Public goods are goods reported to have two distinct aspects: "nonexcludability" means that it is hard to exclude people of consumption of a good (the "free rider problem"); everyone will try to "free ride" by allowing others to pay for it and as a result the good will be unproduced, even if there is a strong demand for it. The second characteristic (considered by some less important) is "nonrivalrous consumption", when the good can be consumed without diminishing anyone else's enjoyment of it or increasing its cost. Because these goods will not be produced in a sufficient amount, or at all, they should be produced by the government (or so it is commonly thought).
There are numerous examples of public goods of varying acceptance, possibly the most widespread is national defense. "To the extent one person in a geographic area is defended from foreign attack or invasion, other people in that same area are likely defended also. This makes it hard to charge people for defense, which means that defense faces the classic free-rider problem. Indeed, almost all economists are convinced that the only way to provide a sufficient level of defense is to have government do it and fund defense with taxes."
Free rider problem
- Main article: 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.
For example, learning to read and write helps the individual and in that sense is a private good, but it also provides a public good because it contributes to the lives of others, even though they do not pay for those benefits. Advanced education similarly fosters greater productivity and innovation, improving the lives of everyone, not just those who bought the education.
In other words, education has positive externalities whose value is not captured by the person who pays for the education. Because these externalities exist, the argument goes, people tend to act as "free riders," receiving the benefit provided by others without paying for it. Thus, fewer people are willing to provide education than would be willing without such spillovers because they are not rewarded for some of the output they produce. Therefore, according to most economists, education will be undersupplied.
These arguments lead inevitably to the claim that the government must help to provide education, and, indeed, governments are heavily engaged in supplying this "public good."
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.
Market failure and political failure
- Main article: Market failure
Market failure is a situation where, in any given market, the quantity of a product demanded by consumers does not equate to the quantity supplied by suppliers. This is a direct result of a lack of certain economically ideal factors, which prevents equilibrium. Public goods are one of the examples of a market failure.
When Paul Samuelson first formalized public-goods theory, it was at a time when many economists subscribed to what Harold Demsetz has called the nirvana approach to public theory. Demonstrating some "market failure" with respect to an abstract optimum was considered sufficient to justify State action. Economists assumed that the costless, all-knowing, and benevolent State could simply and easily correct any failure.
Since then, economists have become far more realistic. Demonstrating "market failure" is no longer sufficient. To justify State action, one must show that the State has the capacity and the incentive to do a better job than the market can do.
Economists within the field of public choice have come to the realization that the free-rider incentive does not only arise for market enterprises. The free-rider incentive can arise for any group, especially political groups wanting to influence State policy.
Assume that a fairly large group of people wishes to change some State policy — for instance, repeal a tax. If enough people contribute money, time, or other resources to bringing about the tax's repeal, they will succeed and all be better off. The money saved in taxes will more than reimburse them for the effort. Unfortunately, once the tax is repealed, even those who did not join our campaign will no longer have to pay it. They will be free riders on this political efforts.
Just as in the case of a non-excludable good in the market, every potential beneficiary of the tax repeal has an incentive, from the perspective of economic self-interest, to try to be a free rider. If enough of them act according to this incentive, the tax will never be repealed. This result can be called a "political failure," completely analogous to the "market failure" caused by non-excludability.
The democratic State makes it much easier to enact policies that funnel great benefits to small groups than to enact policies that shower small benefits on large groups. Because of this free-rider induced "political failure," the State has the same problem in providing non-excludable goods and services as the market—with one crucial difference. When a group successfully provides itself a public good through the market, the resources it expends pay directly for the good. In contrast, when a group successfully provides itself a public good through the State, the resources it expends only pay the overhead cost of influencing State policy. The State then finances the public good through taxation or some coercive substitute.
Moreover, the group that campaigned for the State-provided public good will not in all likelihood bear very much of the coerced cost of the good. Otherwise, they would have had no incentive to go through the State, because doing so then costs more in total than simply providing themselves the good voluntarily. Instead, the costs will be widely distributed among the poorly organized large group, who may not benefit at all from the public good.
