I consider Ludwig von Mises the best economist, but I’ve found little written by him about the public goods doctrine (which uses public goods and free riders as an argument for government intervention in the economy). Other Austrian economists have made great points about it, which this article covers with quotes and commentary. Then I share additional arguments defending the free market against the public goods doctrine.
Economic Science And Neoclassicism by Jörg Guido Hülsmann:
The Austrian view of the public-goods problem is based on three arguments. First, there is no way to judge whether people really want a good, and how much they want of it, other than by looking at their actions. It is therefore unwarranted to call for government action to provide a good that otherwise would not be produced in sufficient quantities. If people are willing to sacrifice enough of their resources, any good can be produced without government intervention.
Second, there is no criterion by which public goods can be distinguished from private goods. This difficulty arises on a level that is even more basic than the common definition of public goods, which stresses non-rivalry of consumption and the impossibility to exclude other users. Fundamentally, a good can possibly be a public good if it brings about desired or undesired effects on people different from its owner (externalities). Yet, these externalities are clearly not a feature of a good as such, but depend exclusively on the subjective feelings of those other people. Whenever any person other than the owner takes an interest in a good, it becomes ipso facto a public good. As a consequence, there is no means to clearly distinguish between public and private goods. All goods can be public goods. And even more awkward is the implication that the status of a good can change from one second to the next by mere subjective whim (see Hoppe 1993, pp. 7f). This makes the criterion of “being public” unsuited as a basis for policymaking on behalf of the good.
Third, even if a good could properly be identified as a public good, it would not follow therefrom that government should provide it. In other words, it would still be necessary to justify state activity by a separate normative argument.
I think that’s a good, short summary of three important points.
Austrian Theorizing: Recalling The Foundations by Walter Block offers another summary:
The Austrian position on public goods is stark and clear.[33] There are no positive externalities of which the police and courts should take cognizance, since they cannot be demonstrated, or revealed through human action. (The market, in contrast, can internalize externalities of this sort, if they exist, in common parlance, through privatization and private property, through condominiums, restrictive covenants, discrimination, segregation, etc.) As for external diseconomies, they fall into two categories. First, smoke, noise pollution, crime, trespass and other physical invasions. It is precisely to counteract acts of this sort that we have police and courts in the first place (Rothbard 1990; Block 1998; Whitehead and Block 1998; Yeatts and Block forthcoming; Whitehead and Block forthcoming; and McGee and Block 1994). Second, are the external pecuniary diseconomies, including all other supposedly negative effects which cannot be demonstrated through human action. For example, I open a grocery right across the street from yours, and “steal” some customers, much to your (not demonstrated, but likely real) consternation. These, too, since they do not constitute uninvited border crossings, are to be ignored by the forces of law and order.
I again agree with these points. I note the footnote giving sources with more info on the Austrian view of public goods cites Rothbard, Hummel, Block and Hoppe, but not Mises.
From the book The Myth of National Defense: Essays on the Theory and History of Security Production, I will quote from chapter 9, National Defense and the Theory of Externalities, Public Goods, and Clubs, by Walter Block.
Many economists maintain that national defense is the sort of thing which, while it indubitably helps those who pay for it (they would scarcely consent to be billed were it otherwise), these benefits cannot be fully captured by them. Rather, a part of the good effect “spills over” onto those who have not paid for it. Each person thinks: “If others pay for protection from external enemies, then I, instead of undertaking the defrayment of these costs, can be a ‘free rider’ on their expenditures.” But if all go through this exercise of logic, then each will wait for the others to finance this operation; they will all operate under the hope that the other guy will pay the freight, and they will be passive beneficiaries. As a result, no one will recompense the private providers of this service, there will be no national defense, and relatively weak foreign armies will be able to overrun us.
What is the solution to this conundrum? For mainstream economists, it is that the government force the citizenry—all of it—to pay taxes for national defense. In this way the cycle of externalities can be broken. No one will ever need fear that others are riding on his coattails. They, too, will be forced to bear their fair share of the common defense.
