The economics of maps

I have always liked maps. When I was growing up, one of my favourite books was my Rand McNally atlas. I may even still have it, tucked away with its spine held together by masking tape (after years of overuse by my primary-school-aged self). When I'm reading some fantasy novel that has a map on the inside cover, I can find myself lost in the map before even getting to read the book, and then flicking back to the map any time some new location is mentioned. Right next to my laptop while I'm writing this is a sepia-toned desk globe than, in truth, takes up too much space on the desk but will not be foregone.

Given my interest in maps, I've been planning to read this 2020 article by Abhishek Nagaraj (University of California at Berkeley) and Scott Stern (MIT), published in the Journal of Economic Perspectives (open access), for some time (like many articles that have sat in my digital to-be-read pile for a long time). Nagaraj and Stern explain the economics of maps. This isn't the economics that uses maps, such as in the field of economic geography, but two other aspects. First, they review the economic and social consequences of maps. Second, they review the economics of mapmaking. Most of the article is devoted to the latter, and that's what I want to focus on as well.

First though, what is a map? In my classes, I use maps as an example of a model - an abstraction or simplification of reality. Nagaraj and Stern note that maps are composed of two elements: (1) spatial data; and (2) a design. As they explain:

At its core, a map takes selected attributes attached to a specific positional indicator (spatial data) and pairs it with a graphical illustration or visualization (design)...

Having separated a map into its constituent elements, Nagaraj and Stern then look at the economics of spatial data, and the economics of design. On data, they note that:

...mapping data is in many respects a classical public good. Almost by definition, mapping data is non-rival insofar as the use of data for a map by any one person does not preclude its use by others; moreover, the information underlying a given database is non-excludable because copyright law does not protect the copying of factual information. While the precise expression included within a database can be protected through copyright, the underlying geographical facts reflected in the database cannot be protected.

And just like most other public goods:

The combination of non-rivalry and non-excludability of mapping data makes its production prone to private underinvestment, providing a rationale for government support. Indeed, many of the most widely used maps rely on publicly funded geospatial data, including US Geological Survey topographical maps, Census demographic information, and local land-use and zoning maps.

On the other hand:

...there are important cases where mapping data is in fact excludable, either through secrecy or contract... Mapping data that allows for excludability exhibits properties more akin to a club good than a traditional public good. Specifically, the significant fixed costs of data collection combined with relatively cheap reproducibility creates entry barriers that supports natural monopolies or oligopolistic competition. It may be efficient for only a single firm to engage in data collection and for the industry to simply license these data (under agreed-upon contractual terms) from this monopoly provider.

Now, even when spatial data is protected and excludable:

...in the absence of perfect price discrimination, private entities may only provide mapping data at a high price (relative to near-zero marginal cost), reducing efficient access. Beyond pricing, the private provision of mapping data may additionally be concentrated in locations with high demand (such as urban areas) to the exclusion of less concentrated regions.

And that all accords with what we see. There are free sources of spatial data, which are public goods supported by governments or universities, alongside proprietary spatial databases that are club goods and only available at relatively high cost (to the dismay of researchers such as me!).

Turning to map designs, Nagaraj and Stern note that:

Like data, designs are also a knowledge good in that multiple individuals can use a particular map design (and so a design is non-rival) and the degree of excludability for a given design may vary with the institutional and intellectual property environment. With that said, a striking feature of a map design is that, almost by construction, a map is created for the purpose of visual inspection, and it is much easier to copy than a database (which might be protected by secrecy or contract). One consequence of this is that there may be underinvestment in high-quality and distinct designs for a given body of geospatial data.

They use this to explain why there is a lot of competition in the provision of map designs, which is why so many maps for particular purposes look the same. As Nagaraj and Stern explain:

A potential consequence of the non-excludability of mapping data and designs is inefficient overproduction of mapping products that compete with each other. Once a given map is produced for a particular location and application (say, a city-level tourist map), copycat maps can be produced at a lower sunk cost; because demand for maps of a given quality and granularity is largely fixed, free entry based on a given map involves significant business-stealing...

Taking both spatial data and map designs together, the role of intellectual property protection is important:

On the one hand, an absence of formal intellectual property protection leads to underinvestment in mapping data and high-quality map design, but inefficient entry by copycat mapmakers. On the other hand, a high level of formal intellectual property protection can shift the basis of competition away from imitation and towards duplicative investment. For example, over the past two decades, no less than four different organizations—including Google Street View, Microsoft StreetSide, OpenStreetCam project, and TomTom—have undertaken comprehensive and qualitatively similar initiatives to gather street-level imagery and mapping coordinates for the entire US surface road system.

So that explains why there are multiple Street View clones available. The firms are over-investing in goods that are protected by intellectual property. Do we really need multiple copycats of Google Street View? Also, in terms of intellectual property protection, I found this interesting:

In addition to employing copyright, firms often invest in additional strategies to protect their intellectual property. In particular, mapmakers have devised the idea of inserting fictional “paper towns” or “trap streets” in maps... This strategy allows them to detect rivals who might copy their data (rather than collecting similar data through an original survey) and thereby protect costly investment in original data collection. Such strategies are commonly deployed by mapmakers to this day for factual data...

Does that help to explain why people have been caught out following roads that don't exist, or trying to find towns that are misplaced? I guess that 'trap streets' or 'paper towns' are a good idea on a paper map, which requires a certain amount of attention to follow, but less suitable for digital maps that people follow blindly.

Nagaraj and Stern's article opens our eyes to the economics of maps, as well as their consequences. And now, I'm going to search my garage for my beloved Rand McNally atlas. If only I had a map to guide me as to where it is hiding!

Even if they are provided by local government, not all of the 'three waters' are public goods

This week, among other things, my ECONS102 class covered public goods. Public goods are goods that are non-rival (where one person using the good doesn’t reduce the amount of the good that is available for everyone else) and non-excludable (where the good is available to everyone if it is available to anyone). Just because a good or service is provided by the government, or you think it should be provided by the government, that doesn't make that good or service a public good. To be a public good, it must be both non-rival and non-excludable.

Which brings me to this article from the New Zealand Herald from earlier this year, about water services in Gisborne:

An overwhelming 90% of Gisborne submitters are in favour of keeping the region’s water services in council hands, with ring-fenced funding and targeted rates...

Previous Mayor Meng Foon was among those who submitted, writing in his submission, “water is a public good” and it should stay in public hands to prevent exploitation.

In general, water is not a public good (as I have noted before, here and here). However, the context here is a little different from the context in those posts, because the 'water' that is being referred to in the article is actually three different water services that are often bundled together and provided by local councils: (1) water supply; (2) wastewater; and (3) stormwater. That is the 'three waters' that had many people losing their minds under the previous Labour government.

Now, as much as Meng Foon may wish it to be so, the three waters are not all public goods. To see why, let's consider each of them in turn.

First, water supply is not a public good. It is a rival good, because one household (or other user) using water from the municipal water supply leaves less water for everyone else. Water supply is also an excludable good, because the consumption of water can be separated into the consumption by Household A, the consumption by Household B, the consumption by Household C, and so on. That means that it is feasible to exclude any of those households from access to the water supply. The council simply turns off the tap that runs to their house. So, water supply is a good that is both rival and excludable. By definition, that makes water supply a private good, not a public good.

Second, and in contrast to water supply, wastewater is probably a public good. Unless the wastewater system is at capacity, it will be a non-rival good, since one household flushing a toilet won't stop other households from doing so (if the wastewater system is at capacity though, then wastewater might be a rival good). Wastewater is also a non-excludable good because, unlike water supply, there is no tap to turn off to exclude a household from the wastewater system (as far as I am aware). If the wastewater system is available to anyone, it is available to everyone. So, unless the wastewater system is at capacity, [*] wastewater is non-rival and non-excludable. Wastewater is a public good.