This makes it possible for organized groups to get the State to provide bogus public goods, goods and services which in fact cost much more than the beneficiaries would be willing to pay even if exclusion were possible and they could not free ride. In this manner, the State generates negative externalities. Rather than overcoming the free-rider problem, the State benefits free loaders, who receive bogus public goods at the expense of the taxpayers.
In addition, individual taxpayers cannot prevent the government from free riding by taxing their incomes beyond what is necessary to provide the public good. If individuals in a given population are too self-interested to fund a public good, this self-interest will manifest in the special interests that back the State. If the free rider assumption is properly understood, the State will tend to exaggerate the cost and over-supply public goods (to at least the same degree). The problem is exacerbated because competition is eliminated in the provision of public goods.
There are several arguments against the public goods theory:
- there is no way of knowing what is the "optimal" amount of the good produced
- because of the imprecise definition, many other goods can be to some degree considered public
- the presence of the state changes the incentive structure. Companies may declare their product for a public good to receive taxpayer funding.
- many of the 'public goods' are successfully produced in the private sector
- the theory does not at all prove that the government should produce these goods
- many of the goods government actually does produce do not correspond to the economist's definition of public goods, so the theory poorly explains the government's actual role in the economy
- there is no reason to expect the government to succeed where the market has supposedly failed. Once the political process, dominated by special interests and the self-interest of politicians and bureaucrats, is analyzed, the economic efficiency justification for government provision of "public goods" falls apart. Even on its own terms, the policy conclusion of public goods theory simply substitutes government failure for "market failure."
- public goods theory starts with faulty assumptions about the real world: that people live atomistically rather than in geographically defined communities and that public goods must be provided in isolation from private goods. More realistically, people live in communities where societal pressures can be brought to bear on would-be free riders and that the provision of public goods can be "tied" to the provision of private and excludable goods.
Public goods over the course of history and their private provision
Private roads and bridges
- Main article: Private roads
There is an extensive record of privately built roads - turnpikes - and bridges throughout the 19th century. Private initiative was the only effective means of providing new highways, because state and county finances were almost nonexistent and town resources were meager.
In view of the apparent free rider problem, the success was striking. The movement built new roads at rates previously unknown in America. Over $11 million was invested in turnpikes in New York, some $6.5 million in New England, and over $4.5 million (excluding state investment) in Pennsylvania. (A turnpike typically had a construction cost of $700 to $3,000 per mile and a length of 15 to 40 miles.) Based on the population of 1830, per-capita turnpike investment was approximately $3.90 in Massachusetts. Between 1794 and 1840, 238 private New England turnpikes built and operated about 3,750 miles of road. New York led all other states in turnpike mileage with over 4,000 as of 1821. Pennsylvania was second, reaching a peak of about 2,400 miles in 1832. New Jersey companies operated 550 miles by 1821; Maryland’s operated 300 miles of private road in 1830. Turnpikes also represented a great improvement in road quality .
Daniel Klein points out that community isolation, citizen familiarity, and weak, decentralized government bred close social ties and a strong participatory ethic. Towns of the early nineteenth century were independent and strong, and in the first three decades of the republic, the township held almost all of the administrative power of government. Alexis de Tocqueville, in his opus Democracy in America, says the towns "are independent in all that concerns themselves alone; and among the inhabitants of New England I believe that not a man is to be found who would acknowledge that the state has any right to interfere in their town affairs." The participatory nature of town government in early America has been well noted. This feature often makes it pointless to draw lines separating private and public works. At the same time, religious congregations often showed a penchant for making themselves busy in various improvement endeavors, such as schools, libraries, and poor relief. By generating the requisite social relations, or "social capital", as well as human capital, the religious and benevolent activities not only incited but empowered the application of voluntary efforts to community goals. The citizens’ cooperation with government efforts is noteworthy, but more significant is the willingness to forge public improvements by voluntary association.
