Prof.
Bryan Caplan
bcaplan@gmu.edu
http://www.bcaplan.com
Econ
410
Week 1: Public
Goods, Externalities, and Comparative Institutions
I.
What Is Public Choice?
A.
Economists usually study and analyze markets; when they need to talk
about government, they often "tack it on" to the analysis in an ad
hoc manner.
1.
Ex: Free trade and tariffs
2.
Ex: The macroeconomy and monetary and fiscal policy
B.
But why not instead study and analyze government in the same way that
we normally study and analyze markets?
1.
Separation of positive and normative questions
2.
Internally consistent models
3.
Looking at evidence
C.
Alternate description: "endogenizing government behavior."
D.
Beginning about 40 years ago, the branch of economics known as
"public choice" has tried to do precisely this.
E.
In addition to "public choice," there are several other terms
that more or less describe the same field of study and approach:
1.
Political economy (or "positive political economy")
2.
Rational choice theory
3.
Social choice theory
4.
Formal political modeling
5.
Economics of governance
6.
Endogenous policy theory
F.
Public choice is one of the fields GMU is best-known for, especially
because of James Buchanan's Nobel prize for work in this area.
G.
Main alternative to public choice: the "public interest" or
"civics textbook" view.
II.
Private vs. Social Benefits and Costs
A.
Background to public choice: realization that private and social
effects can differ.
B.
Ex: A thief clearly enjoys private benefits of stealing. But looking only at the thief's benefits
misses the big picture: The thief making himself better off by making others
worse off.
C.
Ex: A person driving a
polluting car is better off from driving, but that person isn't the only one
who consumes the exhaust.
1.
Contrast with: Worker safety trade-offs.
D.
How to measure "social benefits"? The same way we always do: willingness
to pay. If some people benefit and
some people suffer from a policy, the net social benefits are the SUM of the
private benefits (positive and negative).
E.
Issues frequently become political when private and social costs differ.
F.
Moreover, once a decision is political, it almost inevitably implies
costs and benefits for people who opposed the decision, not just its
supporters.
III.
The Tragedy of the Commons
A.
Economists usually focus on how ownership gives people incentives to
use resources in a sensible way.
B.
But it is possible for
something to be unowned. This has
frequently happened. For example, a
pasture may be "common property." Oceans are normally unowned, accessible
to all.
C.
Frequently, however, common ownership gives rise to what economists
call the "tragedy of the commons." Since no one owns it, people use it
without regard to the effect on others.
D.
And, once you realize that people think this way, you also have an
incentive to take as much as possible NOW, because the resource won't be useful
very long. This can
"snowball" into an awful outcome that benefits no one.
E.
Key idea: If one person owned the fisheries, or a forest, or a pasture,
they would have the incentive to maintain it, improve it, and take a long-term
perspective.
F.
That is the benefit of property rights that is absent in the commons -
a benefit not just for owners, but for users as well.
IV.
Negative Externalities
A.
In sum, the basic idea of the tragedy of the commons is that when no
one owns a resource, it gets over-used.
B.
Question: But what exactly does "over-use" mean in economic
terms?
C.
Answer: It means that there are costly side effects that selfish agents
don't factor into their decisions.
Economists call these costly side effects "negative
externalities."
D.
How do you diagram negative externalities? In addition to the demand curve, draw a
"social benefits curve."
With negative externalities, the social benefits curve will lie below
the demand curve.
E.
Social optimum is at the intersection of the social benefits curve and
the supply curve, but market equilibrium is at the intersection of the demand
curve and the supply curve.
F.
Economists call this a market failure, since self-interested
behavior leads to inefficient results.
G.
Negative externalities are also often called "public bads,"
especially when the externalities are large relative to demand (so the socially
optimal quantity is close to zero).
H.
Ex: Pollution. People value
better air, but polluters normally have no incentive to care.
I.
The key: non-excludability.
1.
There is no feasible way to exclude non-payers from the cleaner
air.
2.
Since you do not have to pay
to use it, selfish people will not
pay to use it.
3.
And if no one will pay for it, why would selfish producers provide it?
V.
Positive Externalities
A.
Positive externalities are the other side of the coin. Positive externalities are beneficial
side effects that selfish agents don't factor into their decisions.
B.
How to diagram? Draw a
social benefits curve above the demand curve.
C.
Positive externalities are also often called "public goods,"
especially when the externalities are large relative to demand (so the
equilibrium quantity is close to zero).
D.
Non-excludability is once again the key attribute. If you can't exclude, there is no
incentive to pay; if there is no incentive to pay, there is no incentive to
produce.
E.
Ex: Defense. People value
defense, but how can suppliers be paid to provide it?
VI.
Understanding Externalities
A.
Many textbook treatments of externalities and public goods/bads also
emphasize "non-rivalrousness" - the low or zero marginal cost of
providing them. But I see this as a
distraction, so we'll ignore it.
B.
David Friedman's two caveats:
1.
Must distinguish benefits from external benefits. (E.g. education).
2.
Must include both positive and negative externalities in your
calculations. (Important case:
"pecuniary externalities").