Third, stormwater is almost certainly a public good. It is non-rival, since one household benefiting from the stormwater system doesn't prevent other households from benefiting from it as well. And it is non-excludable, because if it is available to anyone, it is available to everyone. Stormwater is non-rival and non-excludable. Stormwater is a public good.

I guess that makes Foon two-thirds correct, if we can agree that wastewater and stormwater are public goods. Water supply is clearly a private good though.

Now, even though water supply is a private good, rather than a public good, that by itself doesn't mean that it shouldn't be provided by the government. The government provides many goods and services that don't meet the definition of a public good, including healthcare and education.

The question of whether a good or service should be provided by the government is necessarily normative, and your preferred answer likely depends on your ideological position. However, as noted in my ECONS102 class, there are a number of principles that apply when deciding whether a particular good or service should be provided by the government or by the private sector. One of those principles is that the government can almost always raise large amounts of money more cheaply than the private sector. That's because governments are low-risk borrowers, so tend to pay lower interest rates than private sector borrowers. This is likely to be somewhat less true of local government than it is of central government, but nevertheless the point is valid. Foon clearly understands this point:

At the hearings, Foon spoke on his submission, supporting the council’s recommended option to retain water services under council control...

“Even though it’s a CCO, your private organisation cannot borrow money as cheaply as the council.”

This is quite relevant, because water services are very costly to establish and so the initial establishment of the infrastructure for water services is likely to be funded by borrowing. To minimise the cost of that borrowing, you want to borrow at the lowest possible interest rate, and governments can better achieve that than the private sector.

However, this particular argument in Gisborne might actually be missing the point somewhat. The argument discussed in the article was about whether to have a council-controlled organisation (CCO) run water services in Gisborne, like Watercare Services does in Auckland. A CCO is not a privatisation at all, since the CCO is fully owned and controlled by the local government. It may make operational decisions at arms-length from the local government, but that doesn't make it wholly a private sector entity. And even if water services are provided by local government, whether directly or through a CCO, that doesn't make all water services public goods.

*****

[*] If wastewater is rival and non-excludable, that makes wastewater a common resource.

Should the government operate petrol stations?

The extent to which the government should be involved in the provision of goods and services generates a lot of debate. Most of that debate is unhelpful, since it involves small-government, market-fundamentalist types arguing against anti-market socialist types. It's all ideological, and there's a pretty good chance that neither of the sides in that argument is right.

This type of argument has come to the fore recently, with the government making noises about a partial privatisation of Kiwibank. Over in Australia, the premier of Queensland has created a bit of a storm by suggesting that the government might open some petrol stations. As this article in The Conversation by Graeme Hodge (Monash University) reports:

Queensland’s Labor government turned heads last week with a bold new election promise. If returned to power, it would set up 12 state-owned petrol stations and limit fuel price rises to just five cents a litre on any given day.

The proposal certainly tapped into a pain point for Queenslanders – Brisbane topped national petrol price rankings last year.

But it was quickly met with a predictable pile on from opposing political commentators, industry bodies and some economists, attracting labels like “risky” and “dumb and stupid”.

Mark McKenzie, chief executive of the Australasian Convenience and Petroleum Marketers Association, called it a “wildly bizarre intervention” in the retail fuel market.

So is the Queensland premier really out of his mind, trying to win votes less than three months out from an election? Or is there actually some merit to this proposal?

It's quite possible that the answer to both of those questions is yes. However, there is a useful question to be asked here. When should the government be involved in the provision of goods and services that the market could otherwise provide (or is already providing, as is the case for banking services or petrol stations)?

First, let's get something important out of the way. Just because the government provides something, that does not make it a public good. By definition, a public good is a good that is non-rival (one person consuming it doesn't reduce the amount that is available for everyone else) and non-excludable (if it is available to anyone, it is available to everyone). There are goods and services that the government provides that are public goods. The police force is one example. There are goods and services that the government provides that are not public goods. Kiwibank and petrol stations would be examples of those (both are excludable, since you can prevent someone from accessing them if they don't pay for them). There are public goods that the government doesn't provide. This blog is one example. So, just because the government provides something, that does not make it a public good. It has to be non-rival and non-excludable.

Coming back to the question at hand, when should the government provide goods and services itself? In my ECONS102 class, we discuss four principles of privatisation (or the reverse, public provision). These principles are adapted from three principles originally outlined in Diane Coyle's excellent book Sex, Drugs and Economics (no relation to this blog), which I discussed in this 2016 post. However, I have expanded on the principles over time (including adding in the third principle, the inspiration for which came from the substantially-less-excellent book The Price of Fish by Mainelli and Harris, which I reviewed here). The four principles are:

1. The government can almost always raise large amounts of money more cheaply than the private sector
2. The government is almost always worse at running things than the private sector
3. Privatisation where there is a lack of competition will likely create a privately-owned monopoly
4. Whenever the good has a large externality, is a public good or merit good, or has a long-term payoff likely to be overly discounted by quasi-rational individual decision-makers, the government is almost always going to have to be involved anyway

These principles seem to me to apply regardless of what you believe ideologically, and they are something that every privatisation (or public provision) decision must grapple with. Is this a good or service that requires a large, up-front investment in order to establish? If so, by Principle #1, it might be good to have the government involved because the cost of borrowing to pay for that up-front cost will be lower. But if the government is running it, by Principle #2, you can expect a worse service. Is there a lack of competition? By Principle #3, privatising would likely create a privately-owned monopoly, and associated problems. Is this one of the markets that requires close regulation or supervision, like healthcare, education, public transport, or financial services? By Principle #4, the government is going to have a large role in the industry anyway, so why shouldn't they be operating in that market?

Should the government be operating petrol stations though? The principles don't answer that question, but they do give you some things to think about. This is not a business that requires a large up-front investment to get started (Principle #1). Sure, it takes some capital to set up a petrol station. Perhaps it takes a lot of capital. But it certainly doesn't take so much capital that you need the government to fund it.

If the government is running some petrol stations, those petrol stations will likely offer a worse service (Principle #2). Why? Government-owned firms lack a profit motive. Privately-owned petrol stations have a strong incentive to give you good service. If they don't, you'll fill up somewhere else next time, and that means less profit for them. If they do a bad enough job, and lose enough customer, maybe they go out of business entirely. A government-owned petrol station doesn't have the same incentive. They can provide a bad service, and still not be shut down, because they exist mainly for political reasons, not profit.

We aren't talking about privatising here, so a privately owned monopoly is not being created. But, reversing Principle #3, this is creating government-owned competition. There isn't a monopoly here, but arguably there is a lack of competition. Adding another competitor, and especially one that is prepared to limit price increases, is going to increase competition. On the other hand, limiting price increases is going to create a government-owned firm that may well make losses, and then it becomes a question of how long taxpayers will be willing to subsidise their loss-making government-owned petrol stations.

In the retail petrol market, there isn't a strong case for the government to be involved anyway (Principle #4). This is not a market that requires strong regulation, in the way that financial services, healthcare, or education does.

Overall, how should we evaluate whether this is a good idea? Principles #1 and #4 don't indicate a need for the government to be involved. So, it really comes down to how any benefits from greater competition (Principle #3) weigh up against the worse service that the government-owned petrol stations would provide (Principle #2). I can't easily judge this, and reasonable people may well disagree.

Closer to home, the government will make a decision on what to do (or not do) with Kiwibank soon. I wish the government would consider these same principles in its decision. Sadly, so much government decision-making is based on fixed ideological positions, that it's unlikely that my wish will be granted.

Read more:

• The case against privatisation

Meta and basic research as a public good

Earlier this week, Meta disbanded a research team that had been working on using artificial intelligence to create a database of protein structures. As the Financial Times reported (paywalled):

Meta has axed a team that used artificial intelligence to create the first database of more than 600mn protein structures, in a signal the company is abandoning purely scientific projects in favour of building moneymaking AI products.

