3. Public Goods
As previously noted, the Standard Model is based on the
assumption that all relevant costs and benefits are internalized in
market price, i.e., there are no externalities. If this
is true then ‘X’ marks the spot.
Allocative efficiency is achieved as is the lowest long-run avergae
total cost per unit and the greatest good for the greatest number.
A good for which market price internalizes all costs and
benefits is a pure private good. Such a good is excludable
and rivalrous in consumption. I have the key to the car and
can exclude you from it. It is rivalrous: if I am driving you
alone can extract its utility.
the other hand, a
pure public good is not excludable or rivalrous in consumption. I cannot stop you from consuming
your consumption does not reduce the amount available to me.
If I watch a fireworks display it does not reduce the
amount available to you. Similarly, public goods are
non-excludable, i.e. a user
cannot be easily prevented from consuming a public good. This
creates the ‘free-rider’ problem, i.e., benefiting without
paying. Extending the fireworks example,
while not willing to pay to enter the stadium I can watch the display from the balcony of my
next door apartment at no out-of-pocket expense.
MKM C11/Fig. 11.1
Reality is, however, more complicated. Thus a seemingly pure
private good such as a chocolate bar can generate negative externalities
when its wrapper is thrown to the ground as garbage. Some one else
must pick it up and they should be paid to do so. Allowing for externalities there is
spectrum of goods ranging from purely private to purely public. In what follows
traditional public goods such as national defense are examined and then
two contemporary examples - common natural resources (CNRs) and the knowledge commons
or public domain of a knowledge-based economy.
i - Traditional (MKM
Traditional public goods
include such things as national defense, mass vaccination, the Census,
etc., as well as public monopolies or francises, e.g., of
urban roads, water and sewers. Public supply may be necessary
because some public goods are 'lumpy' requiring a very large initial
investment with returns spread over a very long time horizon to achieve
and maintain minimum optimum scale, or because:
a) the State does
actors to provide them, e.g., national defense per se.,
because of the monopoly power such private actors would enjoy.
Changing times and political parties, however, means that goods once
entirely provided by the State may be privatized, e.g., the Royal
Mail in the U.K., or similarly, ones once privately provided may become
a State responsibility, e.g., Medicare; and/or,
market demand does not support a price
at or above the break even point of even the most efficient producer (Fig.
1 Public Good).
The more public a good the less likely it is that private
producers will willing supply a socially optimal output and
the more likely only the State will do so. Public
provision is also necessary because some consumers will willingly pay for
some but not all public goods creating a `free rider`problem and hence compulsory taxation becomes the
necessary revenue source. The State can subsidize or substitute
in full or in part,
private demand shifting the MPB curve up to the right, ideally merging
with the MSB curve to attain a socially optimal price/quantity outcome.
ii - Natural Resource
If the modern environmental
movement was born with publication of
by Rachel Carson in 1962 it was in 1968 that Garrett Hardin, a biologist, published
Tragedy of the Commons” igniting the contemporary ecology movement. Hardin demonstrated
that unfettered competition for natural resources within and between countries
was destroying the natural commons, a.k.a., the environment or biosphere
including the air, water, land and biodiversity living on this planet. Given such
resources belong to everyone but to no one, i.e., they are public
goods, competitive self-interest dictates getting for oneself as much as
possible as quickly as possible with little or no consideration for others – past, present
or future. This is “The
Tragedy of the Commons”. Unfortunately,
a variation also plagued Second World or communist command
economies resulting in even greater environmental damage, debilitation and
Extending the geometric Standard Model,
Fig. 2 Common Natural Resource illustrates one facet of the
problem. Producers explicitly pay for the extraction of a common natural
resource (CNR) but do not pay for the resource itself, i.e., it is not
included in their accounting of explicit costs. This was the view of
philosopher/economist John Locke who saw output as the result purely of
labour, both living and dead embodied as capital plant and equipment.
Natural resources had to be shaped by labour to have any value.
They were a cost free input. This is the Labour Theory of Value.
Unlike the Standard Model that takes market price as the measure of
value, the Labour Theory argues value is measured by labour content
both physical and mental -
of a good or service.
To a firm, from a cost
perspective, the production function thus appears as Q = g (K, L, - CNR)
where (-) means no explicit cost Take ocean going fish like
salmon or tuna. Firms pay for the capture and canning but not the
production of the fish or any associated negative externalities, e.g.,
of a mixed
catch - marketable and non-marketable fish. In effect it is hunting what Nature has
supplied cum Locke. The supply curve (MPC) and demand curve (MPB) are in equilibrium
at A. If, however, producers had to pay to raise the fish, as fish
farmers do, then that cost added vertically to MPC results in a distinct MSC
curve that is, ideally, in equilibrium with MPB at B, the social optimum.
To the firm the production function, from a cost perspective, becomes Q = g (K, L, + CNR).
Failure to internalize such costs results in a larger output at a lower price
with its attended deadweight loss that is not socially optimal.