Block objects that it doesn’t make sense to use force against the citizens for the purpose of protecting them from force. Then:
Another difficulty is that this argument is “too good.” It proves too much—far too much. Were it true, it would apply not only to individuals but also to groups of people: to cities, states, even entire nations. Consider Mexico, the United States, and Canada in this regard. During the Cold War, if America arms to protect itself against the Russian imperialist bear, then according to this argument, this benefit will of necessity spill over to its two neighbors, to the north and south of it. Therefore, the U.S. will not invest in a military establishment. Similarly, for Canada and Mexico.
But the U.S. did invest in a military, so the free rider argument is missing something.
two considerations give rise to an item being considered a public good or not: excludability and rivalrousness.
Block explains how goods don’t cleanly fit into these categories. They can seem to shift categories based on what you focus your attention on. And actually, in short, everything is excludable and rivalrous, including militaries and lighthouses.
One basic difficulty with the entire public-goods schema is that whether or not there are costs at all, and whether or not they are positive or negative if they exist at all, is entirely a subjective matter.[25]
In other words, people have different tastes and values. What I consider a benefit, you might dislike (consider a cost).
Then Block points out that the government is worse at excluding people from goods than private companies are. Then:
It is a mistake to count the lighthouse as a pure public good in category D.[26] The private lighthouse owner had a credible threat to hold over the head of the boat owner who refused to pay the fee: the next time he was in need of this service, it would be turned off if there were no other ships in the area. The nonpayers could of course try to ride on the “coattails” of others in the industry. But this would unduly increase the risks of collision, either with other vessels or with rocks on shore. Further, the nonpayer would have to tailor his schedule to match those of other travelers, which might be more costly than the lighthouse fee. Alternatively, he could trim his sails to try to disguise himself as another boat. This, too, however, would be expensive and even dangerous. And, in the era of steamships, this became all but impossible.
Great example. To add my own example: lighthouses could be stocked with different types of lights (e.g. brighter at close range, more visible at longer range, or different colors including colors outside the visible spectrum that could only be detected with special equipment) which differentially benefit different ships. The choice of which types of lights are used at which times could be determined only by paying customers. As another example, the lighthouse could have a giant billboard on top, and only put up ads from paying businesses and exclude free riders from choosing ads. These ideas could be combined by a lighthouse which puts a silhouette of an advertisement in front of its light, so that the advertisement is shown to boats.
Also ignored is the phenomenon of “internalizing externalities.” The problem with the lighthouse is that there is a vast unowned resource interfering with the analysis of markets. To wit, the ocean has not yet been fully privatized. Were this to occur,[27] the owner would likely provide lighthouses in much the same manner as other entrepreneurs (e.g., grocers, bowling-alley owners) commonly offer lighting services to their customers.
In a similar vein, some economists claim that street lighting is a pure public good, to be placed in D, since it is well nigh impossible to restrict this service to those pedestrians who pay for it. The simple answer is to make it a package deal: combine access to the sidewalk with the lighting, and charge for both. Restaurant owners, after all, never charge separately for lighting; this is figured into the price of the meal. And as to restricting entry to sidewalks to customers, it may well be that when all such thoroughfares are privatized, access to them will be offered for free, as a loss leader, in exactly the same manner that mall owners do not now charge for use of their passage ways.[28]
I like the generalization of lighthouses as a lighting service like the lights in restaurants, and I like the point that mall owners provide free passage on their privately owned land.