The social media giant had employed a group of about a dozen scientists on a project called ESMFold, which trained a large language model capable of processing vast amounts of biological data to predict protein structures. The effort has been lauded by those involved in the development of new drugs and treatments...

Though the protein-folding team was small compared with the thousands of AI scientists and engineers still employed at Meta, the move to axe their project showed the company’s desire to abandon blue-sky research in favour of AI projects that can generate revenues, the people familiar with the matter added.

The problem here is one of public goods. Public goods are goods that are non-rival (non-rival means that one person consuming the good does not reduce the amount of the good or service available for everyone else), and non-excludable (non-excludable means that if they are available for anyone, then they are available for everyone). Examples of public goods include streetlights, policing, and basic research.

The ESMFold team were created a database of predicted protein structures that could then be used by other researchers. A database like that is non-rival (one researcher using it doesn't prevent it being used by other researchers). Is it excludable? It need not be, but because Meta was releasing the database for researchers to use for free (it is available here), they made it non-excludable. As a non-rival and non-excludable good, the database is a public good.

The problem with public goods is free riders - some researchers may use the database, and might have been willing to pay for it, but many would use it without paying (and Meta wasn't asking for payment in any case). That makes the costs of providing the database difficult to justify for a firm that is profit-maximising. It is not a sustainable position (as evidenced by Meta shutting the team down), which is why public goods are usually provided by the government (either directly, or through procurement from a private provider).

Meta is redirecting the resources the ESMFold team was previously using into other AI applications, which are also non-rival but are excludable. These are club goods, which Meta can charge subscribers for access to. That they would redirect the resources in this manner does raise a question though - why didn't they simply make ESMFold pay-for-access (that is, excludable)? There was no need for it to be treated as a public good and shut down. Although perhaps, having already released earlier versions of ESMFold for free access, many researchers may have already downloaded a copy of the database, so making it excludable would simply drive those researchers to use their own free version instead? That suggests that Meta believes the benefits (in terms of subscriber revenue) are exceeded by the costs of continuing to fund the ESMFold team.

Another related question is why Meta released ESMFold as open access in the first place. This makes more sense than it appears at first. The database user community probably gave a lot of feedback to the ESMFold team, which was not only useful in improving the AI capability within that team, but had more general use as well. With an excludable database, the user community, and the quantity and quality of feedback received from the community, would likely be much smaller. Now, with AI development much more advanced, perhaps the value of the feedback received from the ESMFold user community has decreased to an extent that the benefits of retaining the open access database are exceeded by the costs.

Basic research is a public good. Even when a private firm like Meta initially provided access to a public good for free, we should not be surprised when the public good eventually becomes unavailable. A private firm will only provide goods (including public goods) for as long as the benefits exceed the costs.

The Tour de France, public goods, and the chicken game

I finally finished watching this year's Tour de France on Sunday. Yes, I was a week behind. That's because I was overseas when it started, and it took me that long to catch up (with big thanks to Sky On Demand!). Jonas Vingegaard well deserved his win. The individual time trial he rode on Stage 16 was amazing to watch (even if his team Jumbo Visma says so themselves).

Anyway, this is a blog about economics. Sports provide lots of great examples of economics in action, because economics is ultimately about choices, and so are sports. One striking example of economics in action in cycling road races occurs when there is a breakaway, and it is getting close to the finish line. The riders in the breakaway face a difficult choice. They can ride hard at the front of the breakaway, ensuring that the breakaway won't be caught by the peloton, and one of the breakaway riders will surely win the race. Or they can hold back, riding in the slipstream of the rider who is riding at the front, which lets them conserve energy for a sprint finish, but at the risk that the peloton catches them.

This exact scenario played out in Stage 18 of the Tour de France this year, with three riders approaching the finish. Victor Campenaerts rode hard towards the finish, ensuring the breakaway would succeed. However, it was Kasper Asgreen who won the stage, having conserved his energy for the final sprint among the breakaway riders.

Let's think about the incentives for a breakaway rider. Riding hard is a public good. It is non-rival (one cyclist benefiting from a rider riding hard at the front of the breakaway doesn't reduce the amount of the benefit available for the other riders in the breakaway) and non-excludable (if a rider is riding hard at the front of the breakaway, they can't easily prevent the other breakaway riders from sitting in their slipstream and conserving their energy).

Public goods, like riding hard at the front of the breakaway group, suffer from a free rider problem (pun intended!). Other riders can benefit from the front rider's hard work, without paying any of the cost themselves. It is difficult for a rider to justify riding hard at the front if other riders are unwilling to contribute, since they face all of the cost of riding hard, but the benefit (in terms of a better chance of winning the race) goes to the other riders (the free riders).

Ordinarily, the provision of public goods breaks down. They cannot be privately provided, because of the free rider problem. In this case though, cycling has developed norms that ensure some cooperation within the breakaway group. The riders tend to take turns at the front of the breakaway group, helping to increase the chances of success. However, the closer the race gets to the finish, the greater the incentives to free ride become. Regular cycling fans will no doubt remember many instances where a breakaway group has been caught, within sight of the finish line, because they failed to work together.

Another way of thinking about the incentives within a breakaway group is to use game theory. To make the problem simpler, let's say that the breakaway group only consists of two riders, and there are two strategies: (1) to ride hard; or (2) to hold back. We'll assume each rider makes their decision just once, and they make their decisions at the same time (a simultaneous game).  The payoffs for this scenario are shown in the table below. If both riders ride hard, they have a 50% chance of winning the race (since they will both be equally tired). If one rider rides hard and the other holds back, the rider that holds back wins the race for sure. If both riders hold back, then they are caught by the peloton, and neither of them wins (and they don't even finish in the top two in the race). What will happen?

To find the Nash equilibrium in this game, we use the 'best response method'. To do this, we track: for each player, for each strategy, what is the best response of the other player. Where both players are selecting a best response, they are doing the best they can, given the choice of the other player (this is the definition of Nash equilibrium). In this game, the best responses are:

1. If Rider B chooses to ride hard, Rider A's best response is to hold back (since winning for sure is better than a 50/50 chance of winning) [we track the best responses with ticks, and not-best-responses with crosses; Note: I'm also tracking which payoffs I am comparing with numbers corresponding to the numbers in this list];
2. If Rider B chooses to hold back, Rider A's best response is to ride hard (since losing and finishing in the top two is better being caught by the peloton and finishing much lower in the order);
3. If Rider A chooses to ride hard, Rider B's best response is to hold back (since winning for sure is better than a 50/50 chance of winning); and
4. If Rider A chooses to hold back, Rider B's best response is to ride hard (since losing and finishing in the top two is better being caught by the peloton and finishing much lower in the order).

In this scenario, there are no dominant strategies. Neither rider has a strategy that is always better for them, no matter what the other rider chooses to do. However, there are two Nash equilibriums (outcomes where both players are playing their best response), which occur when one rider rides hard, and the other holds back. Neither rider will want to be the rider that rides hard, so both may be holding out hoping that the other rider will ride hard. This is the free rider problem described earlier. This game is an example of the chicken game (which I have discussed here). If both riders hold back, hoping that the other rider will ride hard, both riders will be caught by the peloton.

The chicken game is an example of a coordination game. To end up at one of the equilibriums (or another), the players need to coordinate their actions. However, in this case neither rider really wants to coordinate on the other rider's preferred equilibrium. Both really want to hold back, especially closer to the finish line, which is why the breakaway can often be caught.

