Economics, Prof Andrew Morriss
Notes from 8/9/06: Public Goods, Free Riders, Common
Problems, & the Role of Government
I.
Public Goods
a.
A public good is
i.
Nonrivalrous: the marginal cost of an additional person consuming
the good, once the good has been produced, is zero.
ii.
Nonexcludable: the good cannot be withheld from one person without
withholding it from all.
b.
Examples: Parks,
lighthouses, national defense (missiles, etc.), fire protection
i.
Which goods
claimed to be public are actually public goods?
Lighthouses have historically been provided privately (the people who
have a vested interest in entering a harbor pay for the lighthouse)
ii.
How can we tell
if something really is a public good? Ask if the good is nonrivalrous
and nonexcludable
(Lighthouses can be excludable)
iii.
Can the political
process differentiate between them correctly?
What features must the process have in order to do so?
1.
Taxes: Can we
charge people through a fee for the good, linking payment to consumption? Or, do we have everyone pay for it regardless
of who uses it? (Example: Education)
2.
Government may
label something a public good even if it is not because of:
a.
Raise more taxes
b.
Self-interest:
Allows people in the government to produce the things that they want to produce
II.
Free Riders
a.
Someone who receives
the benefits of public goods, positive externalities, or other goods without
contributing toward the cost of producing the good he receives.
b.
Problem: Where we
can’t exclude non-contributors from sharing in a good, people will undercontribute toward production of the good.
c.
Solution:
i.
Exclude
non-contributors
ii.
Reward
contribution
1.
Example:
Environmental groups give contributors bumper stickers to thank them for
contributing.
iii.
Force
contributions (taxes)
d.
Social insurance
(Musgrave, p. 73): “it is in the public interest that all individuals be
required to insure. If left tot heir own
volition, the reckless may abstain, leaving it to the prudent to bail them out
later on. A minimum level of insurance,
whether private or public, has to be made mandatory to protect against free
riding.”
e.
“Good fences make
good neighbors” à Minimizes negative externalities
III.
Tragedy of the
Commons
a.
Class of economic
problems concerning public goods; problem of managing access to a resource
i.
Garrett Hardin, The Tragedy of the Commons, 162 Science
1243-48 (1968) à Drew from English medieval agriculture; “The tragedy of the commons…is
averted by private property, or something formally like it.”
b.
Where no
individual bears the full costs of his/her behavior and there is no
means to regulate access to a common resource, each individual’s
cost/benefit calculation leads him/her to overuse the resource.
i.
Example: Deep-sea
fishing, Coral reefs
IV.
Questions
a.
How big should
government be?
i.
Musgrave à big; Buchanan à limited
b.
How much should
it be involved in providing public goods, solving free rider problems, and
ending tragedies of the commons?
c.
Why is Buchanan
more worried about expanding government than Musgrave is?
i.
Buchanan is
reluctant in increasing government’s role because of the corruptibility of
government institutions and officials, as well as inefficiency, the
principle-agent problem (non-transparency of government), and limitations in
options and change à In private industry, there is more accountability and more tools for
solving the principle-agent problem because you can sell stock (short-selling)
or buy stock in competitors
d.
What is the
“electoral fallacy”?
i.
Natural
discrimination of majority rule (see graph on page 114) à problem of efficiency
1.
Pareto optimal
choice (named after Vilfredo Pareto)
2.
Kaldor-Hicks
optimal choice (less restrictive version of Pareto option)
ii.
Possible
outcomes:
1.
Equal taxes,
equal benefits
2.
Majority
coalition, minimal cost (cost to minority is less than benefit to majority)
3.
Majority
coalition, waste (cost to minority exceeds benefit to majority)
4.
Majority coalition,
redistribution among majority (cost to minority equals benefit to majority)
iii.
Buchanan believes
that majority rule without restrictions to protect minorities will always
result in inefficient solution
1.
Possible
solutions: Supermajority, Unanimity
2.
Musgrave says
that there are a lot of benefits we miss out on by requiring unanimity, so he
would want to loosen those restrictions
V.
Tastes
a.
How much do I get
to impose my tastes on you? Can I use
government to make you comply with my tastes?
i.
People use public
goods or externalities arguments to justify such imposition
ii.
Buchanan says
that such arguments are utilized by majority – or at least those with authority
– to impose restrictions on minority.
b.
Buchanan, p.
84-85: “A lot of opposition to markets comes about because people don’t like
what [other] people prefer. They don’t
like [other] people’s tastes and, therefore, they want to impose a better
standard.”
c.