Block explains how national defense is excludable too, and mentions that defense of sidewalks could be bundled with them, just like street lights (or like lighthouses with ocean locations):
Who, then, will protect people as they go about their daily routines of living at home, commuting back and forth to their jobs,[33] with daily side trips to stores and movies, weekly ones to bowling alleys, golf courses, and shopping malls, monthly ones to downtown, and annual vacations to faraway places? Why, the owners of these amenities, that is who. Remember, unlike at present, wherever a person goes he will still be on private property. Each owner thereof will be highly motivated to ensure that no crimes occur on his premises, because if they do, there goes the present discounted value of his property.[34]
How well might this work? Block has a great example with Disneyland compared to a government park (my bold):
Moreover, unlike the public police and governmental soldiers, in addition to having a patriotic or esprit-de-corps motivation for guarding life and limb, they will also have a financial incentive to do so. It is no accident that the thoroughfares in Disneyland are far safer than those in New York’s Central Park. Let one or a few rapes and murders occur in the former establishment, and profits will begin to plummet, as customers stay away in droves. Allow a few more, and bankruptcy looms, and with it the threat that the present owners will lose their property to entrepreneurs able to maintain a safety level consistent with a healthy bottom line. In very sharp contrast, when Central Park becomes a quasi militarized zone where criminals run riot, no one in a position to do anything about it loses money. Fees for the upkeep, maintenance, and safeguarding of this park are derived from taxes, that is, compulsorily. No bankruptcy is possible. The only feasible remedy is a political one. But for that, the park users may have to wait as long as four years. Even then, they have no way to directly express their dissatisfaction with park safety. They must choose between two mayoral candidates who are responsible for far more than the protection of a few acres of land.
This gives an indication of how private companies can provide defense more effectively than the government can, and how the incentives work.
I’m impressed with the Austrian arguments against the public goods doctrine, and I have further arguments defending the free market.
Businesses produce a complex set of goods, and only attempt to sell some of them. Some of those goods are more or less “public” (more easily excludable and less rivalrous) than others. Regardless, it’s the business’ job to figure out which goods to sell and how to thereby make a profit. This is not a special situation justifying government violence, it’s the normal situation of every business.
Businesses always capture a limited fraction of the value they create for others. Trade is for mutual benefit, so customers pay less than the value of the good to them – the business gets a fraction. And businesses don’t charge for everything. E.g. a store’s indoor lighting helps light up the street outside for non-customers walking by, and a business’ advertisements are freely available to people studying for a career writing ad copy or who otherwise find them interesting (marketing materials often provide some education about a problem a product can solve and how the product can solve it, which is similar to a puzzle and its solution, and that information can be used for designing rival products or homemade solutions).
The value of the things depend on people’s opinions – how much a person values it. One person may see a benefit where another sees a cost. We can’t measure this well, except to say that customers value goods higher than the price they paid. But we don’t need to measure specific numbers to use the concept of value capture.
It doesn’t harm a business to have fractional value capture, including not charging anything for some types of value it creates. That’s the normal way all businesses work, including highly profitable ones. So free riders – people getting value while paying a lesser amount, or paying nothing – are both everywhere and harmless. If a business had the same sales plus more free riders, it wouldn’t be any worse off.
To the extent we can make estimates about value capture fractions, good businesses often appear to have low value capture. My iPhone is worth far more to me than I paid for it. A pen, a fan, or a good book are all cheap compared to the value I can get from them. Google gives away its search service, email service and more without capturing a dollar of sales revenue from me. Google creates many products and only charges for some of them (primarily ads); that’s OK.
Low value capture fractions are common because they’re easier for businesses to achieve. It’s easier to sell a product for 1/4 of the value a customer gets from it than to sell it for 3/4. Consequently, the most net-value-creating businesses have the easiest times finding a way to make a profit, and, in total, they commonly benefit others much more than themselves. (If the value capture fraction is 1/4 on average, then customers get 3 times the benefit that the company gets.) It’s no big deal to give away the majority of the value your business creates if you also make a large profit; that’s normal.
The free rider problem becomes more of a concern when a business – whether it produces a “public good” or not – is creating too little value, so it must capture (get paid for) a large fraction of the value created in order to stay in business. So the economic logic here creates a tendency for business projects to happen which are more beneficial to society, and have more margin for error if anything goes wrong. That’s a good thing. There are plenty of great business ventures to pursue; we don’t need the businesses at the borderline. We don’t need businesses which are not currently profitable due to voluntary customers, but which claim they are valuable and would make a profit if only every last person would pay 90% of the value the business owner believes, in his opinion, that he’s providing to them.
There is nothing government can do to change any of this logic or help with this non-problem (that some goods are harder to charge money for than others, and businesses must figure out which of the goods they produce they should sell, at what prices, by what sales strategies, and how to make an overall profit from that). Government can, however, put some people out of business while collecting taxes to sustain money-losing businesses with good lobbyists.
