods.

These policies reflect the principle that the tool of capitalism should still be used where it is the best tool for the job. It also illustrates how capitalism is not always the best tool for the job.

The military is only one area where the existence of a public good makes it a poor candidate for a free-market solution. Others include:

Law Enforcement: The police and the court system increases everybody's security. If the police capture and lock up a rapist, then everybody has obtained a measure of protection from having that person removed from society. The benefits cannot be limited only to those who pay a private fee to a law-enforcement agency, so we have a free-rider problem. To solve the free-rider problem, people are required to contribute to the police and court systems through taxation.

Education: People who acquire an education can generally make more money. However, the social benefits of having a well-educated population goes far beyond what each citizen can get in terms of a higher wage. One of these benefits is illustrated in the fact that a community benefits from having a doctor even if the doctor never gets used. The doctor is still available. Well-educated people are also better able to make better decisions regarding policies that affect others. For example, they can better understand the issues they vote on and cast more informed votes. These are just some ways in which education is a public good that calls for some measure of public funding and support.

Because people can harvest some personal benefits of an education, it is reasonable to have individual students cover some of the costs. However, to the degree that a well-educated population is a public good, there is reason for government funding to be used to make sure that society can benefit from this public good.

Flood control: If you build a dam on a river to control downstream flooding, then everybody living next to the river downstream benefits whether they pay for the dam or not. Therefore, the dam becomes a public works project, paid for by tax dollars, so that we can reduce the problem of free riders.

Clean Air (Global Warming and the Environment) . If one person has clean air, then everybody has clean air. Other than walking around with bottles of air for one's personal use, we typically breathe whatever air is available. Therefore, no person who pays for clean air can arrange that he is the only person receiving it. As a result, clean air would be under funded on the open market. This argues for making clean air a government concern.

On the issue of clean air, as with the issue on greenhouse gas emissions discussed in the previous blog, this does not imply that there is no room for free-enterprise solutions. A system for buying and selling emissions rights mixes government elements along with free-enterprise elements. The governments set the overall objectives (by saying, for example, how much of a particular emission would be allowed). However, by allowing rights to be bought and sold, it allows the market to decide which sources of emission are worth keeping and which sources we can best afford to get rid of.

Ecological Preservation. If a wilderness area is preserved, then it is preserved for all people who value ecological protection. If Person A wants a particular species or ecological system preserved, and Person B goes to the effort of preserving it, then he provides Person A with a benefit regardless of the fact that Person A contributed nothing to the effort. None of those who value ecological and species protection needs to pay for it. Therefore, species and ecological protection is rife with free riders. Government action is needed to make sure that these goods are provided at a level that the free market would provide them if not for those who are getting a free ride.

Here, more so than in the other categories discussed, the issue comes up that some people do not value the protection of any species or ecology, and they should not be forced to contribute to maintaining this good. Two points can be raised against this. The first is that genetic diversity, for example, provides a potential benefit to everybody because it allows us to get more information about how living things work. The second is that we would not allow a person to argue, “I want no police protection; I will defend my own property,” as a way of getting out of his taxes. The lack of an individual benefit does not justify immunity from a share of the tax burden.

Space Development: I have argued that to the degree that all of our human eggs are on this one planetary basket, to that degree the survival of the human species is at risk. (see “NASA’s Space Budget”) If we do prevent our extinction by spreading out across the solar system, everybody who values this outcome will obtain a benefit of having that interest better secured regardless of how much or how little they contribute. Therefore, this is an area where the government should step in to make sure that the task of spreading out across the solar system is properly funded.

This is another area where I believe we can do more by efficiently blending free market with government solutions. Instead of spending $100 billion to place a base on the moon, or $500 million to land a probe on Mars, the government can instead offer a substantially smaller prize to the first private entity to accomplish the government's objectives. So, it can offer a $10 billion prize to the first 10 organizations that can put four people on the moon, leave them there for a week, and bring them safely home. It can offer $50 million to the first private entity that succeeds in bringing it the data that it wants from Mars.


Contemporary political debate seems to be dominated by two extremes. There are those who say that Adam Smith's "Invisible Hand" can do no good, and others who say that it can do no evil. In fact, capitalism, like all tools, is useful in some situations and not useful in others. The situations above are all cases where a good cannot be made available only to those who pay for it. In this type of situation, capitalism tends to ensure that these goods are under produced. These are cases where Adam Smith's "Invisible Hand" does not do good. This does not change the fact that there are other situations (e.g., scarce oil) where interfering with the free market will do far more harm than good.

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