Things have changed a lot since 1810. Neighbors are often strangers, so how can we expected social pressure and the like to curtail free riding? Klein has two remarks: one, whether it be a street association or the American Cancer Society, suasion tactics often yield results, as reported regularly in Nonprofit and Voluntary Sector Ouarterly. Second, if voluntary forces are deemed ineffective in providing public goods, that in itself is a policy issue. The ability of voluntary association to provide infrastructure, education, security, and poor relief depends on the exercise and spontaneous development of certain institutions, activities, and sentiments. Since governmental bodies dominate these services it is no surprise that the faculties of sodality remain degenerate. When a problem arises government is expected to deal with it. Participation does not become a personal responsibility and organizing leadership does not become a source of social esteem. Thus there is a lesson in the broader circumstances of early America which bred effective voluntary forces, as well as in the specific ways those forces established turnpikes.
Many other enterprises were undertaken to make improvements, and it is debatable whether they can be counted as business corporations. There were marine and agricultural societies, but then come corporations for land improvement, lumber cultivation, and inland navigation. For example, a "case near the line" is the River Machine Company, incorporated in 1790 to dredge the Providence River. "The merchants of Providence had agreed to raise $1,000 in forty ’equal shares’" for the project. The company was to collect tolls from certain vessels, but any surplus was to be used at the end of twenty years for other improvements. "Thus no dividends were contemplated."
In the American colonies were private corporations of many different types, alongside of unincorporated associations more numerous and varied. Most of the incorporated bodies were engaged in promoting ends which appeared to be of general public utility. This is true whether we consider the churches, which were so important elements in the social fabric of the day, the schools and hospitals, mutual benefit societies like the marine societies or the insurance and water supply companies, or even the most business-like of the business corporations. There are hardly any to be found which were so thoroughly "private" as probably the majority of corporations in the present day. Yet many have arisen in the colonies as private undertakings and been carried on under private control.
Public infrastructure debate in the early US
Many American states subsidized canals and railroads during the late 1830s and later but the subsidies usually turned out to be disastrous. Ohio was one of the most active states with regard to granting subsidies for internal improvements. But there was so much waste and corruption that Ohio "stood as one of the chief examples of the revulsion of feeling against governmental promotion of internal improvement." In 1851 the state amended its constitution to prohibit both state and local government subsidies to private companies.
Indiana, Illinois, and Michigan were even less successful with their subsidy programs, enacted in 1836 and 1837. In three short years the subsidized canal, road, and railroad projects were all bankrupt and unfinished. By 1840 each of these states also amended their constitutions to prohibit state subsidies for internal improvements.
The most powerful proponent of subsidies for internal improvements in the Illinois state legislature was Abraham Lincoln, who was the leader of the Whig party in Illinois at the time (and later to become the general counsel of the Illinois Central Railroad). The program that was enacted under his supervision was considered to be a "model" of the Henry Clay/Whig "American System" but in reality it was a wildly irresponsible squandering of millions of taxpayers’ dollars. Most of the projects were abandoned before completion; only a part of one railroad was completed and then sold for a fraction of its cost. A new state constitution, adopted in 1848, prohibited state aid to private companies. Chicago went on to become the nation’s greatest railroad center without the dubious benefit of any state or city tax funds.
In 1837 Michigan began subsidizing private railroad companies but the projects quickly exhibited the familiar characteristics of mismanagement, corruption, and massive cost overruns. The state sold the Michigan Central and Michigan Southern Railroads for less than half of what it had spent on them. "The state’s venture in internal improvements was so universally regarded as a failure that prohibitions against both public works and mixed enterprise were voted almost without discussion for inclusion in the constitution of 1850."
Government subsidies for internal improvements in the 1830s were a complete, total, financial disaster. As described by historian John Bach McMaster: "In every state which had gone recklessly into internal improvements the financial situation was alarming. No works were finished; little or no income was derived from them; interest on the bonds increased day by day and no means of paying it save by taxation remained."
Wisconsin and Minnesota learned valuable lessons from the above-mentioned states. When they entered the union in 1848 and 1857 respectively their constitutions forbade both grants and loans to private companies. In Iowa the state courts even held that local aid to private companies was unconstitutional. Louisiana began subsidizing railroads before Illinois and most other states (1833) and, consequently, was one of the first states to turn around and forbid state aid for internal improvements (1845).
