By John Kessler for the Indiana Policy Review print and online editions, August 14, 2015.
Public goods have two characteristics – non-rival and non-excludable. Non-Rival – making the good available to one person makes it available to others and one person’s use of it does not diminish someone else’s use.
Non-Excludable – you can’t prevent people from using it so it is difficult to limit its use to only paying customers. Examples of public good – broadcast television (make point about finding ways to pay for it) and national defense (make point about Free Rider Problem).
It is the Free Rider Problem that makes it difficult for markets to provide public goods and why we may want to consider government production if the market can not find another way to pay for it (like we did with advertising).
Now that we know what the government should do, lets look at some of the problems government faces when they try to do things. Here it is important to point out two economic concepts – incentives matter and opportunity cost.
Incentives matter - It is important to realize that politicians and voters are people and we know that people respond to incentives.
We all, hopefully, grew up learning about the tyranny of the majority. The reason we don’t have a direct democracy in America is because our founding fathers recognized the potential harm of the tyranny of the majority. So instead we got a representative democracy. What we did not grow up learning about is the tyranny of the minority – when small groups of people can inflict their will on the majority of people.
This is where the economics of Public Choice Theory is helpful and explains a lot about why we get the public policies that we do. In a representative democracy like we have special interest groups have a disproportionate influence over the system. Here is why: Benefits to a few – usually the wealthy. Costs to the many – usually the poor.
When policy outcomes lead to benefits to a few and costs spread out over many then the tyranny of the minority can happen.
Let’s illustrate this by taking one example of an economic development proposal and look at it through the lens of what we’ve discussed so far. One of the favorite proposals of economic development committees is to build a stadium in the city.
I bring up this example because recently Presidential candidate and Governor of Wisconsin, Scott Walker has proposed a near $500 million subsidy to the Milwaukee Bucks to pay for a new stadium.
First, is this something that government should be involved in – is it a protective function? (NO!) Is it a public good? Is it non-rival and non-excludable? (NO!)
Second, then why do we do it? Benefits to the few – owners; Costs to the many – taxpayers. In a direct democracy if someone said we are going to vote on whether to take some of your money and give it to another person you would vote no and it wouldn’t happen. But in a representative democracy it might. What incentive do owners have to lobby in favor? What incentive do taxpayers have to lobby against?
This leads me to the other economic concept that is important to this conversation – opportunity cost.
2. Opportunity cost – there is always an alternative use of our money and resources.
When the government, or anyone for that matter, decides to do something there is always an opportunity cost. What else might the taxpayers have done with the money? Where else might the workers have worked? What other public issue might have been better served with the money?
It is very difficult for the government to spend money and create economic development that wouldn’t have happened somewhere else instead. The government merely shifts where the money is spent and no new economic activity is created (only a different kind).
When thinking about what kind of activities government should pursue we should limit ourselves to those things that fall into the protective function category or are clearly public goods that are non-rival and non-excludable in nature and there is no alternative for the market to provide it alone. Of course, we will be tempted to go outside of these bounds because of the incentives of the political process so we should try to focus on the opportunity cost of our decisions so that we will hopefully do the most good that we can for people with our scarce resources.
If you are going to subsidize something you should always subsidize the consumer and never the producer. Producer will take subsidy and have no incentive to give quality product at low cost. Consumer will take subsidy and shop around for best deal and the market will force producers to give good quality at low cost.