Lynne Kiesling
Such was the question discussed at the Liberty Fund conference I attended over the weekend. Our discussions ran the gamut of all of the theoretical and practical issues associated with the question, from the extent to which basic science is a public good to the costs of governments trying to pick technology winners and the politicization of science.
One thing the discussion highlighted for me was how the Samuelsonian/neoclassical argument about public good provision has permeated even the thinking of the non-economist. It has become common to argue, following Samuelson, that if something has public good characteristics it will be underprovided in equilibrium, and therefore necessarily cannot be provided optimally through market processes.
That logic is false. It ignores this logic, which is a fundamental, basic point in economics: if someone can capture enough benefit at the margin to make it worth it to them to incur the marginal cost, they will provide the good. If marginal benefit is greater than marginal cost, you do it. If others derive benefit and free ride on you, so what?
Of course, that is a static argument, so let’s introduce some dynamics and see what kind of strategic behavior we might see. Only here I want to keep my framework in which one agent’s marginal benefit exceeds his/her marginal cost. Suppose that is the case, and suppose further that government has bought into the false Samuelsonian presumption of inefficient free riding in equilibrium. In that situation, does the agent with MB>MC have an incentive to provide the good? No, because if someone else will pay for it, then I can enjoy the MB without having to incur all of the MC. So conditional on the existence of government funding, the agent who would otherwise pay for the good becomes a free rider.
My point is that the free rider problem is an empirical one, and it’s a dynamic and strategic question. We have all sorts of evidence, empirical and experimental, that inefficient free riding does not always occur in public good situations, but it can occur, depending on the context and institutions governing the transaction. We have empirical evidence that private agents will engage in basic research. But will they engage in enough? Of course, one of the difficulties is that we do not know the optimal amount of research.
Not only is the free rider problem in research empirical, it’s important to remember not to commit the Nirvana fallacy. Just because private agents may underprovide research relative to some theoretical government-funded benchmark, that doesn’t mean you are making the correct comparison. The correct comparison has to incorporate the transaction costs under both alternatives, the potentially negative effects of being too commercially focused in private research, the effects of short-term focus in both private and public funding, the dissipation of value through rent-seeking for public funding, and the costs of the politicization of research that can arise with public funding.
I agree with you that the marginal cost/benefit calculation is independent of the public good, but remember that the marginal benefit has to outcompete alternative investments. In research, where the supply of people and equipment capable of carrying out a particular research project is rather limited, a project with positive marginal benefit and large public good may never reach the ‘front of the queue’. In these cases it may be appropriate for government to put a ‘thumb on the scales’ to reduce the marginal cost of a project.
We have to be careful, though, about the alternative, increasing the marginal benefit. One example is the Orphan Drug program at FDA, which tries to increase the supply of drugs for rare (a.k.a. orphan) diseases by increasing the benefit side of the equation through protection from competition. Once approved, these drugs can cost over $100,000 per year for each patient, much of which is paid for by Medicare/Medicaid. Gross profits often exceed 99%, and these prices can persist for many years past the point of paying for the development costs. The government then finds itself in the position of paying through the nose for drugs, while at the same time blocking competition which could lower the prices of those drugs.
Take a Free Ride
Lynne Kiesling writes It has become common to argue, following Samuelson, that if something has public good characteristics it will be underprovided in equilibrium, and therefore necessarily cannot be provided optimally through market processes. That l…
How would you treat the old Bell Labs. that invented the semiconductor Although they were not government funded they were not the product of unregulated capitalism either. They existed because of a costs-plus regulation scheme.
but it does seem that your final paragraph lays down enough conditions that one could never have any public funding.
John, your points are simply not relevant to Lynne’s excellent post. The fact that if governments spend money on research some benefits will accrue does not demonstrate that the same, or superior, benefits would not have accrued from another policy. So the answer to your question is, no, no-one needs to be reminded that some products have come about because of tax-funded research. It is just that Lynne is leading a more interesting and sophisticated discussion than the one you have tried to join in.
Quentin Langley, Editor of http://www.QuentinLangley.net