Can tastes and
preferences be developed by circumstances?
VI.
Lessons from the
American West
a.
Hernando
b.
The Plains Cattle
Industry (Lewis Atherton, The Cattle Kings, 1961; Walter Prescott Webb, The
Great Plains, 1931)
i.
Motivations for
raising cattle
1.
Cattle are a more
efficient way of producing meat (fewer negative externalities than buffalo) à motivation to increase supply
2.
Refrigerated
train cars allowed beef/cattle to be transported to other parts of the country à increased demand à motivation to increase supply
ii.
Problems
encountered in
1.
Hard winter of
1886-1887 à many cattle died à created commons problem (how do we identify whose cow is whose?) à Process of branding was invented
2.
Who owned the
“mavericks” (the calves separated from their mothers)?
iii.
Cattlemen’s
Association
1.
Cattlemen formed
an association, which conducted one roundup (more efficient than doing it
separately) and shared costs and externalities à incentive to belong à Assessed members for stock detectives, required
bulls, and coordinated political action (became dominant political force in
Wyoming)
2.
Problem: Association
couldn’t own the land because it was
owned by the federal government.
Homesteaders would claim land near rivers and block access for cows.
iv.
The Johnson
County War (woman prostitute executed for accepting cattle for payment)
v.
1.
Land sold à Enforced property rights (fences, barb wire, land
improvements, better stock, windmills, rotation of pastures) à Internalized externalities
2.
Different
behavior between cattle ranching in
3.
Peaceful
transition from range cattle to mixed use à Ranches profit from sale of land to farmers and towns
vi.
Lessons
1.
Private solutions
are possible to serious problems
a.
b.
2.
Institutions can
frustrate private solutions
a.
Land laws
prevented Cattlemen’s association from implementing their own private solutions
b.
Violence resulted
from institutional failures
VII.
Constraints
a.
Both Musgrave and
Buchanan agree that some constraints
are necessary on the power of the state, which limits its ability to solve
commons, free rider, and public good problems.
i.
Why?
ii.
What are they?
b.
Buchanan &
Musgrave differ in the weight they each give to the good and the bad possible
outcomes.
c.
James Buchanan, Public
Finance and Public Choice, p. 89 à quote about whether or not to muzzle a pet tiger
(Buchanan would argue that it is in a tiger’s nature to do things that might unintentionally
be problematic or bad à government has a lot of power that, while trying to do good – as is in
its nature -, might result in negative consequences; therefore, we must
constrain its power to keep its inadvertent negative effects in check)
Notes (cont)
I.
Human Nature
(Buchanan) à We care less about other people the further away we get from ourselves
a.
“Humans possess
moral capabilities that allow them to incorporate the interests of others than
themselves as motivating forces of behavior, but that these capacities are
limited along the dimensions that measure the number, locational
proximity, and relationships involved.” à We may say that we care about everybody, but not
equally.
b.
“Political
interaction, of logical necessity, involves or includes all members of the
relevant political community, in comparison and contrast with private
interaction that reduces the direct relationship among parties to those that
are voluntarily chosen, including the buyer-seller setting for the exchange
nexus.” à We care about family
and private exchange/business partners more than we would about people in a
political relationship (where we have a much larger group)
c.
“A person’s moral
capacities are more challenged in a political, or collective, interaction than
in any voluntaristic relationship.”
d.
People are
willing to except greater inequalities in distribution the more that the
distribution is tied to merit.
e.
Three types of
societies we might live in:
a.
Moral anarchy:
“reflects the pursuit of (p. 209)
b.
Moral community:
“at least a large number treat others in the community as extensions of their
own selves and behave as if the inclusive community is the relevant moral unit
(p. 209)
c.
Moral order (for
large groups): “people do not treat the interests of others as their own (save
for family members). (p. 209-210) à people exist at potential reciprocating partners,
which serves as reason enough to treat others well à this is the best we could hope for in a large society
f.
Implications
a.
“much of the moral rot that we observe, in both private and
public behavior, is traceable to the exaggerated size of the public sector
relative to the total economy.” (p. 217) à we don’t distribute government money based on a way
that truly benefits those receiving it; we do it in such a way as to maximize
benefit to those distributing the money.
1.
Example: Welfare
office compared to competition between Catholic Church and
2.
Much emphasis on
protection of due process has stemmed from welfare system
b.