The resource is over exploited.
Beyond the geometry, however, there are issues about differences between
renewable and non-renewable natural resources and the appropriate
definition of sustainability as well as the appropriate present value or discount
rate to be applied to the future value of CNRs (For those interested, please see
Ecological, Environmental & Natural Resource Economics).
If a CNR
- fish in the sea, the air we breathe, the rain that falls - belongs to everyone but to no one then
Externalities one solution is to assign property
rights to someone. That someone will then have a
vested interest in
conserving the resource, ideally at a socially optimal
price/quantity outcome. Establishing legal property rights for CNRs
is increasingly common domestically and internationally, i.e.,
between Nation-States. CNRs once thought free belonging to
everyone but to no one now includes the oceans, atmosphere and
biodiversity of Planet Earth. Even Space immediately above the
planet and beyond is and increasingly will be the subject of such
propertization, i.e., legal property rights will be
established. This is a precursor to economic commodification,
i.e., turning everything into 'property' that can be bought and sold.
I will mention four multilateral or global
agreements that vest CNR property rights in the Nation-State. It
is up to the Nation-State how such rights may be exercised.
As will be seen, some countries download or commodify them into tradable
permits so that they
can be bought and sold in a marketplace of private buyers and sellers.
For those interested, please see
Common Natural Resource Treaties: the 1982
UN Convention on the Law of the Sea;
UN Convention on
Kyoto Protocol to the 1992
Framework Convention on Climate Change; and the 2003
UNESCO Convention on Intangible Cultural Property.
The best known of these multilateral
agreements is the
Kyoto Protocol to the 1992
Framework Convention on Climate Change opened at the Rio or Earth
Its objective was to stabilize greenhouse gases,
especially carbon dioxide, to maintain current 'normal' temperature distribution around the world.
The Protocol established quotas for Member States of the
First World, reduction targets, emissions trading and other quasi-market
mechanisms. As with land locked countries with respect to deep-sea
mining under the Law of the Sea Convention, Third World countries
benefit by First World investment in Third World `green` energy projects
thereby offsetting quota obligations. From 1997 India (Third
World) and China (Second World) were exempt from obligations to reduce
their own emissions. At the Paris climate conference (COP21),
December 2015, 195 countries adopted the first-ever universal, legally
binding global climate deal. Tradable quotas remain part.
If a participating country comes in over its quota it
must buy part of the quota of another Nation-State that has come in
under its quota, or as noted above, invest in Third World projects.
Thus CNR property rights now exist by legal alchemy that can be bought
and sold in markets. Some countries, especially members of the
European Union, in turn, divide up their national quota into marketable
permits auctioned off to industries generating green house gases.
Companies compete among themselves. If a firm exceeds its
permitted output it must buy quota not used by another firm. A
financial incentive is created to reduce green house gas emissions.
In all three cases, Law of the Sea, Biodiversity and Climate,
Nation-States have created legal property rights allowing a market
driven by financial incentives to conserve CNR and, ideally, achieve a
socially optimum price/quantity outcome. How successful such
markets have been is the subject of much debate. It is important
to note that the United States has not ratified any of the three above
iii - Knowledge Commons
hears much about the ‘knowledge-based economy’. Yet in
economic theory such an economy is a contradiction in terms - an
oxymoron. Knowledge is a public good, a good for which a natural market
does not and cannot exist. As we have seen a private good
is excludable and rivalrous in consumption. If one owns a car one has
lock and key to exclude others from using it. And when one drives the
car no one else can drive it, that is, driving is rivalrous. A gross
example is an apple. I buy it excluding you from that particular apple
and you cannot eat it after I have - rivalrous.
A public good,
on the other hand, is not excludable nor is it rivalrous in
consumption. Consider knowledge. Once something is published, a term deriving from the Latin meaning ‘to make
public’, it is hard to exclude others from learning it and if another
does it does not thereby reduce the knowledge available to you.
How can you
have a market if the good being sold can be easily appropriated and its
appropriation does not reduce one’s inventory? As will be seen
below it is only through Law – contract and statutory – that a market
and therefore a knowledge-based economy can exist. It is a market born of government
created either through statutory intellectual property rights (IPRs)
including copyright, patent, registered industrial design and trademark
or through legal enforcement of confidentiality and non-disclosure
clauses in contracts of employment for service or services. Put another way,
without the State there can be no knowledge-based economy.
And it is a
market only for new knowledge.
I say ‘new’ knowledge because the vast, vast majority of knowledge resides
in the public domain or knowledge commons where it is freely available to any and all. Thus
knowledge which begins as a public good becomes protected by intellectual property rights
but eventually falls
into the public domain or knowledge commons, a virtual space
where, as Isaac Newton noted, we all “stand on the shoulders of
giants”. Put another way, what begins as a public good is converted by
Law into private property bought and sold for a limited time before
again becoming a public good entering the public domain to
fertilize the imagination of generation onto generation.
