The one-handed economist

Background

James Buchanan and Gordon Tullock are among the co-founders of the so-called “Virginia School” of economic thinking, which draws on public choice (bureaucrats, as people, may serve themselves before citizens), constitutional design (read my review of Buchanan and Tullock’s 1962 Calculus of Consent) and law and economics (see, e.g., my comment on Coase’s 1959 FCC paper).

Thus it’s easy to see how Buchanan might be suspicious of “good government” solutions, and how Buchanan might not agree with Paul Samuelson’s opinion that the existence of “public goods” means that the government should create and/or fund them.¹ Samuelson gave this opinion in “A pure theory of public expenditure” (1954), a three-page (!) paper in which he shows (or argues) that “the planner” should levy taxes to supply public goods in accordance with a “social welfare function” that aggregates the preferences of all citizens. (This paper’s reliance on mathematical innuendo over common-sense perspectives makes it hard to follow.)

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I am grateful that Alain Marciano explained this tussle over public finances in his 2021 article [open access].

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Buchanan opposed Samuelson’s model for three reasons: First, there’s no way to aggregate a social welfare function (to find out how much of the public good to provide) without knowing everyone’s preferences (such “interpersonal comparisons of utility” are hindered by “the knowledge problem“). Samuelson’s theory ignores this empirically important issue. Second — even if such a calculation of “necessary production” was quantified, Buchanan opposed the idea of taxing all citizens to pay for something that some will value at less than their taxes paid. Samuelson did not worry about this problem, since the Kaldor-Hicks model (read this post) justifies losses to some if net gains are positive. Third, public goods often suffer from under-provision, i.e., nobody wants to pay for something they can get for free (non-exclusion).

Rather than just criticise, Buchannan offered club goods as an alternative to government-proclaimed and taxpayer-funded public goods.

Clubs, communities and segregation

I had read Buchanan’s paper long ago, but I am re-reading it because I want to compare Buchanan’s work on club goods (this 1965 paper) with  Samuelson’s 1954 work on public goods (to which Buchanan was reacting), and the Ostrom’s work on common-pooled goods² (1977, but as early as 1971). These three papers are relevant to my teaching and research (see this, this  and this), and this post is a “warm up” for integrating these ideas into my forthcoming Little Book of The Commons

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I have always assumed that exclusion (restricting demand) is trivial (“you’re in the club or you’re not”) and non-rivalry (providing supply) is easy to fix (“club members will cover costs”).³ I hadn’t expected controversy over funding club vs public goods, but the third concern above (under-provision due to insufficient finances) arises from the same concerns.

Aside: I’ve always treated club and public goods separately because they are provided by markets and government/community, respectively, but I had forgotten an earlier step of “which channel?” Many debates over public provision, PPP, privatization, etc. focus on this channel issue, which is relevant to drinkig water but also prisons, schools, broadcasting, security, standards, housing, and so on.

Buchanan, in essence, argued that some “public goods” should not be funded by taxes or provided by government. Instead, he proposed that clubs should provide them to dues-paying members.³ The following two examples show how such a simple formulation could be troublesome:

Good club: You and your friends buy a boat together, sharing expenses so that everyone can use the boat on their appointed weekend.
Bad club: You and your friends start a school for your kids; kids from “the wrong families” are not invited to join the club.

It’s obvious that “freedom of association” includes the right to exclude others, but what if your association lowers quality of life for those excluded others?

Although public and club goods appear similar in supply (both are non-rival, meaning that everyone can consume as much as they want) and different in demand (people can be excluded from club goods but not public goods), it’s also really important to recognize that club goods can substitute for public goods.

Schools can, in theory, be funded and operated as club goods (a “private school”) or public goods (“a public school”),⁴ but when it comes to reality, we run into issues of “whose money, where?” that readers from the US will recognize. This money (or funding) question is important because some citizens are happy to support their private schools but opposed to their taxes supporting others’ public schools. The parallel with governance is the same: Parents care about their kids’ schools more than schools with other people’s kids (more here).