Riders are motivated by the chance to win the race. That is why breakaway groups form in the first place. However, the incentives outlined above work against the breakaway succeeding. And riders are aware of these issues. One thing that often happens is that, towards the end of a race, one rider will ride especially hard, breaking away from the breakaway group. There is no free rider problem when a rider is riding by themselves. Sadly, solo breakaways are seldom successful (except on mountain stages), because the effort required to remain clear from a group of breakaway riders who suddenly become more motivated to work together and catch the solo breakaway rider is very high. The solo breakaway rider is often caught, after which the chicken game and free riding begins again.

One thing that can increase the success of a breakaway is to have multiple teammates in the breakaway group. Teammates are more likely (but not certain) to be able to coordinate their strategies, and work together, reducing the free riding problem. That's why riders in the peloton are more vigilant and energetic in chasing down an early breakaway group that has multiple riders from the same team. Most of the time, a breakaway group will only go clear if every rider in the group is from a different team. Riders in the peloton don't want the breakaway to succeed, and having all breakaway riders from different teams decreases the chance that a rider from the breakaway wins the race.

There is a lot of strategy in sports, and cycling is no exception. There are also a lot of choices for athletes to make, and choices involves trade-offs. That, along with the transparent rules and the obvious goals of the athletes involved (they want to win), is why sports can provide a lot of useful illustrations of economic concepts.

Healthcare isn't the only example of a two-tier system

Merit goods are defined as goods that are deemed to be socially desirable. Socially desirable things can often be provided by the market. However, merit goods are deemed to be somewhat problematic because either: (1) the market doesn't provide enough of the good, compared with the socially efficient (economic-welfare-maximising) quantity; or (2) the good is important, and if it was distributed by the market, some people would miss out on the minimum quantity of the good that is deemed to be necessary. Who decides what is socially desirable or what the minimum quantity of the good is? Those are political decisions. In other words, what constitutes a merit good is mostly a political decision, not an economic decision.

If merit goods are not provided in sufficient quantities, or are provided in sufficient quantities but not to everyone who we think needs them, then that suggests a role for government. That means that the government either subsidises merit goods or provides the merit goods itself. I was tempted to provide some examples that fit into each of those two categories, but it turns out that, for every example I considered (health, education, public transport, the arts) the government tends to do a mixture of both subsidising and public provision.

However, let's focus on public provision of merit goods. There is no free lunch. When the government spends on health or education, that means less spending on other things. There are trade-offs, and that makes it difficult for government to provide gold-plated goods and services to everyone. Sometimes, people just want more than the government is able to provide. That's why in New Zealand, alongside the public healthcare system, there is a growing private healthcare system, accessed mainly by those with private health insurance. This unavoidably creates a disparity in people's access to healthcare. Some people can only afford to access the public healthcare system, while others can choose to access public healthcare, or to pay extra (either directly or through health insurance) to access private healthcare.

Many people take issue with the disparity in access, arguing that it creates a two-tiered system and is therefore unfair. Take this article from The Conversation yesterday, by Elizabeth Fenton and Robin Gauld (both University of Otago):

Many seem to accept the argument that a two-tier public-private health system is not morally problematic, given most essential health services remain free to all. Some might go further and argue justice demands a two-tier system because health is only one public good the state is obliged to provide. Limiting non-essential healthcare services ensures it can meet those obligations.

The second private tier protects the liberty of those who want and can afford to purchase those services, while the first public tier focuses on meeting everyone’s needs to a sufficient level.

But the justice argument supports this conclusion only if the services and benefits provided in the first tier meet that threshold of sufficiency. Where exactly this threshold lies has been the subject of perennial debate.

Fenton and Gauld are clearly in favour of a more generous public healthcare system, which in turn would limit the necessity for the private healthcare system. Their argument is valid. It's simply a question of prioritisation of government spending (but keeping the trade-offs in mind). However, I do want to take issue with this bit from their article (aside from them saying in the quote above that health is a public good, when it isn't [*]):

When the worse-off are required to accept services below reasonable expectations of routine care (and the demonstrable harms that result), individuals are no longer in the same boat. The better-off live in a world of social goods and privileges inaccessible to the worse-off.

Why we accept this in health and not other sectors is an important question. It is hard to imagine school teachers only taking bookings months out to see parents seeking help for their troubled children, or denying entry to public schools due to limited capacity.

It is also doubtful we would accept teachers setting up private classes and consultation times to provide a timely service to those who can pay.

Fenton and Gauld need to reconsider their example of education. Education is a two-tier system as well. There are both public schools (nominally free) and private schools (with high fees). Parents can (and do) pay for private tuition for their children as well. Some of that private tuition is conducted by people who are teachers in their regular day job (a consequence of the education system paying teachers poorly). And that isn't even considering post-secondary education, where there are both public and private providers as well. 

Healthcare isn't the only example of a two-tier system. Consider transport (public transport vs. taxis or Uber), justice (legal aid vs. private lawyers), or security (police vs. private security firms). Unless there is some law that prevents the private sector from operating, any time the government is publicly providing a good or service, we'll end up with a two-tiered system, with one tier accessible to everyone, and a separate tier accessible to those who are willing and able to pay more.

*****

[*] Public goods are goods that are non-rival (meaning that one person's use of the good doesn't diminish the amount that is available for everyone else) and non-excludable (meaning that no one can be prevented from accessing the good). Healthcare doesn't meet either of those conditions (for some further explanation with other examples, see here and here). Healthcare is a private good - it is both rival and excludable. It may be a publicly-provided good (in many countries like New Zealand that have a public healthcare system), but that doesn't make it a public good.

Ethnic diversity of local government and decision-making gridlock

Is it better to have more (ethnically) diverse local government, or less diverse local government? There are valid theoretical arguments in both directions. If local government leaders (e.g. elected council members) are more diverse, then they will have a diversity of opinions and preferences, possibly leading to more disagreements and less consensus decision-making, and government may become 'gridlocked', unable to make key decisions. On the other hand, local government leaders do feel electoral pressure, including the pressure to conform, and to the extent that there is effective electoral pressure, gridlock would not be a problem.

Whether more diverse local governments spend less on public goods (or not) is the subject of this 2017 article by Brian Beach (College of William & Mary) and Daniel Jones (University of South Carolina), published in the American Economic Journal: Economic Policy (ungated version here). They use data from the:

...California Election Data Archive (CEDA), which provides the names and number of votes for every candidate in every local government election occurring between 1995 and 2011.

For the 5177 candidates who won elections (or were close but lost) over the period from 2005 to 2011, they collect data on ethnicity, either directly from city councils, or by asking workers on Amazon Mechanical Turk (mTurk) to classify the candidates' ethnicities. They got 10 mTurk workers to classify each candidate, and had 94 percent agreement overall (they drop the 31 candidates who had low agreement from their sample). This was similar to the level of agreement between mTurk workers and city council data (95 percent).

Beach and Jones then measure the ethnic diversity of each city council, using indices of fractionalisation and polarisation. As they explain:

Both indices range from zero to one, where zero corresponds to a situation where there is no diversity. Fractionalization is maximized when each council member is of a different ethnicity. Polarization, on the other hand, is maximized when the seats are distributed into two ethnic groups.

The outcome variable that Beach and Jones are most interested in is public goods expenditure, which they calculate:

...by taking a city’s total expenditures for the year and removing expenditures on “government administration” and debt repayment. The “public goods” category therefore includes all spending on roads, parks, police protection, sewerage, public transportation, etc.

Now, a simple regression approach would be to look at the relationship between diversity (fractionalisation and polarisation) and public goods spending. The problem with that approach is the potential for endogeneity - maybe there are city-level factors that affect both the diversity of local government and local public goods spending. For example, perhaps having a more diverse population requires a greater variety of public goods, and more public goods spending, but also tends to lead to a more diverse city council. In that case, the relationship between diversity of the council and public goods spending is biased because of the relationship of both variables to the diversity of the population overall. Beach and Jones deal with that problem by looking at what happens subsequent to close elections, where one of the candidates is the majority ethnicity, and one is a minority. In sufficiently close elections, it is close to random which candidate is ultimately elected, provided some random variation in the diversity of the council, that doesn't depend on any other variable.