“properly
designed institutional-constitutional change can move behavior at least some
direction toward the classical liberal set of minimal standards that seem
necessary.” à designing government to provide incentives to those who work in
government so that they will be motivated to be good
1.
Example of
c.
Generality
requirement in imposition of taxes and provision of public goods reduces
incentive for special interest favor seeking.
d.
Public as commons
(Rick Stroup) à Good government is a common good.
II.
Human Nature
(Musgrave)
a.
Current market is
not enough to provide for personal relationships à “the market, efficient and helpful as it is (p. 233)
b.
“individuals as
citizens of their community share common obligations and do so on a daily
basis, including their conduct of the public sector (p. 233)
c.
(Buchanan’s view
of perfect society is moral order)à Musgrave adds justice, fairness, equality, and other
concerns as motivation for our interactions: “one that combines the
self-interest-based of the market as an (p. 226)
d.
Implications:
a.
Public sector is
needed to accomplish certain moral ends (in addition to providing tangible
goods and services) that cannot be provided by private institutions
b.
Primary issue is
to avoid causing distortions via the funding mechanism (taxes, fees). à Provide these things (above) without messing up the
market.
c.
Can have people
behave themselves in government à They will behave themselves
because of this moral inclination.
III.
Questions
a.
Whose view of
human nature is more realistic?
b.
What are the
consequences of structuring our society based on one view or the other?
c.
Do we have to
decide such issues to make political decisions about the structure of governments? That is, for example, do we really need to
have a complete understanding of human nature before we can write a
constitution?
IV.
Fiscal Federalism
(Musgrave)
a.
Reason for
federalism is economically-driven
b.
Competition
between jurisdictions within a state
a.
Resources should
move to the jurisdiction that is doing a better job with regard to both taxing
and spending
b.
Cost of moving
limits
c.
Capital vs. labor
– Capital moves relatively easily compared to labor
1.
2.
Bad policies
relating to labor will last longer than those relating to capital
c.
Matching
principle
a.
Match resource
provision to problem solution (if a state is successfully solving a problem, it
should be receiving the resources)
b.
Make jurisdiction
levying tax as close to boundaries of area benefiting as possible
1.
Example of
shoving cost on someone else: Power plant on border of
d.
Decentralization
brings government closer to people
a.
People in a
region better understand the needs and preferences in that region and have more
of an incentive to find effective and efficient solutions
b.
Sorting by tastes
c.
Better
representation
e.
“The optimal size
of the public sector with finance by lump sum taxation would be one thing, but
that with income or even value-added taxation is another.” (p. 65-66) à Lump sum taxation is the most efficient à Different types of taxation will result in different
optimal sizes of government
a.
What does he mean
by the “optimal size” of the public sector?
How many public goods/solutions to commons problems are we going to buy?
b.
Why does it
matter how the government is funded?
f.
International
competition
a.
Competition or
harmonization? à Should states work together in the international economy, or compete
with one another? à EU and US are examples of working together
1.
Tax rate
competition
a.
EU: Ireland has
low rates, France has high rates à Ireland was willing to give up some of the size of
the government in order to attract more business; France needed high tax rates
in order to keep large government
2.
Regulatory
measures
a.
Beer example à EU negotiated rules about what can be called beer
(helps
b.
Enhancing
transparency
1.
Euro – It is
easier to tell if one state is charging more than another when there is no
currency conversion required à Can facilitate competition
c.
Race to the
bottom or race to the top?
1.
Race to the
bottom: Example of air pollution (better economy at the cost of greater air
pollution) à race to the lowest possible standard (
2.
Race to the top:
Compete to the most efficient level of pollution control; as we see GDP per
capita rise (past $5000), people tend to demand higher environmental standards
V.
Political
Federalism (Buchanan)
a.
Reason for
federalism is politically-driven
a.
Competition
between states: “a means by which you restrict or have some control, through
built-in institutions that will control the government.” à States compete so that they can take credit for
solving a problem (if national government takes over in order to solve a
problem, states lose their power) à This argument has become less persuasive in recent
years because of grants-in-aid
b.
More
opportunities to leave because there are more places to go to: Enhance the
opportunities for exit by reducing the cost of leaving (it is easy for me to
move to any of the 50 states)
c.
Gregory v. Ashcroft, 501 US 452, 458 (1991): “Just as the separation and independence of the
coordinated branches of the Federal
b.
Rationales
a.
Differing local
tastes
1.