It’s not club vs public goods, but common-pooled taxes and governance.

By now I hope you are seeing how Buchanan’s theory of clubs can be misused to support separate but equal, justify rich private schools and poor public schools, explain how white flight eroded the tax base, and so on.

And although Buchanan doesn’t directly say that clubs offer a way for rich whites to avoid subsidizing poorer non-whites, his words in this paper certainly allow for it:⁵

Hence, the theory of clubs is, in one sense, a theory of optimal exclusion, as well as one of inclusion… If individuals think that exclusion will not be fully possible, that they can expect to secure benefits as free riders without really becoming full-fledged contributing members of the club, they may be reluctant to enter voluntarily into cost-sharing arrangements. This suggests that one important means of reducing the costs of securing voluntary co-operative agreement sis that of allowing for more flexible property arrangement and for introducing excluding devices. If the owner of a hunting preserve is allowed to prosecute poachers, then prospective poachers are much more likely to be willing to pay for the hunting permits in advance (pp 13-14).

Substitute “school” for “hunting lodge,” and you can see how a rich minority might use this logic to exclude the poor majority from “free riding” on their money, i.e., by avoiding taxes and/or undermining government’s ability to run schools. OTOH, you can also see the problem with public goods: Who will pay for them when they can free-ride instead? There’s no good answer to that one, but culture, solidarity and/or enlightened self-interest can play a role (topics covered by the Ostroms).

But what about clubs?

Whew! That’s a lot to consider, but don’t forget Buchanan’s insights:

1. Clubs can limit demand via exclusion.
2. Clubs can provide “efficient” supply to all members in proportion to each member’s willingness to pay (e.g., different levels of membership), without recourse to a “social welfare function”
3. Due to these characteristics, clubs can avoid “tragedies of the commons” (too much demand from members) by altering internal prices, exclusion and/or supply.
4. In this (#3) sense, clubs and well-managed commons (those in a “situation” rather than a “dilemma,” in the terms of Ostrom) are similar. A well-managed commons uses boundary rules to exclude outsiders and  sanctions to punish insiders who take too much or provide too little.
5. Buchanan writes “Goods that exhibit some ‘publicness’ at low income levels will, therefore, tend to become ‘private’ as income levels advance” (p 12) because richer people can afford to form clubs to provide goods at less-efficient economies of scale because they can control quality and reduce free-riding. We see this when country clubs replace public parks, private beaches replace public beaches, private cars replace public transportation, etc. People who switch from public to club are not racists (minorities leave poor neighborhoods when they can). They are using their wealth to get a better mix of costs and benefits.

My one-handed conclusion is that clubs make it easier to efficiently provide the right quantity and quality of goods to its members, in comparison to a government- or community-directed program funded by taxes on all. At the same time, it’s also important to consider if or how clubs can undermine the provision “for the common good” or worsen the impacts of inequality.

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Notes

1. For a comparison of private, club, common-pool and public goods, see this post. I am not a huge fan of Samuelson, whom I think used too much math in “proving” his points, but this post is more about his public finance philosophy than his math (see that Marciano paper).
2. You’ve surely heard of Garrett Hardin’s “tragedy of the commons” paper from 1968, but he was more concerned about over-population than goods. He was definitely not writing about sustainably providing, protecting or consuming common-pooled goods (i.e., solutions). The Ostroms were.
3. Read this post on Coase’s ideas for pricing club goods. Buchanan disagreed, but his “solution” (willingness to pay) is harder to implement.
4. There’s a lot of confusion over “public,” which can refer to the definition of goods, goods/services supplied by the government, and/or goods/services that any member of the public can purchase or use. I can’t resolve all of them here, so I am using “” a lot. Sorry if it’s confusing.
5. Read this review of a book on American Conservatism to see Buchanan’s intellectual opposition to government programs aimed at “melting together” people of different incomes, preferences and (relevant!) races.

I often tell students that Ronald Coase won the economics Nobel for two papers — The problem of social cost (1960), or PSC, and The nature of the firm (1937) — but I had also heard this article mentioned more than a few times. So I acquired a copy (sci-hub ftw!) and got to reading.