Beach and Jones identify 684 close elections with candidates of different ethnicities over the period from 2006 to 2009. Using that data, they find that:

Regardless of whether we measure diversity with fractionalization... or polarization... there is a strong and positive relationship between the election of a non-modal candidate and the diversity of the city council.

No surprises there. Electing a minority candidate increases the diversity of the council. Moving onto the effect on public goods, they find that:

...per capita spending on public goods falls by approximately 13 percent (significant at the 1 percent level) following the election of a non-modal candidate. The effect on nonpublic goods spending remains positive (roughly 14 percent) but is not significant at conventional levels.

So, more diverse local governments spend less on public goods. Beach and Jones then drill down into potential mechanisms that explain their results, and the consequences, and show that:

Our results indicate that diversity leads to gridlock. Cities reduce the amount they spend on public goods as their city council becomes increasingly diverse. These effects are largest for segregated cities and cities with more income inequality (where the potential for disagreement may be largest). We also find that all members of a council that experienced an exogenous shock to diversity receive fewer votes when they run for reelection. This latter point suggests that the city’s population is dissatisfied with the decline in public goods, ruling out the possibility that diverse councils simply achieve greater efficiency in public good provision.

So, ethnic diversity of local government appears to encourage gridlock, reducing local public goods spending, and it isn't an outcome that citizens favour. However, one thing that Beach and Jones didn't consider, is whether (or to what extent) a match between the majority ethnicity of local government and the majority ethnicity of the population matters. Or whether the effect is different at different levels of ethnic representativeness. Those would be interesting follow-up questions.

Also, the negative implications of this research need to be juxtaposed with the problem of groupthink. Groupthink occurs when there is too much consensus, leading to decision-making that lacks critical evaluation. This is more likely when the group of decision-makers is less diverse. So, perhaps the quantity of public goods spending is higher when there is less diversity in local government, but perhaps the quality of that spending is lower?

Coin-operated fountains as a public good

I'm in Whanganui this week on a writing retreat. This afternoon, we went for a walk around Rotokawau Virginia Lake. When we arrived, we noticed a pretty sad looking fountain in the front of the lake, called the Higginbottom Fountain. However, after walking around the lake and on our way back to the car, I noticed a sign that made it clear that the fountain was coin operated ($1 for 10 minutes, and $2 for twenty minutes). One $2 coin later:

That got me thinking about paying for public goods, which are goods that are non-rival (one person consuming the good doesn't reduce the amount of the good or service available for everyone else) and non-excludable (if it is available for anyone, then it is available for everyone). Fountains like the Higginbottom Fountain are a good example of a public good. One person admiring the fountain or taking a picture of it doesn't stop anyone else from doing the same (non-rival), and if the fountain is viewable by anyone, it is viewable by everyone (non-excludable).

The problem with public goods is that private willingness-to-pay for the public good is often not enough to ensure that the public good is provided to the socially efficient quantity (on a related point, see here). So, if no one is willing to pay the full cost of operating the fountain by themselves, then no one will pay and no one will benefit from it, even if everyone in total would be willing to pay the cost. The problem is that many people will elect to be free riders - receiving benefit from the public good, even though they aren't paying anything towards it. In this case, until we arrived no one was willing to pay the $2 cost by themselves, but everyone ends up benefiting after we paid the cost ourselves (and if we hadn't, the fountain would not have operated).

In discussing in my ECONS102 class the problem of paying for public goods when there are free riders, I often use street lights as an example. I then make the joke that street lights you could make street lights excludable (and limit the free rider problem) if they were coin-operated - pedestrians put a coin in the base of each light, in order to make the next one light up. Well, it appears that the joke is on me. You can sometimes fund public goods that way.

Starbucks and the tragedy of the bathrooms

Back in 2018, Starbucks hit the news for its bathroom policies. As Vox reported at the time:

Starbucks will treat anyone who walks into one of its cafes as a customer, whether or not they buy anything, the company said on Saturday. The announcement is the latest step the coffee company is taking as part of its ongoing response to the public outcry over the arrest of two black men at a Starbucks in Philadelphia. The men were waiting for a business associate to arrive and had asked to use the bathroom in April when Starbucks employees called the police, eventually leading to them being arrested and escorted out...

The arrest of Rashon Nelson and Donte Robinson on April 12 in Starbucks kicked off a major firestorm. The company initially issued a less-than-satisfying apology, and CEO Kevin Johnson later issued a lengthy statement on the incident in which he apologized to the men arrested, laid out plans to investigate the incident, and affirm Starbucks’ stance against discrimination and racial profiling. “You can and should expect more from us,” he wrote. “We will learn from this and be better.” 

What effect did the change in bathroom policy have? In a 2020 paper, Umit Gurun (University of Texas at Dallas), Jordan Nickerson (MIT), and David Solomon (Boston College) investigated that question. They first collated anonymised cellphone location data from SafeGraph (which I really wish was available for New Zealand, but it turns out is only available for the US, UK, and Canada), and compared the change in monthly visits to Starbucks before and after the policy change, with the change in monthly visits to other nearby coffee shops, and the change in monthly visits to restaurants (essentially, this is what we refer to as a difference-in-differences analysis). Using data covering the period from January 2017 to October 2018, they find that:

...Starbucks stores experienced a 7.0% decrease in visits after the enactment of the policy, compared with similar coffee shops and restaurants... After the policy change, Starbucks saw a small time-series increase in visits, whereas absent the policy a much larger increase would have been expected. Put differently, the general boom in visits to all coffee shops at the time helped disguise the fact that the new policy appears to have significantly reduced visits to Starbucks.

So far, so unfortunate for Starbucks. However, Gurun et al. aren't done. They look at how the effect of the policy differed depending on the distance to the nearest homeless shelter, and find that:

Strikingly, the decrease after the policy enactment is significantly larger the closer the location is to a homeless shelter. Stores less than two km away experienced declines of 8.5% relative to nearby coffee shops, while stores more than 10 km away experienced declines of only 4.8%. Again, this decline in attendance is not from worsening economic conditions in these areas – rather it captures the change in Starbucks relative to nearby coffee shops experiencing the same local economic conditions.

Their results hold when they switch to a synthetic control method as a robustness check. Interestingly, they have some evidence that different types of customers are affected differently as well:

Starbucks also experienced a significant change in the demographics of who visited the store. Relative to other coffee shops and restaurants, Starbucks saw a larger decline in visitors from relatively wealthier home locations. The estimated income of Starbucks customers declined by 0.4%, relative to changes in other coffee shops and restaurants... Despite the racial angle on the initial controversy, we find no difference in the racial demographics of the home locations of Starbucks visitors after the policy. In other words, the new policy appears to have deterred both black and white customers in roughly equal amounts.

To summarise those results so far, Starbucks' change in bathroom policy decreased their customers relative to other coffee shops, and the effect was greater for Starbucks stores closer to homeless shelters, and presumably had a larger effect on its wealthier customers.

Was there anything good that came out of this policy change? Gurun et al. look at the effect on crime for a subset of cities where appropriate crime data are available (Austin, Denver, and Pittsburgh), and find that there was:

...a decrease in public urination citations near Starbucks locations relative to other areas after the policy change. By contrast, a wide range of other minor public order crimes show no significant changes or consistent signs of effects.