In many ways the knowledge commons is the inverse of a
natural resource commons. First, use of the public domain
does not reduce the quantity of resources available to others.
Second, in its normal state the public domain grows and will
continue to grow until the collapse of human civilization in its
contemporary incarnation. Third, while there can be no
over exploitation of the public domain, additions are not
simply additive. Rather, additions combine with existing knowledge
mutating and generating yet more new knowledge '"standing on the
shoulders of giants".
The public domain is not a domain of scarcity but of
abundance. In this sense the public domain, unlike any natural
resources commons, exhibits increasing returns to scale. For those
interested in more information, lease see
The Knowledge Commons.
One aspect of knowledge as a
public good can be seen by e
xtending the geometry of
the Standard Model. In
Knowledge-Based Average Cost Curve
one can see that the initial
unit, e.g., of Windows 10, may cost hundreds of millions of
dollars to create but the second and all subsequent units cost 99 cents, the
price of a blank disc. Thus unlike manufacturing
with its 'U' shaped average cost curve in the knowledge-industries the
average total cost curve is 'L' shaped.
This applies not
just in the Natural & Engineering Sciences but also in the Humanities &
Social Sciences as well as the Arts. Take the artist Van Gogh who
spent much of his life in an insane asylum, cut off his ear and sent it
to his girlfriend yet out of all his pain and suffering came
Starry Night and the
Sunflowers that today can be bought at the dollar store for 99
While economics is poor at
prediction it is extremely good at ex poste rationalization,
e.g., it cannot accurately predict the next Depression but can explain it
very well after the fact. Thus intellectual property rights (IPRs) have
evolved over the course of centuries (Chartrand 2011)
and, as economist
Paul David observed, they were not created “by any rational,
consistent, social welfare-maximizing public agency” (David
1992). The resulting regime is what he calls “a Panda’s thumb”,
i.e., “a striking
example of evolutionary improvisation yielding an appendage that is
inelegant yet serviceable” (David
1992). Paralleling development of IPRs is the evolution of
multilateral and national cultural property rights (CPRs) (Chartrand
In economic theory, IPRs today are
justified by market failure, e.g., when market price does not
all benefits are received by the paying consumer and all costs of
production are paid by the producers. If so there are external costs and benefits, i.e., external to
market price. IPRs, in this view, are created by the State as a
protection of, and incentive to, the production of new knowledge which
otherwise could be used freely by others (the so-called free-rider
problem). In return, the State
expects creators to make new knowledge available and that a market will
be created in which it can be bought and sold. But while the State
wishes to encourage creativity, it does not want to foster harmful
market power. Accordingly, it builds in limitations to the rights
granted to creators. Such limitations embrace both Time and Space. They
are also granted only with full disclosure of the new knowledge, and
a fixed period of time, i.e.,
either a specified number of years and/or the life of the creator plus a
fixed number of
fixation in material form, i.e.,
it is not ideas but rather their fixation or expression in material form
(a matrix) that
Eventually, however, all
intellectual property (all knowledge) enters the public domain or
knowledge commons where it
may be used by one and all without charge or limitation. Again, a
public good first is transformed by Law into private property then
transformed back through Time into a public good. Growth of the public domain
and encouragement of learning are, in
fact, the historical justification of the short-run monopoly granted to
Even while IPRs are in force,
however, there are exceptions such as ‘free use’, ‘fair use’ or ‘fair
dealing’ under copyright. Similarly, national statutes and international
conventions permit certain types of research using patented products and
processes. And, the Nation-State retains the sovereign right to waive
all IPRs in “situations of national emergency or other circumstances of
extreme urgency” (WTO/TRIPS 1994, Article 31b), e.g., following the
anthrax terrorist attacks in 2001 the U.S. government threatened to
revoke Bayer’s pharmaceutical patent on the drug Cipro (BBC News October
Statutory IPRs include:
Copyrights - protecting the
expression of an idea but not the idea itself;
Patents - protecting the function
of a device or process but only after disclosure of all knowledge
necessary for a
person normally skilled in the art to replicate the
device or process;
Registered Industrial Designs
(design patents in the U.S.) – protecting the aesthetic or
non-functional aspects of a
Trademarks – protecting the name,
reputation and good will of a Maker, Legal or Natural, as well as Marks
of Origin such as Okanagan Made.
Contractual rights to knowledge
include Know-How and Trade Secrets. These take the form of
non-disclosure and/or confidentiality clauses in commercial contracts as
well as contracts of employment.
the exception of a few new IPRs like DMRs, the IPR regime evolved before
and during the Industrial Age. Arguably it served well then but not so
much in the emerging post-industrial KBE. Originally intended to
provide an incentive for new knowledge the current regime has, according
to many observers, become an impediment stifling competition and
include, among other things: patent thickets as defensive and aggressive
weapons in patent wars (think Apple and Samsung); copyright and patent
abuse by rights holders; and, cyber-trolling of individual consumers and
producers. Some observers suggest that high tech American firms today
spend more on legal defense of existing intellectual property than on
research & development.
