Tuesday, 5 February 2013

Defining a public good: don’t forget the production side

Ask any self-respecting economics graduate the definition of a public good and they will tell you the answer: it is a good that is non-excludable and non-rivalrous. Which means that once it is provided everybody gets to consume it, and that one person’s consumption of the good does not detract from another person’s enjoyment of it. Simple enough, one might think. But, I sense a lot of disagreement about the nature of public goods. For example, I presented a paper recently on step-level public goods, and the audience was keen to dispute that a step-level public good ‘really is’ a public good. So, what’s the problem?
   The definition of a public good only tells us about the consumption side. It leaves a complete blank as to how the public good will be produced. And this is where the differences start to surface. To most economists, if you say public good, the picture that first comes to mind is of a smooth linear or concave production function; the more people contribute towards the public good the more is produced. To most psychologists, if you say public good, the picture that comes to mind is seemingly of a step level production function; contributions need to reach particular thresholds to provide the good. We need not stop with these two examples. One can have a minimum-effort production function in which the quantity of the public good is determined by the minimum contribution. Or, one could have a best-shot production function in which quantity is determined by the largest contribution.
   How a good is produced is irrelevant in determining whether or not it is a public good. So, if people have a picture of what the production function of a public good ‘should be like’ we get a source of confusion and disagreement. The problem, however, is a little bit deeper than this. If the production function is smooth then the public good is underprovided by the market. If the production function is of the step-level, minimum effort or best-shot type then the public good can be efficiently provided by the market.  Economists are educated that public goods are underprovided by the market; hence it is natural for them to associate public goods with smooth production functions. Psychologists focus more on the coordination aspect of providing public goods; hence it is natural for them to associate public goods with step-level production functions. The confusion and disagreement is not, therefore, just about production functions, its also about whether markets can provide public goods efficiently.  
   This is worth keeping in mind when looking at public goods. Economists, for instance, are almost certainly biased towards thinking public goods cannot be provided by the market. Many public goods are, however, provided by the market. It is crucial, therefore, to also think about how public goods are produced.

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