Hidden Assumptions of Public Goods and Information

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This is another post on public goods inspired in part by Santiago’s previous post on the under provision of entrepreneurship as a public good argument. I admit that this post does not fully respond to the precise argument, as that would require a more fundamental critique of equilibrium analysis (hence, a potential future third post on this), but it’s still necessary to flesh out a more robust view of public goods.
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Here, I want to focus on another aspect of public goods theory, as applied to a particular type of “good” – information. This is equally applicable to things that would today be patented (inventions) or copyrighted (creative expressions) under intellectual property laws, my research area, but also to information itself, as is disseminated via the price system.

In many ways, information is the purest (only?) public good. If we apply Samuelson’s (1954) typical public goods analysis, we find that once information is produced, it is instantaneously available for everyone to use simultaneously (non rivalry) and it’s damn near impossible to contain the spread of information to prevent others from using it (non excludability).
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Now, to be complete, both the inputs to producing information (the research and development expenditure, the erection of a specific complementary capital structure), and oftentimes, the products that result from produced information (physical products born of invention, CDs, DVDs) are excludable, if not also rivalrous. There are complications, but it’s largely the information itself that is the “messy” part of the economic analysis. Thus, following traditional public goods/welfare economics theory, the market will under-provide information (and inventions and creative expressions, etc).
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Naturally, any of us at this blog and many of our colleagues, friends, and readers would turn to public choice (sure government could try to correct this under-provision, but is the benefit not outweighed by the cost and risk of the system being abused/captured/used for rent-seeking?) or market process analyses (how such interventions would distort the price system’s ability to disseminate distributed knowledge by affecting entrepreneurship). For the first, you could look at Boldrin & Levine’s masterwork, for the second, might I humbly suggest my forthcoming article.
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However, I want to see if we might address the common argument with a neoclassical framework before resorting to these other (valid and complementary) perspectives. As I argued previously, the traditional theory is exogenous, where the conclusion of under provision logically follows from the way we define goods as inherently possessing particular qualities. Likewise, in this case, producing information supposedly exhibits a free rider problem because the non rivalry and non-excludability prevents the producer (discoverer/inventor/artist) from capturing the full social value of their information, as it is largely dissipated away amongst the rest of society (including rival producers).

Yet, as Richard Wagner (2012, 2013) argues, the free rider problem is not inherent in the provision of the good itself, but is an “artifact of particular institutional assumptions.” The true problem is that there is some inalienability of ownership over the good, which is often the result of some institutional failure, often in the public realm.

In the traditional view of information, there seem to be a number of implicit assumptions that are unwarranted and must be jettisoned. The usual story seems to assume two things (in addition to non-rivalry & non-excludability):

1. Once an idea is discovered, it is instantly and costlessly broadcasted anonymously to everyone

This statement has a lot of moving parts to it that need to be dissected. First, ideas are rarely broadcasted like a TV-show over the air out of NBC to all who have a (legal or illegal) receiver. Furthermore, those ideas that are broadcasted do not reach everyone. Take blogs for example, the paramount form of hailed modern citizen-journalism, open to all who have internet access (assuming it is not passworded or private). Most blogs will ultimately be accessed by a select group of people.
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This leads to the second point, that only some interested minority will receive any given idea. Tune into C-Span at any random time during the day. This is the Samuelsonian ideal type: a speaker is literally broadcasting ideas to everyone watching. But notice how many empty seats there are in Congress, not to mention the millions of Americans (I venture to say 99%) who chose not to watch C-Span, even if they were somehow all made aware of the schedule of speakers and topics.

Third, ideas are rarely anonymously spawned and disseminated. One can think of “memes” on the internet. Few people know who started the “Doge” meme (though Know Your Meme is doing the Lord’s work trying to find out). It obviously passed through a network of people commenting and sharing jokes on places like Reddit, which got out to 9Gag, and Facebook, and finally even U.S. Senators start using it (when you know it’s time to abandon ship). Though, in principle, anyone with internet access could potentially discover it, it is not until it flows through channels of social networks that it becomes “a thing” and is copied, remixed, and parodied.

Finally, ideas are not disseminated costlessly. Perhaps this is not a large effect, and there are plenty of cases where they could be diffused at negligible cost, say if J.K. Rowling stood on a soapbox in Trafalgar Square and shouted out the text of Harry Potter to passersby. But there still needs to be strong investments to generate hype and advertising. Imagine how much harder it would be for her, further, if she did this before anyone had heard of Harry Potter. The most obvious example of this effect for us is our capacity as educators. The failures of us economists to inform and teach the public about economics, despite our massive investments in teaching capital makes this plainly obvious. Any of us will tell you that getting our students interested and having them actually absorb and learn the information is not easy or costless.

We also have to worry about potential distortion from transmission. This is the classic “telephone game” dilemma we all played in elementary school: – in sending a complex message across many people, the message gets distorted, misremembered, ad libbed, or even (from the joksters) intentionally altered for comedic effect. Take a look at news reporting of major events and scandals. Often the news media (whether intentionally for ratings or genuine mistakes) focuses on some sound clip or particular aspect of a message and distorts it. The missteps of the news media and social media in identifying the 2013 Boston bombing suspect are instructive here. Even in the internet world of costless CTRL-C CTRL-V, there are problems.

