Free rider problem

The free rider problem refers to a situation where some individuals in a population either consume more than their fair share of a common resource, or pay less than their fair share of the cost of a common resource.

Analysis
A free rider is a person who enjoys the benefits of goods without contributing to the full cost or partial cost of providing them. This problem usually arises when there are spillover benefits or costs in the provision of goods.

The free rider problem is usually more acute in the case of public goods. Public goods are those where we cannot exclude others from their consumption, unless incurring substantial cost if the goods are provided at all, and the consumption by anyone does not reduce the amount available to others. Examples of pure public goods are national defense and environmental quality. The spillover effects of public goods deem it necessary to provide these goods collectively either through taxes and/or subsidies.

The owner of a dam, for example, cannot provide flood control separately to the individual farmers residing downstream. Non-excludability creates opportunities for free riders, who will pay for the service only if doing so is absolutely necessary to receive it. From the perspective of economic self-interest, every potential customer has an incentive to try to be a free rider. If enough of them act on this incentive, the service will not be produced at all, or at least not in an optimal quantity.

However, the existence of any voluntary ethical behavior at all faces a free-rider obstacle. Society is much more prosperous if we all cease to steal and cheat, but the single individual is better off still if everyone else behaves ethically while he or she steals and cheats whenever able to get away with it. Thus, everyone has a powerful personal incentive to free ride on other people's ethical behavior. If we all succumbed to that incentive, society would be very unpleasant.

Some have the mistaken impression that the State's police forces and courts are what prevents most stealing and cheating. The police and courts are only capable of handling the recalcitrant minority who refuse voluntarily to obey society's norms. If all members of society or even a substantial fraction became ethical free riders, always stealing and cheating whenever they thought they could get away with it, the police and court system would collapse under the load.

The steady advance of the human race over the centuries becomes a succession of successful surmounting of the free-rider obstacle. Civilization itself would be totally impossible unless people had somehow solved the public-goods problem, voluntarily. As Rothbard observes, "Thus the free-rider argument proves far too much. After all, civilization itself is a process of all of us 'free-riding' on the achievements of others. We all free-ride, every day, on the achievements of Edison, Beethoven, or Vermeer".

Free rider problem and public provision of goods
The problem with public provision is that the task of ensuring that the government supplies the proper quantity and quality of "public goods" is itself a public good. When the government supplies a product, paid for indirectly by taxpayers rather than by the direct recipients of the product, few have an incentive to spend the time and resources to make sure that the government supplies the right quantity and quality. If the theory of public goods is correct, relatively few people are likely to spend time and resources making sure that someone else’s education (or health care or justice) is adequate.

As a result, the public good may be provided badly — oversupplied, undersupplied, or poorly supplied. The root of those problems is precisely the same as that of the free-rider problem associated with private production of public goods. No one has a strong incentive to make sure that the public good is well provided.

Funded through taxation, rather than through voluntary purchases, public entities have monopolistic power — without even the restraint of traditional monopolies, which must obtain their revenues from voluntary purchases. Moreover, organizations like government schools operate largely without competition.

Example
Suppose Jones proposes to ensure that every retired American enjoys at least a minimum annual income. Jones' plan is to ask every working American to voluntarily contribute money each year to a fund that he will set up and administer. After a few years, when the fund has accumulated enough dollars, Jones will start to distribute a portion of the money every year to each retired American.

Each worker will be told that, by contributing today, he or she will enrich a fund that in the future will pay to him or her in retirement a minimum annual income. Thus, this collective fund will be maintained — and will grow as the number of retired Americans grows — by Americans continuing to make voluntary contributions to it.

If Jones' fund will pay an income to every retired American — even to those who did not contribute to the fund — too many Americans will fail to contribute to the fund. Even if everyone agrees that a fund to guarantee minimum incomes to retirees is a fine idea, everyone also recognizes that what economists call "the free-rider problem" will result in the fund being incessantly underfunded.

This reality is the rationale behind the requirement that all workers "contribute" to the Social Security fund. Everyone must pay; there's nothing voluntary about it. Trouble is, requiring every worker to "contribute" doesn't solve the free-rider problem. It simply shifts that problem to another arena.

As currently arranged, Social Security allows today's retirees to free-ride on other people's money. By voting for candidates who promise to maintain (or even better, to increase) Social Security's stream of payments to each retiree, retirees free-ride on the earnings of current workers.

Or if Uncle Sam borrows the money to pay today's retirees, these retirees free-ride on the earnings of future workers, who will be taxed so that Uncle Sam can repay his creditors.

Links

 * Public Goods by Tyler Cowen
 * The Free Rider as a Basis for Government Intervention (pdf) by E. C. Pasour, Jr., 1981
 * Vertical Restraints and the Retail Free Riding Problem: An Austrian Perspective (pdf) by David W. Boyd, 1996
 * Free Rider Problems in Insurance-based private Defense (pdf) by Robert Danneskjöld, 2011
 * The Common Good and the Free Rider by Mack Tanner, October 1993
 * Free Riders and Collective Action Revisited (pdf) by Richard L. Stroup, 2000
 * The Common Good and the Free Rider by Mack Tanner, October 1993
 * Free Riders and Collective Action Revisited (pdf) by Richard L. Stroup, 2000