Two qualifications are needed to
the above description of Law as it relates to knowledge. First,
rights of creators vary significantly between Anglosphere Common Law and
European Civil Code traditions. Thus under the Civil Code
artists/authors/creators enjoy imprescriptable moral rights, i.e., they
cannot be signed away by contract. This includes employees. Such rights
are viewed as human rights based on the Kantian conception that original
works are extensions of their creator’s personality. Where in the
Anglosphere moral rights are recognized, e.g., in Canada, they
subject to waiver if not outright assignment to a proprietor. This
reflects among other things the Anglosphere legal fiction that Natural
and Legal Persons enjoy the same rights. This is not the case
under in Civil Code jurisdictions. Imprescriptible rights
significantly enhance the bargaining power of individual creators, an
important question in a knowledge-based economy
characterized by increasingly contract and self-employment rather than a
life long employer.
Second, in the course of
the current digital revolution content is being converted from analogue
to digital format. By this act a new term of copyright begins for each
new fixation. For those
interested see my 2500 word
Summary Survey of Intellectual & Cultural Property in
the Global Village.
4. Public Choice (MKM
Competition all costs and benefits are internalized in market price.
Strictly private goods are bought and sold with no external costs or
benefits in consumption or production. Allocative efficiency is
achieved as is the greatest good for the greatest number at the lowest
long-run average cost per unit. There is no need for intervention
by Government except for reasons of Equity.
If, however, there is
Imperfect Competition (monopoly, monopolistic competition or oligopoly)
or there are externalities not accounted for in market price or if
necessary public goods are required then there may be a need for
Government intervention. Whether or not and how to intervene
involves Public Choice. This brings us to the economics of
democracy and cost/benefit analysis.
Economics of Democracy (MKM
Arguably the seminal text in what today is called 'rational
choice theory' was published in 1957 by
Anthony Downs: An Economic Theory of Democracy. Other
economists have followed as have other disciplines including Law and
Political Studies. For our purposes there are three primary
actors in the public policy process:
b) Politicians; and,
The objective function of the voter is maximizing
utility when that function includes Equity, Externalities and Public Goods. They are constrained primarily by what
is alternatively called Rational
If one is to be an informed voter one must learn about the issues - time
& effort. Having determined the issues one must then decide where
one stands - time & effort. Having decided one must chose the
politicians who reflects one's views - time & effort. Having
selected the candidate one must get out and vote - time & effort.
Time & effort represent costs to the voter who unless strongly motivated
is rational to be apathetic and stay ignorant of the issues and stay at
home on election day. This is why we say a government is not
elected but rather defeated. Thus in federal elections only about 60%
turn out to vote; in provincial elections only about 50%; in municipal
election about 10%; and for school and hospital board elections only
about 1% get out and vote. This has significant
implications. Taking just the federal level it means that 30% of
the electorate can elect a majority government which can use the
'notwithstanding' clause to abrogate any of those rights and freedoms in
spite of the courts. The same
holds for the Provinces but where
only 25% can elect a majority government. This reflects what
Jeremy Bentham called "legislative omnicompetence" - the supremacy of
the House of Commons under Parliamentary democracy.
Another characteristic of voters (and citizens in general)
is adverse selection. This is most apparent i
n the case of
insurance. Adverse selection occurs when one's demand is related to one's risk but
the insurer cannot adjust pricing. This may occur
because risk information is known only to the individual (information
asymmetry), or due to regulations or social norms
preventing the insurer from using certain information to set
prices, e.g., gender, ethnic origin, genetic test
results or preexisting conditions. The latter case it is
called "regulatory adverse selection". Thus if an insurer does not
vary prices according to smoking status, life insurance is a better buy
for smokers than for non-smokers and smokers will be tend to buy more
insurance than non-smokers. For the insurer the higher mortality
of smokers is adverse. Something similar happens in politics.
If one is unemployed one will tend to vote for the politician promising
government intervention which raises the cost of government.
Yet another characteristic is m
Paul Krugman describes moral hazard as "any situation in
which one person makes the decision about how much risk to
take, while someone else bears the cost if things go badly." For example, bank
bailouts by governments, central banks or other
institutions may encourage risky lending in future because those taking
the risk believe that they will not have to bear all the losses.
Fire insurance is another example. One buys fire insurance to
cover losses but by insuring against fire one may be tempted to commit
arson to collect the insurance payout. Politically, similar
problems have been associated with government programs as noted by
Rational Expectationalists, e.g., the American urban homesteading
The objective function of politicians is to get elected or
re-elected. They are constrained primarily by Arrow's
If a politician receives 51% support on every issue in an election
campaign that politician looses the election! Why? Rational
Apathy. The 51% comfortable with the politician's position tend to
stay at home in large numbers while the 49% opposed are motivated and
turn out and vote. Again t
his is why we
say a government is not elected but rather defeated.