By 1861 state subsidies for internal improvements were forbidden by constitutional amendment in Maine, New York, Pennsylvania, Maryland, Minnesota, Iowa, Kentucky, Kansas, California, and Oregon. West Virginia, Nevada, and Nebraska entered the union in the 1860s with similar prohibitions. Missouri and Massachusetts were the only two states where the law sanctioned state subsidies for internal improvements, and Missouri amended it constitution to prohibit them in 1875.
The intellectual and philosophical debates over internal improvement subsidies may have been won by the opponents of the subsidies as of 1861, but the proponents ultimately prevailed in the policy "debate," literally, by force of arms.
During the period of "Reconstruction" (1865-1877) the federal government, which was synonymous with the Republican party, was responsible for extraordinary waste, fraud, and corruption related to railroad subsidies in the southern states, which at the time were governed by military "governors" appointed by the Republican party. Government bonds were typically sold before work began on railroads and "dishonest promoters sold these bonds for what they could get and never built the roads," writes historian E. Merton Coulter. "Railways that had been owned in whole or in part by the states were grossly mismanaged, and were exploited for the profit of politicians," observed William Archibald Dunning, and "the progressive depletion of the public treasuries was accompanied by great prosperity among [Republican] politicians of high and low degree. . . . Bribery became the indispensable adjunct of legislation, and fraud a common feature in the execution of the laws." So-called Reconstruction came to be known as the "Era of Good Stealings."
The advocates of government subsidies for transcontinental railroads made the argument that such railroads would never be financed by private capital markets. But railroad entrepreneur James J. Hill proved them wrong by building the Great Northern Railroad, which was by far the most efficiently built and most profitable of all the transcontinentals. "Our own line in the North," Hill proudly boasted, "was built without any government aid, even the right of way, through hundreds of miles of public lands, being paid for in cash." The Mormons also built four railroads in Utah without any government subsidies. New Hampshire and Vermont gave no aid whatsoever to railroads, yet a privately funded line was built across the rugged terrain of the two states. Unlike many other states, New Hampshire even refused to grant the right of eminent domain to private railroad companies and, in so doing, encouraged them to pay free-market prices for any rights of way.
Public goods on the sea
National defense and lighthouses have been among the most frequently cited examples of public goods. In both cases, it is typically claimed that only a government can effectively provide them. However, maritime history, especially that concerning the age of sail, is rich with examples of privately supplied goods that today are often thought of as being "public".
Life at sea, especially in the days before steamships, radio, and radar, was remarkably close to life on the various land "frontiers". Governmental decrees often went unheeded, a high degree of self-reliance was taken for granted, reciprocal relations regarding benefits and responsibilities were the norm, and voluntary cooperation was very common. Perhaps above all, traditions provided a framework for solving problems and resolving disputes. Customary law, not authoritarian (or state-created) law, was normally the basis for conflict resolution.
One of the most instructive of all examples from maritime history is that of privateering, that is, the employment of profit-seeking, private armed ships during wartime. Privateers often had a significant, perhaps even deciding, impact on the course of wars between maritime nations. In Europe between 1600 and 1815, privateers "probably contributed much more than warships to the actual harm done the enemy". On the other side of the Atlantic, "without the presence of the American privateers in the Revolutionary War and the War of 1812, the United States would never have been able to hold off the British Navy".
Privateering disappeared precisely because it worked so well. It was effectively legislated out of existence in 1856 by means of the Declaration of Paris. The signatory nations wished to eliminate privateering, because it offered a low-cost but effective alternative to those nations who did not want to undertake the massive expenditures required by public navies. Privateering was not a market that can be shown to have ‘failed’.
The standard argument regarding lighthouses has been that, once the structure is built and as long as it is maintained, its service cannot be restricted only to those who pay for it. In short, there would be large numbers of "free riders". Therefore, private construction of lighthouses could never be profitable and must be a function of government. But, the building and operating of lighthouses by private firms and individuals was actually quite common. The owners of these structures gained their revenue from fees paid by shipowners, who benefited enormously from the service, so much so that they regularly petitioned the government to permit new lighthouses to be built. The lighthouses were built, operated, financed, and owned by private individuals, who could sell the lighthouse or dispose of it by bequest.
