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Dr. Harry Hillman Chartrand, PhD

Cultural Economist & Publisher

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h.h.chartrand@compilerpress.ca

215 Lake Crescent

Saskatoon, Saskatchewan

Canada, S7H 3A1
 

Curriculum Vitae

 

Launched  1998

 

 

Microeconomics

6.0 Market Failure (cont'd)

 

 

3. Public Goods (MKM C11/235-50)

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 cannot. I alone can extract its utility. 

On the other hand, a pure public good  is not excludable or rivalrous in consumption.  I cannot stop you from consuming it and 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 thus a 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 C11/238-40)

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 want private 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,

b) 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 for, 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 Commons (MKM C11/242-8)

 If the modern environmental movement was born with publication of Silent Spring by Rachel Carson in 1962 it was in 1968  that Garrett Hardin, a biologist, published “The 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 destruction.  

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 as with 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 Observation #10:  Common Natural Resource Treaties: the 1982 UN Convention on the Law of the Sea; the 1992 UN Convention on Biodiversity; the 1997 Kyoto Protocol to the 1992 United Nations Framework Convention on Climate Change; and the 2003 UNESCO Convention on Intangible Cultural Property

The best known of these multilateral agreements is the 1997 Kyoto Protocol to the 1992 United Nations Framework Convention on Climate Change opened at the Rio or Earth Summit.  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 mentioned treaties.

iii - Knowledge Commons

Today one 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 Observation #11: The Knowledge Commons.

One aspect of knowledge as a public good can be seen by extending the geometry of the Standard Model.  In Fig. 3 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 cents!

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 2009).

In economic theory, IPRs today are justified by market failure, e.g., when market price does not reflect 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 only for:

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

years; and,

fixation in material form, i.e., it is not ideas but rather their fixation or expression in material form (a matrix) that

receives protection.

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 creators.

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 24, 2001).

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

device; and,

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.

Unfortunately with 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 innovation.  Impediments 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 are 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 C22/491-509)

Under Perfect 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.

 

i - Economics of Democracy (MKM C22/499-503)

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:

a) Voters;

b) Politicians; and,

c) Bureaucrats.

a) Voters

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 Apathy or Ignorance.  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 'notwithstanding' clause 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 in 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 moral hazard.  Economist 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 program.

b) Politicians 

The objective function of politicians is to get elected or re-elected.   They are constrained primarily by Arrow's Impossibility Theorem.  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 this 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.

c) Bureaucrats 

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 not 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 examples abound!

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 confidentiality

ii - Cost/Benefit Analysis (MKM C11/241)

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 and benefits.

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 and benefits.

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 economist Thorstein Veblen who introduced the concept of 'conspicuous consumption'.

Having 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:

a) Taxation;

b) Property Rights

c) Regulation;

d) Prosecution; and,

e) Subsidies.

a) Taxation (MKM C8/171-181)

Taxation 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 Fig.16.4).

b) Property Rights (MKM C10/228-30)

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 Sovereign.

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 by conquest.

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 private property.

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 legal Title.

John R. Commons observed in his classic The Legal Foundations of Capitalism (1924) 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. Rose 2003).

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 status (Kneen 2004).

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 see: "The Innovative State Governments Should Make Markets, Not Just Fix Them" by Mariana Mazzucato, Foreign Affairs, January/February 2015.

c) Regulation (MKM C10/220 & C15/341-2)

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 reflected geometrically. 

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 the 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 the 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 State directly;

2. the State subsidize private producers to produce it; or,

3. 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 proposed in "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 Anglosphere.

d) Prosecution

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 a firm's or industry's negative externalities are subject to individual and class action suits as a tort, i.e., non-contractual loss or harm to someone 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.

e) Subsidy

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. 

 

 

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