This encourages politicians to take a
middle-of-the-road position on most issues thereby avoiding painting a
target on their backs. Similarly political party platforms tend to
avoid alienating voters by taking
a middle-of-the-road position.
The objective function of bureaucrats is 'steady as she goes',
'no waves', 'smooth'. The bureaucracy should run like a fine tuned engine.
There are two distinct types of bureaucracies - political and
professional. In the U.S. all positions from the director level to
Secretary of State are political appointees. Each serves at the pleasure
of the sitting President. This is part of the political spoils
system. It is relatively easy to appoint loyalty over competence.
In the parliamentary democracies like Canada there is a profession
public service that fill positions from clerk up to deputy minister.
Theoretically competence is valued over loyalty to the party in power.
In both cases bureaucrats are constrained by politicians and voters.
It is, however, of the parliamentary democracies of which I coined the Three Laws of Technocracy.
Two qualifications: first, they are based on my career experience;
second, the term 'technocracy' was coined by
John Kenneth Galbraith to explain large
corporate bureaucracies. To the degree competence is the
test in both the following apply to both. The bureaucrat can relax constraints in three ways:
Confuse & Conquer
A minister in government is generally
a specialist in the subject area. The professional
bureaucrat usually is. When the politician proposes a new policy
that will make waves for the bureaucracy the bureaucrat can make the
question so complicated that the politician backs off or leaves it to
the bureaucrat - confuse & conquer. The self-regulating
professions are similarly capable of making an issues so complicated the
client leaves it to their better judgment.
What We Don't Know Won't Hurt Us
For all the talk about freedom of information the reality
is the bureaucrat and the politician often practice 'What we don't know
won't hurt us!' With information politicians and voters may ask
questions that require the bureaucracy to answer creating waves and
causing the fine tuned engine to stutter. If information is simply
not collected then questions cannot be asked and therefore there is no
need to answer. No waves. No stutter. Real world
When in Doubt Privatize
One aspect of parliamentary democracy is
the role of the Auditor General who is an officer not of Her Majesty,
i.e., the executive branch, but rather an officer of the House of
Commons. The office was originally established to ensure that tax
revenues authorized by the House were used
by the Crown for their voted
purpose. If, however, a Crown Corporation is established
or an activity is privatized but financially supported
by the government
then the cloak of commercial confidentiality falls over
its financial operations and the Auditor General usually does not have
authority to check the books. In fact the most powerful form of
privacy in a capitalist system is commercial
ii - Cost/Benefit Analysis
The preeminent economic technique for determining the
appropriateness of public
intervention in the marketplace or in the production of public goods is
cost-benefit analysis. Innovated by the Tennessee Valley Authority
during the 1930s (part of the ‘New Deal’) cost-benefit analysis involves
calculating all relevant cost and benefits of a project. In the
simplest terms, if benefits outweigh costs the project goes forward; if
costs outweigh benefits it does not.
Benefits and costs, however, come in two flavours – those
that can be quantified and generally expressed in dollars and cents and
those that cannot. These can be called tangible and intangible costs
and benefits. Ideally all tangible costs and benefits are quantified at
market prices. Some intangibles can then be estimated in quantitative
terms using techniques such as ‘willingness to pay’ surveys. Others
cannot. At the end of the day, in good cost-benefit analysis, the
quantitative cost/benefit ratio is calculated but then subjected to a
value judgment with respect to the importance of non-quantifiable cost
In addition to tangibles and intangibles, cost-benefit
analysis also recognizes first-round, second- round and subsequent
effects. A market example is the impact of a frost on Florida orange
juice. The first round effect is a higher price. A second round effect
involves consumers shifting from more expensive orange juice to less
expensive apple juice. The increase in demand for apple juice, however,
causes its price to rise (second round effect) which in turn leads to a
shift towards other substitutes and so on and so on. In cost-benefit
analysis a decision must be made as to how many ripples should be
included in the analysis.
Costs and benefits also have a spatial dimension. Should
only local costs and benefits be included or also regional, national and
international ones? Similarly some are near term while others stretch
out into the distant future. How far out in time should the analysis
stretch? Furthermore, both costs and benefits are subject to increasing
risk as they stretch further and further out into the future. Some
risks can be subjected to probability calculation; some cannot. And
some risks have a high probability but limited impact while others have
a low probability but significant impact – so-called ‘Black Swan’
events. In addition costs and benefits of an intervention are
distributional in nature. Some win; some lose raising questions of
equity or fairness. Needless to say cost-benefit analysis is a
technically demanding field involving specialized expertise. In some
cases cost-benefit analysis is simply not possible. In such cases a
second-best approach may be used - cost-effectiveness.
