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.

What is a Public Good, Anyway?

This will be the first of a two or three part series on public goods as inspired by Santiago’s recent post about the argument that entrepreneurship is a public good that is under provided by markets.
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I argue in “Public Goods” or “Good for the Public?” – Endogenizing Public Goods (currently under review) that our view of “public goods” as economists is fundamentally incomplete.
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Typically, we define public goods technologically, as any good that exhibits non-rivalry (my consumption does not prevent you from also consuming) and non-excludability (I cannot prevent you from consuming). Look in every economics textbook and this is what you will find, along with examples of parks, national defense, tornado sirens, etc. I call this the “exogenous” theory of public goods — we automatically know what goods are “public” by the very way we define them. Public goods theory and welfare economics argues that in the presence of goods with these features, markets under provide them and therefore the government must intervene somehow to increase provision because they are socially valuable.
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There are a number of problems with this view that many scholars have already found. I won’t spend much time on them, and simply catalogue them as follows (for references and elaboration, see the paper):

  1. Private markets and voluntary organizations do provide public goods
  2. Governments largely provide private goods, not public goods
  3. Many historical cases of government correcting market failures were just ex-post facto justifications for rent-seeking
  4. Impracticalities of mundane positive externality compensation
  5. Distortions of taxation and political allocation
  6. How do we know what is efficient/optimal?

One of the more fundamental issues is that somewhere along the way, economists in public finance and welfare economics conflated positive explanations of what government actually spends its money on with the theory of public goods–a normative theory of what government should do. (Perhaps here is where Santiago will argue this is precisely why we must jettison the normative theory entirely.)

What is a public good, much like the degree of the externality it poses, is often subjective. Suppose Bob is a fervent vegetarian, and does not believe anyone should be allowed to slaughter animals. Ann, on the other hand, is carnivorous and believes that everyone should be allowed to consume meat. To Bob, a law that prohibits slaughtering animals is a public good (under the exogenous definition): everyone can simultaneously enjoy living in a society where animals are treated ethically, and (assuming perfect enforcement) no one can prevent others from that enjoyment. Ann on the other hand, would view this law as a public bad, as it creates a negative externality (from her view) on everyone. Perhaps a law affirming meat-consumption, maybe even a subsidy to meat-producers, would constitute a public good for her.

Perhaps that example is silly and hyperbolic. But it can be applied to nearly any partisan wedge issue today and be perfectly accurate. Take gay marriage: opponents of gay marriage argue that a law permitting it would be a public bad and harm the very moral fabric of society, while proponents argue that having such a law would be a public good because everyone would live in a tolerant society (not to mention the concentrated benefits upon gay couples). Both of these arguments fit perfectly well within the exogenous framework of public goods (nonrival, non-excludable benefits/harms), but they reach contradictory conclusions (perhaps because they are arguing over different goods).
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For a more robust (and positive) view, I argue that we need an “endogenous” theory of government activity, that incorporates the fact that what goods are provided by the state is a complex product of political entrepreneurship and the very heterogeneous preferences I just described:

In laying out a theory of public goods, it might be useful to start with an analogy to the theory of private goods which may seem tedious at first: Oil in the ground is mere black goo. Were geologists or physicists to discover it first, they may derive technical and conceptual definitions for oil based on its chemical content, fluid dynamics, or other objectively verifiable characteristics. It takes a subjective act of entrepreneurship, however, to make that black goo into something of value for society (beyond mere scientific study). An enterprising individual must recognize, and personally bear the risk to bring about, in hopes of personal profit, the potential benefits of extracting, refining, processing, and selling oil and oil by-products to consumers and other firms as a fuel source to be used to power automobiles, factories, and the modern world. It requires integration with the current capital structure of complementary goods all calibrated to serve the demands of consumers through time. Entrepreneurship is what creates value from land.
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I propose that there is a similar analogy for those types of goods we colloquially call public goods. Welfare economists have formally conceptualized a type of good that exhibits certain technological features (jointness in consumption, high costs of exclusion), and defined it as a “public good.” Operationally, however, there is an implicit understanding that those goods that government provides are public goods, with the technical definition is not necessarily overlapping. Instead, it requires the acts of choice by individuals, that will affect others externally, to consider a good to be worth producing politically or privately. It takes an entrepreneur, often in the political realm, to recognize and bear an opportunity for personal gain, to convince members of the public (as voters, bureaucrats, legislators, firms) that a good must be provided by the government to meet the needs of society. As the realm of politics is largely one of language, it requires considerable rhetorical investment in the scientific language of public goods (the exogenous definition) in order to convince a sufficient number of people that they are “good for the public.” Thus, just as oil in the ground is only given value by private entrepreneurship, I argue that goods only take on “publicness” attributes by public entrepreneurship.
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