The other crimes that they looked at included disturbing the peace, simple assaults/fighting, marijuana possession, shoplifting, theft of service, threats/harassment, and vandalism. The overall question is whether this was a good policy change for Starbucks - Starbucks face all of the cost, but aside from some good press (or, more accurately, a reduction in bad press), the benefits are public. Gurun et al. link this to the private provision of public goods, concluding that:

Our results suggest that companies may be better off focusing on donating money to worthwhile causes, and effectively using a division of labor, whereby Starbucks specializes in making and selling coffee, and engages in CSR by supporting organizations who specialize in social policies. Our results show that trying to incorporate the two within a single company may result in outsized negative externalities for the underlying business that makes CSR possible in the first place.

I don't agree. Despite the adjective, public bathrooms are likely not a public good. Public goods are good that is non-rival (where one person using the good doesn’t reduce the amount of the good that is available for everyone else) and non-excludable (where the good is available to everyone if they are available to anyone). Opening your bathrooms up to non-customers changes the bathrooms from excludable to non-excludable. However, I'm not convinced that they are non-rival. Anyone who has had to queue for a public bathroom would have to agree - one person using the bathroom reduces the amount of bathroom capacity available for everyone else (and makes you wait). So, at least during peak times, public bathrooms are a rival good. Goods that are rival and non-excludable are referred to as common resources.

Common resources are vulnerable to a problem that we refer to as the Tragedy of the Commons, a problem that was first described by William Forster Lloyd in 1833, but was brought to modern attention by Garrett Hardin's 1968 article of that title published in the journal Science. In the Tragedy of the Commons, private incentives and social incentives differ. The social incentive is to keep the common resource well-maintained, so that it is available in sufficient quantities for everyone. The private incentive is to use as much of the common resource as possible, because each user faces the full cost of restraining their activity, but receives only a small share of the benefits of their restraint.

Turning back to the example of public bathrooms, users have a low incentive to keep them clean and tidy. Which is why, and I'm sure you can relate to this experience, public bathrooms may in general be some of the grossest places on the planet. It's little wonder that fewer people would want to visit Starbucks, if the quality of their bathrooms has degraded. The paper by Gurun et al. seems to focus attention on the types of people using the bathrooms (hence, the homeless shelters angle). However, bathroom users don't have to be homeless to fail to keep the bathroom clean.

So, Starbucks likely faces costs on two sides from their policy change - reduced foot traffic (relative to other coffee shops) as shown empirically by this study, and theoretically higher costs of bathroom clean-up as well. And Starbucks' only benefit appears to be avoiding negative attention. Is it paying off for Starbucks? It must be, because the policy remains in place today.

[HT: Marginal Revolution, last year]

Incentivising coronavirus vaccination, part 2

A couple of weeks ago, I posted about incentives for coronavirus vaccination, noting that:

...the government could find some other way to incentivise more production and consumption. Right now, we're in a situation where governments want to roll out coronavirus vaccines in the face of a substantial amount of vaccine hesitancy. Some governments have started to incentivise vaccines through more than just subsidising them and making them available for free.

Continuing the theme, the New Zealand Herald reported last week:

A Florida music event promoted will charge a premium to those who have not had the Covid-19 vaccine.

The concert promoter has come up with a discounted ticket at $18 for those who have been vaccinated, and will charge $999.99 to those who haven't.

The idea is to encourage people to get the coronavirus vaccine, especially before attending a large gathering such as a music gig...

[Leadfood Promotions' Paul Williams] said feedback for his idea has been "overwhelmingly positive" and, so far, no one has bought any of the $1000 tickets.

A general point about incentives is that, when the benefits of doing something increase, we are more likely to do it. If the benefits of vaccination now include cheaper concert tickets, that may encourage a few additional people to get vaccinated.

My earlier post about incentivising vaccinations drew on behavioural economics (specifically, prospect theory). On a related note, Alex Tabarrok also raised a good behavioural economics point recently:

A vaccination is all about immediate costs and future benefits and it’s more difficult to act on future benefits than immediate costs, ala hyperbolic discounting. A free beer, donut, or lottery ticket provides an immediate benefit to offset the immediate cost and so may encourage vaccination, especially for those who are very present oriented. Note, however, that a lottery ticket might be expected to be less beneficial than an equivalent-cost donut because the donut is truly immediate while the lottery ticket is not. On the other hand, if vaccine hesitancy is driven by over-estimated fear of rare side-effects then perhaps a lottery ticket balances with an over-estimated hope of rare-benefits.

And then this point on funding public goods through lotteries (an excellent point that I had not considered before):

Even within a risk-neutral, rational model, however, there are good reasons to tie public goods to lotteries (ungated). Charities, for example, often use lotteries or raffles to fund public goods. Why? The reason is that a lottery is a natural counter to free-riding. Imagine that there is a public good but no one contributes because they each hope to free ride off other people’s contributions. As a result, the public good is not provided. Now introduce a fixed prize lottery. If no one else contributes then a contributor wins the lottery for certain so it can’t be an equilibrium for everyone to free ride (reminiscent of my dominant assurance contract mechanism for producing public goods). Note that the lottery in this model can’t just be a regular lottery ticket where you have to match X numbers to win. It has to be a raffle where the probability of winning is 1/N where N is the number of contributors. Thus, the Maryland and Ohio vaccine lotteries, which draw winners from the vaccinated, are much better than New York version which just hands out free lottery tickets. Thus, I expect the Ohio and Maryland versions to be more successful than the New York version.

So, let me reiterate: New Zealand should be considering what incentives to put in place to encourage vaccination now. The last thing we need is to fall short of herd immunity targets, and have to continue an isolationist stance on migration, while the rest of the world is opening up.

The market demand for a public good, and the optimal quantity to provide

The market demand for a good or service is determined by the sum of the demands for the good or service from each individual consumer. Essentially, you add up the individual consumers' demands to determine the market demand. For a rival good (a good where one person's consumption reduces the amount that is available for everyone else), it is as simple as adding up the quantity demanded at each price. So, if there are only two consumers, and at price P1 the first consumer demands Q1 units and the second consumer demands Q2 units, then market demand at the price P1 is (Q1+Q2).

However, when a good is non-rival, it is no longer quite that simple. Non-rival goods are those where one person consuming the good does not reduce the amount of the good or service available for everyone else. Disney+ is one example. If one person pays for a Disney+ subscription, that doesn't reduce the amount of Disney+ subscriptions that are left for other people. Another example of a non-rival good is a public good. Public goods are goods that are non-rival, and non-excludable (non-excludable means that if they are available for anyone, then they are available for everyone - we'll come back to this point later). Examples of public goods include street lights, or policing.

Now, if we want to know the market demand for street lights, we can't add up the quantity demanded at different prices. That's because two people can consume the same light - remember, it is a non-rival good. The market demand for a non-rival good is found by adding up the marginal private benefit that each consumer gets from the good, to give you the marginal social benefit.

To see how this works, consider the diagram below. There are three people (A, B, and C), and their marginal private benefits for street lights are shown by MPBA, MPBB, and MPBC respectively. The diagram is quite busy, so let's break it down and note what it shows. Person A benefits a lot from street lights. They receive a marginal benefit of P5 for the first little bit of street lighting, and continue to benefit from street lighting all the way out to a quantity of Q4 (this is their marginal private benefit curve, MPBA). Person B benefits less than Person A. The receive a marginal benefit of P3 for the first little bit of street lighting, and continue to benefit from street lighting up to a quantity of Q3 (this is their marginal private benefit curve, MPBB). Finally, Person C receives a marginal benefit of P4 for the first little bit of street lighting, and continue to benefit from street lighting only up to a quantity of Q2 (this is their marginal private benefit curve, MPBB).