As benefits and costs extend out into the future they
become ever more uncertain. One calculates their current worth – their
present value - using a discount rate. The higher the rate, the lower
the present value of future benefits or costs. Determining the
appropriate discount rate is critical to properly valuing future costs
With respect to public intervention or production of
public goods there is, however, an added dimension to present value –
politics. While future benefits or costs may be significant they are
politically discounted to maximize election and re-election of
politicians and governments. Three examples demonstrate. First,
with an aging electorate politicians are more concerned with present
older voters than with future generations. Quite simply future
generations are not politically relevant unless the current generation
says so at the ballot box.
Second, there is the political
‘edifice complex’. A new $100 million bridge or building bearing a
politician’s name is much more valuable politically than an annual
$20,000 paint job required to preserve and maintain an existing
structure for 100 years. Arguably the much reported deterioration of
public infrastructure in the United States and Canada reflects this
political discount rate.
Third, no matter political
intentions about the future the reality is we simply cannot know for
certain what future generations will want, need or desire from us
today. This is especially important when considering questions of
sustainability. The concept of sustainability is roughly analogous to
the economic concept of a 'steady state' where the existing pattern of
economic activity continues through time. In the view of some
economists resources are highly substitutable or fungible.
Technological change will, in this view, provide a substitute for any
resource that is depleted through current use. Whether or not it is
appropriate to preserve a current resource for future generations thus
becomes a question of substitutability.
An alternative to cost/benefit analysis is the precautionary principle. Applying it means that if a
new initiative has any chance of generating irreversible harm, no matter
its short-term benefits, it is rejected in spite of a positive
cost-benefit ratio. In fact, the precautionary principle is both an
economic and moral criterion. It invokes a social responsibility to
protect the public from harm even if scientific investigation finds no
probable risk. In the Rio Convention mentioned above and in the
European Union, the precautionary principle has been made into a
statutory requirement. Its application is most apparent with respect to
genetically modified foods. In the Anglosphere cost-benefit analysis
has consistently found them to be a good investment. In most cases
natural and genetically modified crops and animals are treated as
equally safe. In the European Union, however, the remote possibility of
irreversible harm to human health or the environment has led to
significant restrictions on the use of genetically modified foods
including labeling of all products.
Dr. Thomas DeGregori argues that this
'plant protection racket' is fuelled by a Veblen Effect, named after
Thorstein Veblen who introduced the concept of 'conspicuous
conducted cost/benefit analysis and determined that State intervention
is appropriate there are, except to direct public investment, at least
five modalities to adjust market
outcomes to account for merit/demerit goods generating positive/negative
externalities as well as producing public goods including appropriate
management of common natural resources
and the knowledge commons. These are:
b) Property Rights
a) Taxation (MKM C8/171-181)
axation pays for forced
consumption by citizens. Subject to the coercive power of
the State citizens are forced to buy public
goods essential for a modern society but which are subject to the free
rider problem if payment is not compulsory, e.g., some citizens
would be unwilling to pay for national defense. Taxation is also
used to encourage consumption and production of merit goods generating
positive externalities, e.g.,
tuition tax deductions, corporate R&D deductions, etc.,
and to discourage consumption and production of demerit goods, e.g.,
cigarettes, pollution, etc.
In this regard, there are many types of taxes - some visible like income
and sales tax and some invisible to the consumer like excise taxes -
including tax expenditures, i.e., forgiving taxes otherwise due.
The resulting tax regime together with spending priorities
reflects the fiscal morality of a State. In the case of merit/demerit goods,
taxes can thus be used to shift public focus from the MPB or private
Demand Curve to the socially relevant MSB Curve and/or from the MPC or
private Supply Curve to the socially relevant MSC Curve striving for the
socially optimal outcome (P&B
b) Property Rights (MKM
Title is the right to the possession, use, or disposal of a
thing, a.k.a., Property. This implies ownership or
‘proprietorship’. In fact under Common Law & Equity there are only two
classifications, Persons (legal or natural) who have rights and Property or
'things' that do not. In feudal times Title referred to a piece of land
under one owner, i.e., a landed estate. Such estates were initially
associated with a Title such as the Duchy of Cornwall. With Title came Property.
Title was granted by the Sovereign and consisted of a bundle of rights &
obligations, e.g., fealty, which were often qualified by the Sovereign.
Some could be inherited; some could not; some rights were included, some were
not. All Property and Persons, however, were ultimately subject to the
Under Common Law, all Property (and, in constitutional
monarchies, all Persons) remains ultimately subject to the Sovereign whether
Crown or State, a.k.a., the ‘People’. Sovereignty is supreme controlling
power ultimately exercised through overwhelming coercive force. The territory
over which Sovereignty is asserted is established by continuing occupancy and/or
Today, Title usually takes the form of a document, deed or
certificate establishing the legal right to possession. The coercive power of
the State may be invoked to protect and defend it. There are three contemporary
forms. There is immovable or ‘real’ Property such as land, buildings and
fixtures which together with moveable Property or ‘chattel’ (derived from the
Anglo-Saxon for cattle) constitute tangible Property. Then there is intangible
Property such as business ‘good will’ and intellectual property such as
copyrights, patents, registered industrial designs and trademarks. Each of these
rights & obligations are granted by and subject to the pleasure of the Sovereign
whether Crown or State. In Law each consists of different bundles of rights &
obligations, e.g., the term of a patent vs. copyright.
