A New Approach to the Economics of Public Goods

Thomas Laudal

• Publisher: Routledge
• Year: 2019
• ISBN:
  9781000706703
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Public goods are typically defined only in reference to the good itself but, as this book argues, the public goods can be better understood if contextual variables are incorporated. This book discusses the production and provision of public goods. It asserts that changes related to public goods are better understood if the category of goods are not decided solely by the properties of the good itself. We also need to focus on how the enabled utility of a good is influenced by the production and the provision of the good.

The book opens with a brief introduction to common conceptions of public goods and a review of the existing literature - highlighting the limitations of current definitions of public goods. It presents a new multi-layered approach to public goods. This has implications for the discourse on public goods and for our understanding of the societal and environmental impact of public goods. The implications are illustrated in several areas; public goods in ancient history, privatization, innovation, competitiveness and prices, democracy and political standards, and economic growth.

The book provides a provocative argument for a new way to analyze public goods which will appeal to scholars and students interested in the economic analysis of public goods, arguments regarding the privatizing or nationalizing of production and services, and method of modelling and measuring sustainable business activities.

1
Introduction

This text addresses the production and provision of public goods. It asserts that changes related to public goods are better understood if the category of goods are not decided solely by the properties of the good itself.¹ Relevant elements external to the good itself are the positive and negative externalities generated during production and the manner in which the good is provided to users/consumers and how this affects their access to the good.

Properties related to the production and provision of a public good are included in many published studies, but they are typically treated as exogenous variables. When the category of a public good is decided only by referring to the good itself, we focus on the potential utility, or the ideal utility of the good. The argument here is that the analysis of public goods also needs to focus on how the enabled utility of a good is influenced by the production and the provision of the good. It is argued that the defining characteristics of public goods should incorporate contextual variables by distinguishing between three public good “layers”:

• The utility-layer: The potential utility of the good itself.
• The supply-layer: The manner in which the good is provided.
• The conversion-layer: Characteristics of the value-added process.

We may consider arguments in favour of or against public goods by referring to the categories in the utility-layer and the supply-layer. We may further qualify public goods by characterizing the goods’ transformation, or the value-added process related to the provision of the good, by referring to the conversion-layer.

We start with a brief introduction to common conceptions of public goods in the economic literature. Then we present examples of changes of public goods that are described by referring to the distinction between a utility-layer and a supply-layer. Thereafter we extend this model by adding a conversion-layer to further qualify the public good. The next chapters look into several cases that show the descriptive and predictive advantages of a multi-layered approach to public goods. Finally we discuss whether the multi-layered approach may help us to better understand trends regarding public goods.

Note

1 The reference to “goods” in this text is meant to capture natural resources, commodities, and services, and both monetized and non-monetized transactions. This is in line with the tradition, starting with Alfred Marshall, when “wealth” became a reference to both “material” and “immaterial” goods (Hill, 1999, p. 433).

2
The economic literature on public goods

Most studies of public goods consider public and private goods as opposites. It is common to refer to two dimensions; a “non-excludable/excludable” dimension, and a “non-rival/rival” dimension. Our current understanding of public goods is based on insights of such diverse authors as Samuelson (1954), Head (1962), Buchanan (1965), Hardin (1968), Musgrave and Musgrave (1973), Ostrom and Ostrom (1977), Cowen (1985), Cornes and Sandler (1996), and Ledyard (1994).

From early on, it was pointed out that management of a public good is difficult when the task is left to a large group. David Hume wrote in the “Treatise of Human Nature”, first published in 1739:

Two neighbours may agree to drain a meadow, which they possess in common; because it is easy for them to know each other’s mind; and each must perceive that the immediate consequence of his failing in his part, is the abandoning the whole project. But it is very difficult, and indeed impossible, that a thousand persons should agree in any such action; it being difficult for them to concert so complicated a design, and still more difficult for them to execute it; while each seek a pretext to free himself of the trouble and expense, and would lay the whole burden on others.

(Hume, 1888, p. 538)

Another example of an early mentioning of the challenge of managing public goods is a lecture by professor of political economy, W. F. Lloyd, published in 1832. Lloyd claimed that contributing to a collective good is challenging when the group is large due to diminishing returns:

beyond a certain point of minuteness, the interest would be so small as to elude perception, and would obtain no hold whatever on the human mind.