What does that mean for the marginal social benefit - the benefit of street lighting to society? The first little bit of street lighting provides Person A with a marginal private benefit of P5, Person B with a marginal private benefit of P3, and Person C with a marginal private benefit of P4. So the marginal social benefit of the first little bit of street lighting is (P3+P4+P5), as shown in the bolder line on the diagram. Now, as the quantity of street lighting increases, the marginal private benefit for each person decreases, until we get to Q2. At that quantity, the marginal private benefit for Person C has fallen to zero. At that quantity, the marginal private benefit for Person A has fallen to P4, and the marginal private benefit for Person B has fallen to P1. So, marginal social benefit at the quantity of Q2 is equal to (P1+P3) - notice that is also equal to P4 (for no reason other than it made it a bit easier to draw the diagram!). Moving on, once we get to the quantity Q3, the marginal private benefit for Person B has also fallen to zero. At that quantity, the marginal social benefit is going to be made up only of the marginal private benefit to Person A, which is equal to P2. And at quantities up to Q4, the marginal social benefit curve is exactly the same as Person A's marginal private benefit curve, MPBA.

Now, we are in a position to consider what happens if we offer street lighting for sale. First, we need to know the price of street lighting. Let's assume that the cost of each unit of street lighting is constant, and equal to P4. That is represented by the marginal social cost curve (MSC) on the diagram below. If we set the price of street lighting equal to its cost (P4), then what would happen? At that price, notice that both Person B and Person C would choose not to pay for street lighting, because the price is above (or equal to) the highest marginal benefit that they receive for the first little bit of street lighting. They would simply opt out of paying for street lighting. Person A is willing to pay more than P4, but they will only be willing to pay for Q1 units of street lighting. The market will provide Q1 units of street lighting, entirely paid for by Person A.

That is a problem. The optimal quantity of street lighting is the quantity where marginal social benefit is equal to marginal social cost. That's the quantity Q3. This market isn't going to provide enough street lighting to maximise welfare for society. The problem here is that the good is non-excludable - you can't easily force Person B or Person C to pay for it. If the street lighting is available to anyone, then it is available to everyone. Person B and Person C will benefit from the street lighting paid for by Person A, and won't feel the need to pay for any additional lighting themselves. Person B and Person C are free-riders. This is the reason why public goods are usually provided by the government. [*] The private market would not provide enough. Consider what would happen if the cost of street lighting was higher than P5. Even though marginal social benefit is higher than that, if the cost (and price) of street lighting was higher than P5, nobody would be willing to pay for it!

Finally, let's consider the economic welfare implications of the public good in this example. If the market provides only Q1 units of street lighting, the consumer surplus (the difference between what society is willing to pay for the good, and what is actually paid for the good) is equal to the area ABDC. You may wonder why the consumer surplus isn't equal to the area FDC, which is the surplus that Person A (who is the only one paying for street lighting receives). [**] Remember the free riders Person B and Person C though - they receive benefit (and consumer surplus) from the street lighting, even though they aren't paying anything towards it. So, the consumer surplus is ABDC, not FDC. Moving on, there is no producer surplus (because price is equal to cost for every unit of street lighting). So, total welfare is equal to the area ABDC.

If instead the government provides street lighting, and provides the optimal quantity Q2, then consumer surplus increases to the area AEC. Again, because there is no producer surplus, the area AEC also represents the area of total welfare. There are welfare gains from the government providing street lighting. Or, another way of thinking about it is that if the market was providing street lighting, total welfare would be lower by the area BED - that is the deadweight loss of private provision of this public good.

*****

[*] Of course, the government doesn't necessarily need to provide the public good itself. It can contract and pay a private firm to provide the lighting, up to a quantity specified by the government.

[**] This important question was raised in my ECONS102 class yesterday, so I thank them for the inspiration to address the point.

Fresh water is still not a public good

Earlier in the month, this New Zealand Herald article caught my attention:

Will 2021 be the year the world really values water?

If Wall Street sets the tone, it will be.

For almost 230 years, agricultural commodities have been bought and sold in New York's finance district.

And now the Nasdaq stock exchange, which celebrates 50 years of activity next month, has put a price on our most vital substance.

Water contracts for five water districts in drought-prone California are being bought and sold.

The new water futures contract allows buyers and sellers to barter a fixed price for the delivery of a fixed quantity of water at a future date.

In December, for the first time, water futures for drought-hit California districts are also being traded on the floor of the world's second-biggest market.

The concept, which has been mooted for decades, finally came about in December.

That all seems pretty sensible so far. A futures contract allows the water user to 'lock in' a future price for water, reducing the risk that they will be caught out by unanticipated future price rises. However, then we get to this bit:

The move was quickly criticised by public health specialists.

Pedro Arrojo-Agudo, the United Nations' special rapporteur on the human rights to safe drinking water and sanitation, was direct in his opposition.

"You can't put a value on water as you do with other traded commodities.

"Water belongs to everyone and is a public good. It is closely tied to all of our lives and livelihoods, and is an essential component to public health.

"Water is already under extreme threat from a growing population, increasing demands and grave pollution from agriculture and mining industry in the context of worsening impact of climate change."

There are several problems with this line of reasoning. First, water is not a public good. As I noted in this 2017 post on the same topic, by definition a public good is a good that is non-rival (where one person using the good doesn’t reduce the amount of the good that is available for everyone else) and non-excludable (where the good is available to everyone if it is available to anyone). Unless you live in Ankh-Morpork [*], the first condition clearly doesn't hold - one person using fresh water leaves less available for everyone else. Fresh water is rival, not non-rival. A good that is rival and non-excludable is a common resource. However, that isn't the case for California water, which is allocated through water rights. You must have water rights to draw water, making water excludable. A good that is rival and excludable is a private good. Fresh water in California is, by definition, a private good.

Second, although the availability of fresh water may be under threat from increasing demand, putting a price on water is a solution to that problem, not something that exacerbates the problem. With a price on water, the price will dictate how much water people use. In times of drought, the price of water should rise (unless the price is controlled by the government, like it is in Auckland), and people will use less water. Goods that are scarcer have higher prices - as water gets scarcer, the price will rise. This is a means of better managing scarce fresh water supplies, not some nefarious plot to take water out of the hands of the people.

Third, water already has a price in California. To draw water, you need water rights, and those water rights cost money. The only thing changing is that a futures contract has been introduced, so that water users can better manage the future uncertainty of water prices. If a drought is expected in the future, then the price of the futures contract will rise. Water users will have an incentive to act now to ensure that their future water use will be lower. That probably makes water use more efficient.

You don't have to be a market fundamentalist to realise that prices can actually help. In the case of fresh water, the alternative is a free-for-all, where the water supplies will almost certainly be depleted faster.

*****

[*] Terry Pratchett noted that the water in the Discworld's largest city must be very pure, because of the number of kidneys it had already passed through.

Read more:

• Fresh water is not a public good
• Why we need tradeable fresh water usage rights

Coronavirus contact tracing and conditional cooperation

In a new article in The Conversation yesterday, Stefan Volk (University of Sydney) discusses coronavirus contact tracing in terms of the prisoners' dilemma (or what he terms a 'social dilemma'):

As governments look to ease general social-distancing measures and instead use more targeted strategies to stop coronavirus transmission, we face a social dilemma about the limits of cooperative behaviour...

Economists define a social dilemma as a situation where individual interests conflict with collective interests. More specifically, it is a situation in which there is a collective benefit from widespread cooperation but individuals have an incentive to “free ride” on the cooperation of others...

That is very similar to the point I made last month in relation to the coronavirus lockdown:

These people aren't stupid. They are selfish, and acting in their own self-interest. Which is why we needed to go into full lockdown, and early, if we wanted to curtail the spread of coronavirus. Any voluntary or partial measures would simply be subject to the prisoners' dilemma.

Lockdown or contact tracing, both are subject to the prisoners' dilemma. Volk then goes on to make a very interesting point in relation to real-world behaviour in prisoners' dilemma situations:

My research (with behavioural economist Christian Thöni of the University of Lausanne) confirms this.