The paper has six parts. I will give a short summary of each part before commenting on the paper as a whole.

1. The development of government regulation: A lack of regulation of radio spectrum can lead to interference among broadcasters, with the powerful drowning out the weak but most broadcasters interfering with each other. The US Navy (!) attempted to take control over radio spectrum after WWI, but regulation was eventually handed to the FCC in 1934.
2. The clash with the doctrine of freedom the press: The First Amendment does not allow censorship of the press but interference among radio broadcasters (and other users of spectrum from everything from TV to mobile phones and wifi) meant that total freedom might lead to chaos. Regulation could prevent chaos, but it could also allow censorship, i.e.,

   
   “Some interpreted the fact that the Commission was denied the power of censorship as meaning that it would not concern itself with programing but would simply act as “the traffic policeman of the ether.” But the Commission maintained — and in this it has been sustained by the courts — that, to decide whether the “public interest, convenience or necessity” would be served by granting or renewing a license, it had to take into account proposed or past programing. One commentator remarked, that by 1949, the “Commission had travelled far from its original role of airwaves traffic policeman. Control over radio had become more than regulation based on technological necessity; it had become regulation of conduct…” [p8, bold added]

   The result was that the FCC had the power to choose who got (or maintained) access to valuable spectrum, which gave it significant power. How did the FCC allocate licenses? The popular term among economists is via a “beauty contest” in which various supplicants competed to promise the “most beautiful” use of the spectrum. Such a subjective system can lead to mistakes in allocation, but it can also encourage corruption, i.e., FCC staff deciding based on relationships, favours and bribes.

3. The rationale of the present system: [As of 1959], the FCC allocated licenses based on the vague directive of “serving public interest, convenience or necessity.” A judge claimed that FCC regulation was needed because demand exceeded supply. Nonsense, says Coase: Markets resolve scarcity problems all the time. The FCC’s economist (!) argued against prices because markets were not perfect (!) and many users were non-commercial entities such as the military or weather stations. A law student, Leo Herzel, countered with a defence of prices and property rights in spectrum. He pointed out (correctly) that the FCC only needed to create rights that could be auctioned to (and resold among) users. Even further, government entities might “waste” free spectrum. This discussion of creating property rights and then allowing trade to allocate those rights to the party who valued them them most (and thus might be able to put them to the highest and best public use) will be familiar to anyone who has read PSC.
4. The pricing system and the allocation of frequencies: Coase uses humor and sarcasm to undermine FCC claims of efficiency (licensing applications could take years to process), honesty (existing radio operators paid nothing for valuable TV spectrum), and accuracy (they could not — as Hayek pointed out — hope to summarise information as well as prices do). This section alone could should crush claims of government advantage in  operating or allocating private goods (anything from spectrum to school places to land).
5. Private property and the allocation of frequencies: Coase invokes the case of the doctor and candy maker (Sturges v Bridgman) — which appeared one year later in PSC — to explain the value of property rights as well as how trades will occur if willingness-to-pay exceeds willingness-to-accept. He does this to highlight the value of spectrum to those claiming they deserve to get it for free and why radio and TV stations with “free” spectrum are sold for high prices. (Coase also notes that markets in rights should be replaced by regulation if too many participants — and thus transaction costs — make it difficult to make deals. This observation is central to PSC.) This section more or less sets up Coase’s case for auctioning rights as the best way to (a) raise revenue and (b) allocate rights. The FCC didn’t auction spectrum until 1994!
6. The present position: Coase summarizes with the recommendation that the government create, sell and enforce property rights in spectrum as a separate step from regulating particular programming. The Public has an interest in promoting and enjoying the highest and best use of scarce spectrum, but the Government (FCC) is not the body to decide such use. That question is best solved with markets in property rights.

My one-handed conclusion is that this paper is interesting for both its contribution to Coase’s PSC and its clear discussion of how and why government regulation can go wrong.