Example: Country A
and Country B, each with 100 residents: 70% of Country A and 40% of Country B
favor a ban on public smoking à Decision at international level, ban wins 110-90 and only 55% of total
population are happy with outcome. If
the decision is left to each place independently, 65% of the people are happy +
people who are not happy have the option to move to the other location, where
they will be happy.
b.
Differing local
physical conditions
c.
Competition among
jurisdictions
d.
Experiments
1.
New State Ice Co. v. Liebmann,
285
c.
Federalist
countries: Switzerland, Canada, Germany, Brazil, United States, Australia,
Mexico, India, Spain, Britain, Russia
d.
Competitive
jurisdictions
a.
Tiebout competition/voting with one’s feet
b.
Capital
mobility/labor mobility
1.
International:
Offshore sector
c.
What constraints
are imposed by such competition?
1.
Impact of
relative mobility on ability to tax (Rich tend to relocate to jurisdictions
with lower tax rates)
VI.
What should the
national government’s powers be?
a.
Should the
national constitutions restrict state powers?
a.
Musgrave: Tax
solution
b.
Buchanan: Tough,
independent governments competing with each other will result in devolution of
power and restraint
b.
Transboundary issues
a.
Pollution
b.
Commerce
c.
Foreign policy
d.
Crime
c.
Representation of
states in the national government? (Note: problem of Senators being directly
elected)
a.
EU’s problems over expansion and voting
d.
Tax powers
a.
“power to tax is
power to destroy”
e.
Grants/bribes
(Grants-in-aid) à Destroys benefits of variation
f.
States as
laboratories
g.
Race to the
bottom vs. Race to the top
VII.
Problems
a.
Weak national
sovereign (Example: Articles of Confederation à constitutional convention solution to completely
replace the Articles)
b.
Interest groups
forum shop (Example: Pick the parent that will give you the answer you want)
c.
Federal “ratchet”
effect (Once the federal government starts taking more power, it continues to
grow more powerful)
d.
Fiscal dependence
on federal government
e.
Regional interest
groups
f.
Exit – who
decides, when, how, etc.
a.
b.
Former Yuogslovia: numerous wars
c.
Former
d.
e.
VIII.
Social Capital
a.
The central
premise of social capital is that social networks have value. Social capital refers to the collective value
of all “social networks” [who people know] and the inclinations that arise form
these networks to do things for each other [“norms of reciprocity”]. à We have value in having connections with one another
a.
Book: Bowling Alone
b.
The term social
capital emphasizes not just warm and cuddly feelings, but a wide variety of
quite specific benefits that flow from the trust, reciprocity, information…
c.
Benefits of
social capital
a.
Information flows
(e.g., learning about jobs, learning about candidates running for office,
exchanging ideas at college, etc.)
b.
Bonding networks
that connect folks who are similar sustain particularized (in-group)
reciprocity
c.
Bridging networks
that connect individuals who are diverse sustain generalized reciprocity.
d.
Collective action
depends upon social networks… although collective action also can foster new
networks.
e.
Broader
identities and solidarity are encouraged by social networks that help translate
an “I” mentality into a “we” mentality.
IX.
Discussion
a.
Buchanan says (p.
177) that he approaches federalism questions “from the point of view of
political philosophy” while Musgrave approaches it “very much from the point of
view of a fiscal economist.”
a.
Question of
Resourcefulness vs. Questions of Authority and Power
b.
Technical vs.
Moral
c.
Economics leads
to questions of society and world à leads to integration with politics and philosophical
approach (what institutions will give me the world that I want in the future? à goes beyond supply and demand curves)
b.
“I think that one
thing that Musgrave fears is that if you have effective interjurisdictional
competition, it is going to be impossible for any one particular jurisdiction
to be grossly inefficient, relative to the other units in the integrated
network or the integrated nexus. There
is no way you can deny that, and in one sense I think those who are opposed to
fiscal competition really are saying indirectly that we want a jurisdiction to
be inefficient in the strict sense of economic efficiency.” (p. 179)
a.
Musgrave sees
race to the bottom; Buchanan sees race to the top
b.
Buchanan: There
will be winners and losers, but a free market will naturally find its way
towards less government, which, overall, is better. (That is, competition has
its costs, but its benefits outweigh these costs)
c.
We live in a
world with lots of trade agreements (hundreds of pages) with lots of
restrictions and exceptions to benefit special interests; fully free market
would require trade agreements only one page in length (no special interests
have comparative advantage); corruption stands in the way of free trade
