Tuesday, 5 December 2017

The Trojan Horse Of Public Goods: Beware Of Politicians Bearing Gifts

Government Minister Greg Clark, the Secretary for Business, Energy and Industrial Strategy, has unveiled a 255-page white paper explaining the party's industrial strategy for the nation. The government is promising to 'invest' in our country and increase productivity with taxpayers' money (although they never mention taxpayers' money, of course).

These are promises that should concern us - and the concern should be based on a well worn economic phenomenon that assesses whether the state should be involved in an industry at all, or whether it is doing more harm than good.

The assessment can be stated like this: if the provision of a good or service would have happened anyway by commercial demand, then it's better if private investors provide it (as I've explained before repeatedly). If the provision of a good or service would not have happened anyway by commercial demand, then it's costly to society for the state to take our money to provide it - even more so when you factor in all the crony capitalism, self-serving lobbyists and special interest groups distorting the market.

The upshot is, when all the costs and benefits are weighed up, there isn't very much that the state should be doing. Consequently, a strategy that's based on all the things the government wants to do for us is going to be one that engenders lots of inefficient use of money that we'd be much better off spending directly out of our own pockets.

One exception needs bearing in mind though - and that is the kind of product or service that is widely desirable but may not be provided by the market - or could be, but may be better provided by the state. These are what are referred to in economics as public goods.

Public goods and private goods
The state provides some public goods from which we all benefit equally, like national defence and rule of law, but it also provides private goods like health care, education and pensions which would be better run under a 'consumer pays' model. The distinction is that we more or less want the same thing when it comes to national defence, but not so when it comes to health care, education and pensions.

Because the private goods and services that the state provides are devoid of a 'consumer pays' model, there is no measurement of consumer demand for the goods and services nor commercial value in how they are costed.

Before we get into this further, let me deviate for one moment to tell you a shocking fact connected to state provision. Once you factor in all the stealth taxes on top of the more transparent taxes, the state takes on average around 60% of our earnings in taxation. To put that into perspective, that means you have to work until roughly August 7th each year until you begin to earn money that the state doesn't somehow confiscate.

A left wing friend of mine said she thought this was good news because it shows how much we as a society are willing to show we voluntarily care for one another in the form of redistribution. As much as I love my friend, this is a strange view to have because it is just about the opposite of the truth. Tax is taken from us precisely because we otherwise would not voluntarily donate to these things (a point I illustrated before by using the example of foreign aid, and here regarding the welfare state). To explain, let me tell you a bit more about the concept of public goods in economics.

A public good is something that is referred to in economics as non-excludable and non-rivalrous, in that agents cannot be effectively excluded from it, and whereby if one person consumes the good it does make that good unavailable for others. Obvious things that do not qualify as a public good are things like a car parking space and a bunch of grapes. If Jack parks in the only available car parking space, Jill cannot also park there. If Jack buys the last bunch of grapes, Jill cannot buy them. The nice view of London’s skyline from Primrose Hill, on the other hand, is a public good because Jack can enjoy it without excluding Jill’s ability to enjoy it too.

The problem with public goods is that they have what’s referred to in economics as a free rider problem. That is, if a good is a public good it is difficult to prevent others from enjoying that good without having to pay anything towards its cost. Suppose there is an alley between two terraced houses owned by Jack and Jill in an area with a recent spate of burglaries. Jack says to Jill ‘Let’s go halves on a £500 gate to make our alley more secure'.

If Jill wants the extra security but figures that Jack will pay for the gate even if she does not pay her half, then Jill free rides on the security, and Jack foots the bill. Jack may therefore decide to not buy the gate, leaving them both with a less secure alleyway. If the situation was favourable, the government could tax the whole street and put up the gates in all the alleyways on the street. Of course if the alleyway gates are worth their cost to all the residents, then everyone on the street is better off.

But then you have to add further consideration, because in a scenario where only some people paid for alleyway gates, the people that didn’t are made more vulnerable because their unguarded alleyways are now more attractive to burglars. The same is true of burglar alarms; if numbers 1, 3 and 5 in a cul-de-sac install a burglar alarm, numbers 2, 4 and 6 that don't have burglar alarms are more likely to get burgled.

The key analysis with tax and government industrial strategy is assessing whether a good or service is like the alleyway gates, and whether everyone involved is better off by paying a tax and sharing the benefits, or better off being left to their own devices in a free market.

One obvious example of a public good that everyone benefits from is national defence: so effectively the nation is treated as a single consumer paying for this through taxation. Another example of a similar service is the police force, as is the infrastructure that provides the framework for the rule of law. There are people, such as David Friedman in his seminal Machinery of Freedom, who maintain that even things like defence, police and rule of law don't need to be provided by governments, but can be sustained instead by non-coercive market and charity-based systems. But we'll give the state the benefit of the doubt for now in terms of providing a few of these public goods, even if it is easy to envisage a time when things may be different.

When taxes are paid to provide things that the government can provide more efficiently than the market then we should support them. But that is the only condition under which a public service like defence or policing is preferable to a private service. As I reminded people in a recent blog post, public services cost about 30% more to provide the same equivalent service provided privately, therefore it is desirable that anything that can be provided by the market is done so, which doesn't leave the state that much it should be doing, because there are not many things it can provide better than the market.