The argument for market failure

A public good, as economists define the concept, is any good from whose enjoyment non-contributors cannot be excluded. The theory of public goods is of interest to libertarians for two reasons: First, because a great many things we care about — highways, education, law enforcement, fire protection, national defence, etcetera — are widely thought to be public goods, or to have public-good characteristics; and second, because the majority of economists are convinced that such public goods cannot be supplied on the free market.

The argument for the inadequacy of markets in this area runs as follows. Suppose there is some good X that two hundred people value; but if X is produced, each of those two hundred will be able to benefit from it, whether or not they contributed to its production. If you are one of the two hundred, what is your reaction if you are asked to contribute?

According to the orthodox theory of public goods, you reason as follows: “Either the other one hundred ninety-nine are going to raise a sufficient amount of money to fund X, or they aren’t. Suppose they do raise enough. Then the good will be funded whether I pay or not, so I might as well not pay, so I can take advantage of the benefits without paying the costs. [This is the Free Rider problem.] On the other hand, suppose they don’t raise enough. Then the good won’t be funded even if I do contribute, so there’s no point in throwing my money away. [This is the Assurance problem.] The chance that my contributing or not will make the decisive difference to X’s being funded or not is so minuscule as to be quite properly ignored. So either way, regardless of what others do, it’s in my interest not to contribute. So I won’t.” And you don’t.

The problem is that the other one hundred ninety-nine people in the group are reasoning the same way, and so X never gets funded — despite the fact that everyone would be better off — by their own standards — if X were funded. It’s in everybody’s collective interest to cooperate, but in everyone’s individual interest to defect; and since it is individuals, not collectives, who make decisions, the result is that no one cooperates and the public good is never produced. The market system of voluntary cooperation appears to have failed.

First solution: Force

There is a way of solving this public goods problem: Make contribution compulsory. If everyone is forced to contribute, then the public good will be funded, and everyone will be better off — in respect of that public good, that is. They will of course be worse off in another respect: They will no longer be free. Nevertheless, coercive force is widely endorsed as the sole possible solution to the public goods problem. Forced contribution, whether of labour or of property, is certainly the solution of choice in the modern state: Taxation, military conscription, eminent domain, and jury empanelment are among the obvious cases.

But is force the only possible solution? By no means. Throughout history, countless so-called “public goods” have been produced through non-coercive means, thus rendering the public-goods problem no more than a bogey from an economist’s fantasy. Economists who proclaim, from their ivory towers, that non-coercive solutions to public-goods problems are inconceivable — without ever bothering to examine the empirical facts of private production all around us every day — are in effect demanding that the rest of us be held hostage to their lack of imagination and observation. Perhaps entrepreneurs who stand to make a profit from solving public-goods problems have more incentive to discover solutions than economists whose income is unaffected by their failure to solve such problems!

Leaving governmental coercion aside as both unethical and dangerous, I here offer five other solutions to the funding of public goods. (My list here is not meant to be exhaustive, and I welcome further suggestions.) As I go along I will consider in particular how each solution might apply to what is generally considered the most difficult public-goods problem: National defence.

Second solution: Conscience

Public goods can be funded through reliance on custom, morality, and non-material rewards. Many public goods are already so funded; volunteer fire departments are an obvious example. A less obvious example, perhaps, is churches: One can walk into a church, listen to the sermon, ignore the collection plate, and walk out. Indeed, everyone who wants to hear the sermon could free-ride in the same way. Hence the economists ought to predict that no churches would ever be built and no ministers paid; yet somehow this is not the case. A still less obvious example of a public good is tipping: Waiters and waitresses provide better service in the hope of getting a tip, so the practice of tipping has the beneficial result of producing better service. (At least I’ll assume for the sake of argument that this is true; I don’t actually know that countries without the practice of tipping really have worse service.) But why should I leave a tip in a restaurant to which I have no plan to return? I benefit from the tips of other diners, and they benefit from mine; but in this case I could free ride, enjoying the benefits without tipping. Why don’t I? The power of custom.

Morality — the conviction that we are obligated to do our part — also plays an important role in overcoming free rider problems. When we consider the millions that are contributed to charity, telethons, etcetera, there is no reason to doubt that there would be at least as much voluntary support forthcoming for the funding of public goods. Indeed, as Robert Axelrod shows in his book The Evolution of Cooperation, both biological and cultural evolution tend to promote the emergence of cooperative dispositions, because those who manifest such dispositions acquire a reputation as a cooperator, and thereby attract other cooperators; as these cooperators flourish by reaping the benefits of increased cooperation, the cooperative impulse is further selected for.

The LiveAid telethon concert generated impressive contributions to feed the starving Ethiopians. Would not people also contribute money to defend their country? (Keep in mind that a military confined to national defence, as opposed to foreign adventuring, would be quite a bit cheaper.) And have not people always volunteered their labor as soldiers in great numbers when their country was attacked? A citizens’ militia, manned by volunteers and funded by charity, has been the standard form of national defence throughout human history.

Third solution: Delegation

The third solution is really a variation on the second, but it is distinctive enough to warrant separate mention. Those wishing to solicit contributions to some worthy cause will raise much more money if they devolve responsibility by assigning local people to collect from friends, family, and co-workers. This strategy is employed with great effectiveness by the United Way. Social pressure, and the desire to look good in front of one’s peers, are powerful incentives — incentives that might well serve to motivate contributions to the patriotic defence of one’s homeland.

