When private markets fail: public goods

Today’s post is about another major reason private markets can fail: public goods.

One requirement for private markets to work well without government intervention is that the good or service in question needs to be both “rival” — meaning one person’s use reduces what’s left for others — and “excludable” — meaning you can stop people from using it if they don’t pay. Many things we consume on a day-to-day basis, like housing, haircuts, and food, meet these requirements.

Public goods, by contrast, are defined as goods that are non-rival, meaning that your use doesn’t reduce availability to others, and non-excludable, meaning that it’s hard or impossible to prevent anyone from benefiting, even if they haven’t paid. Now these are excellent properties for a good to have in general, but the problem is that private markets struggle to provide enough public goods-if they provide any at all.

Let’s start with a classic example: national defense. If the military protects the country from attack, you benefit from that protection whether or not you pay taxes. We can’t exclude you, and your protection doesn’t diminish mine. That’s a public good.

Another example is clean air. When air is clean, everyone breathes it. If I work to reduce pollution, everyone else benefits too. But that also means a firm can’t just charge people for reducing air pollution, which makes it hard to fund the cleanup through private markets.

A very important public good is basic scientific research or knowledge more generally. When researchers make new discoveries and publish their results, those ideas become public knowledge. Others can build on them, create new technologies, and launch businesses. But if the original researcher can’t profit from that broader impact, they may underinvest in the work. Again, the private market underprovides.

Public goods lead to something called the “free rider” problem-when the good in question is a public good, people have an incentive to under-contribute and enjoy the benefits for free. And when everyone thinks that way, too little of the good in question gets provided.

So what do we do? In many cases, the government steps in to fund public goods through taxes, either directly or by subsidizing their creation. That’s how we pay for defense, roads, scientific research, clean water systems, and more. This kind of spending isn’t wasteful or inefficient, it’s filling in a major gap that private markets simply can’t fill themselves. In the case of knowledge, patent laws help ensure that innovators can profit from their inventions, although they also create other problems by granting the inventor a monopoly.

Of course, government policy isn’t always perfect. Governments can misallocate resources or spend inefficiently. But without government involvement, we’d likely have far too little of public goods.

Originally published at https://mytwocentsandcounting.substack.com.