2.9 Market failure - public goods
Public goods refer to goods that are non-excludable and non-rivalrous, e.g. streetlights, national defence.
Non-excludability means that it is not possible to prevent individuals who have not paid for a good from using it. Non-rivalry means the consumption of the good by one individual does not prevent simultaneous consumption by another individual. For instance, when one person is using the streetlight, other people can simultaneously access the streetlight. Table 2.9.1 provides a comparison of goods grouped according to their excludability and rivalry nature:
| Rivalrous | |||
| Yes | No | ||
| Excludable | Yes | Private goods
(e.g. scissors, barbers) |
Club goods
(e.g. blogs) |
| No | Common access resources
(e.g. fish in international waters, earth atmosphere) |
Public goods
(e.g. lighthouse, statue in a public square, digital music) |
|
Free rider problem
Because a public good is non-excludable and non-rivalrous, there is the free rider problem: consumers can take advantage of a good without paying for it. Private providers cannot reap benefits sufficient to cover the cost of the provision, and under a market system there would be no provision of public goods in private markets. For instance, it is not possible to exclude individuals from the protection provided by national security. Individuals are protected regardless of whether they have paid or not. There is little reason for a self-interested individual to contribute to the payment for national defence. Hence, under a market system, the provision of public goods is “missing”, resulting in market failure, where the market fails to provide incentives for the provision of public goods.
Government intervention in response to public goods
Direct provision
As public goods usually have positive externalities, the government can correct market failure by providing public goods itself. Aside from budgetary implications and the difficulty in estimating the benefits of a public good, government provisions may in some cases involve redistribution of welfare from other taxpayers to public good users. For instance, shipping lines might make heavy use of a lighthouse placed near a port, but an individual household might not. Government provision of the lighthouse would involve subsidisation of shipping lines at the expense of the households.
Around 79% of Singapore’s population lives in public housing managed by the state Housing and Development Board (HDB). HDB apartments are issued by the state on 99-year leaseholds, and the price of each apartment depends on the size, type, and location of the property, with extensive government support available to those looking to purchase properties. Buyers generally acquire leasehold ownership for the remaining term of the lease rather than freehold ownership. This is distinct from renting a flat.
Classification: An individual flat is rival and excludable, so public housing is not a pure public good. This case illustrates government provision for housing affordability and equity. Government ownership or subsidy alone does not make a good non-rival or non-excludable.
HDB apartments are located in housing estates with their own schools, supermarkets, hospitals, and sports and recreational facilities, plus train stations and bus stops to provide transport links to the rest of the city. Some HDB flats are also reserved for those who cannot afford the cheapest forms of public housing despite being provided with government financial support. Flats are also allocated according to a quota system of ethnicities, which ensures that each block has an ethnic breakdown roughly comparable to the national average.
Contracting out to the private sector
The government can also correct the market failure by working with the private sector, providing the financing for the establishment of the good, and then allowing the private producer to run it. This is sometimes assumed to increase efficiency, as a private producer will be more incentivised to have efficient outcomes than the government might be. However, it may be assumed that the private producer will only partner with the government if there are profits to be earned; this makes public-private partnerships controversial.
There are a number of private companies which are contracted to provide healthcare services under the UK’s public healthcare service, the National Health Service (NHS).
The UK’s Private Finance Initiative (PFI) was a form of public-private partnership in which private firms financed and delivered public infrastructure, often providing associated services under long-term contracts. In October 2018, the government announced that it would no longer use PFI or its successor PF2 for new projects. Existing contracts continued. The case below concerns the historical model.
There are several potential benefits of using the PFI to provide public infrastructure and services. Since the private sector is believed to be more efficient than the public sector, PPPs might improve efficiency; they might also provide extra investment which can help the government to achieve more projects. PPPs also encourage the contracted firm to deliver the asset quickly, as they are not paid until the asset has been delivered. However, the PFI has been criticised on the grounds that it adds to public debt, represents poor value for money as long service contracts are difficult to change, and increases the government’s administration costs.
Hospitals and schools are not pure public goods simply because the government finances them. Their services can be rival and excludable. This example concerns the choice between public and private delivery, which is separate from the economic classification of the service.
A related example of NHS outsourcing is Ramsay Health. The original case reports 30 hospitals, 3 neurological units and over 3,500 staff, with NHS patients accounting for around 77.3% of its patients in 2016. These figures belong to the historical case. Contracting a private hospital to treat NHS patients does not, by itself, establish that the arrangement is a PFI infrastructure project.