There’s a particular good, produced by most businesses, but rarely sold or bundled with anything that is sold, which has been widely overlooked. It’s the option value to buy things from the business. It helps demonstrate that free riders (that is, people benefitting from capitalism without paying – which is a good thing, a benefit) are everywhere, and that businesses don’t sell all the value they produce.
Stock market options (to be able to buy a certain stock at a certain price during a certain time window) cost money, but I don’t have to pay Safeway for the option to go buy their food. Safeway makes many products available to me at certain times, locations and prices. I may not have a contract guaranteeing me these options, but Safeway does put effort into making these options reliable for me (they try to have regular hours, have stable prices, rarely change locations, and have a standard array of products consistently available).
Stock market options offer benefits even if they expire unused. They help with risk mitigation and other aspects of financial planning. So, too, are there benefits from the option to buy from Safeway – even if I don’t buy anything. It means I can keep fewer foods in my home, knowing that should I want a food I don’t have or ran out of, I have the option to go get it from Safeway as a backup plan. Without Safeway and other stores providing me free options to buy their products, I’d have to manage my food differently (in a way that’s worse for me, or else I’d be doing it already).
Stock market options are correctly seen as having tangible value, and are sold for money. Options to buy products from businesses are also valuable, but are usually free. As a demonstration of the value, consider that new stores opening near your home can raise the price you can sell the home for – as a small town becomes a large town, its homes become more valuable. And home owners don’t have to pay the new businesses anything in return for receiving this benefit, they get it for free. (Similarly, Silicon Valley tech companies have raised home prices in the area by offering lots of high paying jobs, but have not charged pre-existing home owners a dime for the increase in home prices that they provided.) A larger selection of available product options is a greater value, like a town with more stores, even if you don’t personally buy most of the available products. (It’s good for you that, should you ever want one of the products you don’t normally buy, it would be available. BTW, note that Amazon offers many product options to the whole country, even if you don’t live near a store, so they have even more free riders than regular stores, which doesn’t seem to be hurting Amazon.) And why do people pay Costco money for a membership? In order to receive the option to buy Costco’s products – an option that members consider to be worth some actual dollars.
Stock market options are valuable despite the fact that you have to pay to use them. That is, I pay $10, now, for the option to buy a share of Walmart stock at any time during the next month for $50. If I actually use (“exercise”) the option, I pay a second time. Options to buy food from Safeway don’t require two payments, because the first payment is $0. With the stock, I pay $10 now and I may pay $50 later if I decide I want it. With Safeway, I pay $0 now for the option to buy toilet paper, and I may pay $5 later if I decide I want the toilet paper. The first payment is the price of the option (which is usually free for most products sold by most businesses, even though it has value), and the second payment is for the good itself.
More generally, I benefit not only from the option to buy from a business, but to trade with it. That includes the option to sell my labor to the business – it’s to my benefit to have many options for where to sell my labor. I also benefit from options for places to sell my used goods. Options are usually given out for free because trade is mutually beneficial (stock options aren’t free because the seller can lose money depending on stock price changes, but the option to create a Vanguard account and buy stocks from them is free). It’s harmless to a business that people get value for free, and actually good – the more free value a business gives out (without increasing its costs), the better, because people will like it more – so the concept of avoiding free riders is misguided. Instead of avoiding free riders, figure out what you can sell to make a profit, and be happy that, as a side effect, you’re also helping people in other ways.
It’s not a flaw of capitalism that free riders exist. It’s part of how capitalism benefits society. Capitalist businesses give away lots of value, and that makes the world a better place. And that’s harmless – it doesn’t stop them from also making a profit.
To summarize, businesses create many valuable things, and charge money for only some of them. They capture only a fraction of the value they provide to other people. Goods are bought by customers for less than the value gained, and other valuable things are given away for free. There are many examples of free things with value, commonly including the option to buy a product. The public goods doctrine claims that the free market will fail to create goods in the special case when there are free riders – some people gain value they don’t pay for – but actually that is the normal situation of all businesses, and it’s part of how capitalism benefits everyone.
For more info on public goods, see my previous essay.