Can the free market provide public goods?

The textbook definition of a public good is:

“A good or service that is non-rival and non-excludable“.

Non-rival means consumption by one person does not reduce the amount available for others to consume.

Non-excludable means you cannot prevent someone from accessing a good. Think about a beach or public park.

So, for examples of public goods, think about law and order, flood defences and streetlights.

Misconception: public goods are goods provided by the government.

This is wrong for two reasons.

First, other goods and services, that are not public goods, are provided by the government.

Healthcare is not a public good – taking up a bed in a hospital reduces the number of beds available for others.

Yet the UK Government provides healthcare free at the point of use, funded through taxation.

Secondly, public goods do not have to be provided by the government.

Free-rider problem

Textbook economics suggests public goods are subject to a market failure. In the case of public goods, this is the “free-rider problem“.

Suppose one consumer pays for a public good, such as a streetlight.
Once the streetlight is built, others will benefit from the streetlight, even though they did not pay. They are “free riders“.
If one person believes someone else will provide / pay for the public good, why would they provide it themselves?
If everybody thinks like a free rider, then nobody provides the public good in a free market.

This is one argument for governments providing public goods. Indeed as a result of this argument, it was accepted for decades that governments should provide public goods.

Yet in the 1960s and 1970s, some academics began to challenge this view. Perhaps, they claimed, public goods could be provided privately.

But how? Consider these examples:

Lighthouses

Traditionally, lighthouses have been viewed as public goods.

However, a 1974 paper by Ronald Coase challenged this idea.

Coase argued that lighthouses were excludable. There was evidence of private building and operation of lighthouses in Britain from the 16th to the 19th centuries.

Coase’s claim was controversial and received heavy challenge.

Privately run lighthouses often did not survive for long. Coase claims this is because of government orders for the purchase of lighthouses; while critics suggest the lighthouses could not rely on voluntary payment.

Lighthouses could raise revenue from “port fees” for use of the lighthouse or for docking in a nearby port. But this was only because a patent from the crown (monarchy) permitted them to do so.

More recently, views on lighthouses have mentioned complementary services to lighthouses. For instance, offering a local pilot to pilot ships through local waters, as well as allowing the parking of ships at harbours.

Complementary private services allow lighthouse operators to raise funds to cover the lighthouse provision. This makes it easier to run a lighthouse, even if it has some (or all) of the qualities of a public good.

Climate controlled walkways

Imagine a tunnel or bridge between two buildings.

This allows pedestrians to move between the buildings, without having to go down to street level and back up again.

Such tunnels or bridges offer protection from weather and separate pedestrian traffic from car traffic.

In the US, these are known as “climate-controlled walkways” or CCWs. Networks of CCWs also exist across several cities in the US.

CCWs meet the criteria for a public good. In particular, they can be subject to free-riding problems. Pedestrian users pay no toll for using the CCW. Owners of one building may free-ride on another company building a CCW to its building too.

Montgomery and Bean (1997) find that CCWs are well-supplied by market forces. In other words, there isn’t the complete market failure (or even underprovision) that one would usually expect following the free-rider problem.

Voluntary provision

Volunteers, including charities, can provide public goods.

At a local level, volunteers may support “neighbourhood watch” schemes to report crime and protect neighbours from crime.

Charities can also provide public goods. 2% of national income in the US goes towards charities.

Altruism (selfless concern for the well-being of others) and the warm-glow effect (the emotional reward of giving to others) may help overcome the free-rider problem.

The internet has created new ways to access voluntary support and donations.

Wikipedia could be seen as a public good, which is funded through donations.

Websites like GoFundMe allow “crowdfunding“, collecting small amounts of money from a large number of people.

Technological transformation of public goods

Moreover, to overcome the free-rider problem, it is possible to transform public goods through technology.

Tolls can make roads excludable, for instance.

Another example is how in the past, all TV channels could be accessed without charge. Now, through technological development, channels can be put behind a paywall.

Even if the government decides to provide public goods, there are challenges.

How should governments decide the right level of the public good?

A government would need to know how much people value the public good – how much would people be willing to pay for national defence?

This is hard to know, without the price and sales information that a private market would naturally show us. The wrong level of provision could create “government failure”.

Other arguments for governments to provide public goods

In many markets, the free-rider argument can be a strong and powerful argument.

There are other reasons why governments may want to provide goods, including public goods:

Coordination advantages. One large public body may be able to better coordinate than several competing smaller firms. More broadly, there may be economies of scale to government provision.
Reduction in inequality in access to services. Private provision can price out those on low incomes from access to the service. However, government provision can price the good for free at the point it is used. It can then be funded through government tax revenues, with more revenue likely to be raised from those on higher incomes.
Positive externality arguments. Government provision may increase the overall level of provision above the free-market level. This takes advantage of positive spillover effects onto third parties. Public parks may help increase the amount of exercise people do. This could improve health and reduce waiting times for healthcare, for example.

Summary

Public goods are non-rival and non-excludable.

Public goods suffer from the free-rider problem. This suggests that providing public goods in the free market is not possible.

There is however some evidence of public goods being provided privately.

In summary, when deciding whether the government should provide a public good:

We need to weigh up the free-rider problem, coordination and access advantages in favour of public good provision;
Against the ability of the private sector to provide, including using complementary goods or voluntary contributions, as well as the issues with public provision.

So, should governments provide public goods? Or can governments leave public goods to private forces in some instances?

My view is that a lot of key public goods should be provided by governments.

However the power of the free market to provide public goods, by selling complementary items and charitable donations, can also solve some public good problems. In particular where governments are unable or unwilling to provide funding, it can be a second-best or at times a first-best approach.

What do you think?

Thanks for reading!

About the author

Tom Furber

Helping economics students online since 2015. Previously an economist, I now provide economics resources on tfurber.com and tutor A Level Economics students. Read more about me here.