Fourth solution: Guarantee

In his book The Limits of Government: An Essay on the Public Goods Problem, David Schmidtz suggests offering moneyback guarantees as a way of increasing the incentive to contribute. Remember that a public-goods problem comprises two elements: The Free Rider problem (the temptation to free ride if others contribute enough) and the Assurance problem (the fear that one will end up a sucker if one contributes and others end up not contributing). If those soliciting funds offer to refund contributors’ money if insufficient funds are raised to fund the public good, the Assurance problem is defused. The Free Rider problem still remains, of course; but once the incentive to defect has been cut in half, the non-monetary incentives to cooperate may be enough to overwhelm it. War bonds could be offered in this way.

Fifth solution: Privatisation

The problem with funding public goods is that non-contributors are not excluded from enjoying the good. An obvious solution, then, is to try to invent some way of excluding those non-contributors — thus privatising the public good. For example, although highways are supposed to be a paradigm case of a public good, we all know about toll roads: If you don’t pay, you can’t drive. At one time in this country fire protection was offered in the same way that insurance is now; firemen only saved houses whose owners had paid their premiums. (This obviously works better if houses are not too close together!) Methods of exclusion may also be discovered as technology progresses; it was once impossible to exclude anyone from viewing television transmissions, but we now have cable television and broadcast scramblers. In addition, any good that can only be enjoyed in a particular location can be turned into a private good by making the location private property.

It is difficult to apply this solution to national defence; if you defend my fellow citizens from foreign invasion, you ipso facto defend me too, whether I contributed or not. There’s no way to let enemy missiles through to hit just the houses of non-contributors while leaving those of contributors alone.

But there are at least ways of slicing the problem up into more manageable pieces. If we consider defence of the continental United States as a whole, it becomes clear that local areas that are net non-contributors can certainly be excluded from that good. So we implement Solution Five by decomposing national defence into a plurality of regional defences, and then allow the other Solutions to operate within those regions. (Solution Three in particular will naturally work better at the regional than at the national level.)

Sixth solution: Packaging

One way to fund public goods is to package them with private goods (from which non-contributors can be excluded). In nineteenth-century England, private roads were built that were not toll roads: They were completely free, and anyone could use them. Why was it in the road-builders’ interest to supply this public good, then? Because the road-builders owned property — a private good — alongside the site of the proposed road, and once the road was built, increased traffic brought increased commerce, and the value of their property was increased. (I learned of this example from Stephen Davies.)

Lighthouses are another example. For decades, standard economic textbooks had loftily explained that lighthouses could never be supplied privately, because ships at sea benefit from the light whether or not they pay. But one day free-market economist Ronald Coase decided to do some research, and discovered that in fact lighthouses in Britain had in the past been supplied privately for many years. True, it was impossible to exclude non-contributors from the light of the lighthouse — but it was possible to exclude non-contributors from using the harbour, so the lighthouse fees were simply packaged with the harbor fees. Once again, entrepreneurs who stood to make a profit were motivated to devise innovations undreamed of by pessimistic academic economists. (Coase’s article may be found in Tyler Cowen’s anthology Public Goods and Market Failures — also published under the title The Theory of Market Failure.)

Broadcast television is another classic public good: Viewers can receive the signals whether or not they pay. If we had never had broadcast television — if we had started with cable to begin with — economists would no doubt predict the impossibility of broadcast television (unless financed by tax revenues). But television broadcasters (and radio broadcasters before them) managed to pay for the broadcasts by packaging them with a private good: Advertising. Providers of goods and services value advertising air time — and this definitely is a good from which they can be excluded, and for which they are consequently willing to pay. Advertising revenue is then used to fund the broadcasts; a public good for the viewers is funded by being packaged with a private good for the advertisers.

Could the public good of national defence be funded by advertising as well? Perhaps so. How much money would Coca-Cola be willing to donate to national defence, in exchange for the right to advertise:

COCA-COLA

WE DEFEND AMERICA!

Quite a bit, I would bet.

Private weapons ownership also represents a kind of packaging, one that operates on its own with no entrepreneurship needed. In a free society, people will have the right to own weapons, and will buy them for the sake of a private good: Defence of their own homes and families. But this pursuit of private good brings along with it an important public good: An armed society, formidable to any would-be conqueror, itself represents a powerful deterrent, and thus, to that extent, serves as a means of national defence.

Perhaps another packaging strategy might work as follows. Suppose a group of private protection agencies, individually specialising in domestic law enforcement, were to make binding and enforceable contracts with one another to form a consortium, pooling their resources for the purpose of national defence. These protection agencies could then sell a package of protection services — domestic law enforcement and national defence — and refuse to sell the former to anyone who would not pay for the latter.

At this point, of course, a new entrepreneur in the security field could come along and try to undersell the consortium by charging for domestic law enforcement only. But at this point Solution Six might be combined with Solution Two; just as many people today practice “socially responsible” investing, refusing to invest in companies with bad environmental records or poor employment conditions, many might refuse to deal with any protection agencies other than consortium members.

All these ideas are only armchair speculations, of course. Once again, I expect that entrepreneurs alert for profit opportunities would be a lot more imaginative than I have been here. Thus I am optimistic about the ability of the market to supply even such public goods as national defence.