C.
Some popular and plausible examples: air pollution, national defense,
highways and roads (especially local roads), law enforcement (especially
victimless crimes)...
D.
Some popular but dubious examples: education, health and safety, fire,
R&D...
E.
Some unpopular but plausible examples (depending on the society):
censorship, persecution of religious minorities...
F.
Further insight from Friedman: "It is easy to misinterpret
problems of market failure as unfairness rather than inefficiency... The
problem with public goods is not that one person pays for what someone else
gets but that nobody pays and nobody gets, even though the good is worth more that it would cost to produce."
(p.278)
VII.
Correcting for
Negative Externalities
A.
A common initial
reaction people have to negative externalities is: "Ban it!"
B.
Obvious
objection: The cure is worse than the disease. Many valuable activities (like driving)
– and even many activities essential to life (like breathing!) - have negative externalities.
C.
If they grasp
this point, many people's next impulse is to set quantitative limits –
like emissions inspections, or technological mandates - like new emissions
standards for cars.
1.
A particularly
crazy variant: "Best Available Technology."
2.
Perverse effects
of technological mandates: Since they raise the price of new cars, they
encourage people to keep driving old cars that pollute a lot more.
D.
These approaches are highly inefficient.
Quantitative limits and technological mandates ignore heterogeneity:
Some firms can reduce pollution more cheaply than others; some people may value
polluting more than others; some technologies may cost more than they are
worth.
1.
Application:
Carpool lanes.
E.
More efficient regulatory solutions that take
heterogeneity into account exist:
1.
Taxes
2.
Tradable permits
F.
Advantage: This
gets you the same pollution level at a lower price. Firms that can easily switch to less
polluting technologies sell their permits to firms where reducing pollution is
expensive.
G.
Complication:
Getting the margin right. A tax on
cars reduces the number of cars produced, but does nothing to discourage people
who own cars from polluting.
VIII.
Correcting for
Positive Externalities
A.
A common initial
reaction people have to positive externalities is: "This is a job for
government, not the market."
B.
Obvious
objection: Overkill. There is no
need for government to take over the whole industry just because of some
positive externalities.
C.
A much less
intrusive option is for government to subsidize activities with positive
externalities.
D.
Getting the
margin right: Suppose there are positive externalities of voter education, but
not math. If you subsidize ALL
education, adjusting for the externalities of voter education leads to an inefficiently
high level of mathematical education.
IX.
Externalities,
Property Rights, and Coasean Bargaining
A.
The economist
Ronald Coase pointed out that government action to correct externalities is
often premature.
B.
Another solution
to the externality problem is to define property rights, then allowing parties
to bargain. So long as
"transactions costs" are low, externalities won't be a problem.
1.
Caveat: Common
sense ethics tells us to distinguish e.g. polluters from pollutees. But from an economic point of view it
can be equally efficient to make polluters pay pollutees for the right to
pollute, or have pollutees pay the pollutees to pollute less.
C.
Corollary:
eliminating property rights can turn any situation into a public goods
problem. (E.g. provision of food).
D.
Interesting
application:
1.
International
pollution trading
X.
Externalities as
a Rationale for Government Intervention
A.
Externalities/public
goods are probably the main economic rationale for government intervention.
B.
When economists
see negative externalities, their usual reaction is to say "Government should tax (or
ban) that."
C.
When economists see positive externalities, their usual reaction is to
say "Government should subsidize (or produce) that."
D.
Big problem: If government has
the power to tax negative externalities, political forces may lead it to tax
all sorts of things with no negative externalities to speak of. Similarly, if government has the power
to subsidize positive externalities, political forces may lead it to subsidize
all sorts of things with no positive externalities to speak of.
E.
In other words, externalities may affect government behavior as well as
market behavior. If so, we face a
choice between market failure and government failure.
1.
Ex: Voter acquisition of information
XI.
The Comparative Approach to Markets and Government
A.
The tale of the Roman emperor and the two minstrels.
B.
Moral: The sensible approach is comparative.
C.
What are the main public goods problems markets face? The main public goods problems
governments face?
D.
How can markets and governments solve public goods problems?
E.
Market solutions to market's public goods problems:
1.
Most general: Have private property rights whenever possible, and don't
restrict bargaining.
2.
The unanimous contract (condo association)
3.
The privileged minority (mowing your lawn)
4.
Bundling (commercials on radio and TV)
5.
Merger (orchard owner marries beekeeper)
F.
Market solutions to government's public goods problems: ?
G.
Government solutions to market's public goods problems: get
around high transactions costs by coercion.
1.
Subsidize/mandate (national defense)
2.
Tax/regulate (air pollution)
H.
Government solutions to government's public goods problems: ?
1.
Constitutional reform is a popular answer, but there is every reason to
think that constitutional politics works just like regular politics.
I.
Important: If the government is unable to solve the public goods
problems of government, then there
is no reason to think that government will want to solve the public
goods problems of markets that it can
solve!
J.
Perhaps this explains why most of what actual governments do has
nothing to do with public goods: Social Security, Medicare, education...