In the British Isles, the role of the government was limited to the establishment and enforcement of property rights in the lighthouses. Charters were dispensed to private entrepreneurs, who then charged fees for the service (a similar system worked in Canada). Not only did the British government often fail to initiate the building of needed lighthouses, it even resisted their construction on more than one occasion. By 1842 had the Parliament eliminated all private ownership of lighthouses. The shipowners, who paid the "light dues", lobbied for the change in the mistaken belief that it would result in smaller fees.
In the early United States, colonists frequently erected beacons and other aids for navigating the coasts. In 1789 Congress created the Lighthouse Establishment, which was given direct control over all coastal aids to navigation. But the new agency was burdened with bureaucratic problems, so little was accomplished until well into the nineteenth century, and of the existing lighthouses it has been said that they "failed in their primary purpose of guiding ships safely at night". At times, characteristics of existing lights have been changed without first informing the maritime community, sometimes with dire consequences. It was not until 1852 that the situation improved.
The old profession of piloting has been vital for maritime safety. Pilots, private suppliers who faced intense competition, would guide commercial vessels safely into and out of the port. The underwriters of marine insurance were often reluctant to insure vessels that did without a pilot altogether, or used a pilot whom the underwriters did not consider competent. Many took upon themselves the duties expected of the Coast Guard, helping ships in distress and rescuing passengers if they capsized. 
One typical and popular example of public goods is the case of dikes or levees. If a dike is built for one person, additional consumers can benefit from its services, i.e., protection from flooding. But once a dike has been built, no one living behind the dike can be excluded from its service, whether he participated in financing it or not. Hence, people would wait for others to build a dike hoping to enjoy it without having to pay for it. But when everyone waits, the dike that everyone needs is not built. This line of thinking ignores individual actions and motivations, and social pressures that may also come into play. People can decide to take the higher subjective risk or come to an agreement of sharing the burden.
Historically, as other public goods that allegedly need government provision, dikes have been built on the private market for a long time. In Germany, mainly in Frisia and Dithmarschen, the first dikes were built without any government help about 1,000 years ago. The population grew quickly in these very fertile areas made accessible by diking. As the population grew and became wealthier, monumental churches were built, symbolizing the success of private dike building. The newly diked areas were almost independent territories. Although they nominally formed part of the Holy Roman Empire, only in some cases were they required to support the army in case of war and pay taxes. They were autonomous with their own jurisdiction and diplomatic contacts. The land of the Fries was without a feudal order or without feudal overlords. Diking not only had the incentive to create new fertile and profitable land but also to create free land. Dikes were not only built without the state, but also can be regarded as seceding areas, that came close to private law societies.
- Tyler Cowen. "Public Goods", The Concise Encyclopedia of Economics, referenced 2009-05-22.
- "Free Rider Problem Definition", Investopedia, referenced 2013-02-06.
- Jane S. Shaw. "Education—A Bad Public Good?" (pdf), The Independent Review, v. 15, n. 2, Fall 2010, ISSN 1086–1653, pp. 241–256. Referenced 2013-02-18.
- "Market Failure Definition", Investopedia, referenced 2013-02-05.
- Jeffrey Rogers Hummel. "National Goods Versus Public Goods: Defense, Disarmament, and Free Riders" (pdf), The Review of Austrian Economics, Vol. 4, 1990, pp. 88-122. Referenced 2013-02-05.
- Art Carden. "A Few Notes on Public Goods", Mises Institute Blog, posted 2004-04-13, referenced 2009-05-22.
- Randall G. Holcombe. "A Theory of the Theory of Public Goods", Review of Austrian Economics 10, No. 1 (1997), Mises Institute, referenced 2009-05-22.
- Roy Cordato. "Public Goods and Private Communities: The Market Provision of Social Services", The Freeman, March 1995. Referenced 2012-12-02.
- Daniel Klein. "Private Highways in America, 1792-1916" (pdf), The Freeman, February 1994. Referenced 2012-12-08.