With respect to ‘real’ Property there are two principal forms of
Title. First, allodial Title refers to absolute ownership without service or
acknowledgement of or to any superior. This was the practice among the early
Teutonic peoples before feudalism. Allodial ownership is, however, virtually
unknown in Common Law countries because ultimately all Property is subject to
the Sovereign – Crown or State. In this sense there is no such thing as absolute
Second, fee simple or ‘freehold’ is the most common form of Title
and the most complete short of allodial. It should be noted that the ‘fee’
refers not to a payment but to the estate or Property itself as in the feudal
‘fief’. Fee simple is, however, subject to four basic government powers -
taxation, eminent domain, police and escheat (derived from the feudal practice
of an estate returning to a superior Lord on the death of an inferior without
heir). In addition, fee simple can be limited by encumbrances or conditions.
These may include limitations on exclusive possession, exclusive use and
enclosure, acquisition, conveyance, easement, mortgage and partition. In
addition it may or may not include water rights, mineral rights, timber rights,
farming rights, grazing rights, hunting rights, air rights, development rights
and appearance rights.
Proprietors may, subject to limitations in their Title, lease,
let and/or rent their real Property. In the Civil Code tradition the legal
right to use and derive profit or benefit from Property belonging to another
person (so long as it is not damaged) is called ‘usufruct’ from the Latin
meaning ‘use of the fruit’, not ownership of the tree. In Common Law, one might
call it ‘tenant title’. It does not constitute legal Title but does entitle the
holder to use the Property and to have that right enforced by the State against
the legal Titleholder and others.
Finally, there is occupancy or possession-based Title. In effect,
this invokes ‘squatter’s rights’. It does not represent legal Title.
Nonetheless, if possession by occupancy is not disputed it may, in time, become
John R. Commons observed in his classic
The Legal Foundations of Capitalism
that Property, in the economic sense of what can
be bought and sold, is the history of its ever increasing intangibility. In this
sense, Property has become not so much the thing in-and-of-itself but rather an
evolving set of rights & obligations associated with it, e.g., a warranty. Thus
Property today includes intangibles like artistic & literary works, inventions,
futures options, equity shares, software and investment certificates in land and
buildings, e.g., ‘CDOs’ or Collateralized Debt Obligations including an unknown
number of sub-prime mortgages that are the proximate cause of the Great
Recession beginning in 2008.
This legal evolution, however, is
all about private property. What about public or common property?
Observing the relative lack of interest in the
concept of common property over the last three hundred years of Anglosphere
legal tradition, Carol Rose has tried to revivify Roman concepts of public
property lacking in the English-speaking tradition. In effect, she concludes
that the evolution of Anglosphere law has been dominated by questions about
private, not public property (C.
There are five categories of public property
under Roman law: res nullius, res communes, res publicae, res universatitis
and res divini juris. To begin, the Latin word res means ‘thing’. Res
nullius refers to things that are unowned or have simply not yet been
appropriated by anyone such as an unexplored wilderness. Res communes
refers to things that are open to all by their nature, such as oceans and the
fish in them. Res publicae refers to things that are publicly owned and
made open to the public by law. Res universitatis refers to things that
are owned by a body corporate, i.e., within the group such things may be shared
but not necessarily outside the group. There are thus 'club goods' or
quasi-public goods, free to members but not to non-members. Finally, res divini juris (divine
jurisdiction) refers to things ‘unownable’ because of their divine or sacred
As has been seen through international agreements (as well as
domestic developments) the concept of Property has expanded to include Common
Natural Resources such as the Law of the Sea,
Biodiversity, Carbon Dioxide and Intangible Cultural Property.
Domestically Intellectual Property Rights are an example how the State by
establishing property rights creates markets. Some observers have
recognized that this ability to define new forms of property represents a
critical tool of the State in management of a national economy. Please
"The Innovative State Governments Should Make Markets, Not Just Fix Them"
by Mariana Mazzucato, Foreign Affairs, January/February 2015.
In a sense all State intervention in the economy involves
regulation. Legislation sets out the
strategy and tactical means for politically justified intervention but
the logistics, where the rubber hits the road, takes the form of rules &
regulations, practices & procedures often developed and always enforced by the bureaucracy.
In the case of State intervention justified by Equity, a
price ceiling, e.g., rent control, or a price floor, e.g.,
minimum wage, must be enforced by inspectors and their support staff,
plant & equipment. The associated cost of State enforcement does
not appear in the analytic geometry of the Standard Model. In
addition there are compliance costs (filling out forms and answering
questions) paid by either the producer or consumer but also not
In the case of State intervention justified by Market
Power a bureaucracy must be built that, in effect, monitors the
production and cost functions of a monopoly or collusive oligopoly.