(Lloyd, 1832, p. 18)

The remedy to these types of cases are “political society”, or “political associations”,¹ according to Hume (1888, p. 538). Other scholars focus on services that are suitable for public administration. Here the main issue is not the challenges of collective governance, but which functions are fit for governance by state institutions. Cohn (1895, p. 144) is one. He claims there are four classes of services fit for public administration:

• Services offered to the individual in exchange for some kind of payment.
• Institutional services that cannot be subdivided.
• Services in exchange for payment but engaged by a group and payed for according to ability, not according to the benefits received.
• Services that are offered to support the needs of one or more classes of citizens.

Modern economists have attempted to express the general challenges related to how large groups consider and share public goods. Paul A. Samuelson is one of the pioneers in this field. A question posed by Samuelson (1954) was whether it is possible to calculate the optimal public expenditure by applying an econometric model. He started out with two categories of goods: “ordinary private consumption goods” and “collective consumption goods”. In a formalized mathematical model, he demonstrates that an optimal public expenditure, defined as a Pareto efficient equilibrium, is not calculable in a decentralized market, or by voting mechanisms. According to Oakland (1969), Samuelson demonstrates how over- or under-production may lead to problems when we deal with both pure and impure public goods. It could be shown that pareto optimal conditions demand that public policy addresses the distribution of these goods (Oakland, 1969, p. 268). The distribution of public goods was addressed by Charles M. Tiebout in 1956. If consumers are mobile, we may see a large number of communities offering different variants of public goods.

The consumer-voter may be viewed as picking the community which best satisfies his preference pattern for public goods.

(Tiebout, 1956, p. 418)

It was assumed that there is an optimally sized community at each location. Consumers will sort themselves into homogenous communities offering the efficient amount of public goods. In these communities a Pareto efficient equilibrium, as described in Samuelson (1954), could be calculated in a decentralized market. It has been left to others to provide more detailed calculations and more realistic assumptions (Batina & Ihori, 2005, p. 311). According to Stiglitz (1982), Tiebout’s conclusion only holds under very special and unreasonable assumptions.

Head (1962) elaborates on the results of Samuelson (1954), when he shows that the discussions on “jointness” and “excludability” of goods are unrelated. Richard Musgrave has since made major contributions in particular by synthesizing earlier contributions in the field (see Sturn, 2010), and Musgrave and Musgrave (1973) and Cornes and Sandler (1996) popularized these insights.

Buchanan (1965) focused on “club goods” which refer to collective goods where exclusion is possible. Later these were labelled “toll goods” in Ostrom and Ostrom (1977). Buchanan found that an optimal relationship between the good and the number of members in a club is calculable given there are certain rules for participation. A key implementation of this is to allow for more flexible property arrangements and to develop exclusion mechanisms. Musgrave and Musgrave (1973, pp. 53–54) summarized the reasons causing market failures of public goods in a table where four categories of goods were determined by two dichotomies “excludability”/“nonexcludability” and “rival consumption”/“non-rival consumption”.

Ostrom and Ostrom (1977) explored the question of how we ought to organize and manage collective goods in general. They referred to the nature of public goods by categorizing public goods in four quadrants determined by two dimensions, first presented in Musgrave and Musgrave (1973): Excludability/non-excludability and joint/individual (rival/non-rival). According to Ostrom and Ostrom (1977) empirical evidence show that small groups and individuals are more successful in providing public goods than large groups.² This is why people seek governmental institutions. However, government distribution (bureaucracy) could lead to tyranny and difficulties in measuring performance, and a lack of communication between production units and consumers. Ostrom and Ostrom (1977) suggested that public goods are manageable when collective consumption is organized apart from production, and when we apply a market-like arrangement among producers and collective consumption units. This has been viewed as a “third way” apart from private and government property and has received much criticism (Block & Jankovic, 2016).