- Daniel Klein. "The Voluntary Provision of Public Goods? The Turnpike Companies of Early America" (pdf), Department of Economics, University of California at Irvine, Reprint No. 18, Economic Inquiry, March 1990. Referenced 2012-12-08.
- Davis, Joseph Stancliffe. "Essays in the earlier history of American corporations (1917)", Cambridge Harvard University Press, Volume: 1, p. 103. Referenced 2012-12-08.
- Thomas J. DiLorenzo. The Role of Private Transportation in America's 19th-Century "Internal Improvements" Debate (pdf). Referenced 2012-12-08.
- Larry J. Sechrest. "Public goods and private solutions in maritime history", The Quarterly Journal of Austrian Economics Vol. 7, No. 2 (Summer 2004), referenced 2009-12-07.
- Philipp Bagus. "Wresting Land from the Sea: An Argument Against Public Goods Theory" (pdf, or html), Journal of Libertarian Studies Volume 20, No. 4 (Fall 2006): 21–40. Referenced 2010-10-07.
- "A Theory of the Theory of Public Goods" (PDF) by Randall G. Holcombe, 1997
- "A Few Notes on Public Goods" by Art Carden, April 2004
- "IP Rights as Monopolistic Grants to Overcome the Public Goods Problem" by Stephan Kinsella, December 2010
- "On Takings and Public Use" by Stephan Kinsella, April 2005
- "The Back Door to Socialism" by Chris Brown, December 2008
- "Is High School Football a Public Good?" by Jim Fedako, December 2006
- "The Public Goods of Tatum O’Neal" by Jim Fedako, November 2007
- "Terence Kealey: “Science is a Private Good: Why Government Science is Wasteful”" by Stephan Kinsella, June 2010
- "Fallacies of the Public Goods Theory and the Production of Security (PDF) by Hans-Hermann Hoppe, Winter 1989
- "Pareto Optimality, External Benefits and Public Goods: A Subjectivist Approach" (PDF) by Barry P. Brownstein, Winter 1980
- "Public Goods and Externalities: The Case of Roads" (PDF) by Walter Block, 1983
- "Ronald Coase and the Lighthouse" (PDF) by Frank Mixon, p.3-4, 1992
- "Of Private, Common, and Public Property and The Rationale for Total Privatization" (PDF) by Hans-Hermann Hoppe, 2011
- "Anarchism and the Public Goods Issue: Law, Courts, and the Police" (PDF) by David Osterfeld, Winter 1989
- "National Goods Versus Public Goods: Defense, Disarmament, and Free Riders" (PDF) by Jeffrey Rogers Hummel, 1990
- "Private Provision of Public Goods: Theoretical Issues and Some Examples from Maritime History" (PDF) by Larry J. Sechrest, March 2003
- "Nonexcludability and Government Financing of Public Goods" (PDF) by Karl T. Fielding, 1979
- "Empire: Public Goods and Bads" (PDF) by Christopher J. Coyne & Steve Davies, January 2007
- "Wresting Land from the Sea: An Argument Against Public Goods Theory" (PDF) by Philipp Bagus, Fall 2006 (republished as Mises Daily here)
- "Who Owns Water?" by Murray N. Rothbard, March 1956
- "Collective Goods" and "External Benefits": Two Arguments for Government Activity by Murray N. Rothbard (from Man, Economy and State)
- The Failure of Market Failure. Part II. The Public Goods Dilemma by Anthony de Jasay, November 2006
- Efficiency and Externalities in an Open-Ended Universe: A Modern Austrian Perspective (pdf) by Roy Cordato, 1992
- Toward a Deconstruction of Utility and Welfare Economics (pdf) by David Gordon, 1993
- The Myth of Science as a Public Good lecture by Terence Kealey, May 2009 (YouTube)
- Oxford Libertarian Society blog: "The Myth of Science as a Public Good"
- Public Spending and Public Goods lecture by Thomas J. DiLorenzo, August 2004 (YouTube)
- The Public Good: As It Appears to Ceasar commentary by Robert LeFevre
- Funding Public Goods: Six Solutions by Roderick T. Long, 1994