This requires knowledge of the industry that usually can only be learned
on the job. In turn this means the bureaucracy or regulator must
include those who formerly worked in the industry or regulatee.
Overtime this can lead to the regulator being 'captured' by the
regulatee, i.e., increasingly sympathetic towards the regulatee's
position vis-a-vis consumers. Thus in directing the
industry towards a competitive outcome t
associated cost of State enforcement does not appear in the analytic
geometry nor do compliance costs (filling out forms and answering
questions) paid by the producer.
In the case of State intervention justified by
Externalities the first cost is detection, i.e., determining
there is an externality and, in the case of a negative externality like
pollution, what is its sustainable economic level? This is usual
accomplished through scientific or policy research. Then follows
Legislation and then Rules & Regulations.
In directing the industry towards a socially optimum
outcome. Ideally t
he associated cost of State enforcement should
appear in the analytic geometry of the extended Standard Model. Compliance costs (filling out forms and answering questions) paid by
either the producer or consumer should be included as
a part of the social cost curve in the case of a negative externality or
as part of the subsidy shifting the private marginal cost curve in the
case of a positive externality.
In the case of State intervention
justified by Public Goods the first cost is determining should:
1. production be done by the
the State subsidize private producers to produce it; or,
the State create property rights and thereby create a
market for its production and sale?
If (1) then an entire production system must be
constructed and operated, e.g., the armed forces.
If (2) then public purpose will be served by private, for
profit interests with the associated problems of accountability and
transparency highlighted in
Government by Moonlight: the hybrid parts of the state.
If (3) e.g., IPRs and marketable quotas, then a
market is created for the production and selling of the public good.
In this case it is the courts that settle disputes between private
parties and, assuming court costs are paid by the losing party, at
little cost to the State beyond a granting and overseeing bureaucracy
such as the Patent Office. This is in fact the policy
"The Innovative State: Governments Should Make Markets, Not Just Fix Them"
by Mariana Mazzucato, Foreign Affairs, January/February 2015.
In all three options one question remains unanswered: What
is the nature of public administration especially regulation? As
noted by Philip K. Howard in
The Rule of Nobody : Saving America from Dead Laws and Broken Government,
W. W. Norton & Company, April 14, 2014 modern bureaucracy is
governed by detailed regulations intended to eliminate arbitrary
decisions by bureaucrats. This follows from Voltaire's call “Let
all the laws be clear, uniform and precise” suggesting that otherwise
judges and officials will mess things up: “To interpret laws is almost
always to corrupt them” (Howard, 2014,16). The result is that:
“The process is aimed not at trying to solve problems,... but trying to
find problems. You can’t get in trouble by saying no”
(Howard, 2014, 8).
Howard concludes that failure to allow the
bureaucrat to exercise principle-based judgment rather that simple
compliance to regulations is strangling the modern State in the
Market failure due to market power,
e.g., monopoly or collusive oligopolistic behaviour, is the subject
of anti-trust or anti-combines legislation. Criminal and civil
suits can be brought by the State and resulting penalties used to
correct outcomes. Similarly, market failure due to
or industry's negative externalities are subject to individual and class action
suits as a tort, i.e., non-contractual loss or harm
creating legal liability for the individual or firm
committing the act. To the degree harm results in loss of life or
limb or threatens national security, criminal proceedings by the State
are also possible. In both cases legal costs as well as any damage
settlement increases cost to the firm shifting the supply curve up to
the left, ideally merging with the MSC curve and achieving a socially
optimal price-quantity equilibrium. Similarly, disputes over
tradable permits - fishing, pollution, etc. - are subject to
contract law and criminal prosecution. Law, and the
probability of its enforcement by the courts or 'the rule of Law', is
critical to the success of any business enterprise.
On the other hand, the cost of the judicial process need be factored
into any cost/benefit Public Choice.
According to the OED, a subsidy is: "Money
or a sum of money granted by the state or a public body to help keep
down the price of a commodity or service, or to support something held
to be in the public interest. Also: the granting of money for these
purposes." The form and purpose of a subsidy varies.
It can assist consumers by reducing the cost of a good or service, for
example, student bursaries and grants. In effect at each
market price the subsidy reduces the cost to a consumer shifting the
demand curve to the right. It can also reduce the cost of
production so that at each possible market price the cost to producers
is reduced shifting the supply curve to the right, e.g.,
subsidies to solar and wind power. A subsidy may also take the of
tax expenditures, a reduction in revenue. To quote Wikipedia:
A tax expenditure program is government
spending through the tax code. Tax expenditures alter the horizontal and
vertical equity of the basic tax system by allowing exemptions,
deductions, or credits to select groups or specific activities.
For example, two people who earn exactly the same income can have
different effective tax rates if one of the tax payers qualifies for
certain tax expenditure programs by owning a home, having children, and
receiving employer health care and pension insurance.
Defining what constitutes a subsidy to
production is one ongoing challenge facing the World Trade Organization.