In the popular text by Hardin (1968), the prerequisites for a sustainable management of commons is discussed. A “commons” is exemplified by a plot of land used for grazing by a herd of livestock. According to Hardin, the rational individual will add animals to the herd to expand their activity, and thereby to increase their revenue. However, this will lead to the soil being depleted, and threaten the livelihood of all. Hardin (1968) claims that the history of human collaboration shows that commons are being abandoned in area after area. He claims that collective management of a commons only succeeds under conditions of low population-density. This view was challenged by scholars (e.g. Ostrom, 1990; Solstad & Brekke, 2011). A common argument is that the capacity of individuals to extricate themselves from various types of dilemmas related to common pool goods is contingent on the institutional environment and that there are many examples of this. Referring to Hardin (1968), Ostrom described a game in which the livestock owners can succeed in making a binding contract to commit themselves to a cooperative strategy that they themselves work out. Based on a number of case studies, Ostrom (1990, p. 90) suggested there are eight design principles that characterize a robust management of a common pool resource. These governance principles ensure broad participation in the governance of these resources and predictability and risk mitigation for the participants.³ Solstad and Brekke (2011) show that a pareto-optimal Nash equilibrium⁴ is achieved in a context where rational individuals manage a common pool resource, modelled as a two-stage sequential game. First, the harvesting of renewable natural resources takes place. Then the surplus from this stage is used for buying private goods and contributing to public goods. In this setting it is shown that the individuals share the objective of maximizing the total surplus.

In experiment studies, a public good is typically regarded as a collective asset managed by voluntary contributions. These studies include different setups involving participants contributing to the asset in the experiment. Central questions are whether people are more or less cooperative or selfish, and what the factors are that influence their willingness to pay for a good. Experiment studies show how participation and attitudes depend on different design factors surrounding the experiment (Ledyard, 1994), e.g. how the participants’ cooperation is improved when certain social norms are internalized (e.g. Rege & Telle, 2004). Other studies show that the willingness to pay for a public good cannot always be calculated by aggregating units belonging to a more general category (e.g. linked to territory or time). If a private purchase of the good is conceivable, as in the case of access to fishing resources for example, we tend to see aggregated values more frequently than if private purchasing of the good is unconceivable, as in the case of air traffic controls (Kahneman & Knetsch, 1992).

In general, most of the economic literature on public goods focus on the optimal distribution and the optimal price, and on problems related to collective governance. There is some agreement among economists on the difficulties involved in calculating the optimal expenditure of a public good. And several social scientists are critical to the mere notion that we are able to calculate or govern public goods by referring only to properties of the good itself. According to Cowen (1985) we need to include the institutional framework surrounding the good, and how the good is produced and provided to determine the category of the public good. Stretton and Orchard (1994) argue that the amount and kind of public goods in mixed economies must be ordered and allocated by a mixture of political, administrative, and market choices. Majority rule – directly at the political level, or indirectly at the administrative level – should influence the amount and kind of public goods, not only markets. Malkin and Wildavsky (1991) also believe the institutional and political framework should influence the public good category, but they underline that efforts to categorize public goods are, and must be, a normative exercise; public goods are socially constructed.

Neither of these critiques present a model which incorporates characteristics of both the good itself, and the relevant institutional framework, though they take the position that institutional or political contexts should be recognized when the type of public good is determined. Cowen (1985) points to the lack of institutional variables in such analysis, Stretton and Orchard (1994) argue that elected entities should have a say, while Malkin and Wildavsky (1991) dismiss the notion that we should look for discrete criteria determining public goods categories.

The aim of the multi-layered approach to public goods is to meet the critique of the institutionalists, the levellers, and the social constructivists by suggesting a model that incorporates the main features of the good itself and the relevant institutional framework.

Notes

1 In the 18th century the term “society” commonly referred to as an association of persons, not to the more general notion of a “community”. Hence, today we should probably understand this reference as a reference to “an association with a political purpose or aim” (Online Etymology Dictionary: www.etymonline.com/word/society).

2 ‘The linking of group size and “public good” dates back to the writings of the ancient p...

Table of contents

• Cover
• Half Title
• Series Page
• Title
• Copyright
• Contents
• Preface
• Acknowledgements
• 1 Introduction
• 2 The economic literature on public goods
• 3 Advantages of studying public goods with reference to a utility-layer and a supply-layer
• 4 The value-added process linking the utility-layer and the supply-layer
• 5 Descriptive and predictive value of a multi-layered approach to public goods
• 6 Public good trends
• 7 A multi-layered approach to public goods
• Literature
• Appendix
• Index