2. Once aware of the idea, all people value it highly enough to costlessly consume it

I already mentioned that not all people are going to value the information highly enough to use it (let alone highly enough to find it profitable to use when its use comes with a significant cost). Even once information is spread to another person, it is not costless to consume and utilize it. Suppose Apple plans to produce a new i-Hologram which creates an internet-connected personalized avatar of yourself in 3-D space. It’s going to revolutionize the market and everyone will want one. That sounds like a nice profitable idea, let’s get in on that, you say. Well how would you go about doing that? Even if you got your hands on one legally before it hit the market, you would have to reverse engineer it. That’s not to say it can’t be done, even done easily, since this clearly happens in the real world. But it is not costless. 

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Once information is reverse-engineered and replicable, it still has to be produced, which requires high investments in a complementary structure of capital with specific uses directed at producing that new product. Again, these costs are not always prohibitive. If Merck reverse-engineers the formula for Phizer’s secret new diet pill, they probably have the machinery and the human capital to replicate it soon enough. But again, it is not costless. And Merck will still be the first-mover in the industry. While they will not be able to capture all of the potential profits of their new diet pill (because of Merck and generic knockoffs), they still may capture enough to make the pill profitable and worth producing for the public.

And to return to the Apple example for a moment. Even if your startup company is able to copy and produce the new hologram device and cut into Apple’s profits, many people will still want to buy Apple’s polished product with an established brand and reputation. Who the hell are you?

Lastly, one reason that discovering and using ideas is not costless is precisely because firms recognize the possibility of lost profits from reverse-engineering and have made contingency plans. To say nothing of patents or copyrights, firms use contracting devices such as non-compete clauses and non-disclosure agreements, and make other attempts to keep their discoveries from spilling out by keeping trade secrets.

In the end, relaxing these assumptions and including a number of types of information and transaction costs can lead to a more robust understanding of public goods problems and information. These also give rise to a number of institutional forms which manage these issues to overcome the free rider problem. Ultimately, our view will not be complete until we address these institutions, as Wagner puts it best through example (2013, 13-14):

Suppose, for instance, that a mayor forms the idea of hosting an open-air music and arts festival under the presumption that residents of the city would value that festival sufficiently highly to make the event worthwhile. Institutionally, how might the mayor go about doing this? Within the spirit of anonymity and free riding, the mayor might install collection boxes in private places and ask residents to make donations. How much or how little a person donates would be known only to that person…

Yet no sensible mayor would operate in such a fashion. The mayor would enlist allies who were of a similar mind about the festival, and these people would in turn establish an architectural pattern of participation that would be far removed from anonymity. That architecture could entail cellular patterns of discussion and contribution where friends ask friends for contributions. It could also entail publicity regarding the identity of contributors, perhaps even ranking them by contribution. In these and numerous other possible ways free riding would be obviated. In any event, an entrepreneurial mayor would never elicit anonymous donations. Instead, sponsors might be solicited, with those sponsors given various forms of publicity. While the festival might be open to all, there could also be places where seating was reserved for patrons who made significant contributions to support the festival. We would also expect to find that those who made larger contributions were those who valued the festival and the associated activities more highly. Under an entrepreneurial institutional arrangement, organization of the festival is possible according to the benefit principle, and the free-riding problem is avoided. Whether the resulting pattern would correspond to some presumptions of postulated equilibrium is impossible to determine because those postulated conditions are just theoretical constructions that do not have existence independently of the relevant process of social organization.

——————
Samuelson, Paul A. (1954). “The Pure Theory of Public Expenditure,” Review of Economics and Statistics, 36, 387–389.

Wagner, Richard E. (2012). “The Institutional Framework for Shared Consumption: Deemphasizing Taxation in the Theory of Public Finance,” Public Finance and Management, 12, 5–20.

_______. (2013). “Public Finance without Taxation: Free-Riding as Institutional Artifact,” George Mason University Department of Economics Working Papers, 13-05.

Equilibrium, Disequilibrium, Non-equilibrium

Equilibrium and non-equilibrium systems have been a recurring theme at many panels in this year’s SEA conference leading me to muse on the differences between them. Please note that non-equilibrium is not the same things as disequilibrium. The difference being that disequilibrium is a property of some systems that have (stable or unstable) equilibria, usually used to characterize the dynamics of the system when outside of equilibrium. On the other hand non-equilibrium systems are systems that do not posses equilibria.
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One common, avoidable, and completely unnecessary confusion is that the way one can tell the difference between disequilibrium and non-equilibrium is through stability analysis, of the type that can only be carried out with mathematical models. We must not confuse physics envy for analytic sophistication. This view entails confusing non-equilibrium for systems with unstable equilibria (typically by analyzing the properties of fixed points in dynamic systems, Strogatz has posted all his lectures online, Yey!). But non-equilibrium is a category that applies to systems, not a property of those systems that have equilibra, a category mistake.
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Consider the definition of economic equilibrium: the vector of prices and the vector of quantities such that all possible gains from trade have been exploited. Two things that have been extensively pointed out by others are immediately apparent, equilibrium can never describe any real economic system unless all change is considered to be exogenous to the system. It then follows that if we assume that all change is exogenous, entrepreneurship is a disequilibrium path that characterizes the response of the system after it gets jolted out of equilibrium. In an equilibrium universe entrepreneurship is the name we give to disequilibrium, which is then by definition always equilibrating. This is as formal a definition of a closed ended economics I can give imagine. An open ended economics can then be defined simply as a non-equilibrium economics, and while it may seem difficult all it entails is to recognize that economic models are not representations of reality in the same sense that physics models are. Entrepreneurship is driving the dynamics (but what of coordination? more on that to come) of the non-equilibrium system, while in equilibrium/close-ended economics, entrepreneurship is merely the name we give to disequilibrium adjustment of the system.
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