Based on reviewing 17 social dilemma studies involving more than 7,000 individuals, we estimate no more than 3% of the population can be relied on to act cooperatively out of altruism – independent of what others do.

About 20% can be expected to act selfishly (i.e. free ride).

The majority – about 60% – are “conditional cooperators”. They cooperate if they believe others will cooperate.

Another 10% are so-called “triangle cooperators”. They behave similarly to conditional cooperators, but only to the point where they believe enough people are cooperating. They then reduce their cooperation.

The remainder – about 7% – behave unpredictably.

The majority of people are 'conditional cooperators'. In the context of a lockdown, they'll obey the rules if they believe most other people are obeying the rules. In terms of contact tracing, they'll download an app and give it access to their location, if they believe that many others are also doing so. Volk makes the point that this has implications for how the lockdown, or contact tracing, is executed. He notes that:

...we must be assured others aren’t getting away with uncooperative behaviour. In other words, free riding must be swiftly and visible punished.

Without these conditions, an expectation of widespread cooperative behaviour is merely a hope.

Punishment of the rule breakers during the lockdown appears to have been swift for some, but not all. And for the most part, New Zealanders appear to have been following the rules. However, it's hard to see how the government would enforce contact tracing - will we be fined for failing to keep a diary of all our daily contacts? It seems unlikely, which means that relying on conditional cooperation is going to be that much more difficult once the lockdown is lifted. That's why it's all the more important that the lockdown has been kept in place until the likelihood of further outbreaks has been reduced to near zero.

[Update: Read this follow-up post]

Read more:

• The prisoners' dilemma, and why we all have to be kept in lockdown

What shareholder activism and lighthouses have in common

In economics, we categorise goods as being either excludable or non-excludable. Goods are excludable if a person can be prevented from having access to them (and therefore benefiting from them). Access can be prevented through laws (property rights) that define who can access the good. A common form of access is a price - everyone who is willing and able to pay the price, can purchase the good. Goods are non-excludable if, when they are available to anyone, then they are available to everyone. In other words, there is no mechanism for preventing any person from benefiting from the good, even if they haven't paid for it.

Non-excludable goods present a problem for a market economy, because if no one can be prevented from benefiting from the good even if they haven't paid for it, then it would be difficult for any private firm to produce the good for profit. The problem here is that some people will be free-riders - people who benefit from the good without paying anything for it. It would cost a private firm to provide the good, but if few people are willing to pay for it (because they can free ride instead), then the firm may not even be able to cover its costs. The good would then not be provided - this is an example of market failure.

This is the case for public goods (goods that are non-excludable, but also non-rival, meaning that one person's use of the good doesn’t reduce the amount of the good that is available for everyone else). A classic example of a public good is a lighthouse. The light from a lighthouse is available to every ship if it is available to any ship (it is non-excludable), and one ship benefiting from the light doesn't diminish the amount of light available to other ships (it is non-rival). However, because the lighthouse light is non-excludable, it would be difficult for a private lighthouse firm to operate, because ships could easily free ride. That is why lighthouses were typically funded by the local government, often through taxes or levies on ship traffic.

Another example of a public good with a free-rider problem is shareholder activism, as explained in this article from The Conversation last year, by Salvatore Ferraro (RMIT University):

Shareholder activism... involves shareholders directly engaging with directors and executives of companies to effect change from within.

To date, little activism has been motivated by altruistic purposes. That’s partly to do with a fundamental problem that limits the ability of activism to influence corporate behaviour for non-financial reasons.

Economists call it the free-rider problem. In essence it’s the problem of individuals having little incentive to contribute to a collective resource when they can enjoy its benefits even if they don’t.

How this applies to shareholders was first outlined by Harvard academics Adolf Berle and Gardiner Means in their seminal 1932 book The Modern Corporation and Private Property.

Ownership of public corporations is generally diffused between a significant number of shareholders. Individual shareholders have little incentive to monitor senior management, because of the cost they bear while others reap benefits.

So, while shareholders (and society, depending on the proposal) could benefit from more shareholder activism, most shareholders are free-riders - preferring to receive the benefits of activism, without incurring any of the costs. Because shareholder activism is also non-rival, it is an example of a public good.

Ferraro's solution to the free-rider problem in shareholder activism is:

Big institutional shareholders in particular could be more active in ensuring boards have skilled, competent directors. They could also foster a culture of openness by supporting directors to challenge senior management without fear of putting their tenure at risk.

The problem with Ferraro's solution is that even big institutional shareholders have an incentive to free ride, unless the benefits of activism are so large that they outweigh the institutional shareholder facing all of the costs of engaging in the activism themselves (which could be true, and indeed we do see examples of activist institutional shareholders). However, that won't work where individual institutional investors have only a small stake in the company. And even if it does work, the activism will likely be limited to proposals that benefit the large institutional investors (and not necessarily those that benefit smaller shareholders, or society more generally).

In such cases, we need some other mechanism, such as an independent shareholder activist organisation that can act on behalf of all shareholders. For instance, New Zealand has the New Zealand Shareholders Association. However, these organisations are currently limited by their voluntary membership. If we were serious about encouraging shareholder activism, we would need to fund it in the same way as a lighthouse - taxes or levies on shareholders, used to fund an activist shareholder organisation.

Would that lead to the 'right' amount of shareholder activism? That depends on what you think the right amount of activism is. One thing is clear though - free-riding is not helping the cause of shareholder activism in the status quo.

Fire protection as a private good, rather than a club good or public good

Two years ago, I wrote a post entitled "Why fire protection is (or was) a club good":

Some goods or services that are categorised as club goods may be contentious. For instance, according to the table fire protection is a club good - it is non-rival and excludable. Provided there aren't large numbers of fires, if the fire service attends one fire, that doesn't reduce the fire protection available to everyone else... So, fire protection is non-rival. Is fire protection excludable? In theory, yes. People can be prevented from benefiting from fire protection. Say there was some sort of fire service levy, and the fire service decided to only respond to fires at homes or businesses that were fully paid up.

Although my earlier post made the case that firefighting could be a club good, public firefighting is usually a public good - a good that is non-rival (one person’s use of the good doesn't diminish the amount of the good that is available for other peoples' use) and non-excludable (a person can't be prevented from using or benefiting from the service). However, now it turns out that some fire protection may be a private good - a good that is rival and excludable. According to this article from the AFP:

Kris Brandini and his crew had just returned from four intense, non-stop days battling fires in western Los Angeles.

They dashed to the neighborhood where wealthy residents like Arnold Schwarzenegger were fleeing their homes, then to the inferno that threatened the Ronald Reagan Presidential Library, then back again.

But unlike state firefighters, Brandini was not concerned with protecting most of the exclusive residences lining these valleys.

He and his team are private firefighters.

"I only protect the houses that are on my list," he told AFP. "I don't just go there randomly -- that's the difference between me and the state firefighters.

"They go out and protect every house. I protect the houses that are actually enrolled in the program."

If private firefighters will only protect houses that "are actually enrolled in the program", then that makes private fire protection an excludable good. Of course, private firefighting is excludable on the basis of price - not everyone can afford to pay for their own private firefighters. It's not time to do away with public firefighters just yet, because I don't think we would be willing as a society to price some people out of the market for receiving fire protection.

Unlike public firefighting, private firefighting is also a rival good, since there are only a limited number of houses that a private firefighter can protect (so, if they are protection House A, they may not have enough time or resources to also protect House B). However, in the case of large wildfires like those in the AFP article, even public firefighting becomes a rival good, since public firefighters also can't be in more than one place at a time. A good that is non-excludable but rival is a common resource.

That makes firefighting an interesting case study for my ECONS102 class - it is a good that can be characterised as all four classes of good - private good, public good, common resource, or club good - depending on the circumstances.

[HT: Marginal Revolution]